12-16-05 STRS Faces Fiscal and Policy Challenges

Volume 18 For Publication Date: December 16, 2005 No. 25

STRS Faces Fiscal and Policy Challenges

With a $24.2 billion pension fund shortage looming, trustees at the State Teachers’ Retirement System (STRS) are facing some challenging choices aimed at cutting costs and raising revenue. In the next two months, STRS officials will meet with school districts, teachers’ groups, and state representatives to flesh out the issues and begin zeroing in on a specific strategy.

The fund will have enough assets to cover benefits for some 60 years if nothing is done, and even if it doesn’t, the state guarantees that all obligations will be met. Trustees are calling for further analysis by actuaries and feedback from outside groups. Eighteen months ago, trustees learned a string of stock market losses and sub-par investment returns had left the fund billions of dollars short to cover benefits paid to retirees over the long run. A second actuarial study put the shortfall at $24.2 billion. As of June 30, 2004, STRS had enough assets to cover 83% of future benefits.

According to Ed Derman, STRS Deputy Chief Executive Officer, “This is a problem that dramatically escalates, if we do nothing, it’s going to get progressively worse.” If trustees don’t tackle the issue, the gap could soar to $212 billion in the next three decades. STRS isn’t alone with a shortfall. Nationwide, about 80% of major public pensions are underfunded, according to a survey by Wilshire Associates, a Los Angeles investment consulting firm.

To tackle funding gaps, some funds, such as the California Public Employees’ Retirement System (PERS) have raised employer contributions. Others have issued pension obligation bonds. Some states, such as Colorado and South Dakota , have limited benefits. At STRS, one option is eliminating a 2% cost-of-living adjustment, a change that would affect all current and future retired teachers. The fund estimates the cut would wipe out a $93 boost in monthly pension checks for the average teacher. Major benefit changes, however, are likely to meet resistance from teachers’ groups.

Unlike PERS, the teachers’ retirement board has no authority to increase state or school district contributions or unilaterally slash most benefit programs. The Legislature must approve any changes. Currently, teachers contribute 8% of their pay to their pension, while K-14 school districts pay 8.25% of payroll and the state pays about 2%.

Options that STRS May Consider

STRS trustees are considering a number of proposals to help meet a $24.2 billion unfunded liability in the future. Most benefit changes would apply to newly hired teachers and the effects are based upon an average per retired teacher. The options include:

· Pension obligation bonds. Trustees must figure out whether the state can sell these bonds without voter approval. Local school districts could issue the bonds and use the proceeds to cover any future increases in pension contributions.

· Increase the amortization period up to 40 years, from the current 30 years. While this reduces the annual costs, the overall bill to provide benefits would be larger.

· Base pensions on the highest compensation over three straight years, rather than 12 consecutive months. This would reduce monthly benefits by $134.

· Take out a career factor used to calculate benefits, which would result in a loss of $378 a month in benefits for each affected teacher.

· Reduce age calculations for teachers who are 60 years old and older, which would result in a loss of $504 a month in benefits for each affected teacher.

· No longer allow unused sick leave in the retirement formula, which would cut benefits by $146 a month for each teacher.

· Drop a 2% teacher contribution for the supplement benefit, which would drop benefits by $81 a month for each teacher.

· Reduce or drop the employer contribution to the supplemental benefit for teachers working extra duties, a cut of $54 month for each affected teacher.

· Don’t extend Medicare premium payments for teachers who retire after July 1, 2006. This would increase each teacher’s health costs by $393 a month.

· Impose an employer contribution for teachers who work after retirement. The total annual cost to districts would be $15 million.

STRS Board Votes to Oppose Dual Pension Plans

A divided State Teachers’ Retirement Board went on record at its December board meeting to oppose legislation aimed at creating a hybrid retirement plan for government workers. For the second time this year, STRS trustees targeted an overhaul measure by Assembly Member Keith Richman (R-Northridge). His latest plan calls for creating a hybrid pension system that opponents argue could lead to administrative headaches for hundreds of school districts and create a divisive two-tier retirement program for teachers. Specifically, this measure, ACA 23, would establish the California Public Employee Defined Contribution and Hybrid Plans. The measure would provide that, on and after July 1, 2007, any person hired by a public agency shall enroll only in a hybrid plan or in a defined contribution plan, and is prohibited from enrolling in a defined benefit plan. The measure would permit an active member of a defined benefit plan, during a specified period, to transfer a sum equal to the member’s interest in the defined benefit plan to a defined contribution plan or hybrid plan.

Six trustees voted to oppose ACA 23, while five abstained, including four appointees of Governor Schwarzenegger, who said they were not prepared to consider the issue. During the last legislative session, legislators and the Governor proposed replacing the current guaranteed pension plan with 401(k)-style private accounts. This proposal was opposed by labor unions, and, as a result, the Governor backed off and vowed to renew his plan this coming year.

The pension issue has wreaked havoc with the 12-member STRS board. After a similar vote earlier this year, the Governor removed four appointees who voted to oppose the initial pension proposal. In a political payback, the Democrat-led state Senate rejected the nomination of the Governor’s fifth STRS appointee.

Stay tuned.

—Sheila Vickers and Arnold Bray