The Current Economic Downturn and PSRS/PEERS

The Current Economic Downturn and PSRS/PEERS
By: M. Steve Yoakum, PSRS/PEERS Executive Director

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 (PSRS) and the Public Education Employee Retirement System of Missouri (PEERS) 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 May 2009, the U.S. stock market has declined 37.3%, while Europe has seen a 39.3% decline and Japan a 29.9% decline. It has truly been a worldwide economic slowdown with few places to hide.

PSRS/PEERS, utilizing a professionally managed investment program and a well-diversified portfolio, fared significantly better over the same time period declining 24.1%. While the Systems have outperformed most markets and the majority of similar institutional investors, we have still experienced a substantial decline in asset values over this difficult period. This decline does not impact our ability to provide the benefits promised, but it will have an effect on the funded status of the plans and future contribution rates.

Fortunately, PSRS/PEERS entered this downturn in good financial condition with a strong prefunded ratio of over 83%. Also, as the largest institutional investor in the State of Missouri, and one of the largest in the nation, the Systems have seen the ebbs and flows of investment markets and have positioned themselves as long-term investors. However, investment declines of this magnitude ultimately have an effect.

Assets and Liabilities Annually Reviewed
Each fiscal year (July 1 to 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 plan increase, as hopefully do the assets. 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% prefunded. In other words, the Systems had over 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
Unlike a Defined Contribution (DC) plan (e.g. 401(k), 403(b)) which provides benefits based on account balances, PSRS/PEERS are “Defined Benefit” (DB) 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 before the Missouri General Assembly to make any benefit cuts.

Article I, Section 13 of the Missouri Constitution and the attendant case law make 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 it 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 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 Systems expect to earn on investments in the future.

As with most similar retirement funds, PSRS/PEERS’ return assumption has been 8% for many years. In years when the Systems exceed the 8% return, actuarial gains are incurred and the funded status improves. Conversely, in periods like this when the 8% 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 1% per year (½% each to the member and the district) and ½% per year for PEERS members (¼% each to the member and the district). The current PSRS member and district contribution rate is 13% and will increase to 13.5% on July 1, 2009. The current PEERS member and district contribution rate is 6.25% and will increase to 6.5% 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 and PEERS use an 8% 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. Given the market decline as well as the projected statutory contribution rates (using the ½% annual cap), and assuming PEERS will earn the 8% rate going forward, with no other changes, the total (member and school district) contribution rate will peak after several years of increases.

What the Future Holds
The PSRS/PEERS Board of Trustees is collaborating with Missouri educational associations to ensure all parties are informed and 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 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.

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	The Current Economic Downturn and PSRS/PEERS By: M. Steve Yoakum, PSRS/PEERS Executive Director 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 (PSRS) and the Public Education Employee Retirement System of Missouri (PEERS) 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 May 2009, the U.S. stock market has declined 37.3%, while Europe has seen a 39.3% decline and Japan a 29.9% decline. It has truly been a worldwide economic slowdown with few places to hide. PSRS/PEERS, utilizing a professionally managed investment program and a well-diversified portfolio, fared significantly better over the same time period declining 24.1%. While the Systems have outperformed most markets and the majority of similar institutional investors, we have still experienced a substantial decline in asset values over this difficult period. This decline does not impact our ability to provide the benefits promised, but it will have an effect on the funded status of the plans and future contribution rates. Fortunately, PSRS/PEERS entered this downturn in good financial condition with a strong prefunded ratio of over 83%. Also, as the largest institutional investor in the State of Missouri, and one of the largest in the nation, the Systems have seen the ebbs and flows of investment markets and have positioned themselves as long-term investors. However, investment declines of this magnitude ultimately have an effect. Assets and Liabilities Annually Reviewed Each fiscal year (July 1 to 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 plan increase, as hopefully do the assets. 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% prefunded. In other words, the Systems had over 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 (DC) plan (e.g. 401(k), 403(b)) which provides benefits based on account balances, PSRS/PEERS are “Defined Benefit” (DB) 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 before the Missouri General Assembly to make any benefit cuts. Article I, Section 13 of the Missouri Constitution and the attendant case law make 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 it 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 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 Systems expect to earn on investments in the future. As with most similar retirement funds, PSRS/PEERS’ return assumption has been 8% for many years. In years when the Systems exceed the 8% return, actuarial gains are incurred and the funded status improves. Conversely, in periods like this when the 8% 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 1% per year (½% each to the member and the district) and ½% per year for PEERS members (¼% each to the member and the district). The current PSRS member and district contribution rate is 13% and will increase to 13.5% on July 1, 2009. The current PEERS member and district contribution rate is 6.25% and will increase to 6.5% 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 and PEERS use an 8% 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. Given the market decline as well as the projected statutory contribution rates (using the ½% annual cap), and assuming PEERS will earn the 8% rate going forward, with no other changes, the total (member and school district) contribution rate will peak after several years of increases. What the Future Holds The PSRS/PEERS Board of Trustees is collaborating with Missouri educational associations to ensure all parties are informed and 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.