April Board News from STRS: Your HC premiums could increase 10% - 15% next year

From STRS, April 20, 2007

This week, the State Teachers Retirement Board held its monthly meeting. Following the regularly scheduled meetings, a report titled "Board News" is posted on the STRS Ohio Web site, as well as mailed to a number of members and education organization representatives who have requested it. As a member of STRS Ohio with an e-mail address on file, you will also receive this report each month. The April report follows.

APRIL BOARD NEWS

PROPOSED BUDGETS FOR 2007-2008 PRESENTED TO RETIREMENT BOARD At its April 2007 meeting, the State Teachers Retirement Board had its first look at the proposed system budgets for the 2007-2008 fiscal year (July 1, 2007-June 30, 2008). Following discussion, staff made additional adjustments resulting in a proposed operating budget total of $97,265,200. This reflects a $7,707,200, or 8.6%, increase over the current year's budget. Three significant changes in the Investments division of STRS Ohio contribute about 7.1% of the total increase, while expenditures in all other areas of STRS Ohio contribute about 1.5% of the overall increase.

STRS Ohio is unique among the public pension plan community in the percentage of its investment assets that it manages in-house. Currently, STRS Ohio associates internally manage about 80% of the system's investment assets and use outside money managers to invest the remaining 20% of the system's holdings. Third-party studies have shown that this practice has consistently proven to be extremely cost-effective for STRS Ohio. Just as an example, internal management saved STRS Ohio more than $93 million in fees in calendar year 2005. For calendar year 2006, that number could reach $100 million.

To ensure that STRS Ohio can attract and retain investment professionals, it provides a cash compensation package to these investment associates that includes a base salary plus a Performance-Based Incentive (PBI) component. About 4.3% of the increase in next year's operating budget reflects changes the Retirement Board made to the PBI program in March 2006 that will be paid in August 2007. This change adds $3.85 million to this operating budget line item for the coming fiscal year.

The maximum incentive payments are only awarded when relative outperformance exceeds what the market would have returned. With an investment portfolio of $70 billion, staff must earn $350 million over the total fund benchmark return. This additional $350 million earned for the system results in a maximum total payout of about $8.5 million in PBIs. The most recent figures presented to the Ohio Retirement Study Council indicated STRS Ohio was the top performing Ohio pension fund over the past three years on both an absolute and relative return basis. Through March 31, 2007, the STRS Ohio fund return is about 14.7% compared to the total fund benchmark return of 13.9% this fiscal year.

During this month's meeting, the Retirement Board also voted to make an adjustment to the base salaries of eligible Investments associates to bring their total compensation (base salary plus PBI) to the 25th percentile of private market levels. Currently, total cash compensation is at the 20th percentile of private market levels. Both the prior change in the PBI program and this change in base salary structure are in alignment with recommendations contained in the comprehensive compensation and benefits review of STRS Ohio completed in December 2005 by the firm AON/McLagan. This salary adjustment adds about $800,000 to next year's proposed operating budget.

The third factor is the completion of placing expenditures for investment research services in the operating budget. Previously, a portion of commission dollars generated on securities transactions was used to pay for some investment research services. For the past several years, STRS Ohio has been transitioning these services to the system's operating budget. With the completion of that conversion during this fiscal year, the budget for next year reflects additional expenditures of $455,000. This follows "best practices" in the investment industry, is more economical for STRS Ohio and adds transparency to the cost of investment services.

Also included in the operating budget is a merit and promotional increase for eligible associates of 4%. These are awarded based on each individual associate's performance. STRS Ohio associates do not receive step increases nor cost-of-living increases. Significant monetary decreases are reflected in such areas as: non-management associates' service awards; printing; telephone; supplies and materials; and Retirement Board expenses. Expenditures for utilities remained flat and the on-site child care center will be cost-neutral next fiscal year. The operating budget also reflects the addition of nine new associates (six in Investments, two in Member Benefits and one in Internal Audit), which will bring the total authorized staff size to 637 full- and part-time associates from 628.

The proposed capital budget for next year totals $2,100,900. Additionally, the system will be spending $6,387,700 on the Vitech project that is currently under way to replace STRS Ohio's obsolete pension management computer system.

In developing the budgets, staff was guided by these board directives:

- Make system operations in all areas as "lean" as possible, without jeopardizing delivery of pension benefits and services and health care coverage to members; adversely impacting investment operations; or failing to meet fiduciary responsibilities or legal requirements.

- Provide an appropriate compensation and benefits package and work environment to attract, retain and engage highly motivated associates.

- Comply with all Board Policies.

