Thursday, January 7, 2010

Time Bomb: Ohio’s Newspapers Weigh In

This article continues the discussion about the perilous condition in which the State Teachers Retirement System (STRS) finds itself. Earlier articles can be found at Time Bomb, Still ticking, and Beginning to Understand.

The January 3, 2010 edition of The Columbus Dispatch ran a batch of stories which the newspaper produced in cooperation with a group of the eight largest newspapers in Ohio. This is an astonishing feat of organization and cooperation, and should give readers a powerful indication of the seriousness of this matter.

My hat is off to the publishers of these newspapers for undertaking this important piece of work.

Here's the situation in a nutshell: The pension systems created to provide retirement income for most of Ohio's public employees are in big trouble. Without significant adjustments, some if not all of these pension funds may well go bust, potentially making it impossible to pay the benefits promised to the large number of people already retired, and those counting on that income when their turn comes to retire. These public employees do not participate in Social Security – this is all they have.

But while it would indeed be a tragedy if this happens, the public employees themselves are among those responsible for this mess. Let me explain why I say this, focusing on the larger of the two retirement funds in which our school district is involved - STRS.

First, let's examine how a pension system works, whether in the public or private sector. While there a lots of moving parts in a pension system, the basic concept is simple:
  1. Money is paid into a fund. Some of the money typically comes from the employees who will be the eventual beneficiaries of the retirement program, and some is usually contributed by the employer. As more money is contributed, the balance of the fund gets larger.
  2. To further increase the size of the fund, the money contributed is invested. It may be invested in CDs, US Treasury Bills, or in a Dairy Queen franchise at the North Pole.

    Each pension system makes its own policies and decisions as to how much risk to take with their money. In the case of STRS, these decisions are made by the Retirement Board, which has eleven members – seven of whom are elected from the ranks of active and retired teachers. This is why I say the STRS members are complicit in this situation – their representatives comprise the majority of the Retirement Board, which determines investment policy.
  3. Money is paid out of the fund to retirees. The fund will have its own rules as to minimum age, service requirements, and benefits to be paid. As money is paid out, the balance of the fund gets smaller.
By law, STRS offers its members three choices in retirement plans: a) defined benefit; b) defined contribution; and, c) a hybrid of the two; but nearly all members choose the defined benefit option. This means that regardless of the amount of money that is paid into the system by its members and their employers, or how much return in generated on the fund balance, the benefits to be paid to a retiree are set when the retiree enters the system, and changing the benefit structure afterward is very difficult. In private industry, it is the employer who takes the risk in regard to funding shortfalls in a defined benefit system. In the public sector, it is the taxpayer. But in neither case is it the employee – generally speaking.

Conversely, with a defined contribution plan, the benefit paid is based on the amount the worker and employer paid into the fund, and how well the investments made by the fund managers performed. But however it turns out, the retirees are paid according to the actual earnings of the fund – whatever that turns out to be. If there have been big investment returns, the retirees get big pension payouts. With meager investment returns, the pension payouts are meager as well. Consequently, a defined contribution plan can never be underfunded.

So when an employee chooses a defined benefit plan, they're taking a bet that their retirement benefits will be better than if they were in a defined contribution system, or had just invested the money themselves. An employee who selects a defined benefit plan is essentially betting that future economic conditions will not be very rosy, and therefore they would prefer the sure thing of a defined benefit plan over having a shot at getting a really big payoff in a defined contribution system.

Why? Because they don't see the potential upside of a defined contribution plan as being a good bet against the chance of working thirty years and having nothing to retire on. In other words, choosing a defined benefit plan is a risk-adverse strategy for the plan member.

However, a defined benefit plan is far from risk free for the employer – in this case the taxpayers of the school district. The employer guarantees the output regardless of the inputs, therefore it's the employer who takes the big risk. As taxpayers, we don't get a choice whether or not to assume this risk for the STRS defined benefit plan – it is written into the Ohio Revised Code that public school teachers will be offered a defined benefit retirement plan, and nearly all take advantage of it.

