Rudy Fichtenbaum
When I ran for my first term on the STRS Board, I had a number of objectives: I advocated index investing, increasing the employer contribution, restoring the COLA, reducing contribution for active Members to its previous level, and greater transparency. A major challenge faced by STRS was its cash flow problem. That is, benefit payments and expenses were (and still are) significantly greater than contributions. To make up this difference STRS relies more heavily than most pensions on investment returns to make monthly pension payments. When returns are low or negative, STRS must sell assets just to make pension payments. This puts the pension in a precarious position.
One of the ways in which transparency was lacking was promoting the myth that all STRS needed to do was to become 100% funded (i.e., to eliminate its unfunded liability), and then benefits could be restored. STRS management led the STRS Board to believe that. Today, we are led to believe that if we meet our 7% assumed rate of return, then STRS would be 100% funded by 2034; this is the projection of STRS’s actuary. But paying for an ongoing permanent COLA starting even as late as 2034 will be impossible unless STRS can also reduce its negative cash flow. This is something that Members were not hearing until I was elected to serve on the Board. I told that hard truth, not to mention others, regardless of whose feathers were ruffled – and I intend to continue doing just that.
When I was elected, no other Board members were advocating an increase in the employer contribution. Everything I heard from senior staff, other Board members, and most stakeholder groups like Health and Pension Advocates was that there was no support for increasing the employer contribution. The only two organizations that advocated for an increase in the employer contribution were OFT and AAUP.
Another way in which transparency was lacking was in understanding how much actively managed investing was costing our Members. For the longest time, STRS staff refused to release unredacted copies of CEM’s reports on investment expenses. (CEM is a consultant hired by STRS.) Even after the reports were finally released, we still did not have a full understanding of our expenses, because CEM’s reports did not include all our expenses for private investments. Last year, after two election cycles in which reformers were elected, for the first time the Board finally received an expense verification report from a third-party showing all expenses for real estate and alternative investments (the two main categories of private investments).
Yet another way in which transparency was lacking had to do with benchmarking and Performance Based Incentives (PBI), known to most Members as annual bonuses for the investment staff. Way back in 2006, a fiduciary audit recommended that STRS stop using its own performance as a benchmark for alternative investments (AI). I find it ironic that the senior staff and the Board simply ignored this recommendation given the fact that now anytime the Board gets a recommendation from fiduciary counsel or our governance consultant, we are told that if we ignore the recommendation, we will be sued. But from 2006 until 2021, it was okay to ignore advice from the fiduciary audit, and no one on ORSC (Ohio Retirement Study Council) seemed concerned. In fact, ORSC is required to conduct a fiduciary audit for all state pensions every 10 years according to the Ohio Revised Code (ORC), but they simply chose to ignore the law and went without scheduling a fiduciary audit for STRS from 2006 until 2021.
The fact is that STRS had a real benchmark for AI, namely the Russell 3000 +1% for private equity (PE) and the Russell 3000-1% for Opportunistic/Diversified (OD). (PE and OD are the two components of AI.) However, this benchmark was never used in calculating the total fund benchmark, something that was only revealed in two small footnotes contained in a table on investment performance.
STRS staff and several Board members justified giving PBI, even when the pension lost money, arguing that without our actively managed investments, we would have lost even more money. But we have no way of evaluating this claim without benchmarks that incorporate opportunity cost (the cost of the next best alternative, e.g., comparing active management with index funds). But clearly using your own performance as a benchmark – as STRS did for fifteen years for AI, recommendation to the contrary notwithstanding – along with other custom benchmarks does not measure opportunity cost. Moreover, STRS’s PBI policy is so arcane that I doubt that most Board members could explain it. Again, the argument given to justify PBI is that staff’s active investment is outperforming the market. But at the asset class level where most of the PBI dollars are doled out, the PBI policy specifies using gross returns, i.e., the returns before expenses. In addition, between 2013 and 2020 when STRS was using the Russell 3000 +1% for PE and the Russell 3000-1% for OD, it never beat its benchmark over any 5-year period. So how were PBI payments for AI paid? Again, buried deep in the PBI policy, it says if you don’t beat a benchmark (which does measure opportunity cost) you get another opportunity to get a PBI, comparing your performance to the STRS absolute return objective for AI, which happened to be 7.09% for several years. In 2021 the Annual Comprehensive Financial Report references the absolute return objective for AI and claims that STRS beat that objective – but the absolute return objective is nowhere in the report. Needless to say, transparency is lacking yet again.
