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Q&A (CalSTRS, the pension fund that provides benefits to retiring Cal- ifornia educators) has made the decision to lower the rate of return from the current 8 per- cent to 7.75 percent — a deci- sion that experts like CalSTRS Chief Investment Officer Chris Ailman and CalSTRS Deputy CEO Ed Derman believe will help stabilize the fund over the long haul. We spoke with Ail- man and Derman to help CTA members understand the situa- tion and what’s being done to improve the position of the pen- sion fund through these tough economic times. T CALIFORNIA EDUCATOR: What does the rate of return mean? CHRIS AILMAN: There are two inputs into a retirement fund, contribu- tions and investment earnings, and the Teachers’ Retirement Board uses the rate of return as- sumption to set the average fu- ture earnings for investments over the next 30 years. This is a difficult assumption to get right, but a key one to the health of the system, so the board looked at 120 years of past finan- he governing board of the California State Teach- ers’ Retirement System CalSTRS lowers rate of return cial information and talked to many financial industry experts in the 10 months leading up to the recent changes. In this case, the lowering reflects the recognition that Cal- STRS investment returns will be more modest than the 9.1 percent that we’ve achieved in investment return annually over the past 30 years. Since 1995, our actuary has predicted an 8 percent return on investments, which would paint a rosy picture had it not been for the drastic economic downturn of 2008-09, which is forcing the hand of many a pension system, including CalSTRS, to down- grade its forecast of income from investments. And because investment re- turns account for the majority of the income the system uses to pay benefits, it means there will be more pressure to make up that lower rate from the sys- tem’s other sources of income — its employers, the state of California, and possibly even its members. What amount will the rate of return be lowered from and down to? ED DERMAN: The Investment Re- turn Assumption, which we use Facts on CalSTRS changes CalSTRS has lowered its expected rate of return from 8 percent to 7.75 percent. What this means for the pension fund: As the unfunded liability continues to increase, CalSTRS members, the California Legislature and the governor will need to develop solutions to contribution rates that everyone can accept. to plan our funding over the next 30 years, has been set at 8 percent since 1995. It was re- vised downward to 7.75 percent on Dec. 2, 2010. CHRIS AILMAN: Keep in mind that while this is a forecast, year in and year out, our goal remains the same: to beat the markets and generate the highest return for the level of risk we’re com- fortable taking. What effect do you feel lowering the rate of return will have on the fund short and long term? CHRIS AILMAN: In the short term, the effect is very little, so we do not expect to make any changes to the current year investment plan. Our task now is to meet or exceed a 7.75 percent rate of re- turn for the next 30 years, but for the investment staff, we know we still need to make an additional $10 billion this year. Long term, it does have profound impact. You have to realize it was a very difficult decision for the board. They reviewed this over 10 months. As I mentioned, there are just two inputs to a retirement fund — so if you expect less from in- vestments, it puts more pres- sure on contributions. Since our rates are set by law, it raises the urgency for CalSTRS to work with the California Legis- lature, the governor and its members to develop solutions to contribution rates that ev- eryone can accept. We know it’s very tough on teachers and the California edu- cation system, and the last thing anyone wants is higher contribu- tion rates for the state, school 26 California Educator | DECEMBER 2010 • JANUARY 2011 districts and educators. But the bottom-line lesson from the 2008 financial crisis and the first decade of the 2000s was that the overall cost to retire went up for everyone, teachers and the gen- eral public. Will lowering the rate of return mean that teachers inevitably contribute more? ED DERMAN: The lawyers who have reviewed this for CalSTRS have concluded that the contribution rates charged to existing mem- bers cannot be increased to pay for the benefits that are already in place. Therefore, existing teachers would not be called upon to contribute more to pay for the liabilities associated with the current benefit plan. Higher contributions can be imposed on new teachers, however, as well as employers and the state. If the rates don’t change at all, CalSTRS will eventually deplete the trust fund and retirement costs would fall entirely to the state. The rates will need to go up for new members, because none of us can expect invest- ment returns to generate a dou- ble-digit return for the next two decades. However, only the Legislature can increase contri- bution rates. What is the amount of the un- funded liability? ED DERMAN: We won’t know the current unfunded liability until we complete the valuation — a snapshot of the health of the system — in the spring of 2011. If the new, reduced investment return assumption had been applied to the last valuation, it

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