There is a branch of management called actuarial science which specializes in performing the financial and statistical analysis necessary to project how such bets are likely to work out. In the life insurance industry, it is the job of the actuaries to figure out how much has to be paid in premiums for a set of policies, how much the insurance company can expect to earn by investing that money, and how much – and when – money will be need to be paid out in benefits. Their analysis is crucial in setting premium rates and determining policy features, such as the death benefit and cash value. When they get it wrong, an insurance company loses money.

The STRS has actuarial advisors as well. The actuaries estimate how much money will be paid into STRS over time, what the investment return will be, and how much will be expected to be paid out over time – all for the purpose of ascertaining the fiscal viability of the plan. The elements of this estimate include projections of the life expectancy of retirees (e.g. the "actuarial tables"), as well as a set of key assumptions, such as the specific rules of the retirement plan. The rules include, for example, what percentage of salary is contributed to the fund by the employee and employer, at what age and with how much service an employee can retire, and the formula that determines what the retiree will receive in compensation.

But other assumptions are just guesses. Hopefully well thought out guesses, but still just guesses. Key among those is the presumed investment rate of return on the retirement fund. Right now, the STRS Board has told the actuaries to assume that the investment return will be 8% per year – a formidable goal in today's investment environment. If the STRS system is a time bomb waiting to go off, then this aggressive assumption of investment returns is the fuse.

One of the basic rules of economics is that risk and reward are (supposed to be) directly connected: the only reason you would take greater risk on an investment would be to have a chance of getting a greater reward. After all, if you could get a 5% return on your money by putting it in an FDIC-insured savings account, why would you ever buy a General Motors corporate bond that also pays 5%? While there is virtually zero risk of losing the money you put in the savings account, there is certainly risk that GM could go bankrupt and be unable to return the money you have invested in their bond. In fact, GM did exactly that last year.

Generally speaking, if you want to take the minimum risk with your money, you put it into Treasury Bills, but you also accept getting paid very low interest rates. Next you might consider Certificates of Deposit at an FDIC-insured bank, which is substantially the same as being insured by the full faith of the US Government. An FDIC-insured bank will pay a slightly higher interest rate than the US Treasury, but generally not much.
If you want to make a significantly higher return than T-Bills or CDs, you have to take more risk. For most of the last twenty years, the choice for those seeking higher returns has been to risk it in the stock market, mostly via professionally managed mutual funds, and mostly with retirement money placed in IRA and 401(k) accounts.

But it isn't just individual investors who were pouring money into the stock market – the pension funds got into the stock market in a big way as well. You could even observe that the pension funds became the most important buyers and sellers of stocks, precisely because they had so much money to throw around, all controlled by a small number of investment managers. I bet it's a lot of fun to play around with tens of billions of dollars of someone else's money, as is the situation for the STRS investment managers.

Returns in the stock market remained so high for so long that a bizarre thing happened – people began to perceive stock investing as risk free. It seemed like everyone was making money in the stock market, and there for a while, pretty much everyone was. So it looked pretty stupid for pension funds to limit their investments to US Treasury and high quality corporate bonds when there was lots of money be made in the stock market, at little perceived risk.

Eventually – despite showing their risk-adverse nature through their overwhelming choice of the defined-benefit retirement plan – the leadership of STRS gave into this temptation, and invested substantial portions of the STRS fund in stocks and the other darling of the last decade – commercial real estate. In its 2008 Investment Plan, the STRS leadership said it would allocate 65% of its money to stocks (40% domestic and 25% foreign), 19% to government and commercial bonds, 8% to real estate, and 3% to 'alternative investments.' In this plan, the STRS leadership said they expected to achieve a 7.42% return on their investment, growing the fund from $75 billion to $78.5 billion.

