Thursday, January 16, 2014

Whoops! Spreadsheet Error: STRS Still in Trouble

I've been writing for a few years about the ticking time bomb which is Ohio's State Teachers Retirement System.  I first became aware of this issue when I came across a blog written by Kathie Bracy, a retired Columbus Public teacher.

This week, STRS was again in the news when The Columbus Dispatch reported that a consulting firm the STRS management uses had a "programming error" in their actuarial evaluation of the investment fund. It turns out that the problem is bigger than was thought.

Pension funds are simple in concept.  Employees and employers pay into a fund during the employee's working career. That money is invested. When the employee retires, the combination of employee and employer contributions, plus the earnings on investments, are used to pay out retirement benefits to the employee.

Pensions have been around for a while, but became popular during the last half of the 20th century as employers competed for workers in the post-WWII boom economy. The best thing about this component of compensation - from the perspective of the employers - is that it was a promise to pay something in the distant future, and not an immediate hit to profits.

Then someone got the bright idea to start increasing the pension benefits so that a retiring worker would receive not just the money he had contributed, plus that contributed by the employer on his behalf, plus the earnings on those contributions accumulated over the years - but also a share of that which was being contributed by active workers, and by the employer on those workers' behalf, plus the earnings generated by those contributions.

Some would call that a classic Ponzi scheme - a kind of con game where the first investors are paid off using money collected from newer investors, who are paid off with money from still newer investors. Ponzi schemes collapse when new investors become hard to find, and there's no money to pay off the earlier investors. This is what happened with the now infamous Bernie Madoff scandal, but there have been many such swindles over the years.

STRS is an agency created by the Ohio law, and governed by a Board which includes officials appointed by the Governor, the Speaker of the House, and the President of the Senate, plus five actively working teachers, and two retired teachers. They don't share exactly the same goals.

Working teachers would like to contribute less, have the employer (ie taxpayers of school districts) contribute more, be able to retire earlier, and have confidence that their eventual payout will be both generous and secure.

Retired teachers want to be sure that they get all that they were promised, and that their benefits won't be reduced, or made less secure, by increasing demands from working teachers, or because of risky investment decisions by the retirement fund managers (unless they pay off).

And the politicians?  They want to get re-elected of course. So they listen to the lobbyists who provide the most in the way of campaign contributions and votes.

What about the voters - the taxpayers - the folks who foot most of the bill for this retirement system?  In politics, the ignorant, the apathetic, and the quiet get ignored. Sadly, this seems to be the majority - the so-called "Silent Majority."

STRS needs more fixing. This actuarial mistake reveals that the current STRS benefits scheme is still designed to pay out more money than can be supported by the current size of the fund, its projected investment earnings (which are still overly aggressive in my opinion), and expected future contributions. Some or all of those parameters need adjustment.

The only way to fix it is to increase contributions and/or reduce benefits. You could of course get even more aggressive in the investment strategy. Rare coins anyone?

Two classes of folks have an interest in the benefits side of the equation: teachers already retired, and teachers who are yet to retire. The latter group has the greater political clout, primarily because of the power of the Ohio Education Association - one of the largest unions in the country. The working teachers also have more seats on the STRS governing board than do the retired teachers. So for now, future retirement benefits are prone to be protected at the expense of the benefits to current retirees. This is what Kathie Bracy and her cohorts have been fighting about.

On the contribution side, the two parties are the working teachers and the employers - the taxpayers. For a number of years, the teachers have contributed 10% of their salary, and the taxpayers 14%. In the last round of adjustments, the teacher share is gradually being raised to 14% as well.

So what's next?

STRS invests heavily in the stock market.  They probably had pretty impressive returns in the past year or so (the 2013 report is not yet out). They've also had some pretty spectacular losses, like in 2007 when they lost nearly half their money - on the order of $30 billion. They're not expecting those kinds of losses again, but they are making assumptions about investment returns which many - including me - believe are overly aggressive. That's means they think they're better off than they really are.

I don't know what comes next, but I remain steadfast in my belief that the taxpayers shouldn't be expected to bail STRS out. Our 14% share seems like it should be enough to fund reasonable benefits, given reasonable contributions from the working teachers. Remember that the while the percentage is constant, the underlying compensation isn't.  If compensation goes up 5% per year, then the taxpayer contribution will go up at 5% per year as well.

