Dennis Leone: Need for a contingency plan

From Dennis Leone, October 25, 2006

Subject: Nervousness

To answer your question: The projections that have been given to the board stipulate that if we receive the full 5.0% increase in contributions (2.5% from actives and 2.5% from employers), and 1.0% of that amount is set aside to help reduce our unfunded liability, the desired stability for the Health Care Stabilization Fund should still occur. Note I used the word "should" -- which is what the board has been told. I am as nervous about it as anyone else.

I am more nervous about the following: We heard good news on Friday that our unfunded liability -- due to terrific investment returns for the past 3 years -- has dropped from 55 years to 47 years. HOWEVER, it also was reported that our projected payroll growth of 4.5% per year from actives has been woefully low. The current 47-year unfunded liability figure assumes a 4.5% payroll growth for the future. Unfortunately, for the past 3 years, our payroll growth has been 3.9%, 2.2%, and 2.0%. This is due to fewer students, fewer teachers, lower pay increases for teachers, and increased charter school activity. The truth is the truth. Our positive investment returns can be wiped out by an adjusted (lowered) payroll growth of less than 4.5%.

I asked our experts, from Buck Consultants, what would happen if we lower our assumed payroll growth from 4.5% to 4.25%. Answer? Our unfunded liability would go up from 47 years to 53 years. I asked what would happen if we lower the assumed payroll growth from 4.5% to 4.0%. Answer? Our unfunded liability would shoot clear up to 62 years. And what, I asked, would happen if we lower our assumed payroll growth to 3.5% (still higher than the average of the last 3 years). Answer? Our unfunded liability would go way over 70 years, which means that we would be at "infinity." What does "infinity" mean? It would mean that we are not able to meet our pension obligations in the future.

There are some board members who think our payroll growth will go back up to the projected 4.5% increase per year (which is was between 1993 and 2003).. Do you agree? I do not. This is another reason, I feel, we need to have a contingency plan approved to mitigate the negative realities of a catastrophe, or a huge drop in the stock market, or an inability to acquire a 4.5% payroll growth.

Dennis Leone

STRS Board Member

-----

From John Curry, 10/24/06
Jim - good question - I'll forward to Dennis. John

-----

From Jim Kimmel, October 24, 2006

John- am I reading the board minute summary right ?

If so then how do we get ahead with the passage of increased active payroll contribution if 1% goes to the health care fund and then the 1% now going into the health care fund will be diverted back to the general fund to help bring down the unfunded liability to 30 years ? Won't we then be right where we are now with the health care level of funding ? Won't this tend to keep the health insurance rates just where they are now ? I thought that the idea of the legislation to increase payroll contributions was to augment the health care fund.

Jim K

-----

From Jim McGreevy, October 24, 2006

Subject: STRS Report to OEA-R

This report contains my observations at last week's STRS Board meeting as well as excerpts from the PERS and SERS Board meetings covered by the OEA Governmental Services Department.

- Jim

-----

The STRS Board met Thursday and Friday, September 19 & 20, and conducted the following business:

New Member Joins Board A new member of the Board, Thomas Johnson, was welcomed to the Board. He is the former Ohio Director of the Budget and is an appointment of Governor Taft. Before taking on the state's top budget job Mr. Johnson was a state representative from the New Concord area, having been elected to multiple terms. He was endorsed by OEA during several election cycles and is considered a pragmatic political moderate. His expertise on budget issues should be a valuable addition to the STRS Board.

Active Member Contributions Hit Record Level Bob Slater reported that for the first time in STRS history active teacher member contributions to the system totaled over $1 billion in fiscal year 2006. Despite this impressive number there is concern that the growth in educator payroll has fallen in the 2% range for the second straight year, well below the anticipated 4.5% and less than the trend since the mid 1990's. This lower than projected growth may be the result of experienced staff being replaced by younger teachers as baby-boomers retire, the competition of charter schools who generally pay less than public schools, or teacher layoffs due to the state's refusal to adequately address the school funding crisis. It shows dramatically how the fate of public education in this state not only affects active teachers but also retired benefit recipients. While we retirees may look with envy at the higher salaries being earned by today's teachers, we have a very real stake in seeing those salaries continue to grow at a robust rate