The numbers geeks out there will observe that a 7.42% return on $75 billion should cause the fund to grow to $80.6 billion. But remember that benefits are also being paid out to retirees. New money comes in as a result of working members and their employers making contributions. The pot is sweetened by the returns on the money as it is invested. Then money is taken out of the fund to pay benefits to retirees. The trick is making sure that the fund always has enough money to pay its future commitments.

Fiscal year 2008 didn't go exactly as planned for the STRS. Instead of growing the fund balance to $78.5 billion, it actually fell to $70.8 billion. Of that $7.7 billion loss, $4.2 billion were investment losses. Where did the rest of the money go?

There is a very significant statement at the bottom of page 10 of this report: "Pension benefit payments and health care costs exceed member and employer contributions. Investment income generally compensates for the difference between benefit payments and contributions." In other words, the level of benefits paid out by the system cannot be sustained by the contributions made by the working members and their respective school districts – the viability of the system depends on making an aggressive return on their investment portfolio. It didn't work out that way in FY08, when the investment losses and net outflow of benefits combined to amplify the loss.

FY09 appears to have been worse. While I have no official source to confirm these numbers, according to numbers published by retired STRS member and activist Kathie Bracy, at its lowest point in March 2009, the value of the retirement fund had dropped to $46.5 billion. Her numbers show the FY09 year end balance to have bounced back to $54.5 billion, and continuing to grow to $59 billion by the December 2009.

The reason for the dramatic drop in value and (partial) recovery is simple – nearly two-thirds of the pension fund is invested in the stock market. When the stock market went down, the pension fund went down with it. As the stock market has regained some of its losses, the fund has risen with it. 'The rising tide floats all boats,' as they say. I suspect that their real estate portfolio is still in the dump however.

So has the STRS Board and management learned a lesson about risk and return?

It doesn't seem so. Their FY10 Investment Plan indicates that they intend to seek total return of 7.7%, and will do so by achieving in excess of 8.5% return on their stocks and 4.8% on their government and corporate bonds. They will keep 65% of the fund in stocks and 18% in bonds – pretty much the same allocations as the past several years. In other words, they're doing little to change their risk profile. If the stock market takes another tumble, they'll get whacked again.

I can understand why they are doing this. There is another statement in the FY10 plan which must terrify the STRS Retirement Board: "With a projected total fund return of about -25% for fiscal 2009, the amortization period for the unfunded liability is likely to increase to an undetermined amount for July 1, 2009, from 41.2 years on July 1, 2008."

That's gobblety-gook to most of us, but what it means is that based on the key elements and assumptions, the fund is in serious trouble – so serious that the Ohio Revised Code calls for special action, namely that the pension Board must file a report within 90 days indicating what they're going to do about it. They need to figure out how to put more money in, take less money out, and/or earn more on their investments. This aggressive investment strategy is meant to address the least painful of those three choices. It's a high-risk bet.

Or is it?

STRS Executive Director Michael Nehf recently issued a public statement on the issue (which can be read here), knowing that these stories would soon appear in the newspapers across Ohio. He mentions a key distinction between STRS and private pension plans – STRS is created and governed by Ohio law, which describes most of the rules under which its members and their employers must operate in regard to STRS.

Those laws don't come out of thin air. They are the result of the political process, including heavy lobbying by the STRS and the Ohio Education Association, the union which represents nearly all Ohio teachers. That political process has been engaged, with the first draft of a new piece of legislation having already been drafted, per Mr. Nehf's announcement.

A cornerstone of this legislation is expected to be an 18% increase in the amount of the employer (taxpayer) contribution, from 14% of each teacher's salary to 16.5%. The teacher's contribution will also increase from 10% to 12.5% - with both increases phased over several years. There will almost certainly also be reductions in retirement benefits as well, although it appears that those changes will be applied to teachers yet to retire, protecting those teachers already retired.