If the STRS members want to gamble with that money in hope of getting even bigger retirement benefits, that's okay by me. But if the bet doesn't pan out, it's the STRS members who have to take the haircut.

Not the taxpayers.


  1. I really can't fathom why current teachers still support STRS. Dave Ramsey, whom I have a lot of respect for, advocates saving 15% of your income which is enough to make you a multi-millionaire when you retire. Teachers were getting 24% of their income invested and somehow there isn't enough money to pay for their retirement??

    Now it seems it's 28%? (Or is the tax-payer portion going down?) And there's still not enough money, and they continue to support it?

    And these are the people we are entrusting with educating our kids?

    Hopefully none of them are teaching personal finance!

    1. Currently the teachers are contributing 11%, but it goes up 1%/year until 2016, when it reaches 14%. The employer share stays at 14%.

      The challenge is with the benefits algorithm for the Defined Benefits option - which nearly all teachers select. Currently it's set to 2.2% of the Final Average Salary times the number of years of service.

      So a teacher retiring with 35 years of service at an FAS of $95,000 would get $95,000 x 2.2% x 35 = $73,000/yr for the rest of her/his life.

      But while the stock market was booming and the investment returns looked to be much greater than necessary to fund that level of benefit, the STRS Board, with the approval of the General Assembly, created a special kicker so that if a teacher retired with at least 35 years of service, the factor would be increased to 2.5%, meaning the teacher with the $95,000 FAS have a pension benefit of $83,000.

      That special kicker was eliminated in the most recent changes, but meanwhile a significant number of teachers retired while it was in effect, and they'll likely receive those benefits for a couple of decades. I suspect that this is what's causing much of the problem.

      Teachers who retired during those "golden years" will receive quite a benefit, but the funding assumptions to support it are not holding true. That means others are going to end up subsidizing its cost.

    2. Right, which is why I can't fathom why existing teachers continue to support the current system and are not crying out for a different one...

  2. Gradually raise the retirement age, or at least the age at which one can collect benefits, to match the private sector's waiting until age 66+. And yes, I realize they have already taken stpes in that direction. Do this for ALL public pensions. The military pensions are currently taking a hit on the COLA adjustments and they are screaming bloody murder, but they can retire at 20 years, meaning in some cases paying pensions from age 38 until death - 40 years or so actuarial. The math simply doesn't work, even for a federal government that can run deficits.

    1. A lot - maybe most - public sector retirement plans got screwed up by assuming that the long bull stock market was a "new normal," which lured the members into thinking it was okay to crank up benefits to an unsustainable level.

      In the private sector, the problem was more often that employers used the extraordinary investment earnings to justify making dramatic reductions to their contributions. And of course, in some cases the employer went bankrupt, ending contributions altogether. While the federal Pension Benefits Guarantee Corporation provides some backup, in most cases, the retirees of bankrupt employers end up getting only a fraction of what they were promised, because their plans also counted on a constant flow of new contributions to pay off pension obligations to those who had already retired. This precise thing happened to my older brother.

      It's sad that members of STRS and other public sector pension funds may never get the full measure of benefits they were promised. But asking the taxpayers to make them whole isn't fair either. Any additional money I am taxed to prop up underfunded public sector retirement plans is money I lose to fund my own retirement...

  3. Paul, you pose some interesting comments re. STRS. The best thing STRS could do for its situation is IMMEDIATELY stop the 88.5% payout for 35 years service. ALL of the other four Ohio pension systems only pay out 77% for 35 years service. The 35% payout was the brainstorm of the OEA dominated STRS board back in 1999 when many of these same OEA endorsed active teachers were nearing the 35 year service mark them it was a sweetheart contract that they had a chance to enact...and they did. STRS cut out health insurance subsidies for retirees' spouses overnight but now are slowly phasing out the 35 year/88% retirements over a period of years. This should be phased out immediately instead of them looking to cut even more COLA from current retirees....many of whom were never eligible for the 35/88 in the first place. Of course, with the OEA still dominating the makeup of the STRS board it will be difficult, won't it?

