Retirement Board Adopts New Actuarial Assumptions — Including Lower Investment Return; Will Consider Benefit Plan Design Changes in April
At its March meeting, the State Teachers Retirement Board voted to approve changes to the actuarial assumptions used to calculate pension liabilities. The vote follows the five-year experience review conducted this winter by the board’s actuarial consultant, Segal Consulting. The experience review measures the system’s economic and demographic assumptions versus the actual experience over the past five years. Based on this review, Segal recommended adjustments to assumptions about expected investment returns, mortality, inflation, salary growth, payroll growth and teacher retirements, disability inceptions and terminations. In total, the new assumptions outlined below have a negative overall impact on the system’s funding. When applied to the July 1, 2016, valuation of the pension fund, the new assumptions would add about $6.5 billion to STRS Ohio’s accrued liabilities (benefits earned by active and retired members).
The most common ways to express the system’s financial condition are through the funded ratio and the funding period. The funded ratio is the actuarial value of assets compared to accrued liabilities. The gap between the assets on hand and what is owed in benefits is called the “unfunded liability.” The funding period is the amount of time needed to pay off, or amortize, the system’s unfunded liability, assuming current contribution rates. When measured with the new actuarial assumptions in place, STRS Ohio’s funded ratio drops to 62.4% from 69.6%, and the funding period increased to 59.5 years from 26.6 years. The funding period falls outside of the state of Ohio’s 30-year funding target, and will require STRS Ohio to present a plan to reduce its funding period to 30 years or less.
Following is a summary of the key changes to the assumptions and how each impacts the system’s funding:
- Reducing the expected investment return to 7.45% from 7.75% — assets are not expected to grow as fast as needed to pay benefits. Financial impact: adds about $3.2 billion to liabilities.
- Change to updated generational mortality tables — recognizes that STRS Ohio members are living longer and STRS Ohio is paying benefits for a longer period of time than expected — and this trend is expected to continue in the future. Financial impact: adds about $4.1 billion to liabilities.
- Reducing the inflation assumption to 2.5% from 2.75% — impacts expected investment return and individual salary increases.
- Reducing salary growth scale for merit and seniority, as well as for inflation — reflects that individual teacher salary increases were lower than expected. Financial impact: reduces liabilities by about $1.3 billion.
- Reducing overall payroll growth to 3% from 3.5% — lengthens the funding period by recognizing that there will be less money coming into the fund through member and employer contributions than expected.
Board to continue discussion on benefit plan design changes
When adopting the assumption changes, the board recognized that benefit plan design changes are now necessary to preserve the fiscal integrity of the pension fund. Models of possible plan design changes indicate the cost-of-living adjustment (COLA) is the most effective means possible to preserve the fiscal integrity of the fund because it by far has the biggest impact on liabilities. The COLA has a significant financial impact because it affects active and retired members of the retirement system. Substitute Senate Bill 342, passed in 2012, gives the Retirement Board authority to set the COLA. The board can choose to indefinitely suspend or reduce the COLA and can vote to restore the COLA when the pension fund is healthy enough to do so. Discussion on potential benefit plan design changes will continue at the April meeting, when a vote on these changes is likely.
Following the completion of the five-year asset-liability study conducted by the Retirement Board’s investment consultant, Callan Associates, the board selected a new asset mix for the system’s total fund with a lower risk-return portfolio. The new asset mix is designed to provide lower volatility with a slightly lower expected rate of return. The asset mix includes investments that will be easier to convert to cash when benefit payments are due each month. The current and new asset mix targets are shown in the table below.
|Asset Class||Current Target||New Asset Mix Target|
|Broad U.S. equity||31%||28%|
|Broad international equity||26%||23%|
|Broad U.S. fixed income||18%||21%|
Callan projects the new asset mix to earn a return of 6.84% over the next 10 years, but said returns could be higher over a longer time horizon.
The asset-liability study began in August to help the Retirement Board determine reasonable risk and return expectations. These studies are typically conducted every three to five years to acknowledge change and uncertainty in the capital markets and to confirm an investment policy to meet return and risk objectives in relation to funding, accounting and policy goals. STRS Ohio’s Investment staff will begin to develop acceptable target ranges for each asset class and will incorporate the newly approved asset mix target in its Investment Plan before implementing the changes.
Board Considers Pathways to Improve Solvency of the Health Care Fund
The board continued its discussion on various plans designed to extend the life of the Health Care Fund. The most recent valuation projects the fund to remain solvent for 22 years; however, there is no dedicated source of revenue for the fund, since all of the employer contribution is directed to the pension fund.
The board has narrowed its focus to four potential plans — or pathways — that would extend the solvency for the health care program to 35 years or more, with the hope that some funding from the employer contribution could eventually be used for health care. The pathways under consideration would continue to provide a higher premium subsidy percentage for Medicare enrollees than for non-Medicare enrollees. This is consistent with the board’s strategic plan goal to establish Medicare as the health care program’s cornerstone. The board reviewed projected monthly premiums and lifetime costs under each of the pathways being considered and saw that costs for all participants are expected to increase — more so for non-Medicare enrollees — as health care program costs continue to grow. In April, the board is expected to approve a pathway to improve the fund solvency.
Retirement Board Election Materials to Mail in April for Contributing Member Seat on the Board; Retiree Candidates Unopposed
The 2017 Retirement Board election packet will mail on April 3 and will include information about the two candidates — Sean Patrick Brennan and Carol L. Correthers — who are running for the one contributing member seat on the board that is up for election this year. The election packet will also include instructions for casting votes online, by phone and by mail. Those eligible to vote in this election include all STRS Ohio contributing members, individuals who have contributions on deposit at STRS Ohio and disability benefit recipients. The deadline for voting is May 1. STRS Ohio will announce the results of the election following certification of the election results by the board of tellers on May 6.
Robert Stein and Rita J. Walters were the only two retired members who filed enough completed petitions for the 2017 election for the two retiree seats on the board. Since they are unopposed, in accordance with Ohio statute, no retiree election needs to be held. The term for Stein and Walters begins Sept. 1, 2017, and runs through Aug. 31, 2021.
The Retirement Board approved 98 active members and 76 inactive members for service retirement benefits.