By the way, under the current retirement plan, a Hilliard teacher who retires in 2010 with 30 years of service and a Master's degree will receive a lifetime annual pension of $54,976. A teacher with 35 years of service and a Masters degree plus 15 additional hours of study would receive a lifetime pension of $76,787.
The public will have no vote in this matter of increased employer contributions. The politicians in the Statehouse will work out their deals, a new law will be passed, and one day the people of Ohio will have the cost of running their school districts jacked up by another painful increment. As an unorganized set of individuals, we will again lose out to the highly organized and well funded special interest groups, led by the STRS and the OEA in this case.

I am reacting strongly to this not because I think the teachers don't deserve a decent pension. The pension was part of the deal when they hired on, and the deal they have continued to serve under, and we need to honor that commitment.

But we have already funded these pension liabilities once.It was the decision of the STRS Board to invest most of their money in risky investments which have tanked – not mine. They took our money in the form of taxes and were expected to be good stewards of our money as well as the teachers', investing it in a way that protected and grew the fund so that reasonable benefits could be paid to those teachers later when they retired.

Instead they got greedy – both the STRS leadership and the teachers who are its members – and put the money into risky investments such as the stock market. There has never been a time when the stock market was risk free, although some have always believed they could mitigate the risk. Those techniques don't usually work in a general crash. A rising tide may lift all boats, but in the same way a falling tide can leave all boats high and dry.

We understand completely what happened – many of us made the same choices with our own retirement savings. The difference is that when we, as employees in the private sector, take a hit in our IRA or 401(k), there is no one we can force to kick in more money to recoup our losses. In fact, many companies which had been contributing some level of matching funds to their workers' 401(k) accounts have significantly cut their matching programs, if not discontinued them altogether. Millions of American workers who thought they were headed for a comfortable retirement in their young 60s are now faced with working indefinitely to preserve a reasonable standard of living. That's our version of an unfunded liability, and the Ohio Revised Code doesn't contain one word of help.

But the STRS, on the behalf of the active and retired teachers, can influence our lawmakers into transferring the cost of their risk-taking to the taxpayers. And that's exactly what they intend to do.

If this situation with the STRS is all okay with you, then relax – you can just sit back and let things happen.

But if you see things the way I do, you need to take action. Write Governor Strickland, State Senator Jim Hughes and State Representative Cheryl Grossman and tell them that if the people of Ohio are expected to bail these pension funds out when the rest of us suffer, some significant things have to change. There has to be limits on the amount of risk these guys are allowed to take going forward, and adjustments made to the retirement benefits commensurate with a more conservative and sustainable rate of return on the investments.

Here are the articles referenced, as they appeared in the January 3, 2010 edition of the Columbus Dispatch:
Additionally, this editorial appeared in the January 7, 2010 edition of the Dispatch. I couldn't agree more…


  1. Did I read in that dispatch article that the increased contribution from the "employer" would not start for at least several years, but the employee's increase would start immediately? Not that I agree with the entire thing anyway but just curious.

  2. Yes, my understanding is that the proposed legislation would phase in the increased employer contribution by 0.5% per year for five years, starting with 2015. I think it's a 'boiling the frog' approach, designed to keep the increases below our pain threshold

    But while the actual pain may be delayed, the law which enacts it is being developed right now.


  3. This is outrageous. If STRS decisions caused this debacle, then STRS (and their constituents, the teachers) should fix it. My pension was frozen a couple of months ago (and many of my neighbors are going through the same), yet we are not crying to the taxpayers to bail us out. If I paid the equivalent % salary that teachers do (which only be 12.5% after the changes), there is no way I could come close to the pension and benefits STRS offers. And before I hear about how this pension makes up for the poor wages, the last I saw on Paul's blog the average teacher salary in Hilliard is right about the average income in HCSD (though most of those folks do not have summers off).

    I looked at Jim Hughes web site and one of his stated goals was reducing taxes. I wonder how this fits into his "plan". On a side note, he also lists expanding education as one of his goals, but this has nothing to do with educating kids and everything to do with supporting a bloated and overly generous pension plan on the backs of those whose retirements are being decimated daily.

