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Teacher’s Pension

I have a friend who has been a teacher for more than 20 years in Cuyahoga County. She is counting on her pension to navigate post retirement living for her and her husband who has also recently retired. Given all I have read and learned about the national problem with pension underfundings I asked her if she could take a “lump sum” option. She is inclined to take the longer term payout because of the more generous gross payments and the possibility of cost of living increases. I also believe deferral allows her to continue favorable health coverage.  I have watched the sacrifices she has made to secure this pension, and I was concerned about her options. So I did a little bit of research.

An Independent View

Each year The Pew Charitable Trusts publish a state by state pension funding report card the latest of which is for 2016. Here is their summary of the funding gap:

“In 2016, the state pension funds in this study cumulatively reported a $1.4 trillion deficit—representing a $295 billion jump from 2015 and the 15th annual increase in pension debt since 2000. Overall, state plans disclosed assets of just $2.6 trillion to cover total pension liabilities of $4 trillion.”

Their report confirms many facts we already know, but there is one new analysis that looks at plan investment risk and volatility by calculating what rate of return is needed that year to match net outflows. Pew calculates the annual net inflows (employer and employee contributions) less plan outflows (retirement payments) and divides that number (usually negative)by actuarially valued plan assets. So if a state has net outflows  of negative $3 Billion and the retirement plan assets are $75 Billion the plan investments would have to generate operating cash flow that year of $3.0 Billion (4%)to cover the deficit.

Liquidity May Be More Important

This “funding as you go” mindset  is important  because state plans may be overvaluing their plan assets for years by assuming they are liquid and stable. By reaching for yield ever since the Big Recession and abandoning low yield safe and liquid assets (30 Year Treasury Bonds)for higher risk, higher volatility asset classes like private equity and hedge funds many state funds have added risk of not being able to fund net outflows. Here are the annual deficits for 2016:

So this means that Ohio, for example, had to earn liquid returns in excess of 5 % in 2016 just to cover outflows for that year.

For my friend this has important implications. Her pension is not just underfunded, but its security may also be challenged by liquidity and volatility concerns. If the Fed wants to manage volatility and asset class liquidity it cannot raise interest rates and stop printing money. If it wants to return to “normalcy” (stop printing money), it may remove liquidity underpinning risky pension asset classes and cause their values to plummet. It is one thing for the US government to be insolvent, but to have that insolvency migrate to state retirement systems just as the boomers are retiring is unthinkable?

Ohio State Teachers Retirement System

My friend participates in the Ohio State teachers Retirement System (“STRS”). The recent report card from their outside consultant was not good:

“Segal Consulting’s latest calculations show STRS Ohio’s funding period is 57.7 years and STRS Ohio’s funded ratio is 62.6%.”

According to Ohio Law STRS is not permitted to have a funding gap of more than 30 years. Their advisors have told them things need to change.,  It  looks like STERS suspended its cost of living adjustment for everyone in the system and that gives them confidence that they are now only 30 years of funding behind. I would not have that kind of confidence when their actual returns since 2007 have been 6.06% against an assumed return of 7.75%

There is not any set of assumptions that can save STRS. They have already benefited from historic stock market returns.  Their own consultants, Callan Associates, have told them to prepare for a low return environment characterized by increasing volatility and challenged liquidity. Segal Consulting also told STERS it had to reduce benefits by $10 Billion just to get back to a 30 year funding gap! It is not clear in any publication I could find how eliminating future cost of living assumptions will raise $10 Billion but that is the path they have chosen?

Don’t Trust The Politicians

If I had a choice of trusting Ohio politicians to fund my monthly STRS payment with a 38% funding gap and a 57 year investment hole  or taking a lesser lump sum payment and putting it in a ladder of investment grade securities, I would bet on cash in hand.

This may not end well for a group of Ohio teachers who have been underpaid and underappreciated throughout their careers and now find themselves dramatically underfunded in their retirement and completely reliant on the FED to continue providing liquidity for risky asset classes.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records. Founder and chairman of CW Industrial Partners (originally CapitalWorks, LLC), he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CW Industrial Partners or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.