The goal of a hybrid plan is to provide an adequate benefit at an affordable cost—a fiscal policy that aligns with any retirement benefit. Reason Foundation’s Pension Integrity Project published best practices for hybrid plans earlier this year. As a compromise between defined benefit and defined contribution structures, hybrid plans, when implemented properly, offer policymakers a best-of-both-worlds blended approach.  

The key consideration for structuring a good DC portion of a hybrid is the actual contribution going into the account. In combination with the guaranteed DB portion, this contribution must be sufficient to help workers plan for and sustain a healthy retirement. Until recent changes were made in Georgia, this was a weakness of the state’s hybrid plan.  

Georgia’s state legislature recently approved a few changes to GSEPS that allow for a greater employer match in its DC portion. Specifically, the employer match contribution was increased from 3% to 5% of a worker’s pay. Moreover, plan members with six or more years of service will see an additional .5% per year, up to a maximum match of 9%. Employer matching contributions are subject to the plan’s vesting schedule; GSEPS vests 20% per year, reaching full vesting at five years of service. 

As a best practice, employee and employer contributions to the DC portion must be sufficient to provide an adequate retirement benefit. For hybrid plans, contributions should be designed in a way that ensures members would get at least a 60% income replacement after 30 years of employment. When designing a plan, policymakers should keep in mind that if roughly 30% of the replacement ratio is coming from the DB plan, the rest should come out of the DC portion. 

For Georgia, the combination of a pension plan and a fully matched 401(k) plan at the newly adopted levels will provide approximately 59% of an employee’s salary in retirement, according to the retirement system’s calculation. With Social Security benefits added, the total benefit could be 90% or more of a member’s final salary, assuming an investment return of 6% over 30 years and a 5% average contribution. For the sake of comparison, the nation’s average 401(k) matching contribution is approximately 3.5%, with only 10% of employers giving a matching contribution of 6% or more. 

In addition to providing an adequate benefit, the creation of a hybrid plan has allowed Georgia to reduce the growth of its pension liability. According to a study performed by the Georgia Department of Audits and Accounts, without the creation of GSEPS, the retirement system’s unfunded accrued liability (UAL) would be $67 million (or 1.5%) higher than it is today and would have necessitated higher employer contribution rates.  

Overall, Georgia’s recent change is a step in the right direction toward ensuring benefit adequacy for the state’s retirees. As it is now designed, the plan ensures that the existing liabilities are managed and a competitive retirement solution is offered. Georgia’s plan strikes a proper balance of risk between employees and employers, provides retirees with secure and predictable retirement, and offers the flexibility they need to get the most out of their retirement contributions.  

The post Georgia reinforces its hybrid retirement plan  appeared first on Reason Foundation.

The interactive map below shows the funded ratios for state-managed public pension systems from 2001 to 2022. A funded ratio is calculated by dividing the value of a pension plan’s assets by the projected amount needed to cover the retirement benefits already promised to workers. The funded ratio values for 2022 are projections based on a -6% investment return. 

Year-to-year changes in investment returns and funded ratios tend to grab attention, but longer-range trends give a better perspective of the overall health of public pension systems.

In 2001, only one state, West Virginia, had an aggregated funded ratio of less than 60%. By the end of 2021, four states—Illinois, Kentucky, New Jersey, and Connecticut—had aggregate funded ratios below 60%.

If investment returns are -6% or worse in the 2022 fiscal year, Reason Foundation’s analysis shows South Carolina would be the fifth state with a funded ratio below 60%. 

Over the same period, 2001 to 2021, the number of states with state-managed pensions with funded ratios above 90% fell from 33 to 20. If all plans return a -6% investment return assumption for 2022, Reason Foundation projects the number of states that have funded levels above 90% would shrink from 20 to six.  The six states with funded levels that would still be above 90% after -6% returns for 2022: Delaware, Nebraska, New York, South Dakota, Washington, and Wisconsin. 

Importantly, the -6% investment return assumption for the 2022 fiscal year used in this map may be too optimistic for some public pension plans. The S&P 500 lost 12% of its value over the 2022 fiscal year from July 1, 2021, to June 30, 2022. Vanguard’s VBIAX, which mimics a typical 60/40 stock-bond portfolio, was down 15% for the fiscal 2022 year ending in June 30, 2022. Thus, given the condition of financial markets this year, the public pension plans with fiscal years that ended in June 2022 are likely to report negative returns for the 2022 fiscal year.  