    Oh, and before I hear how this is necessary to "retain teachers in a tough profession", I recently heard a local district had well over 1000 resumes on file, and unemployment is at 10+%. Not sure where we need to "retain" them from going to.

    Thanks for the contacts Paul - I plan on contacting the state reps and governer.

  4. As one of those STRS retirees to whom you are referring, we are victims of the STRS retirement administration and Investment Dept.
    Many of us have told Mike Nehf and the STRS Bd. that things need to change. We have been telling them this for years, and yet, they continue to invest as they see fit and to award huge bonuses to the Investment Staff for losing money!
    Yes, we do vote for the members of the STRS Bd.; however, it is very difficult to get a person elected who does not have the big bucks OEA puts into getting their "chosen" candidate elected.
    So, don't put the blame on the STRS stakeholders, they are the victims of mismanagement and greed.

  5. When STRS was enjoying a high rate of return, there was no talk of lowering the employer contribution, was there? Instead, the STRS members decided to take money out of the system and pay themselves a "13th paycheck" - money that should have been held in reserve to fund the retirements of future retirees.

    When did the OEA become a "them" for you anyway? Wasn't the OEA the union that put you in the position of having a decent retirement program? What motivation does the OEA membership have in screwing up STRS - the very retirement system that active teachers are counting on when they retire?

    Is it because the active teachers fear the retirees are going to consume all the assets before the active teachers get a chance to enjoy their own retirement? Do the retirees fear the active members are going to preserve resources for themselves by reducing benefits to you?

    You folks in OEA and STRS can fight this out among yourselves - just leave the rest of us out of it. If you've blown STRS up with bad investment decisions, it's up to you and the OEA to figure out.

    We've paid our fair share into the system on your behalf once already. After that, the consequences of your risk/reward choices are yours to bear.

  6. To the STRS retiree:
    You may be a victim, but not a victim of the taxpayers, so why should the taxpayers bail you out? In a way, I can sort of feel for the retiree's as some of the older ones, in particular, did not enjoy the benefits of 7% salary bumps every year. However, your union has gone way overboard in recent years regarding compensation demands, and the taxpayers are revolting big time. Keep in mind I feel more sorry for the private sector retirees even more, as they have no guarantees whatsoever. It should be up to the currently employed to cover the retirees, just as it is for Social Security recipients. And you should expect the same cuts as SSA folks put up with.
    Regarding the election of OEA backed board members, welcome to our world. The OEA backs candidates for school boards and state legislatures too, and then those entities rubber stamp the OEA demands. Problem is, the goose is no longer laying the golden egg. Sorry.

  7. Unfortunatly, the 2.5 increase most likely will be enacted. There is too much political pressure to hope for anything else

    Simply the 2.5 % is an expense items that is going to increase.
    It will need to be covered by a tax increase on the property owner

    So, the next contract of three years needs to be flat. The 2.5% increase will need to start being accumulated now, so we have the dollars to fund it. Otherwise it will come out of current programming

    While the smart play, and acknowledged by the Audit and Accountablility that our expenditures will be exceeding revenue the next contract for the first two years should be a base increase of 1% with no step raise.
    or vice versa. Not one penny more than that. The board should be starting that dialogue now and not wait until the last minute.

    If we wait to start this conversation with the HEA we will get back into a corner

    There are thousands of teachers who I am sure would like to come here and teach given the facilities, infrastructure, and pay scale. I know of 3 myself who
    would come right now.

    So if the strike comes, we simply start hiring their replacements.

    I am also ( for anyone interested)
    almost ready for a petition drive directed at the school district about insuring that our graduating seniors equally across the board receive the proper paper work,
    and attention to insure our students do not run into the same issues as the last "working to the contract" anything related to students positive move forward
    toward their college careers.

    This should be a no brainer but unfortunatly no one at the admin. level or the HEA members seem to give a rats.

