Originally posted Feb. 24, 2009

February Board News

Continued Deterioration of the Global Markets Triggers Long-Term Contingency Planning Process
The current impact of the downturn in global financial markets on STRS Ohio’s pension and health care funds dominated the agenda at the Retirement Board’s meeting in February 2009. As noted by STRS Ohio staff during the meeting, the downturn is much deeper and faster than most economists and investment professionals were projecting even a few months ago. The impact on individuals’ personal savings, as well as on institutional investors and pension funds across the country, has been exponential. At STRS Ohio, the preliminary market value of investment assets stands at $49.7 billion as of Jan. 31, 2009; the rate of return for the fiscal year to date (July 1, 2008–Jan. 31, 2009) is –27.7%. The value of the investment assets reflects a drop of $20.7 billion from the close of fiscal year 2008 on June 30, when assets totaled about $70.4 billion. Unfortunately, most indicators suggest that the eventual market recovery has not yet begun, and when it does, it will be long and gradual.

As part of its discussions with the board in February, staff reiterated that current retirees’ pensions are safe; there are no short-term problems regarding the cash flow needed to pay current pension benefits when they are due.

However, the next actuarial valuation of pension benefits in October 2009 is likely to show that the reduced level of assets, along with the normally expected rate of growth, may not be sufficient to amortize the unfunded liability over a reasonable period of time.

To determine a pension fund’s solvency, two common measurements are used: funding period and funded ratio. The funding period is the number of years required to pay off the pension fund’s unfunded actuarial accrued liabilities. (In layman’s terms, this would be similar to a home mortgage.) The funded ratio is the market-related (smoothed) value of assets compared to liabilities. In short, it is the percentage of assets STRS Ohio has on hand to pay all benefits accrued by STRS Ohio members to date — even though the liabilities are not payable all at once.

At the end of fiscal year 2008, STRS Ohio’s pension fund had a funding period of 28.3 years and a funded ratio of 80.1%. However, the Retirement Board also undertook a five-year actuarial experience review that was completed in October 2008. This led the board to adopt changes to some actuarial assumptions, including payroll growth and retiree life expectancy. These changes to reflect expected future experience resulted in the final actuarial valuation for the pension fund showing a funding period of 41.2 years and a funded ratio of 79% as of June 30, 2008.

At the end of fiscal year 2008, defined benefit assets were $66.8 billion, and STRS Ohio expected to pay future benefits over 41 years by achieving an 8% annual rate of return. However, with assets currently under $50 billion, assumed investment returns of 8% going forward leave a shortfall.

Health Care Program Funding Also Affected by Market Issues
STRS Ohio’s Health Care Stabilization Fund has been similarly impacted by the market downturn. Health care costs for the STRS Ohio Health Care Program are paid out of this fund. Currently, monies for the fund come from premiums charged to STRS Ohio retirees and their dependents who are enrolled in the program, 1% of payroll from employer contributions and investment earnings on these funds. Each year, the Retirement Board also receives an actuarial valuation report on this fund. This report tells the board the solvency period of the fund, and the percentage of contributions (known as annual required contributions or ARC) needed to fund the health care program on a long-term basis.

During calendar year 2008, the health care fund was impacted by investment losses, as well as losses generated by changes in actuarial assumptions from the five-year experience review noted previously. The results of the most recent valuation, which the board received at the February meeting, showed that the health care fund as of Jan. 1, 2009, stood at $2.69 billion, reflecting a reduction of $1.34 billion from its starting value of slightly more than $4 billion one year earlier. In only one year, the projected life of the STRS Ohio Health Care Program was shortened to nine years from 13 and is now projected to last until 2018. Further, the annual required contribution (ARC) is now 5.01% (assuming an investment return of 8%), slightly exceeding the 5% contribution increase that is being requested in the health care legislation proposed by the Retirement Board and supported by the Health Care Advocates for STRS.

STRS Ohio is still seeking an ongoing, dedicated revenue stream for the Health Care Stabilization Fund. However, for a contribution increase to succeed in meeting the program’s financial needs, the ARC must be lowered. Currently, the funding shortfall is being covered by withdrawing principal from the Health Care Stabilization Fund. Reliance on the principal rapidly depletes the health care fund, leaving only the 1% employer contribution, enrollee premiums and Medicare Part D subsidy to sustain the fund. With the current 1% employer contribution and no program changes, the ARC will increase further in 2010 and every year thereafter.

Therefore, at the February meeting, staff proposed that, in addition to seeking a contribution increase, the board must also begin looking at long-term changes to coverage, premium subsidies and eligibility for the health care program due to its deteriorated financial situation. The initial goal is program changes that achieve a minimum of $83 million in program cuts. This would return the ARC below 5% and preserve the principal balance in the health care fund in calendar year 2010. If additional contributions to the fund are not found, even more significant changes will need to occur in future years. By beginning the discussion now, STRS Ohio can give its members some lead time for retirement planning.

Contingency Planning Process Will Begin in March
In recognition of the difficult economic times and its current and potential impact on STRS Ohio, the board will implement a Long-Term Fiduciary and Financial Contingency Planning Process that it approved during the January 2009 planning retreat. This process provides a framework for the board to evaluate options to restore prudent funding levels for the pension fund over the long term, as well as ensure the continuation of the health care program.

The contingency planning process provides the transparency and structure that will allow the Retirement Board and staff to objectively evaluate the pros and cons of possible changes to plan design or future benefits. The first discussions will be held at the March 2009 board meeting.

Board Approves Staff’s Recommendations for Reducing Operating Expenditures
At the February meeting, STRS Ohio Executive Director Michael J. Nehf presented several recommendations designed primarily to reduce STRS Ohio’s operating expenditures. The changes, which were approved by the board, include:

• Implementation of an associate head-count freeze at the current number of 605 associates, effective immediately;

• Implementation of a salary freeze for all associates effective immediately through June 30, 2010; and

• Implementation of a standard 40-hour workweek across the organization, effective Jan. 1, 2010. With the latter change, there will be no additional compensation provided to associates currently working 37.5 hours per week.

The board also ratified the Friday following Thanksgiving as an STRS Ohio paid holiday in accordance with past practice over the last 30 years. With this change, STRS Ohio’s combined total for holidays/floating holidays/personal days is still comparable to its sister pension systems, the State of Ohio and the Treasurer’s Office. Finally, the funding structure of the current associate Long-Term Disability Plan will be changed to partial self-funding, effective April 1, 2009. Estimated savings to STRS Ohio will be approximately $120,000 over the next three years.

Retirements Approved
The Retirement Board approved 111 active members and 106 inactive members for service retirement benefits.