Another useful long-term trend to look at are the unfunded liabilities of state-run pension plans. Whereas a pension system’s funded ratio takes the ratio of assets to liabilities, unfunded liabilities are the actual difference between the pension plan’s assets and liabilities. Unfunded liabilities can be conceptualized as the pension benefits already promised to workers that are not currently funded by the plan. Again, the values for the 2022 unfunded liabilities map are a projection using an investment return of -6%. 

The five states with the largest unfunded liabilities are California, Illinois, New Jersey, Pennsylvania, and Texas. In fiscal year 2021, the unfunded liabilities of those states totaled $434 billion and would jump to $620 billion in 2022 with a -6% return.  

For more information on the unfunded liabilities and funded ratios of state-run pensions, please visit Reason’s 2022 Public Pension Forecaster.

Notes

ⁱ The state-funded ratios in this map were generated by aggregating (for state-managed plans) the market value of plan assets and actuarially accrued liabilities. Prior to 2002, Montana and North Carolina reported data every two years, therefore for 2001 figures from 2002 are used. Figures for Washington state do not include Plan 1, an older plan that is not as well funded.

ⁱⁱ The discount rate applied to plan liabilities will impact the funded ratio of a plan. Therefore, the map above can be best thought of as a snapshot of state-funded ratios based on plan assumptions by year. Overly optimistic assumptions about a pension plan’s investment returns will result in artificially high-funded states. Conversely, pulling assumptions downward, while prudent, will result in a worse-looking funded ratio over the short term.

ⁱⁱⁱ In addition to projections for fiscal 2022, some public pension plans in 29 states have yet to report their complete fiscal 2021 figures and therefore include a projection estimate for 2021 as well. Thus, 2021 projections were used for at least one plan in the following states: Alabama, Alaska, Arkansas, California, Colorado, Georgia, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Missouri, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oregon, Pennsylvania, Texas, Tennessee, Utah, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.

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Based on a -6% return for fiscal 2022, the aggregate unfunded liability of state-run public pension plans will be $1.3 trillion, up from $783 billion in 2021, the Pension Integrity Project finds. With a -6% return in 2022, the aggregate funded ratio for these state pension plans would fall from 85% funded in 2021 to 75% funded in 2022. 

The 2022 Public Pension Forecaster below allows you to preview changes in public pension system funding measurements for major state-run pension plans. It allows you to select any potential 2022 investment return rate to see how the returns would impact the unfunded liabilities and funded status of these state pension plans on a market value of assets basis.

The nation’s largest public pension system, the California Public Employees’ Retirement System (CalPERS), provides a good example of how much one bad year of investment returns can significantly impact unfunded liabilities, public employees, and taxpayers.

If CalPERS’ investment returns come in at -6% for 2022, the system’s unfunded liabilities will increase from $101 billion in 2021 to $159 billion in 2022, a debt that would equal $4,057 for every Californian. Its funded ratio will drop from 82.5% in 2021 to 73.6% in 2022, meaning state employers will have less than three-quarters of the assets needed to pay for pensions already promised to workers. 

Similarly, the Teacher Retirement System of Texas (TRS) reported $26 billion in unfunded liabilities in 2021. If TRS posts annual returns of -6% for the fiscal year 2022, its unfunded liabilities will jump to $40 billion, and its funded ratio will drop to 83.4%. The unfunded liability per capita is estimated to be $1,338. 

The table below displays the estimated unfunded liabilities and the funded ratios for each state if their public pension systems report -6% or -12% returns for 2022. 

Estimated Changes to State Pension Unfunded Liabilties, Funded Ratios

The first three quarters of the 2022 fiscal year clocked in at 0%, 3.2%, and -3.4% for public pensions, according to Milliman. The S&P 500 is down more than 20% since January, suggesting that the fourth quarter results will be more bad news for pension investments.

Considering the average pension plan bases its ability to fund promised benefits on averaging 7% annual investment returns over the long term, plan managers are preparing for significant growth in unfunded liabilities, and a major step back in funding from 2021. 

The significant levels of volatility and funding challenges pension plans are experiencing right now support the Pension Integrity Project’s position last year that most state and local government pensions are still in need of reform, despite the strong investment returns and funding improvements in 2021. Unfortunately, many observers mistook a single good year of returns—granted a historic one—as a sign of stabilization in what was a bumpy couple of decades for public pension funding. On the contrary, this year’s returns, as well as the growing signs of a possible recession, lend credence to the belief that public pension systems should lower their return expectations and view investment markets as less predictable and more volatile. 

