Tuesday, August 01, 2006

A letter from Herb Dyer to Dennis Leone, May 22, 2003: Diversionary tactics to avoid addressing the issues in Dennis’ 5/16/03 investigative report

May 22, 2003

Dr. Dennis Leone, Superintendent
Chillicothe City Schools
235 Cherry St.
Chillicothe, OH 45601-2350

Dear Dr. Leone:

We appreciate you sharing your comments with the Retirement Board and myself both in your written paper and in your personal appearances before the board. You invited us to respond to your comments. I have not tried to respond to each item individually. Rather, I would like to provide you with some information that I believe addresses your major concerns regarding the following:

· Retirement Board expenditures;
· Overall administrative costs;
· Salaries and performance incentive awards; and
· Investment losses and expenses.

Please read on to appreciate how I come to different conclusions than you do.

Retirement Board Expenditures

The majority of the Retirement Board consists of six elected individuals – five active teachers and one retired teacher – who have firsthand knowledge of the needs and expectations of STRS Ohio members and benefit recipients. These individuals receive no pay for sitting on the board and are reimbursed only for their expenses. Also at the board table are three ex officio voting members: the auditor of state, the attorney general and the superintendent of public instruction.

The most significant responsibility the board has is to provide fiduciary oversight of STRS Ohio. Upon election, Board members become trustees for an organization that currently issues nearly 2 million benefit payments totaling more than $3 billion in benefits annually. The Board legally administers Chapter 3307 of the Ohio Revised Code and must comply with many sections of the federal tax code. STRS Ohio staff invests for the Board nearly $45 billion on behalf of more than 400,000 active, inactive and retired members in assets that include domestic and international stocks, commercial real estate in the USA and abroad, and a wide array of fixed-income securities.

Recognizing the importance of carrying out this oversight role well, the Ohio Revised Code demands that Board members prepare themselves to perform such responsibilities competently. They do so by undertaking a number of rigorous knowledge development and awareness activities. These development activities include attendance at seminars, workshops and certificate courses offered by entities like The Wharton School at the University of Pennsylvania and Stanford University, as well as meetings and training seminars offered by the National Council on Teacher Retirement, the International Foundation of Employee Benefit Plans, the National Conference on Public Employee Retirement Systems and Board-appointed consultants. These tailored activities by universities and national and international educate and enlighten public fund trustees across America and are not offered locally in Ohio. A board member must travel to and stay in the cities where they are to benefit from them.

Overall Administrative Costs

The goal of STRS Ohio is to provide outstanding service to members as efficiently and effectively as possible. These services for 400,000 members include a telephone call center that handles more than 325 calls per year; many thousands of one-on-one counseling sessions either in Columbus or at other locations around the state; educational workshops to help members prepare for a financially secure retirement; an interactive Web site with password-protected personal data; print communications that provide accurate and up-to-the-date information about benefits, services, investments and administrative costs; and assistance to 940 contributing employees around Ohio. Survey after survey shows that STRS Ohio members and benefit recipients are getting and are extremely satisfied with the service levels provided by the system.

The recently adopted 2003-2004 STRS Ohio administrative budget, which covers the period July 1, 2003, through June 30, 2004, is actually 3% less than the current year’s budget. Capital expenditures are also lower. In addition, actual expenditures for the current year are running millions of dollars below budgeted amounts.

Salaries and Performance Incentive Awards

Compensation and Benefits

Current independent studies show that STRS Ohio associates’ total compensation including bonuses falls just above the middle of market rates for comparable positions. Associate benefit costs – as a percentage of gross payroll – are reasonable. STRS Ohio staff benefits comprise 30% of gross payroll, a bit more than federal Bureau of Labor Statistics say is 26% for average state and local governments employees. Facilities where STRS Ohio associates perform their work for teachers are comparable to other mid-town office buildings in Columbus, like Ohio PERS and the Rhodes Office Tower.

The competitive compensation and benefits package provided to STRS Ohio associates contributes to its consistently low staff turnover rate. In 2002, the STRS Ohio turnover rate of 5% was just one-third the industry average of 15%. This helps ensure consistency in service to members and reduced expenses for training.

Performance-Based Incentive Award Program

Nationally recognized Buck Consultants in Chicago conducted a thorough analysis of STRS Ohio’s performance-based incentive award program in 2002. This program rewards associates for work over and above their routine assignments completed during the previous fiscal year. Buck staff found that:
Similar incentive plans are in place at 44-65% of all employers;
The structure of the STRS Ohio plan is consistent with best practices; and
Total cash compensation for eligible associates is competitive with the market.

The performance-based incentive award program, as part of STRS Ohio’s total compensation and benefits program and competitive work environment, help the system attract and retain the type of associates needed to provide accurate and timely benefit payments and highly rated services and to manage billions of dollars in investment assets.

Investment Performance and Expenses

Investment Performance

STRS Ohio has for decades assumed its assets would earn about 8% over long periods of time. As a pension fund, STRS Ohio must invest for the long-term. The average rate of return the system did earn over the decade that ended in 2002 was in fact 8.1%.

