Report on Pension Costs Charged to Federal Programs for Members of the State Teachers Retirement System of Ohio

EXECUTIVE SUMMARY:

This report provides the results of our audit to assist in negotiations concerning pension costs charged to Federal programs for plan members of the State Teachers Retirement System of Ohio (STRS). Our audit of pension costs generally covered the period July 1, 1992 through July 31, 1993. The purpose of the audit was to determine whether pension costs charged to grants and contracts were in compliance with Federal regulations, generally accepted accounting principles (GAAP), and actuarial standards.

Pension contribution rates must conform to cost principles contained in Office of Management and Budget Circular A-87. The rates must be calculated in accordance with generally accepted accounting and actuarial standards and be actuarially determined. We determined that certain practices clearly do not conform with Federal cost reimbursement principles or applicable actuarial cost methodology.

Our audit determined that excessive charges of pension costs to Federal programs result from (i) establishing a contingency reserve to cover liabilities that could result from deviations from actuarial estimates and projections and (ii) using pension fund investment earnings (actuarial gains) to fund a health care reserve instead of to reduce the retirement fund's unfunded liability.

Office of Management and Budget (OMB) Circular A-87 states that contributions to contingency reserves are not allowable charges to Federal programs. The funding of the health care reserve was not in accordance with prescribed actuarial cost methodology, nor was the reserve actuarily determined. Both of these reserves were funded with retirement fund investment earnings which should have been used to reduce the plan's unfunded liability for future retirement benefits. Since amortization of this future liability is a component used in calculating the employer contribution rates, retirement costs charged to Federal programs are overstated. Federal cost principles do not allow reimbursement of increases in employer contributions to a pension plan that result from the maintenance of special reserves which are actuarily unsupported and unjustified.

By using the investment earnings to fund and maintain the two reserves, instead of to reduce the plan's unfunded liability for future retirement benefits, there is a potential future financial impact of approximately $75 million on programs administered by State of Ohio agencies and other entities within the State, including universities and county and local school districts.

We are recommending that the Division of Cost Allocation (DCA) consider these issues in rate negotiations with the State agencies and other entities whose employees participate in STRS. Future pension costs allocable to the Federal government should be reduced by a share of the retirement fund earnings (actuarial gains) inappropriately transferred to the contingency and health care reserves. Effective July 1, 1996, the reserve for future health care benefits must be based on acceptable accounting methodology in accordance with the revised OMB Circular A-87, using either actuarially determined costs or pay-as-you-go financing. The health care reserve maintained during our audit period clearly did not meet either of these criteria.