State pension plans, in aggregate, have struggled to reduce unfunded liabilities to below $1 trillion ever since the Great Recession, seeing this number climb to nearly $1.4 trillion in 2020. Great results from 2021 seemed to finally break this barrier, with the year’s historically positive investment returns reducing state pension debt to about $783 billion. Now, state-run pension plans will again see unfunded liabilities jump back over $1 trillion, assuming final 2022 results end up at or below 0%. 

It is important not to read too much into one year of investment results when it comes to long-term investing. But during this time of economic volatility, policymakers and stakeholders should recognize that many of the problems that kept public pension systems significantly underfunded for multiple decades still exist. And many pension plans are nearly as vulnerable to financial shocks as they were in the past.

Going forward, state and local leaders should continue to seek out ways to address and minimize these risks, making their public retirement systems more resilient to an uncertain future. 

Webinar on using the 2022 Public Pension Forecaster:

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This investment performance is in stark contrast with last year when ERS had a negative 3.6% return (a loss) and TRS saw a modest 2.9% gain. The high investment returns are not unique to Georgia: Nationally, public pension plans have averaged investment returns of 27% for the fiscal year 2021.

The high returns are great news for ERS, a multi-tier public pension plan that enrolls all new employees to a hybrid defined-benefit (pension) and 401(k) plan. The structure of the hybrid benefit provides accountability and manages the burden that unfunded liabilities have on government budgets and taxpayers. According to the latest reporting, ERS now has $2.3 billion in unfunded liabilities and is 87.6% funded, a significant improvement from the previous year when it had $4.2 billion in unfunded liabilities and just 76.2% funded.

Strong investment returns are great news for Georgia’s teachers as well. Unfortunately, a year of good returns will hardly be the long-awaited salvation for TRS, which is the pension plan serving the state’s educators. As pointed out in a previous analysis, the teachers’ retirement plan faces several significant challenges that will require more than a single year of great investment returns to fix.

Going forward, it should not be assumed that Georgia’s pension plans’ high investment returns will continue. Experts predict the average investment return for public pension systems over the next few decades is likely to be less than TRS’ current target of 7.25%. Regardless of the high investment returns now, TRS should quickly lower this investment return assumption, which is above the national average of 7.0%. One year of excellent returns will not change the fact that TRS is most likely underestimating its unfunded liabilities.

Before the COVID-19 pandemic, there was a discussion of possible reforms to TRS. Among the proposals discussed were lowering assumed investment return rate assumptions, shortening the amortization schedule, and creating a new benefit tier.

The Pension Integrity Project at Reason Foundation pointed out that lowering the return rate assumption can improve a public pension system’s ability to keep promises by reducing the risk of insolvency and improving the long-term predictability of contribution rates. Shortening the time frame to pay off pension debt, in turn, can reduce the total long-term costs of the pension system. Creating a new benefit tier would not result in any changes to the benefits of current participants or increase state contributions, and it could lower the overall risk of plans’ underperformance.

A single year, or even several years, of exceptionally high investment returns, would be welcome news for TRS. Even a streak of high returns, however, will not change the harsh truth that TRS and many other public pension plans still face significant funding risks and unfunded liabilities going forward.

Georgia’s policymakers need to address these risks to protect taxpayers, employees, and retirees. Absent meaningful pension reforms to reduce financial risk and improve the solvency of the teachers’ retirement plan, the state will increasingly have to divert money away from other public priorities, such as K-12 education and infrastructure repairs, to pay its rising pension costs.

A version of this column was originally published by the Georgia Public Policy Foundation.

The post Georgia’s pension plans pose financial risks to public employees, taxpayers appeared first on Reason Foundation.

Funded ratios are a simple and useful metric that can help to assess the financial health of a pension plan. Calculated by dividing the projected value of a pension plan’s assets by the cost of its promised pension benefits, funded ratios can reveal if a pension system is on track to be able to pay for the retirement benefits that have been promised to workers.

Over time, changes in a pension plan’s funded ratio, also referred to as a pension’s funded status, can show the rate at which the plan’s debt is growing.

In 2001, West Virginia was the only state where public pension plans had an aggregate funded ratio of less than 60 percent. However, 18 years later, in 2019, nine states faced aggregate funded ratios below 60 percent.