Investments Continue to Beat Benchmarks The Investment Department reported continued strong performance for STRS investments. The market value of STRS assets at the close of business September 30, 2006, was $67.9 billion, a 4.9% increase over the previous month. STRS continues to do well in all types of investment and remains heavily invested in the real estate market. Board member Thomas Johnson questioned whether we should be in this segment of the investment market considering recent downturns in this part of the economy. It was explained that STRS focuses on the commercial real estate sector which continues to be strong. As an example it was noted that STRS recently sold a major suburban Cleveland office building for a figure that was a record (in per square foot costs) for that city. The property, Lakepoint Office, was purchased in 1995, generated net income since then of $7.7 million, and sold for a gain of $1.5 million over the purchase price, representing a nearly 9% annual return on investment.

Real Estate has been a very high-performing part of the STRS portfolio and its importance underlies the significance of finding highly qualified managers to fill vacancies in the Investment Department. The search for these managers by a nationally recognized "headhunter" firm continues to be a matter of some controversy on the Board due to the price tag for their search - $315,000. Damon Asbury explained that it was essential we find highly qualified personnel for these jobs and that headhunter firms in this league are not cheap, but in the long run are worth the cost. STRS' real estate profits last year were among the highest in the system's portfolio.

STRS Selects New Auditor STRS has hired a new auditor, Clifton Gundrerson, Inc., replacing KPMG. CG will provide financial statements, reports on internal controls, management letters suggesting needed changes, and financial statements STRS is required to file with the state of Ohio for their financial records. The Ohio State Auditor's office actually enters into the contract with the auditor, but generally follows the STRS recommendation on the selection of an auditor.

Internal Investment Management Saves Big $$ An external consulting firm, CEM, reported that the use of internal investment managers by STRS has resulted in an annual savings of $93.6 million as compared with the cost of paying external managers to handle our investments. This includes the cost of all investment department overhead, salaries and bonuses.

Actuarial Report Presented Kim Nicholl of Buck Consultants presented the Actuarial Valuation Report. This is a statistical snapshot of the condition of STRS relative to some standards of financial stability. It gives you some idea of the financial soundness of the system and can provide a sort of "early warning system" for potential problems. The calculations include data on benefit recipients and active members, financial data, benefit structure, actuarial assumptions (life span, age at retirement, etc.), and some mathematical formulas designed to assess asset values and other financial statement data.

One of the main stats presented was the Funding Period, the number of years necessary to pay off the unfunded liability of the system. Currently, STRS has a Funding Period of 47.2 years, down from 55.5 years a year earlier. While this is a nice improvement, the state of Ohio expects a Funding Period no more than 30 years, so there is considerable work to be done to continue to lower this.

Another key statistic is the Funded Ratio, a comparison of assets to accrued liability. STRS' Funded Ratio is 76.6%. Our high point for this statistic was in Fiscal Year 2000 when we hit the 92% mark. The stock market drop in 2001 and 2002 immediately depressed that figure to the 75% range as the value of our assets declined. Pension systems generally try to achieve a ratio of 85%, so once again there is work to do. Continued strong performance of investments and meeting our other assumptions (like annual payroll growth) hold the key to improving this number. The passage of the Health Care Proposal would also provide an additional 1% of state educator payroll as that amount is re-directed back to the pension fund and away from the Health Care Stabilization Fund.

The Board began a discussion on whether or not our actuarial assumptions needed to be examined to reflect reality more accurately. The general consensus was that it was indeed necessary, although Thomas Johnson pointed out that despite individual variances in some of the assumptions (like payroll growth) the overall picture was very accurate and that retirees and active members should be very pleased with the system's performance through some difficult economic times.

Computer Systems Upgrade Continues on Track The Information Technology Services Department reported that the project to upgrade the computer systems at STRS (Vitech V3) is proceeding on schedule and within budgeted amounts. The total cost of the project when completed will be a bit more than $19 million. Thus far about $5 million of the total has been spent.

