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  • Rudy Fichtenbaum


By Rudy Fichtenbaum

A while back, someone posted a slide taken from the presentation Aon made to the Board at the November meeting, showing a basic equation that displays the flows of money that come in to and are paid out of a pension each year. That equation was

C + I = B + E.

C stands for contributions, both employee and employer contributions. I is commonly called interest, but it really stands for all investment income. B is benefits. E stands for expenses. Now in reality the equality does not have to hold. If C + I < B + E, the pension takes in less than it pays out; similarly, if C + I > B + E, the fund takes in more than it pays out. Since STRS has a significant unfunded liability, it is important that it take in more money than it pays out over time to reduce the unfunded liability.

Expenses at STRS receive a lot of attention in the Forum. As a Trustee, I agree that STRS should do everything it can to reduce unnecessary expenses. However, reducing expenses alone will not restore benefits.

To see why, let’s look at the relative magnitude of C, I, B and E. I am going to use numbers for the defined benefit plan (DB) only; these numbers apply to fiscal year 2023, which ended last June 30.

(C) Contributions for the DB plan in 2023 were approximately $3.6 billion: $1.7 billion in member contributions, $1.8 billion in employer contributions, plus $0.1 billion coming from transfers from the defined contribution (DC) program and other retirement systems.

(I) Investment Income was $7.0 billion. This is gross investment income; see (E) below for expenses associated with this investment income.

(B) Benefit payments, including refunds to members who withdrew their money, were $7.5 billion.

(E) Expenses. Investment expenses were $283 million ($41 million in internal investment expenses plus $242 million in external investment expenses), and administrative expenses were approximately $73.5 million. So, altogether E was $356.5 million, which for simplicity I will round to $400 million, i.e., $0.4 billion.

Here is what our equation C + I = B + E looks like with the four numbers above plugged in. All four numbers are in billions of dollars.

$3.6 + $7.0 = $7.5 +$ 0.4

which by arithmetic reduces to

$10.6 = $7.9

The truth of course is that $10.6 is not equal to but much greater than $7.9. That is, in 2023, the incoming money side of our equation – C+I – was much bigger than the outgoing money side of our equation – B+E. What happened to all that money? It reduced the pension’s unfunded liability. In 2022 the inequality was reversed; that is, C+I was much less than B+E; in fact, in 2022 the DB plan spent $8.5 billion more than it took in contributions and investment income.

Here is a key point to understand. In a typical year, the DB plan will pay out approximately $7.9 billion but will take in only $3.6 billion in contributions; so, just to break even, it needs to earn $4.3 billion in investment income. In round numbers the pension needs to earn a minimum of 5.1% on investments just to break even, since it had approximately $83.7 billion in assets in the DB plan.

Expenses are approximately $400 million ($0.4 billion). But even if expenses were zero, the pension would still need to earn $3.9 billion every year just to break even, i.e., keep the unfunded liability from increasing.

Every year that STRS does not break even or better, it must sell assets to meet its obligations, and that lowers the level of assets available to pay benefits and earn investment income. When the pension had assets of $90 billion and it would have needed to earn $3.9 billion even if expenses had been zero, which translates to a 4.3% return on investments. With $83.7 billion in assets, it would need to earn 4.7% (again assuming zero expenses). Every time the level of assets goes down, it increases the rate of return needed just to break even.

Going back to our example from 2023 – in which the plan had $83.7 billion in assets, took in $3.6 billion in contributions, paid out $7.5 billion in benefits, and had $0.4 billion in expenses – it needed 5.1% in investment earnings to break even. But suppose a miracle occurred, and STRS could somehow have cut expenses in half; that would have reduced expenses from $0.4 billion to $0.2 billion, cutting the total outflows (B+E) to from $7.9 billion to $7.7 billion. With current expenses, we would still need to have earned 4.9% to break even!

Should we reduce unnecessary expenses? Yes! Where are the biggest expenses? About 79% of STRS’s expenses are investment expenses. But even if we were to reduce unnecessary expenses to zero, would we have enough money to restore 30 years and pay a COLA? The answer is clearly no!

Therefore, the focus of members needs to be on 1) increasing employer contributions, which should be funded by a separate appropriation from the state and 2) increasing investment income without taking additional risk. There is an old joke about a guy who is looking for his lost keys under streetlight. Another person walks up to him and asks, “What are you doing?” The guy replies, “I am looking for my keys.” So then the person asks, “you lost then right about here, eh?” The guy replies, “No, I lost them across the street.” And the person asks, “So why are you looking for your keys over here?” The guy replies, “Because this is where the light is.” If we want to restore benefits, we need to start looking where we can find billions of dollars e.g., increasing employer contributions and focus less on saving a few million dollars that we can find under a streetlight!

Rudy H. Fichtenbaum is an American economist. He is a professor emeritus at Wright State University, and in 2012, was elected the president of the American Association of University Professors. He is the Chair of the STRS Ohio Retirement Board.



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