In that same time period, the number of states with funded ratios below 70 percent (but above 60 percent) grew from three to 14. Together, these numbers show that, as of 2019, 23 states had less than 70 percent of the assets on hand that they need to be able to pay for promised future retirement benefits.

Perhaps even more alarming is the fact that over the last two decades, the number of states with fully-funded pensions fell from 20 to just one. As of 2019, South Dakota was the only state without any public pension debt.

The interactive map below shows the change in each state’s aggregated pension plan funded ratio from 2001 to 2019. Because many states administer multiple public pension plans we combined the pension liabilities and actuarial value of assets of all the pension plans in a state to calculate their aggregate funded ratio for the data visualization.

We recommend viewing this interactive chart on a desktop for the best user experience.

Previous analysis has shown that the average state-level funded ratio, using the market value of assets, dropped from 97.7 percent in 2001 to roughly 73.6 percent in 2019. This decline of 24.1 percentage points is cause for concern for workers, taxpayers, and lawmakers.

As public pension debt grows, so does the cost of saving for retirement benefits. Public pension underfunding not only puts taxpayers on the hook for growing pension debt but could jeopardize the retirement security of teachers, public safety officials, and other state employees. Left unaddressed, pension debt will also continue to pull resources from other public priorities like road repairs and K-12 education in most states.

The post Public Pension Plans’ Funded Ratios Have Been Declining for Years appeared first on Reason Foundation.

The legislature’s inability to generate consensus on any of the proposed bills is a bad sign. However, given that the legislation did not sufficiently address the scale of the problem that existed even before the COVID-related crash, there is an opportunity for better reform in the future.

During the past two legislative sessions, Georgia’s House Retirement Committee has deliberated on four bills—HB 662, HB 667, HB 109 and HB 830—aimed at improving the solvency of the state’s Teacher Retirement System (TRS). For the purpose of this discussion, we will assume that the legislature—which at press time remained quarantined in a suspended legislative session—is unlikely to take action on these bills prior to Sine Die for the 2020 legislative session once scheduled.

In a February analysis, Reason Foundation’s Pension Integrity Project found that HB 662 and HB 667, while not comprehensive solutions to the challenges facing TRS, would have significantly improved the system’s long-term solvency. HB 109 would have marginally helped by adding contributions, but HB 830 would have likely increased risk and lessened valuation transparency, which seems counterproductive.

Actuarial consultant Milliman recently predicted that pension funding ratios would decline by over 20% as a result of COVID-19. If warnings like this come to fruition the pandemic’s impact on the global capital markets is almost certain to expose pension plan vulnerabilities across the country, including Georgia TRS. Because of this, it is important to understand the impact that the proposed bills could have had in order to guide future policy decisions.

Taken together, the proposed bills reveal that the legislature senses pension risks need to be reduced and addressed. Yet it seems that the legislature is also counterintuitively clinging to a false hope that the problem can be solved by investing in riskier assets that bring in even higher volatility and unpredictability.

If anything, the current fiscal distress facing TRS highlights the need for a comprehensive approach to adjusting TRS assumptions, funding policy, and plan design elements. Doing so would create a resilient, fiscally stable pension system that would deliver earned benefits to employees without becoming an overly-burdensome drag on annual budgets. Therefore, it is more important than ever to keep the conversation about potential improvements alive for future legislative sessions. Below is an analysis of previously proposed legislation:

HB 662 – Lowered Assumed Rate of Return

This bill would have lowered the TRS assumed rate of return (ARR) from 7.25 percent to 6.75 percent, recognizing a more accurate accounting of the plan’s promised benefits. It would have resulted in a much needed additional $17.7 billion in employer contributions over the next 30 years (see Figure 1). As our previous analysis discussed, this outcome, while a significant increase in cost, would have improved the system’s ability to keep promises by reducing the risk of insolvency and improving the long-term predictability of contribution rates.

With the failure of HB 662, the risk of rapidly growing pension debts remains high. Lower investment return scenarios, similar to what we appear to be experiencing now, meant that the system’s unfunded liabilities and costs of servicing pension debt would grow more than they would have under the reduced ARR in HB 662. Like any debt—especially debt that grows at an annual rate matching the plan’s ARR, 7.25 percent in TRS’s case—the more you prepay now, the less you pay overall in long-term interest costs.