Executive Director's Report Executive Director Damon Asbury reported:
* The proposal to provide a dedicated revenue stream for retiree health care "continues on a steady course." There is some hope it will be introduced during a lame duck session following the November election, but no one anticipates fast action on the legislation.
* The Ohio Retirement Study Council has directed its consulting actuary to compile data on the impact of purchased service credit on the five state retirement systems. The actuary (Milliman) will present their findings by January 31, 2007.
* The open enrollment period for health insurance is ongoing. Many calls have come in regarding the changes to the Basic plan because of enhancements in coverage of preventive services.
* Aetna Insurance has informed STRS that it plans to phase out its Long Term Care insurance plans. Aetna will continue to support the group plan offered by STRS. About 14,000 members are currently enrolled. These members will continue to have coverage unless the enrollee cancels the insurance or exhausts their benefits. Enrollee premiums will not change as a result of this action, and the inflation protection provision also remains in effect. Additional charter schools have increased the number of participating employers to 1,112.

Board Member Questions "Headhunter" Fees Following the lunch break on Thursday Board member Dennis Leone raised an issue concerning the compensation we must pay for the "headhunter" (Ferguson Group) to recruit candidates for the Real Estate investment managers. He was concerned that under provisions of the contract that STRS would have to pay Ferguson a fee if we hired someone for one of the positions that was not on their list of recommended candidates. The staff responded that this is not the case unless the candidate was originally recommended by Ferguson or we hire them within the term of the contract with Ferguson. This is apparently standard contract language for "headhunter" organizations so that someone will not bypass their organization when word gets around that there's a job opening at a specific location. Another concern about travel expenses connected to the search process was resolved when it was explained that such expenses would be in accordance with STRS associates' guidelines for travel.

Public Participation Five members took part in the "Public Participation" portion of the meeting.
* Nancy Hamant of Warren County voiced concerns over reductions in the Medicare Part B subsidies. (Staff later in the meeting noted that this was largely beyond the control of STRS unless the Board voted to divert other resources to those subsidies.)
* Bill Leibensperger, co-chair of the Health Care Advocates, brought a unanimous request from that group that the Board recognize the contributions of Mike Billirakis to the HCA effort over the past two years.
* Ralph Roshawn, a retired school superintendent, cited several areas of concern including his opposition to the "88% Rule" for 35 years of service, the HCA proposal as too expensive for local school boards to handle, and a few other spending issues at STRS.
* Dr. Glen Kiefer, a retired superintendent, expressed his dissatisfaction with the Board decision to no longer offer STRS insurance to retirees who resume employment either in the public or private sector.
* Jim Reed thanked Board members Leone and Lazares for their work on behalf of STRS members.

Contingency Plans Discussed During a further report on investments, Dennis Leone raised the issue of a contingency plan should some catastrophe result in e plunging stock market. He asked specifically if The Russell Group (OEA's investment consultant) would be making some kind of recommendation as to what steps could be taken in the event of such an occurrence. The answer: Russell may provide some ideas at the November meeting, but it was pointed out that the advice generally given by experts when a disaster strikes and drives down the market is to stick to your investment plan and make daily decisions based on the conditions of the moment. It was explained that the impact of a disaster is immediate and can't really be reacted to quickly enough to protect the organization from short-term losses. The key is to remain focused on long-term recovery. A good example of that is the recent past when the stock market tanked in 2001 - 2002. If we had panicked and abandoned the stock market for "safer" investments we might have missed the rally of the past three years that has quickly restored the asset base of STRS. There will unquestionably be further discussion on this at future Board meetings.

STRS and OPERS Cooperate in PBM Selection Process On Friday the Board heard the report of the Member Benefits Department on Health Care. One of the major points of this report was the discussion surrounding the selection of a pharmacy benefits manager (PBM) after the contract with Caremark expires in December of 2007. Ohio's largest public pension system, The Ohio Public Employees Retirement System (OPERS), is working jointly with STRS to find the best provider at the most affordable price. It is hoped the two systems can agree on the same PBM and thus enjoy economies of scale resulting in lower costs to STRS and its members.

New Contract Review Process Established The Board adopted a policy on contract review by the Board. Essentially any contract that meets one of three conditions will be summarized on a one page form for the Board. Additionally, Board members may review any contract in its totality prior to Board action. The conditions that trigger the review process are: 1) contracts of $100,000 or more, 2) contracts that provide services directly to the Board to facilitate the performance of their duties, and 3) contracts not provided for in the adopted budget.