When I first was elected to the Board, I was told by senior staff that surveys show most of our Members were very happy. My response was that I would rely more on the election results for Board seats than survey. As more reformers started running for and winning Board seats, what did the STRS senior staff do? They doubled down on the Potemkin Village myth by putting out the Reflections Series. And as time went on, a survey that STRS commissioned by Saperstein finally showed exactly what the elections did: Members were not happy. Again, we have another example of where transparency was lacking.
Ever since I have been on the Board, I have been pointing to the negative normal cost for active Members. On numerous occasions, I explained that the negative normal cost means that active Members are paying more on average each year than the value of the benefits they earn for that year. Since STRS is the only major public pension in the U.S. with a negative normal cost, it is certainly fair to say that active teachers have the worst deal in the country. But how did STRS respond to this claim? In the middle of an election, STRS’s communications department issued a statement saying that Members receive far more money from STRS than they contribute, so they are getting a good deal. It goes without saying that this statement was a fundamentally misleading comparison – a red herring.
Recently, ORSC seems to have discovered STRS’s negative normal cost and has made a big deal about it, claiming that the unfunded liability is creating intergenerational equity, i.e., active Members are paying 14% and getting a pension worth approximately 10.4%. The reason for this is that 3.6% of active Member’s contributions are going to pay off the unfunded liability. The term intergenerational inequity is in this case being used to try to drive a wedge between active and retired Members. It falsely implies that retirees are freeloading off active Members.
But the real problem is Ohio’s pensions are nearly unique in having a fixed employer contribution. Pensions are not designed to have a fixed employer contribution. In virtually all other states, employer contributions are variable. The reason for the variable contributions is so that when investment performance is poor the employer contribution goes up, and when investment performance is outstanding, it goes down. This mitigates the impact of negative cash flows and is one of the reasons why other teacher pensions with similar or even worse asset-to-liability ratios are able to pay COLA’s to retirees.
If ORSC were doing its job, it would have recommended years ago that the legislature enact variable contribution rates. At a minimum, they should have supported some increase in the employer contribution as part of what was euphemistically referred to as “pension reform”. Is it not genuine intergenerational inequity for an entire generation of retired teachers not to get the COLA they were promised, especially during a period of high inflation?
As pressure mounted by the election of more reformers, the Board finally started talking about trying to reduce years of service and having a one-time (as opposed to an ongoing) COLA. The senior staff referred to these changes as “sustainable benefit enhancements.” Hah! Here’s yet another example of a lack of transparency. What Members were demanding was the restoration of cuts. “Enhancement” implies a new benefit, but the truth is that a tiny sliver of the cuts were undone.
Making change at STRS requires the support of a majority of Board members. Building a majority committed to change is hard when there are 7 elected members and 4 appointed members. Just when it appeared that people who were committed to reform were going to have a majority, the Governor illegally removed appointed Board member Wade Steen, who was an outspoken advocate for reform. So, we had to wait for another election cycle. Then, just after Wade was reinstated to the Board after winning a lawsuit, the Attorney General stepped in and filed a lawsuit against me and Wade for violating our fiduciary duty. I view this lawsuit as an attempt to instill fear and to intimidate Board members who support reform.
So let me address the elephant in the room: the lawsuit filed by the Attorney General against me. The lawsuit is based on an anonymous complaint delivered to the Governor’s office by an STRS staff member. The Governor turned the complaint over to the Attorney General who promised to do a fair, thorough and impartial investigation – but less than a week later filed a lawsuit against me for violating my fiduciary duties.
