Rudy Fichtenbaum: If we want to restore benefits, we need to start looking where we can find billions of dollars; e.g., increasing employer contributions and focus less on saving a few million dollars that we can find under a streetlight!

From Rudy Fichtenbaum

June 7. 2024

Understanding the Significance of C + I = B + E

By

Rudy Fichtenbaum

A while back, someone posted a slide taken from the presentation Aon made to the Board at the November meeting, showing a basic equation that displays the flows of money that come in to and are paid out of a pension each year. That equation was

C+ I = B + E.

C stands for contributions, both employee and employer contributions. I is commonly called interest, but it really stands for all investment income. B is benefits. E stands for expenses. Now in reality the equality does not have to hold. If C + I < B + E, the pension takes in less than it pays out; similarly, if C + I > B + E, the fund takes in more than it pays out. Since STRS has a significant unfunded liability, it is important that it take in more money than it pays out over time to reduce the unfunded liability.

Expenses at STRS receive a lot of attention in the Forum. As a Trustee, I agree that STRS should do everything it can to reduce unnecessary expenses. However, reducing expenses alone will not restore benefits.

To see why, let’s look at the relative magnitude of C, I, B and E. I am going to use numbers for the defined benefit plan (DB) only; these numbers apply to fiscal year 2023, which ended last June 30.

(C) Contributions for the DB plan in 2023 were approximately $3.6 billion: $1.7 billion in member contributions, $1.8 billion in employer contributions, plus $0.1 billion coming from transfers from the defined contribution (DC) program and other retirement systems.

(I) Investment Income was $7.0 billion. This is gross investment income; see (E) below for expenses associated with this investment income.

(B) Benefit payments, including refunds to members who withdrew their money, were $7.5 billion.

(E) Expenses. Investment expenses were $283 million ($41 million in internal investment expenses plus $242 million in external investment expenses), and administrative expenses were approximately $73.5 million. So, altogether E was $356.5 million, which for simplicity I will round to $400 million, i.e., $0.4 billion.

Here is what our equation C + I = B + E looks like with the four numbers above plugged in. All four numbers are in billions of dollars.

$3.6 + $7.0 = $7.5 +$ 0.4

which by arithmetic reduces to

$10.6 = $7.9

The truth of course is that $10.6 is not equal to but much greater than $7.9. That is, in 2023, the incoming money side of our equation – C+I – was much bigger than the outgoing money side of our equation – B+E. What happened to all that money? It reduced the pension’s unfunded liability. In 2022 the inequality was reversed; that is, C+I was much less than B+E; in fact, in 2022 the DB plan spent $8.5 billion more than it took in contributions and investment income.

Here is a key point to understand. In a typical year, the DB plan will pay out approximately $7.9 billion but will take in only $3.6 billion in contributions; so, just to break even, it needs to earn $4.3 billion in investment income. In round numbers the pension needs to earn a minimum of 5.1% on investments just to break even, since it had approximately $83.7 billion in assets in the DB plan.

Expenses are approximately $400 million ($0.4 billion). But even if expenses were zero, the pension would still need to earn $3.9 billion every year just to break even, i.e., keep the unfunded liability from increasing.

Every year that STRS does not break even or better, it must sell assets to meet its obligations, and that lowers the level of assets available to pay benefits and earn investment income. When the pension had assets of $90 billion and it would have needed to earn $3.9 billion even if expenses had been zero, which translates to a 4.3% return on investments. With $83.7 billion in assets, it would need to earn 4.7% (again assuming zero expenses). Every time the level of assets goes down, it increases the rate of return needed just to break even.

Going back to our example from 2023 – in which the plan had $83.7 billion in assets, took in $3.6 billion in contributions, paid out $7.5 billion in benefits, and had $0.4 billion in expenses – it needed 5.1% in investment earnings to break even. But suppose a miracle occurred, and STRS could somehow have cut expenses in half; that would have reduced expenses from $0.4 billion to $0.2 billion, cutting the total outflows (B+E) to from $7.9 billion to $7.7 billion. With current expenses, we would still need to have earned 4.9% to break even!

Should we reduce unnecessary expenses? Yes! Where are the biggest expenses? About 79% of STRS’s expenses are investment expenses. But even if we were to reduce unnecessary expenses to zero, would we have enough money to restore 30 years and pay a COLA? The answer is clearly no!

Therefore, the focus of members needs to be on 1) increasing employer contributions, which should be funded by a separate appropriation from the state and 2) increasing investment income without taking additional risk. There is an old joke about a guy who is looking for his lost keys under streetlight. Another person walks up to him and asks, “What are you doing?” The guy replies, “I am looking for my keys.” So then the person asks, “you lost then right about here, eh?” The guy replies, “No, I lost them across the street.” And the person asks, “So why are you looking for your keys over here?” The guy replies, “Because this is where the light is.”

If we want to restore benefits, we need to start looking where we can find billions of dollars; e.g., increasing employer contributions and focus less on saving a few million dollars that we can find under a streetlight!

Dr. Rudy Fichtenbaum, current chair of the STRS  Ohio Board, is Professor Emeritus of Economics at Wright State University.

From our fellow MOFer Jim Stoll to the Columbus Dispatch....