Executive Director Asbury's Contract Extended The Board approved a contract extension for Executive Director Damon Asbury. Details of the contract were not made public as the final elements of the agreement had just been finalized. These will be forthcoming. Dennis Leone objected to considering the contract since it had not been placed on the agenda but the Board on a 5 - 2 vote rejected this position. The vote to approve the contract was also 5 -2 with members Leone and Lazares voting "No."

Associate Legal Fees Payment Determined to be Legal The issue of payment of legal fees for private attorneys for STRS associates called for questioning in the Hazel Sidaway ethics case was resolved with the reception of a letter from State Auditor Betty Montgomery to the effect that although she might have voted not to grant the expense reimbursement there was nothing illegal about the expenditure of that money. Dennis Leone expressed his continued disappointment about the decision to pay those legal expenses. A heated discussion about this issue between Board members Leone and Geoffrey Meyers ensued.

Routine Business Conducted During the conclusion of the Friday afternoon session the Board approved service retirements, disability retirements, and other routine matters.

The Board adjourned around 2:30 p.m.

------------
The following information is reprinted from the OEA Governmental Services Department's report on Ohio Retirement Systems. SERS and PERS meetings are covered each month by Robert Davis, OEA Lobbyist.

Report Shows Dismal Funding for SERS Health Care Program

At the SERS Board meeting on Thursday, September 21, 2006, Buck Consultants, the Board's actuary presented the Board a report on the funding status of the SERS health care program. The report showed that the current SERS health care program is only 3.3% funded. Further, it would require a contribution of 27.95% of payroll to fully fund the current level of benefits on a full reserve basis. As a point of comparison, the current SERS contribution to health care is 4.92% of payroll.

System	Valuation Date	Solvency	Funded ratio	Annual Required Contribution	Current Contribution
OPERS	12-31-05	2024	35.4%	17.19%	4.5%
STRS	1-1-06	2021	36.7%	4.58%	1.0%
SERS	1-1-06	2012	3.3%	27.95%	4.9%

These figures clearly demonstrate a structural funding problem for the SERS health care program that is both dire and immediate. The SERS health care fund is projected to run out of money in fiscal year 2011. It is in the best interest of both current and future retirees to continue the program for as long as possible and to make reasonable effort to provide the highest level of benefits to current and future retirees who have dedicated their careers to public service in our schools.

On October 5, 2006, the OEA officers, OEA Executive Director and staff met with leaders from the Ohio Association of Public School Employees (OAPSE) to discuss the SERS health care issue. The organizations agreed to discuss the forming of a coalition of all stakeholder groups to work with the SERS Board in establishing a strategic plan for health care. In order to provide affordable health care for current and future retirees, the coalition will review the current program as well as options for ensuring additional revenue to fund health care benefits. These are difficult decisions that are best addressed with all parties at the table working toward a common goal.

SERS Board Meeting (October 19-20)

The SERS Board decided to bring together a group of stakeholders to collectively work on the issue of health care. Stakeholders include labor groups, retiree groups, employers and members of the board. The group would look at what adjustments can be made to the SERS health care program to extend program solvency. Representatives of OEA, AFSCME Council 8 and OAPSE all spoke in favor of this development and expressed willingness to be involved in the discussions. The Board also stated its desire to survey SERS members, active and retired, about their support for policy changes on the state and/or federal level to address the rising cost of health care and to communicate those views to policy makers.

OPERS Board Meeting (October 17-18)

The OPERS Board held a retreat to begin examining viable solutions to sustaining the health care program. Currently, the program is projected to be solvent through 2024 and the Board has a goal of 15-25 years of solvency. However, the Board recognizes that the system will have to be actively managed over time in order to meet or exceed the current goal. The Board held a broad ranging conversation of options including plan design, eligibility, and wellness initiatives. Staff is going to survey Board members in order to provide direction on a few areas to pursue.

The Board also acted to accept the results of the retirement board election that was certified by the Secretary of State's office on October 2, 2006. Current Board member Ronald Alexander was re- elected as the state employee member of the Board. He defeated Matthew Schulz 4,745 to 3,099. Sharon Downs was also re-elected as a retiree member of the Board; defeating Jerry Krupinski 25,284 to 9,503.

James McGreevy