When I was running for my Board seat, I advocated for an increase in the employer contribution because I knew that STRS could not restore benefits based only on improved investment performance. But as I stated earlier, there seemed to be very little if any support at the time for an increase in employer contributions. My first choice was always and still is an increase in the employer contribution. I know that some have argued that taxpayers should not be required to pay more to support teacher’s retirement. But I would argue that it all depends on which taxpayers would have to pay. For years the wealthiest Ohioans have been having their taxes cut. If we are going to have a system of public education, then we must have a fair retirement system for teachers, above all one that keeps it promises. That should entail the wealthiest Ohioans paying their fair share. But I am also a political realist and recognized there was not then enough support for an increase in the employer contribution. So, I thought it was my fiduciary duty to look for other ways the pension could make more money and take less risk. Indeed, Steen and I both asked (fruitlessly) the investment staff and consultants repeatedly for ways STRS could earn more money with less risk.
When I was told about a proposal that by a firm named QED, I was very skeptical. However, seeing no other alternative, I thought I should investigate it especially because it seemed to have support from other Board members and a former Board member.
The proposal we brought to the Board in November 2021 has been mischaracterized as turning over $65 billion to QED; in fact, it would have started with a much smaller stake which would have been subsequently ramped up only with proven success.
QED’s proposal was aimed at increasing STRS’s cash flow by allowing STRS to earn fees. Let me elaborate. In any market there are two sides: a buyer’s side and a seller’s side. Investors are the buyer’s side; they buy assets and hope to earn a return in the form of capital gains, interest, dividends, and (in the case of real estate) rent. The seller’s side (Wall Street) makes money by earning fees. The QED proposal was for STRS to continue earning investment income but supplement it by earning fees by also becoming a market maker, i.e., being on the seller’s side. STRS would have remained on the investor side but would have supplemented investment income with fee-based income. This strategy has been used successfully by the Healthcare of Ontario Pension Plan (HOOPP), arguably the best performing pension in North America. I listened to the due diligence meeting between Cliffwater (then STRS’s consultant for AI) and QED. I spoke with HOOPP’s Robie Goobie, who had agreed to work with QED. I listened in on a conversation between QED and Goldman Sachs to verify the fees for the various trades. After all of this and seeing no other viable alternative for restoring a COLA and reducing the number of years active teachers would have to work, I decided to participate in making a presentation to the Board about this idea. I along with Wade Steen and Bob Stein (former board member) tried to make a presentation to the Board about this idea. Those of you who heard the attempt at making a presentation know that the presentation was sabotaged by the staff. At our attempted presentation we were prepared to make a motion to ask, “the Ohio attorney general…appoint a special counsel to negotiate a business partnership named Ohio AI between the State Teacher’s Retirement System and QED.” Our view was that there would be no way to negotiate a contract to form a partnership without understanding how the strategies proposed by QED would work, so there would have been an additional due diligence performed in that process. At that point, if the Board was not comfortable going forward, it could simply not approve the contract.
I have said before and I will say it again: I never accepted nor was even offered any compensation or gifts of any kind from QED, JD Tremmel, Seth Metcalf or any other party. I believed STRS should have honestly explored what seemed like a credible idea for the pension to make more money and take less risk – a necessary pair of objectives since at the time increasing employer contributions was not viable. My fundamental objective was what I have stated already: STRS should keep its promises to teachers, restoring the COLA and reducing to previous levels the number of years needed for an unreduced pension.
I am running for reelection to my seat on the Board because I believe that over the last three and half years, I have played a positive and constructive role in bringing change to STRS. If I am reelected, I pledge to continue advocating on behalf of all Members, both active and retired, to restore benefits and to ensure that everyone who has taught, is teaching, or will be teaching in the future in Ohio has a dignified retirement.
