President's Report
Last year we saw the passage of pension reform. It will not end there. At the time, numerous people pointed out that the reforms the legislature passed would not significantly affect the financial state of STRS. STRS was underfunded and still is. The state legislature is now looking to address the underfunding, and STRS has presented a report to the legislature about the current state of STRS and some possible actions that could be taken. If they do act, it will probably mean changes taking place in our contribution levels either next year or the year after.
Why is STRS underfunded? I’ve heard people offer a variety of explanations. What I have not read is a careful financial analysis of why it is underfunded with identified causes along with attribution of the size of that cause in its contribution to the problem. What I’ll offer here are some of the issues I’ve heard and my own guesses at their relative importance.
Most commonly, the financial crisis is cited as the main culprit in the underfunding. No doubt if we were looking the state of funding in 2009, the financial crisis would be the most significant reason for underfunding. However, is the financial crisis still the main culprit with stock indices hitting new historic highs? I’ve loosely tracked financial investment returns for the last 25 years in order to prepare for my own retirement. Asset performance over the last 25 years is greater than my own planning parameters set 25 years ago. We have gone through two major financial crises, but the stock market is still where one would likely to have expected standing in 1990. This makes me highly skeptical as to whether much of the current funding crisis is responsible for the underfunding. Over the long run, I’m talking decades, my tracking of stock market returns are running above expectations set by historical performance.
Another factor identified at a meeting on pensions a year ago was the state’s “contribution holiday.” The person making this point went as far to say if the state hadn’t taken a contribution holiday, STRS would be fully funded today. The funding of STRS comes from three sources: employees (you pay 8%), employers (the school pays 8.25%), and the state. Ignore that all of the money ultimately comes from a single source. In the late 1990’s in response to the tech-bubble, the state reduced its contribution level from something like 5% down to a little over 2% (I think those are approximately the right numbers). For more than a decade, the state has been putting in less than it did in the 1990’s. No doubt this reduction in funding has affected the STRS fund balance, but I don’t think it’s the biggest factor.
I think the biggest factor is the increase in benefits. In the late 1990’s, STRS became overfunded because of the tech-bubble. The state increased benefits to STRS members in response. Those benefits included the diversion of large portion of your contribution to a new supplemental benefit. This change, which has since ended except for overloads, was larger than the state contribution holiday. Another change in benefits was allowing your final compensation to be based on your highest year alone, not three years. A longevity bonus was granted to people who had been in the system a certain number of years. Finally, the largest benefit change, I believe, was the age-factor increase from 2% to 2.4%.
by Paul Harvell
| "The combination of causes has led to an underfunded STRS system. The current value of assets that STRS owns is not sufficient to pay out all of the benefits it has promised. It is important to understand that arriving at this finding is not a trivial calculation. It involves assumption about a 'typical' return to STRS’s investment portfolio and many facts about retirees. Because of the high level of uncertainty and speculation, some argue that we should ignore the underfunding issue and wait until the situation becomes direr." |
That alone is a 20% unfunded increase in benefits. That is, the state started paying 20% larger benefits to many recipients without any increase in contributions to fund it. I suspect this benefit increase is the largest factor in explaining the underfunding (but again, I haven not read any analytical financial breakdown of all the causes and their relative impacts on the underfunding. I’m making guesses).
The combination of causes has led to an underfunded STRS system. The current value of assets that STRS owns is not sufficient to pay out all of the benefits it has promised. It is important to understand that arriving at this finding is not a trivial calculation. It involves assumption about a “typical” return to STRS’s investment portfolio and many facts about retirees. Because of the high level of uncertainty and speculation, some argue that we should ignore the underfunding issue and wait until the situation becomes direr. Right now, the system is expected to remain solvent for at least another 20 years.
There are two main arguments why action now is prudent. First, if we wait until the assets of STRS are depleted, the rough estimate is that our contribution level will need to approximately triple to fund the pension payouts. STRS would become a “pay-as-you-go” system where the money that comes in from contributions would be paid out immediately to retirees. To fund the system that way it takes something like a contribution rate of 25% from employees and 25% from employers. The second argument for acting now is that the sooner and larger you act, the less you have to act. By doing something of significance now, we could do much less.
There is one major impediment to acting right now. Past legal decisions suggest that the state cannot increase our contribution without offering a comparable improvement in benefit. The state can, and has as described above, do the reverse: increase benefits without an increase in contribution. The increase in benefits from the 1990’s are now locked in, and contribution levels cannot be increased in response. Another impediment is any change in STRS must be made by the state legislature. PERS does not have this restriction.
What I have now heard from several sources is that there are STRS experts who believe they have a way to change the contribution level. STRS makes full COLA (cost of living adjustments) to retiree’s pensions once the real value of the pension has fallen to a certain level. This COLA is not contractually promised. It’s something STRS has done. One plan is to make this COLA adjustment a contractual obligation. In return for that promised benefit (that we are currently getting but are not guaranteed), we’ll make larger contributions. How much larger? The number I hear floated is about a 2% increase in contribution from employees, 2% from employers, and for the state to go back to its approximate 5% contribution. Will this solve the problem? No. To be fully funded, estimates suggest it would require an increase in contributions more than double what is suggested above (though I have some questions about that number).
So looking into the crystal ball, what I see is to not be surprised if 2% more of your paycheck is going to STRS either next year or the year after. I would also suggest that you shouldn’t be angered by this. Your maximum retirement is now at least 20% higher than it was about 15 years ago.