Legality of CalSTRS Medicare payment questioned

A CalSTRS program that provides Medicare coverage for retirees, begun a decade ago when the chronically underfunded retirement system had a brief surplus, may not be permitted under current law, a consulting actuary told the board last week.

Medicare coverage for some retirees was one of a half dozen benefit increases enacted a decade ago when CalSTRS, only about 30 percent funded during the 1970s, reached full funding as investment earnings soared during a booming stock market.

After peaking around the year 2000, the CalSTRS funding level plunged and was 78 percent in the last valuation, June 2009. Now CalSTRS is estimated to need an additional $3.8 billion a year to reach full funding.

The Medicare program is one of two benefit increases begun a decade ago that were paid for by “redirecting” part of the annual employer and employee contributions to the California State Teachers Retirement System.

Employees continued to contribute 8 percent of pay and school districts 8.25 percent of pay. But some of the money was used for the two programs, rather than going into the pension fund where it might have reduced the growth of the pension debt.

A small part of the employer contribution, an estimated $1.25 billion over 15 years when the program was created in 2000, covers the main Medicare premium for a limited (an estimated 29,000 at the outset) and declining number of retirees.

The program that pays for Medicare hospitalization (Part A) is mainly for retirees whose employers, before a change in 1986, did not provide Medicare. About $35 million was paid last year for 6,475 persons, said Ricardo Duran, a CalSTRS spokesman.

The Medicare Premium Payment Program accounts for $625 million of the CalSTRS unfunded liability, which is estimated to be $40.5 billion over the next three decades.

In the other program, a quarter of the employee contribution, 2 percent of pay, was redirected to a separate individual investment fund, the Defined Benefit Supplement, that adds a 401(k)-style plan to teacher pensions.

The supplemental fund earns what the CalSTRS investment portfolio earns, which was 12.7 percent last year. But a guaranteed minimum prevents the supplemental fund earnings from dropping below the 30-year Treasury bond, now about 4.7 percent.

The redirection to the Defined Benefit Supplement, $652 million last fiscal year, expired after a decade on Jan. 1. Duran said the supplemental fund holds about $7.4 billion for 544,000 active and retired employees.

The report last week by a consulting actuary, Cheiron (a wild and lusty centaur in Greek mythology, part man and part horse), is a check of the work done by the regular CalSTRS consulting actuary, Milliman, routinely performed every five years.

Cheiron replicated Milliman’s work for 2008, even traveling to the Milliman office in Seattle to look at documents. The result was within a half percentage point of Milliman, well within the 5 percent range used by the IRS in the private sector.

One of the Cheiron findings was that the Medicare program, not scheduled to expire until July of next year, should be reviewed by legal counsel because it may not be legal.

Cheiron said the state education code seems to say that the employer contribution can be “redirected” from the pension fund only if the full 8 percent of pay employer contribution is not needed to fund pensions over 30 years.

“If this interpretation of the statute is correct, the redirection to the Teachers Health Benefit Fund (for Medicare coverage) may not be permitted at this time,” said the Cheiron report.

In his written comment on the Cheiron report, the CalSTRS staff actuary, Rick Reed, said: “This issue has been raised before, but clarifying statutory language may be appropriate.”

Another Cheiron finding is that the Medicare and supplement programs may be preventing a small but automatic increase in the state contribution under a formula linked to the 1990 funding level.

“Our concern is that these redirections may be inadvertently shielding the state from having to make additional contributions for the 1990 benefit structure, while simultaneously diverting funds that would otherwise be used for the DB (pension) program,” said Cheiron.

The state contribution to CalSTRS, $1.257 billion this year, is expected to increase to $1.35 billion next year. It’s 2 percent of teacher pay for pensions, and 2.5 percent to keep inflation from dropping pensions below 85 percent of original value.

When the two programs that redirect part of the employer and employee contributions were created in 2000, a report to a CalSTRS board committee said the fund had an $11 billion surplus and contributions were 2.25 percent of pay above normal costs.

“Both of these surplus resources are available to finance the enhancement of benefits provided by CalSTRS,” said the staff report.

The legislative analysis of the bill that created the Medicare program, SB 1435, did not mention how the cost would be covered. But a brief analysis of the supplement bill that redirected billions, AB 1509, made a bold statement.

“No (state) general fund effect and no effect to the solvency of STRS,” said the analysis. “The STRS surplus will absorb the cost of the DBSP (Defined Benefit Supplement Program).”

Five other bills enacted a decade ago did a number of things to increase teacher pensions (notably a longevity bonus that expired Jan. 1 and a retroactive increase for retirees) and reduced the state contribution to CalSTRS.

As investment earnings soared during a booming stock market, the California Public Employees Retirement System and the UC Retirement plan also raised pension benefits and cut contributions.

Now all three of the state retirement systems are underfunded and need major contribution increases for full funding, mainly because of huge investment losses in the stock market crash two years ago.

CalPERS was able to cut $200 million from its state contribution, dropped to $3.7 billion in December, after most but not all state workers agreed to new labor contracts that increased employee contributions and cut pensions for new hires.

Pensions promised current workers are protected by court decisions. UC Regents adopted a similar long-range plan in December that would, if labor unions agree, phase in employer and employee contribution increases and lower pensions for new hires.

CalSTRS is in a different situation. Unlike the other two state retirement systems, CalSTRS lacks the power to set employer contribution rates, needing legislation instead.

The current statewide CalSTRS contribution rate paid by teachers, 8 percent of pay, was set by legislation in 1972, a half dozen years before teachers were authorized to form labor unions and bargain for pay.

Teachers in CalSTRS do not receive Social Security in addition to their pensions, unlike many public employees. It’s a problem for teachers if membership in CalSTRS causes a reduction in Social Security benefits earned on other jobs.

But not having to make a Social Security contribution, 6.2 percent of pay, is money that teachers can put into 401(k)-style tax-deferred individual investment plans, if they choose.

A report to the CalSTRS board in June 2009 found that a teacher at age 63 after 34.5 years of service could retire with 103 percent of final pay, if they have the pension, the supplement and have put $100 a month into a tax-deferred investment plan.

The pension of the typical CalSTRS retiree, however, is about 62 percent of final pay. The CalSTRS pension formula is 2 percent of final pay for each year served at age 60, similar to the lower CalPERS pension under the new state worker contracts.

A report to the board last week mentioned another way CalSTRS is different. A legal analysis concluded that teacher contributions, which are not bargained collectively, cannot be raised without providing another benefit of equal value.

The report also said CalSTRS needs an annual contribution increase of 13.9 percent of pay, $3.8 billion, to be fully funded over the next three decades. So what can CalSTRS do if it can’t raise contribution rates?

CalSTRS issued a one-year contract last year that could pay two public affairs firms up to $600,000 to help build support for a contribution increase.

“Contractor shall implement a coordinated, multi-layered outreach strategy with identified communications channels to educate and engage CalSTRS members, school district employers and members of the Legislature about the need for prompt action to address the Defined Benefit Program’s unfunded liability,” said the contract.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 16 Feb 11

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