    1. The 88.5% enhanced benefit ends with teachers who retire before Aug 2015 - next year - which pretty guarantees that any teacher who has 35 years of service by then will retire. We're certainly seeing many retire in our district, including our Superintendent, who retired last Spring.

      I'm not clear whether you're advocating that the enhanced benefit be eliminated effective immediately, cutting out this last batch getting ready to retire, or whether you want to take back the enhanced benefit from those who have already retired.

      The interesting dynamic is that a serious campaign to "claw back" the enhanced benefit from those already receiving it would likely fire up thousands of recently-retired teachers who are otherwise pretty silent right now. Could that lead to greater representation for retired teachers on the STRS Board?

  4. Any change in make up of the board would have to be accomplished by legislative action. Currently there are not quite twice as many actives as retirees BUT the ratio of actives vs. retirees is 5:2 which is not in line with the number of STRS stakeholders, is it?

    1. Classic case of Tyranny of the Majority wasn't it (when the 88% enhanced benefit was created)? One wonders what will happen as the active portion of the STRS board becomes dominated by teachers who are no longer eligible for the 88% enhanced benefit. I suspect that this has already come to be.

      Are there data showing the portion of the annual benefit payout which is going to folks getting the enhanced benefit? Perhaps it's not really that big of a deal.

      Here's an interesting calculation. The numbers are real, taken for the actual CBAs with the Hilliard Education Association. If a teacher retires at the top of the pay scale in 2016 (Masters+30 and > 23 years), then the FAS would be $92,500. The pension benefit would be 77%, or $71,200.

      That's about the same as for a teacher who retired in 2008 with a FAS of $82,500, but with the 88% benefit.

      In other words, as salaries continue to climb, the payout under the 77% regime begins to exceed that of the 88% regime. And in reality, the teachers who retire in 2016 will not have paid much more into the system that those who retired 8 years earlier.

      That's the consequence of basing the payout on end-of-career earnings when there has been a rapid run-up in salaries in the latter portion of their careers. That in turn puts more dependency on the new money coming into the system.

      And we back to talking about Ponzi schemes...

  5. Paul,

    The system is a mess. The gold plated system is a mess and we (HCSD) helped make the financial position worse.

    Lets take the best private system in the area (name withheld). The employer pays 2.3% into a defined benefit program. In addition they pay 6.2% into social security (match by the employee), in addition they match 401k money to the tune of 4%. That makes total employer contribution 13.4% when the employee pays in 10.2%, not much difference from the teacher position. Other than it is at age 65, if at 55 it woould be only 55% of the full amount at 65.

    If the 401k was placed in a fixed investment vehicle for the employee with a final annual compensation arount $100,000. The total of retirement, social security and the interest off the 401k is around 85% in year 5. All cost of living increased have been maxed out and the only increase will be social security of which is only 24% of the total. (also remember social security pays for community items something STRS does not.)

    That is the deal when someone works for the best employer in town until age 65 and more than 40 years of service. The teacher may start out at 77%, but grows every year until it is 100%. That is the same gold plated plan the private industry offers, only 15% higher. So at a younger age the STRS person gets more quicker.

    We (HCSD) helped drain the STRS fund. Lets say the teacher who took the buy out we offered was going to work 4 more years. They were making $100,000 per year, so the total deposit to STRS would have been (24,000 x 4) $96,000. Now instead of making deposits into the system they will draw ($85,000 x 4) $340,000. This is with no cost of living added in. The total $96,000 not being paid in plus $340,000 means the start of the fifth year there is $436,000 less in the STRS investment fund. If they were going to retire anyhow, we spend a whole lot of money in addition to the strain on STRS.

    We the tax payers paid for a gold plated plan for the teachers. One far better than the average tax payer has who funds the plan. If they get into trouble so be it. Let the the teachers pay more or get less at retirement.

    We have paid enough!!!!

    Joe Taxpayer.

    1. There's a slight flaw in your math in that retiring 4 years earlier would reduce the payout to the teacher by 10%. But I don't disagree that motivating a teacher to retire early puts additional pressure on STRS. Their rules, not ours.

      We had to look at what's best for our own budget, and having the opportunity to replace a teacher making $90,000 with one making half that is significant. It plays a part in helping us not have to be on the ballot this year (along with the boost in state funding we received).