Molly Janczyk, Dennis Leone and Jim McGreevy: Comments on December STRS Board meeting

From Molly Janczyk, December 18, 2008
Subject: Re: FW: Report to OEA-R on Recent STRS Board Meetings

I hope I NEVER see the Board speak as one voice though I am sure I will as of 9/1/09!!! Speaking as one voice is what got us into misspending and ethics violations!!!! We live in America and Americans KNOW Boards SHOULD BE places of strong debate and open mindedness. This Board, we well know, thinks a wave is the end of the world. Passionate debate was no enemy of the Tom Mooneys of the world. Unfortunately, his organization's reps see no place for it. Tom said he was often the loudest in the room. What is the problem with the STRS Board CLONES who feel they must sit nicely and play well regardless if it is in our best interests or not!!! Healthy debate and competent oversight is what shareholders want and NEED in these times. This will NEVER be learned at STRS! They need to go to some REAL board meetings and see what transpires to get things moving-FAST , EFFICIENTLY AND EFFECTIVELY!

At STRS, it is the Stepford mentality all the way. How many times I have heard: "Well, we didn't make waves!" Is that the fiduciary duty at ORTA, OEA, OEA-R and STRS?

From Dennis Leone, December 18, 2008
Subject: Re: FW: Report to OEA-R on Recent STRS Board Meetings

Speaking as one STRS board member whom the rest have attempted to gag in each of the last 2 meetings (first by trying to prohibit amendments to minutes I desired to make sure our financial condition was fully reported as a record, and secondly by publicly stating that the board speaks as "one voice" and I shouldn't talk to reporters), I appreciate what you written below.

D. Leone

From Molly Janczyk, December 18, 2008
Subject: Re: FW: Report to OEA-R on Recent STRS Board Meetings

STRS Board: We have seen the lack of wisdom is staying in funds to heap the rewards of catching the wave riding up again at some point. We can continue to lose beyond a bottom line stop gap point waiting for this to occur in bad times. Please consider moving funds into safer areas UNTIL the rise is definite and not a day up and then day down scenario. During these times, most prudent investors move to lower gain but secure investments as NO ONE has any idea when or even if high times we have seen will be with us again. Some experts predict a more modest growth when the growth again appears for many years to come and others predict a very long time before growth is a predictable course. The investors who find this good buying time have money to lose. If funds can be found that are down with no other course but to rise in the future, great. But, who has the crystal ball saying which funds will simply end and which will rise again in the foreseeable future. Many stockholders of some of these funds are still waiting for their once $80+ per share to rise again from its current below $2 or $3 dollar a share for the last decade or so.

Prudence is the standard according to the ORC. Taking chances is not a viable path to conserving our money at this time. We want safety and long term assurance as we cannot afford to lose another 30% of our funds. THERE IS NOT AN INVESTOR ANYWHERE THAT CAN GUARANTEE A FUND WILL GROW AS PREDICTED BY SOME IN THIS REPORT BELOW! That is akin to realtors telling buyers to choose adjustable rates because they KNOW rates will go lower next year or will not increase, etc. Those buyers have lost homes and gone into bankruptcy. Different 'experts' are predicting far different scenarios. We can all chose the one we want to base our actions upon.

From James McGreevy, December 18, 2008
Report to OEA-R on Recent STRS Board Meetings

Below is my report on three recent meetings at STRS. The first occurred on Monday, December 8. It was a special meeting on the question of Performance Based Incentives (bonuses) for STRS investment managers. There was also a regular, monthly Board meeting on Thursday, and a special one-day seminar on Health Care on Friday.

Board Examines PBI Program
The Staff Benefits Committee of the STRS Board spent the entire day Monday studying the investment staff’s compensation policies, and found that they still could not reach consensus on what changes to make, if any, in the program.

Here are a few pertinent facts concerning compensation for STRS investment managers:

During the administration of Executive Director Herb Dyer at STRS, bonuses were routinely handed out to all STRS employees, even those who had nothing to do with investments. The bonuses were somewhat arbitrary and not based in any measurable, objective evaluation of job performance. This practice was ended with the reforms that were adopted in 2005. Following a lengthy study, the Board then adopted a new compensation strategy. Bonuses for good investment performance would be included in the calculation of total compensation for investment management staff only; no other employees would be eligible. The goal of placing investment staff in the 25th percentile of private investment firm salaries for similar positions was established in order to remain competitive in attracting and retaining the necessary level of talent to achieve the STRS investment targets. The combined total of base salary plus the maximum bonus possible would hit this 25th percentile target. Investment managers achieve the bonus portion of their compensation by “beating the market” by a fixed percentage in their area of investment. If they don’t reach that benchmark, they receive no bonus. Additionally, even if they hit their personal targets and the overall funds suffer a loss, their PBI payments are reduced by 20%. Thus, the investment department employees are not in competition with each other over a “fixed pie” but are incented to work together for the overall success of the fund. This system mirrors other public pension funds in the country and is considered to be an industry “best practice.” Investment department PBIs can be earned in “losing years” although at a reduced level. The benchmarks they must hit are relative to the overall market. For example, in Fiscal Year 2008 the staff returned value to the fund about $215 million better than the industry established benchmarks. These figures are not arbitrary and are verified by outside auditors. So, even in FY 2008, a down year, the investment staff earned bonuses that were paid in Fiscal Year 2009.

All of this has taken on new meaning in many minds in light of the recent meltdown in the financial markets. Board member Craig Brooks said “…we probably would not even be having these discussions if the funds hadn’t suffered the huge losses we’re seeing because of the recent troubles on Wall Street…” Brooks offered a modified PBI plan that would create different levels of reduction in bonuses dependent on the severity of losses. Board member Dennis Leone advocated for suspending all bonuses if there is any loss, but offered he would be willing to pay even greater bonuses if earnings exceeded the benchmarks by greater margins. Other Board members indicated they did not see a need to react precipitously to change a system that seemed to be meeting the long-term needs of the system. Some members reminded others in the room that STRS has a very long-term horizon for investments, stretching over six or seven decades, and that changes in policy should reflect that long view.

I favor the Brooks approach. A single fixed cut, regardless of the size of investment losses, seems to me to make about as much sense as a two-step salary schedule. Craig Brooks idea, although not completely fleshed out, recognizes a need to be proportional in response to bad times. I don’t favor the complete elimination of PBIs. I believe it matters what kind of talent STRS can attract and retain, and although there is nothing “magic” about the 25th percentile compensation goal, I would tend to agree with the Board’s expert consultant, Maclagan, that this figure puts STRS in a good position.

At the end of the meeting, it was determined that more data and more time was needed to make a prudent decision, and it was decided the issue would be continued to another special meeting after the first of the year. Stay tuned.

STRS Board Gets Another Bad Investment Report
In recent months, the Investment Department Report has become the most anticipated news to be offered at STRS Board meetings, and not for positive reasons. The bad news afflicting the entire world economy continues to impact STRS investments. Chief Investment Officer Steve Mitchell reported that November saw an additional loss of 5.1% in total fund assets for a year-to-date total of a negative 25.4%. Significantly, STRS investments are trailing industry benchmarks rather significantly, possibly making the whole debate over PBI payments somewhat moot for FY 2009. At close of business November 30, STRS total fund assets stood at $51.48 billion, nearly $29 billion lower than the peak value reached in October of 2007, the system’s all-time high.

It should be noted that the reason for this has a great deal to do with the asset allocation strategy at STRS. Because STRS has a total fund return target of 8% - 10%, there is a heavy emphasis on domestic stocks. The equity markets are down more than other financial segments, so any fund heavy with equities (stocks) will do worse than a fund that is more invested in fixed income or other more stable, but generally less productive, instruments. Many private pension funds whose view is not as long-term as STRS, or who have lower necessary rates of return than ours, have shifted to these lower performing investments. Russell Investments, consultant to STRS, recommended not doing this to be ready to take advantage of the opportunities when the market turns, something they believe will happen as soon as late in the second quarter of 2009. The Board is currently in the midst of an asset allocation study that will conclude in late winter. It is the Board, not the investment staff that must make this decision. Most experts maintain that nearly 90% of a fund’s returns are dependent on this asset allocation decision, vastly more than even the best active management, market-timing, or stock-picking can produce.

Rep. Wolpert’s Bill Attacks Defined Benefit Plans
The lame ducks in Columbus are up to some mischief. Rep. Larry Wolpert (R-Hilliard) introduced HB 645 that would require all new pubic employees be placed in a defined contribution (DC) pension plan instead of a defined benefit (DB) plan such as the one selected by over 95% of STRS retirees. Although there would be no immediate effect on anyone already retired, the slow erosion of numbers from STRS would, over time, undermine the stability of the pension fund. The Financial Institutions, Real Estate and Securities Committee (commonly called the FIRES Committee) has been assigned the bill, but they have announced they will hold no further hearings on this bill and it will die at the end of the session in December. Rep. Wolpert is leaving the legislature so there is little chance this bill in this form will be introduced again, but it is a wake-up call that there is a good deal of “pension envy” abroad in the land and we must be vigilant in our opposition to any similar bills in the future.