From: Jim Stoll

To:Letters@Dispatch.com
Mon, Jun 3, 2024

Dear Dispatch,

I hope you will publish my letter as a rebuttal opinion to that of Professor Brent Sohngen's letter regarding STRS on May 31st. Thank you. I can be reached on my cell at [xxx-xxx-xxxx] if you wish to discuss or need further clarification.

Jim Stoll - Director of Business, Deer Park Community Schools.

Opinion Letter Regarding STRS:

You seem to have strong agreeable opinions with the guest columnist Brent Sohngen’s opinion letter (May 31, 2024) regarding the STRS Ohio Pension System, without either of you really knowing everything that has been going on, how the system is funded, or how many years a teacher has to work to qualify for an unreduced pension. Please allow me to educate you.

Except for the Police & Fire Pension and the Highway Patrol Plans, which allow members to retire at younger ages, STRS Teachers must work the longest careers of all other Ohio Public Pension Plans. Until recently teachers had to work until at least age 60. Thankfully, that and the 35-year work requirement have been changed and now our teachers can retire after 34-years at any age.

Realistically, Ohio teachers would normally graduate with their Bachelor degree at age 22-23. Since they are required to obtain a Master degree, many teachers are age 25 before they begin teaching, making their likely retirement age 58-59. Also, about 70-80% of all teachers are women and they may have had to halt their careers for a few years or more as they raised their own children. Then, when they find out that purchasing pregnancy leave time is so expensive that it is unaffordable, they are looking at age 62-65 for retirement.

About those overly generous payouts you mentioned. Really? Teachers pay 14% of their earnings into the retirement system, more than twice as much as you pay into Social Security. Ohio teachers do not pay into or receive Social Security on their earnings. If they also have less than 20 years of work under Social Security, due to second jobs to survive and properly raise a family, they will likely lose 60% of a normal benefit due to WEP provisions under Social Security. It's even worse for widows and widowers of/or teachers who are married to Social Security recipients, since they lose 100% of their spouses’ Social Security due to GPO provisions. The STRS Employer contributions have also not been increased in 40 years. Teachers pay that 14% on all 100% of their earnings, unlike Social Security which only charges 6.2% on the first $168,600 of earnings and nothing thereafter. Of course, that amount is well over twice as much as the average teacher earns in Ohio.

And about those strong cost-of-living adjustments you think our retirees are receiving: Ohio Revised Code 3307.67 was changed in 2013 to provide no COLA for that year, followed by 2% COLAs from 2014-2016. That was a 33% reduction over the previously guaranteed, lifetime annual 3% COLA. Since then, however, STRS has defaulted on that contractual guarantee. No COLA was provided in 2017, 2018, 2019, 2020, 2021; a one-time-only COLA was provided in 2022 and 2023; and now we are back to zero COLA in 2024 and beyond. Additionally, any teacher who retired between 08/01/2013 and 06/01/2014 did not receive their first COLA for nine years; 2014 retirees, eight years, 2015 retirees seven years, 2016 retirees six years, and — for all retirees after that — there is a five year wait. However, since STRS has already declared that there will be no COLA again beginning 07/01/2024, this means that the 2019 retirees will also not receive their first COLA for at least six years.

It's even worse for pre-2012 retirees who were guaranteed in writing to receive a lifetime annual 3% Simple COLA upon retirement. Unlike the COLA for Social Security recipients, who receive a compounded COLA every year, STRS has not even been able to pay the annual guaranteed Simple COLA to this group of retirees, who now find themselves 26% behind what they were promised.

And about the 13th check to which you referred: These were eliminated in 2001; they were small checks that averaged about $14 per year of service and retirement; and they were never the size of regular pension checks anyway. Over 90% of our current retirees never received a penny from one of those checks. I do agree with you that, even though they were small checks, they should never have been approved by previous STRS Boards because we could certainly use the compounded accrual value of that money today.

Lastly, STRS Management still refers to our pension system as a "Top Quartile" plan. It may very well be for them, given their extreme salaries and bonuses, but it is not for the teachers of Ohio and its retirees. There are multiple publications, including the 2020-21 Wisconsin Legislative Council Study, which examined 87 major public pension plans and ranked STRS Ohio as one of the worst in the nation! On page 22 of this study, it shows STRS Ohio as the only pension plan in the Nation that had a negative "Normal Cost" and by a whopping (- 3.14%). What that means is that of the 14% in pension contributions made by teachers, their actuarial pension benefit is worth only 10.86%.

Then we have the 2023 Audit of STRS by Keith Faber, Ohio State Auditor, which states on page 28 of his report, that STRS Internal investors underperformed the SP 500 Index in 13 of 22 years from 2000-2021. This underperformance cost STRS as much as 90 Billion dollars by doing their own active investing and forcing changes to how long active teachers had to work, as well as eliminating cost of living for retirees. Yet, each and every year the STRS Board and management rewarded the investment staff with lavish bonuses. In fact, in 2022 when STRS had a 5.3 Billion dollar fiscal year loss, they rewarded their investors almost 10 million in bonuses! That led one Southern Ohio State Senator to say, "It sure seems like STRS management and board are using the State Teachers Retirement System as their own slush fund." Therein, lies the real Mess at STRS!

Jim Stoll
Director of Business
Deer Park Community Schools