Your retirement—How safe is it?

There hasn’t been an event that has created more questions and concern than the current economic downturn. As you might expect, since this downturn began, the Public School Retirement System of Missouri and the Public Education Employee Retirement System of Missouri have fielded numerous questions from members, retirees, taxpayers and others concerning the possible effects of the market decline on the Systems.

Economic downturn
Since the U.S. stock market began declining in October 2007, the decline has rivaled a similar period—the Great Depression. From October 2007 through March 2009, the U.S. stock market has declined 45.8 percent, while Europe has seen a 50.2 percent decline and Japan a 42.6 percent decline. It has truly been a worldwide economic slowdown with few places to hide.

PSRS/PEERS, using a professionally managed investment program and a well-diversified portfolio, fared significantly better over the same time period, declining 30.3 percent. Although the Systems have outperformed most markets and the majority of similar institutional investors, they have still experienced a substantial decline in asset values over this difficult period. This decline does not affect the ability to provide the benefits promised, but it will have an effect on the funded status of the plans and future contribution rates.

PSRS/PEERS entered this downturn in good financial condition with a strong prefunded ratio of more than 83 percent. Also, as the largest institutional investor in Missouri, and one of the largest in the nation, the PSRS/PEERS has seen the ebbs and flows of investment markets and has positioned itself as a long-term investor. However, investment declines of this magnitude ultimately have an effect.

Annual review of assets and liabilities
Each fiscal year (July 1-June 30), the PSRS/PEERS actuaries compare the assets and liabilities of the Systems to determine the funded status and contributions necessary for the future. With each year of service earned by Missouri’s educators, the promises (i.e. liabilities) of the plans increase, as do the assets—we hope. When measured over time, this comparison of assets and liabilities results in the prefunded ratio. As of June 30, 2008, both PSRS and PEERS were slightly more than 83 percent prefunded. In other words, the Systems had more than 83 cents of each dollar of future-benefit promises made to Missouri’s educators—a very healthy position.

As complicated as funds like PSRS/PEERS can be, there are really only three “levers” that affect the funding levels of defined benefit retirement plans like PSRS/PEERS:

• benefit promises

• investment earnings

• contribution rates

Benefit promises
Unlike a Defined Contribution plan (e.g. 401k, 403b), which provides benefits based on account balances, PSRS/PEERS are “Defined Benefit” retirement plans and provide benefits based on a formula using a member’s final average salary and years of service. These benefit promises for PSRS/PEERS members are made by the Missouri General Assembly and codified in state statute. The benefit provisions of PSRS/PEERS, such as retirement ages, eligibility, benefit levels and cost-of-living adjustments are all established and controlled by state law. The PSRS/PEERS Board of Trustees and staff do not set these benefits but instead administer them. Any reduction in benefit levels or promises would have to be passed by the Missouri legislature and signed into law by the governor. Unlike many other states, there have been no bills introduced or any pending before the Missouri General Assembly to make any benefit cuts.

Article I, Section 13 of the Missouri Constitution and the attendant case law makes the argument that the relationship between PSRS/PEERS and the members of the plan is contractual in nature and the benefits may not be diminished or impaired. While changes in benefits and plan design cannot be completely ruled out in the future, this Constitutional provision makes such a change difficult.

Investment earnings
This is the most important lever of the three because investment income accounts for almost two-thirds of the revenue needed to fund the retirement benefits for Missouri’s educators. The remaining one-third is split almost evenly between member and school district contributions. PSRS/PEERS actuaries, to establish contribution rates needed to adequately fund those benefit promises, must make assumptions about how much money the system will earn on its investments in the future. As with most similar retirement funds, PSRS/PEERS’ return assumption has been eight percent for many years. In years when the Systems exceed the eight percent return, actuarial gains are incurred and the funded status improves. Conversely, in periods like this when the eight percent assumption is not met, the actuarial losses result in a decline of the funded status.

In order to lessen the volatility in liabilities and contribution rates, PSRS/PEERS actuaries use a five-year smoothing period to value gains and losses in the investment portfolio for funding purposes. Still, with historically low investment returns in 2008 and that trend continuing in 2009, these declines will ultimately be considered by the actuaries in the funding and establishment of future contribution rates for members and school districts.

Contribution rates
Once the benefits are set and the investment return is known, the actuaries will calculate the contribution rate required to fund those benefit promises. Missouri law requires the actuaries to annually compare assets and liabilities and develop contribution rates. The law also limits any change in contribution rates for PSRS members to one percent per year (one-half percent each to the member and the district) and one-half percent per year for PEERS members (one-quarter percent each to the member and the district). The current PSRS member and district contribution rate is 13 percent and will increase to 13.5 percent July 1, 2009. The current PEERS member and district contribution rate is 6.25 percent and will increase to 6.50 percent July 1, 2009.

The actuaries must make numerous assumptions about demographics, life expectancies, retirement patterns, and most importantly, future investment returns, to determine the contribution rates needed to adequately fund the plan in the future.

As noted earlier, PSRS/PEERS uses an eight percent assumed rate of return on investments for funding purposes. The investment market volatility we have experienced lately makes future contribution rate projections difficult. Even when investment gains and losses are “smoothed” over five years as done by PSRS/PEERS, future contribution rates are greatly determined by investment returns.

Projection of future contribution rates
Because the investment returns have such a powerful effect on the funded status and contribution rates, it is difficult to project them far into the future with a high degree of accuracy. However, we have asked the actuaries to project the estimated future contribution rates needed for PSRS using the following parameters:

• No change in benefit levels, patterns or provisions
• Investment return of -20 percent for Fiscal Year 2009
• Investment return at a rate of +8 percent for all years in the future beginning Fiscal Year 2010

Future
The PSRS/PEERS Board of Trustees is collaborating with Missouri NEA and other Missouri education associations to ensure all parties are educated about the market conditions and how they affect the Systems. Together, we are working to identify financial solutions to safeguard the stability of the Systems. So what does this all mean?

• The recent drop in investment markets is substantial and is a concern worldwide.

• We are long-term investors with a focus on providing a secure retirement for future generations of Missouri educators. From a historical perspective, we feel confident the market’s peaks and valleys will balance out in the long term.

• PSRS/PEERS assets are invested in such a way as to meet cash and benefit requirements, while also being able to participate in market recovery as it happens.

• Negative investment returns have a direct and substantial impact on future contribution rates.

• Contribution rates are expected to increase for several years in the future; how long will be determined by future investment returns.

The PSRS/PEERS Board of Trustees and staff are working to ensure that future generations of Missouri’s teachers and support staff will inherit a retirement system as strong and reliable as the one we have today.

By M. Steve Yoakum
PSRS/PEERS executive director

sb, summer '09