- Address Retirement Board priorities.

- Demonstrate and communicate to members that STRS Ohio is managing operating expenses prudently.

The Retirement Board will be asked to approve the budgets at its June meeting.
RETIREMENT BOARD BEGINS DISCUSSING HEALTH CARE PROGRAM FOR 2008 At the April meeting, STRS Ohio staff began discussing the premium outlook for calendar year 2008 for the STRS Ohio Health Care Program. Early estimates show that health care premiums could increase between 10% and 15%, based on three months of claims data recorded for January-March 2007, because of increased utilization and cost increases for health care services.

During its presentation to the Retirement Board, staff noted that there is limited ability to mitigate rising premiums through incremental cost-saving measures or health care plan design changes, such as changing an annual deductible amount. Only a substantial change in the program structure can impact monthly premium amounts in any significant way. Further, in keeping with the program's Strategic Plan, it is important to maintain a premium structure and plan design that keeps the annual required contribution at or below 5%. This annual required contribution amount, which puts the Health Care Stabilization Fund on a 30-year funding period, is the basis of the Retirement Board's legislative initiative that it developed in conjunction with the Health Care Advocates for STRS. That proposal calls for increasing member and employer contributions by a total of 5%, phased in over a five-year period, to create a dedicated revenue stream for the health care program. In 2008, STRS Ohio will continue to participate in the Medicare Part D Program, but there may be some operational changes required for the prescription drug program covering Aetna, Medical Mutual and Paramount plan enrollees depending on the vendor selected in the current project being undertaken with the other Ohio systems to jointly select a prescription drug manager. Finally, as staff looks at options for 2008, it will preserve the current member premium contribution strategy. (The premium contribution strategy, which was adopted by the board in 2004, provides a 2.5% premium subsidy to benefit recipients for each year of service between 15 and 30 years. Benefit recipients with less than 15 years of service, spouses and dependents receive no premium subsidy.)

Any proposed changes to the STRS Ohio Health Care Program will be presented to the board for its consideration in May and June. At that time, additional claims data will be available. The board will then be asked to approve premiums for 2008 at its August meeting.
RETIREMENT, INVESTMENT TRANSACTIONS APPROVED The Retirement Board approved the following retirements and investment transactions:

- 184 active members were approved for service retirement; 139 inactive retirements were approved.

- In March, fixed-income purchases totaled $432 million, domestic equity purchases totaled $2.3 billion, and real estate purchases totaled $85.9 million.

ADDITIONAL ITEMS REPORTED AT THE MEETING BY EXECUTIVE DIRECTOR DAMON ASBURY

HOUSE BILLS AFFECTING STRS OHIO ARE INTRODUCED House Bill 151 that requires divestiture by the retirement systems of any foreign companies doing business in Iran received its first hearing on April 19 in the House Financial Institutions, Real Estate and Securities Committee. The Treasurer, the State Board of Administration, Bureau of Workers' Compensation and the five retirement systems are covered by the bill. The bill requires the Treasurer to certify independent research providers. One of these providers would then be hired by STRS Ohio to review the portfolio for companies doing business in Iran. The research firm would determine which publicly traded foreign companies are doing business with or in Iran. In addition, any non-publicly traded foreign firms and any outside asset managers, who run funds, would have to certify annually that none of their operations are in Iran. Any holding in foreign companies doing business with Iran (except for humanitarian and journalism organizations) would have to be divested within one year. While several items need to be clarified in the legislation, preliminary data indicates it seriously affects STRS Ohio's International investment program. Approximately $4.6 billion of the $18.7 billion in International holdings would potentially be illegal. Prohibited foreign companies likely would include Siemens AG NPV with 2,242 employees in Ohio, Daimler Chrysler AG EUR with 9,350 Ohio employees, BP with 750 Ohio employees (not including stations), and Honda with 17,350 Ohio employees. The bill does not cover subsidiaries of U.S. companies that may be doing business in Iran. Further, only contributions by public employees to the public funds are being required to divest. Contributions going into alternative retirement plans offered by private vendors are not required to divest.

On April 17, House Bill 152 was introduced by Rep. Chris Widener, who is chair of the Financial Institutions, Real Estate and Securities Committee. This bill would require school boards to offer private vendor alternative retirement plans (ARPs) to teachers and school employees. To put this in context, approximately 25% of STRS Ohio active members currently have less than five years of credit and represent about 14% of the total payroll to the system. This bill is identical to House Bill 700, which was introduced during the lame-duck session of the General Assembly in December 2006. There was no action on that bill. Staff anticipates this bill will be put on a fast track.