New Board Member Seated
Gov. Ted Strickland has named Regina F. Burch as his appointee to the State Teachers Retirement Board.
Burch is an associate professor at Capital University Law School in Columbus. She holds a bachelor's degree from Harvard College, a master's degree from the Sloan School of Management at Massachusetts Institute of Technology, and a juris doctor degree from the Hastings College of Law at the University of California. Her term on the board will run through Sept. 28, 2012.

Additional appointments will soon be made by the President of the Ohio Senate and the Speaker of the Ohio House (a joint appointment) and also by the Treasurer of the State of Ohio. When this occurs it will be the first time in well over a year that all of the seats on the Board have been filled.

Reemployed Health Care Rule About To Be Implemented
STRS Health Care Services reported that 998 insured retirees have yet to reply to the Verification of Employment and Employer Health Care Access forms that were mailed out in July. If you are currently enrolled in an STRS health insurance program and do not respond by December 31, your insurance will be canceled on New Years Day, January 1, 2009. STRS has continued efforts to contact these few remaining retirees. If you have questions about your status, call the STRS toll free helpline at 1-888-227-7877.
Health Care Seminar Held on Friday
A well-attended health care education session took place at STRS on Friday and it underscored the concern over health care funding as STRS looks to the future. It was reported that the efforts to secure a dedicated revenue stream for retiree health care will continue into the next session of the Legislature. The bill currently labeled HB 315 will be reintroduced in some form with Rep. Scott Oelslager (R-Canton) continuing as sponsor. Additional co-sponsors from both parties are being lined up. Whether or not there will be modifications to the bill to answer some of the criticisms leveled by Ohio School Boards Association and Ohio Association of School Business Officials is yet to be revealed. But as any experienced negotiator knows, you don’t counter your own offer. You get the item on the bargaining table and work for the best possible agreement.

Another item receiving considerable attention at the meeting was the idea of offering a Medicare Advantage program. About a year ago the Board rejected a pilot project for the Canton area that would have field-tested an Advantage program sponsored by Ault-Care, a prominent health care provider in that part of the state. Opposition at that time centered on widespread feeling that what amounts to a “privatized” Medicare approach was just a way to pump profits into insurance companies without any measurable benefit to those insured under such plans. On Friday, the Board heard reports from industry experts that indicated that was not the case, and held out the possibility of better coverage for less cost to the insured. No decisions were made, but you can bet your bottom health care dollar that we have not heard the last of this idea.

The status of STRS’ Health Care Stabilization Fund (HCSF) was also discussed at length. The balance in the fund has dropped to approximately $2.8 billion, largely due to a drop in fund assets due to the stock market plunge of recent months. That drop has also required the system to dip into fund assets to make up for the shortfall in income and premiums. Although it is a separate fund for accounting purposes, the HCSF funds are invested along with the pension fund and rise and fall at the same rate. It was noted that the fund had also fallen to $2.6 billion back in 2003, but rebounded with the sterling investment performance of the next four years. No “life expectancy” of the HCSF was offered, but it’s clear that without a market rebound plus additional funding as might be provided by HB 315 or similar legislation, the HCSF could run dry sooner than the 2021 date mentioned in recent years. Without additional cash and/or investment returns, the only way to extend the life of the fund would be by adjusting eligibility requirements, the subsidy, plan designs or some combination of the three.

The staff presented a series of examples to illustrate how changes in various aspects of the plan would impact the life of the HCSF. It was emphasized by Member Benefits head Sandy Knoesel that none of these “what-if scenarios” should be viewed as a recommendation but only were used to give Board members an idea of how much impact various moves could have.

By far, the most positive possible impact would result from passage of HB 315 or similar legislation. The fund would have more than thirty years of life, virtually fully funded. Such legislation will be difficult to obtain given the hard financial times and opposition from OSBA and OASBO, but compromises in the legislative process could produce positive developments as well. A half a loaf is better than no loaf at all. And no one knows if the incoming Obama Administration may eventually be able to move the health care coverage “ball” further downfield to our benefit. The next few years offer challenges but also great opportunities.

James McGreevy