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Why OP&F's DROP is working while another system struggles

Media reports have brought attention to the strain the Dallas Police and Fire Pension Fund (DPFPF) is under, specifically it’s Deferred Retirement Option Plan (DROP). Ohio Police & Fire Pension Fund (OP&F) members may wonder if their DROP could face similar troubles.

The answer is no. OP&F’s DROP is working as intended and is a financially sound benefit option. OP&F’s DROP is well-designed and meant to be cost-neutral, therefore, has not harmed the system’s ability to pay pension benefits.

When the problems in Dallas became public, OP&F staff began comparing the two systems. This examination showed glaring differences. These disparities allow OP&F to remain stable, with prudent management by a team of trained professionals that understand fiduciary principles and apply those principles on a daily basis, from our customer service team to our investment professionals to our Board of Trustees.

The following information explains how the problems in the Dallas system originated and reassure OP&F members that their retirement system – and more specifically OP&F’s DROP – is on solid financial footing.

At DPFPF, poor investment decisions coupled with overly generous benefit packages caused the system’s funding ratio to drop from 72 percent in 2011 to approximately 35 percent by the end of 2016. When DPFPF members learned about plans to reduce benefits they began withdrawing money from the system’s DROP, intensifying the problem.

There are significant differences between OP&F and DPFPF. The Dallas fund:
• Is a single employer (City of Dallas)
• Has 5,415 active members
• Has an annual payroll of $365 million
• Includes 4,556 retired members and beneficiaries
• Has annual disbursements of $286 million
• Has an assumed return on investments of 8.5% actuarially smoothed over a 10 year period
• Has total assets as of 12/31/2015 of $2.7 billion
• Used a 10 year period to smooth assets, which can mask a funding problem and it may have slowed the realization that significant changes were needed.

OP&F consolidated in 1967 as a statewide system. OP&F has:
• 917 employers
• 27,769 active contributors
• 27,963 retirees and beneficiaries
• Annual disbursements of $1.370 billion
• Annual payroll for public safety members in the OP&F system of $1.986 billion
• An assumed return on investments of 8.25% return and has returned on average just under 8.8% per year over 30 years
• Total assets as of 12/31/2016 of $14.5 billion.

The investment programs also have major differences. A look at recent performance between the two systems reflects the following annual returns over a three, five and 10 year period.
3-year 5-year 10-year
OP&F 7.91% 8.27% 6.35%
DPFPF (0.7) % 1.00% 2.70%

DPFPF’s investments include an unusually high amount of risk and it is not as diversified when compared to other funds of this size and scope. After accumulating 25 percent of its assets in real estate, major losses have been realized due to direct investments that did not perform.

OP&F does not invest in real estate directly. Several years ago OP&F decided to use comingled real estate funds. OP&F’s allocation of 11 percent to real estate is more in line with the suggested allocation for an institutional pension program.

Cost of Living Adjustments (COLAs) are another significant difference:
• DPFPF’s COLA is four percent for retirees
• OP&F’s COLA is three percent for those who were grandfathered prior to pension reform legislation in 2012, and equals the Consumer Price Index for those with at least 15 years of service as of 7/1/13.

Active member contribution rates:
• 8.5% of pay DPFPF
• 12.25% of pay for OP&F

DROP program:
• DPFPF credits 8.0 percent interest to DROP balances up until recently, now dropping 1% a year until 1/1/17 when it’s fixed at 5%
• OP&F’s interest credited to DROP is currently at 2.45 percent as of the first quarter of 2017, and it is adjusted quarterly to the 10-year U.S. Treasury Note Business Day Series with a 5.0 percent the maximum.

After an actuarial experience review in 2015, DPFPF reduced its long term investment return assumption to 7.25%. This change, in addition to significant write downs in its real estate portfolio, pushed a once sound system close to insolvency, with projected depletion dates of 15 years. As a result, a run on the DROP program began and continued until a decision by the Board of DPFPF to freeze lump sum withdrawals from the system in December 2016. In January the Mayor of Dallas asked for a criminal investigation.

With assets on hand appreciating at a less than desirable rate, increases to DROP withdrawals can magnify underperformance of an investment portfolio because withdrawals continue to lower the asset base.

The stability of the DROP program at OP&F, reflected in its actuarially neutral impact on the total fund, is imperative to continuing a program that has clearly helped members but most importantly, underpins the long term security of OP&F not only for today but for generations to come.

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