I appreciated your kind remarks about the good work you think Steve Mitchell and investment team did during the Nineties. More recently, STRS Ohio is not the only institutional investor that has experienced losses during the past three years. Corporate and public pension plans, insurance companies, money managers and financial institutions alike have been negatively impacted by this unprecedented downturn in the markets, as have millions of Americans’ individual savings plans, such as 401 (k), 457 and 403 (b) plans.

Since 2000, I can’t believe everyone suddenly lost their ability to make good investment decisions. The reality is that the economy is cyclical, with both growth and recessionary periods. That is why Ohio state statutes require the earnings rate assumption for STRS Ohio’s assets stood at $42.4 billion. A few weeks later, the market value of STRS Ohio assets has risen to $45 billion.

Several years of negative returns have hurt all investors. We expect it will take a number of years for the markets to fully recover. In the interim, a steady, long-range focus on investment opportunities, a prudently diversified asset mix and consistently monitored cost controls will allow STRS Ohio to “ride out the storm” of these fluctuations. Promised pensions are being and will be paid when due.

Corporate Misdeeds in the Private Sector

One factor that is complicating the market situation is the extreme acts of corporate misconduct and dishonesty that have occurred in this country. It is difficult to make investment decisions based on corporate financials if the numbers are false. Again, millions of large and small investors alike have lost money in such companies as Enron. In fact, it has been estimated that the losses to public funds from Enron alone approach $1.5 billion.

However, as noted earlier, investment gains and losses cannot be viewed in just quick snapshots. STRS Ohio is now part of a class action suit against Enron, its officers and its auditors filed by the Attorney General of Ohio on behalf of STRS Ohio and OPERS (Ohio Public Employees Retirement System). In this suit, STRS Ohio’s allowable litigation loss is around $56 million. However, if you look at STRS Ohio’s total history of Enron investments (including its predecessor companies Houston Natural Gas and InterNorth), the total investment losses associated with this one investment are reduced to $14 million due to gains on earlier transactions.

STRS Ohio also has aggressively pursued strong reform measures at the national level to protect the integrity of the financial markets, as well as included provisions in its own policies addressing corporate accountability.

Further, some years ago the Retirement Board established a policy for pursuing and maximizing recovery of losses caused by corporate misconduct. STRS Ohio has recovered more than $20 million under this securities fraud litigation policy. STRS Ohio is participating in all of the current lawsuits alleging corporate misdeeds. However, such cases are usually pending in court for several years before conclusion, so it is likely to be some time before the outcome of the current cases can be evaluated.

Investment Expenses

Many public pension plans use “outside” commercial money managers to manage their assets at significant cost. The State Teachers Retirement Board determined 30 years ago that it was more financially prudent to hire its own skilled investment staff to manage the majority of assets (8.5%) in-house. That is why STRS Ohio has a large investment staff. For example, in real estate assets alone, STRS Ohio internal real estate staff manages hundreds of directly owned properties worth billions of dollars. This practice is virtually unique in the public sector and allows us to retain tons of millions of dollars for use by the Board to pay benefits. By way of contrast, other Ohio public retirement systems pay outside firms to manage their holdings in this asset class.

Independent studies have confirmed the cost saving wisdom of the Retirement Board’s decision. Comparison studies conducted by Cost Effectiveness Measurement, Inc., a Toronto-based firm, show that STRS Ohio effectively saved $53.8 million in just calendar year 2001 alone on the assets managed internally instead of using outside firms. That’s an extra $53.8 million still here for teachers, instead of in New York or Boston.

Teachers’ Benefits

As noted earlier, STRS Ohio provides retirement benefits, along with survivor benefits and disability protection, to Ohio’s public educators. In addition, STRS Ohio is one of only about 10 teacher retirement systems out of nearly 80 nationwide that provide any kind of optional health care benefits for its retired members.

Over the past 10 years alone, the amount of assets and the total benefits paid have increased significantly. Benefits (including health care) have increased to more than $3 billion during fiscal year 2003 from $1.3 billion in fiscal year 1993. Presently, STRS Ohio’s monthly net benefit expenditures are about $195 million – about $8 million of which is being spent for benefit increases allowed through legislative actions initiated by the Board in the last five years.

When Ohio law and high investment returns permitted it, the Retirement Board also issued supplemental payments often called “13th checks.” These helped older retirees deal with losses in the purchasing power of their pensions that happened even after payment of annual cost-of-living adjustments. Since the COLA is not a compounded figure, the annual adjustment did not keep up with the dost-of-living in past periods of high inflation. The supplemental payment and other Board-initiated legislatively enacted purchasing power restorative catch-ups have worked to keep the major effects of inflation in check for most pensioners.

It has taken me a lot of words, Dr. Leone, as I thought about how to address your concerns. I accept that you and I may still not agree on how to view these issues. I can tell you, though, that I believe all decisions at STRS Ohio are made with the best interest of our members and retirees foremost in our minds.

Sincerely,

Herbert L. Dyer
Executive Director

C Retirement Board
Laura Eckler [sic], Director, Communications
Larry KehresMount Union Collge
Division III
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