Archive for the ‘Operations’ Category

Generous CalSTRS ‘hybrids’ have unexpected risk

February 9, 2015

Two CalSTRS “hybrid” plans can provide monthly retirement payments based on 10 percent investment earnings, higher than the pension fund’s long-term earnings forecast of 7.5 percent.

Last week the CalSTRS board, after looking at seven ways to strengthen the funding of the hybrid plans, selected one method for a possible vote in April and asked for an analysis of whether payments based on 10 percent earnings are legally protected.

CalSTRS officials estimate that roughly half of the members in the hybrid plans opt for a lump sum payment when they retire. But the rest choose an annuity that can provide monthly payments based on 10 percent earnings.

“If people really understood how good a deal this was, you would have everyone doing it,” Mark Olleman, a Milliman consulting actuary, told the board.

The two small hybrid plans are separate from the central California State Teachers Retirement System pension plan, which had investments valued at $190 billion last year but only 67 percent of the projected assets needed to pay future pension obligations.

A pension funding solution enacted through legislation last year will phase in a $5 billion-a-year rate increase over the next six years, mainly by pushing school district contributions to CalSTRS from 8 percent of pay to 19 percent of pay.

The two small hybrid plans are individual investment plans, much like the 401(k) plans common in the private sector. But a key difference is that the CalSTRS hybrids have a guaranteed minimum investment return based on the 30-year Treasury bond.

CalSTRS pension and hybrid investments are expected to earn a long-term average of 7.5 percent a year, a forecast critics say is overly optimistic. For the hybrid plans, the minimum investment return is expected to average 5 percent.

So, what makes the annuity option a “good deal,” compared to the lump sum, is that a retiree can get a monthly payment based on 7.5 percent earnings, plus a 2.5 percent credit given hybrids in surplus years to meet the minimum guarantee in the long run.

“This is roughly equivalent to receiving a benefit based on 10 percent returns: an initial annuity assuming 7.5 percent returns in all future years plus 2.5 percent annuity credits in the future,” said a Milliman report to the CalSTRS board last week.

Another problem reported by the actuaries is that funding for the hybrid plans is riskier than previously thought. There is a 23.5 percent chance of the funding level dropping below 50 percent.

“We don’t know exactly what the magic funding level is,” Nick Collier, another Milliman consulting actuary told the board last week. “But we are pretty sure we don’t want to be less than 50 percent, because it’s very hard to come out of that without additional contributions.”

One of the hybrid plans, the Cash Balance Benefit Program, is a small well-regarded option for part-time educators established in 1996. Employers and employees contribute to an individual investment fund, usually 4 percent of pay from each.

In the latest report, the Cash Balance Benefit Program had 31,000 non-retired members with a total fund of $167 million.

A larger and controversial hybrid plan for full-time educators, the Defined Benefit Supplement, began in 2001 by diverting a quarter of the teacher CalSTRS contribution (2 percent of pay from the total of 8 percent) into an individual investment fund for 10 years.

Now contributions come from work beyond the standard year and short-term pay raises. The latest report shows the Defined Benefit Supplement with 521,241 members with a total fund of $7.4 billion.

STRS

The creation of the Defined Benefit Supplement was sharply criticized at a CalSTRS board meeting two years ago by Lois Shive, a California Teachers Association representative working on pension issues at the Capitol when the legislation passed.

She said a “rogue member” persuaded a legislator to push for the creation of the supplement with a “2 percent side car” that “short-funded this wonderful pension fund by a huge amount, building on to what we have now is a snowballing effect.”

Shive later declined to identify the “rogue member” and amended her view of the 10-year diversion of a quarter of the teacher CalSTRS pension contribution, saying it was a small part of the funding problem.

A school lobbyist and CalSTRS and Capitol staff would only say the bill emerged from negotiations. Like a typical back-room deal, the bill was not heard in committee and, with a “gut and amend,” put into an existing bill on a different topic, credit cards.

The Senate analysis of the bill (AB 1509 in 2000) cited the brief Assembly analysis: “No General Fund effect and no effect to the solvency of STRS, the STRS surplus will absorb the cost of the Defined Benefit Supplement Program.”

The “surplus” was a CalSTRS funding level that reached 110 percent in 2000, after a long climb from 30 percent during the 1970s. A final push came from more state funding in 1990 and investment earnings during a stock market boom.

The Defined Benefit Supplement was among a half dozen bills around 2000 that spent the CalSTRS “surplus” by cutting contributions from teachers and the state, while increasing retirement benefits in several ways.

For example, retired CalSTRS members were given a 1 to 6 percent pension increase, depending on when they retired. The bill (AB 429 in 2000) was said to be “equitable” with a similar increase (SB 400 in 1999) for state worker retirees.

Two years ago the Milliman actuaries calculated that if CalSTRS was still operating under the 1990 benefit structure, without the changes made around 2000, the funding level would have been about 88 percent instead of 67 percent.

With a smaller funding gap to close, there would have been no need for the huge $5 billion rate increase that will more than double school district contributions to CalSTRS, squeezing the funding available for classrooms.

The Defined Benefit Supplement, with its 10-year diversion of a quarter of the teacher contribution, was said by Milliman to have had a “very small” impact on the CalSTRS funding level, barely visible on a bar chart showing drivers of the change.

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 9 Feb 15


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