    So, if you are interested let me know. Working to the contract is a far cry from the districts crap about it being about the kids

    Apparently we have negotiated our rights to the HEA in the contract for so many things. It is time we as taxpayers are treated equally
    for every student, not the chosen few. The financial ramifications can be interesting

  8. Among the many letters posted on Kathy Bracy's blog about these newspaper articles was this one written by a retired teacher. For someone who is supposed to be skilled at using and teaching critical analysis, Mr. DiColibus made some glaring errors.

    Chief among them is this statement which I've seen a number of times in this debate:

    "School boards haven't seen an increase in the rates they have to contribute for 24 years."

    Because school boards (ie the taxpayers) contribute 14% of a teachers' salary to STRS, the dollar amount of contribution made has increased directly in proportion to the teachers' salaries. In the case of the majority of HCSD teachers, that has meant annual increases of 7.95% for the 2005-2007 contract and 7.27% for the 2008-2010 contract.

    Consequently, the dollar amount of the retirement contributions made by the school district for each teacher will have increased 55% between the beginning of 2005 and the end of 2010.

    If the average teacher salary today (in round numbers) is $68,000, then just prior to the start of the 2005-2007 contract, the average teacher pay would have been around $44,000, and the employers' contribution to STRS would have been around $6,200. By the end of the 2008-2010 contract, the average teacher pay would be around $68,000 and the STRS payment would be around $9,500 - an increase of approx $3,300/yr per teacher.

    That doesn't sound like nothing to me.

  9. Response from an e-mail I sent:

    Thank you for sharing your concerns regarding public pensions in Ohio.

    The topic of maintaining solvent pension funds in Ohio remains a very high priority.

    Based on the briefings that I have received, the recommendation will be that pension contributions reflect more what is done in the private sector than has been done in the past.

    I certainly understand your concerns. At this point, nothing official has come before the Ohio House concerning recommendations that are being finalized.

    I will keep your concerns in mind when this issue is addressed.

    Again, I appreciate your taking the time to express your concerns.

    Cheryl Grossman
    Assistant Minority Whip
    Ohio House-District 23

  10. Thanks... pretty much a non-answer, huh?

  11. Yep, I thought it was a pretty nice dance too. As far as Mr. DeColibus' blog post, all I can say is I am glad he is retired and not actively teaching. He is obviously way out of touch with economic reality, especially in regard to those of us in the private sector. Our employer pays only 6.75% into Social Security for us, not 14% and I can say as an employer, that is figured into what we can pay our employees. All payroll costs are a part of a companies budget for labor, including taxes, health insurance, etc. When any of those costs rise, the employee is getting a "raise" whether they want to acknowledge it or not - I am fortunate that most of mine do. And in what rarefied air are employers giving those kind of matches to 401(k) programs? How many employees have had to scale back their own contributions due to no raises for the last 3 years on top of decreased matching? How many private sector companies have ANY kind of pension for their employees? I deal mostly with small businesses (the backbone of our economy) and none, that I know of, offer a pension, and most have scaled back or eliminated matching of 401(k) contributions.
    Mr DeColibus goes on to say that the reason his pension is so high (by his own admission it is a great pension!) is that STRS has invested all of those contributions over the years. WRONG! It is so high because it was guaranteed, regardless of the performance of the fund. It is so high BECAUSE the fund was not managed properly and so now it looks like it might be in trouble, contrary to his "the difference isn't we're unreasonably greedy, the difference is the government doesn't intelligently invest its citizen-workers pension contributions" statement, which if he stopped to think for about one nanosecond, he would realize exactly the opposite is what the entire issue is about!

    BTW, it's good to be back on board around here - I have checked in regularly and finally have found the breathing room to have time to post; I had even lost my password
    which is why I posted anonymously previously in this thread, including the response from Cheryl Grossman. I hope to pick up where I left off a few months ago!

  12. Welcome back Hillirdite - we've missed you.


  13. Here's yet another letter from an STRS retiree to their State Representative claiming that there has been no increase in the employer contribution to STRS.

    I very much like the response the retiree received from Rep Lynn Wachtmann, from northwestern Ohio.