Unfunded liabilities will continue to grow if the ARR is missed. This is a very likely scenario in both the short and long term. Actuarial forecasting shows that a long-term average investment return of 6 percent would have led to unfunded liabilities growing as high as $43 billion under the pre-COVID status quo. Unfunded liabilities would have fallen to $39 billion under HB 662, demonstrating that although it would have reduced the total amount of accumulated debt over the next 30 years, the serious level of risk facing the system would have remained, along with the need for more aggressive shifts in assumption setting.

Figure 1. Projected Employer contributions under HB 662

Source: Pension Integrity Project actuarial forecast of Georgia TRS under HB 662.

HB 667 – Shortened Amortization Schedule

The purpose of HB 667 was to shorten the schedule of pension debt payments by putting all new unfunded liabilities accrued each year on shortened 15-year payment schedules. This would have resulted in paying off legacy unfunded liabilities by 2039, a decade sooner than the currently planned 2049 end date. Much like any other type of debt, unfunded pension liabilities require additional payments that increase the overall cost. The longer the amortization schedule used to pay off pension debt, the higher the long-term cost of servicing that debt. Shortening the timeframe to pay off pension debt reduces the fund’s exposure to this factor,  significantly reducing the ultimate long-term cost to taxpayers. Although the bill would have meant increased near term contribution rates, it would have reduced the total long-term cost by $7 billion over the 30-year timeframe (see Figure 2).

Figure 2. Projected Employer Contributions under HB 667

Source: Pension Integrity Project actuarial forecast of Georgia TRS under HB 667.

The reform would have significantly improved the system’s ability to keep pension promises. Assuming average market returns match the TRS expectation of 7.25 percent, the legislation would have helped the plan reach fully funded status by 2039. Even if the legislation was enacted, TRS would still face significant risks from an overly optimistic assumption on returns. However, because of the faster debt payment schedule, HB 667 would have improved the predictability of contribution rates in the long-term.

HB 109 – Creating a New Benefit Tier

House Bill 109 would not have made any changes for current participants or increased state contributions. Rather, it would have created a new tier of membership in the existing defined benefit plan for individuals hired on or after July 1, 2019. The new tier would offer a cap on pensionable compensation, remove the ability to retire at any age with 30 years of service and increase the allowable employee contribution rate range to 6-10 percent (from 5-6 percent).

Notably, HB 109 did not address the key variables that have contributed to the system’s debt, which were at least partially addressed by HB 662 and HB 667, including underperformance risks associated with the ARR, actual demographic experience not lining up with assumptions, and amortization policies.

Figure 3. Projected Employer Contributions under HB 109

Source: Pension Integrity Project actuarial forecast of Georgia TRS plan (baseline) and HB 109.

Note: Chart includes all the changes made to asset smoothing and ARR made during 2019-2020 legislative session.

HB 830 – Alternative Investments

House Bill 830 intended to allow TRS to make changes to its asset allocation by permiting so-called “alternative” investments to increase to as much as 10 percent of the total portfolio share. These types of assets include investments in real estate, private equity, hedge funds and private debt. Alternative investments have been attractive to pension funds in recent years because of the perception that they can “make up” for the growing gap between risk-free interest rates and investment return targets for public pension portfolios. As we have written prior, our modeling suggests that the probability of TRS achieving its target return was somewhere between 10 percent and 31 percent before the onset of the COVID pandemic-driven global market turmoil of early 2020.

In contrast to HB 662, which attempts to de-risk the pension system by lowering the assumed rate of return, HB 830 actually exposes the system to more risk by adding assets that carry significantly more uncertainty.  Although alternative investments can be an attractive addition to the portfolio while the system is in search of higher yields, there are certain complications, such as an inherent difficulty to objectively value alternative assets. Reason colleague Marc Joffe has written: “The reliance on assumptions and judgements for these alternative investments can result in large discrepancies between valuation estimates and true value.” A better alternative is to lower the investment return to reduce the need to chase higher yields.

Conclusion

Though this legislation is not expected to pass, all four bills attempted to elevate the impact of the Teachers Retirement System of Georgia’s solvency crisis. However, whereas HB 662 and HB 667 were targeting some of the main causes of TRS’ $22 billion in pension debt, the other two would have resulted in potentially reducing some marginal costs without solving the key issues that have driven the growth of unfunded liabilities in the first place.

Going forward the legislature needs to adopt a comprehensive approach to achieving fiscal sustainability for TRS. This is for the benefit of the employees and retirees it serves and the taxpayers responsible for covering the spiraling costs of pension debt. This means adopting policies like lowering assumed return assumptions and shortening amortization schedules, which would both pay off existing debt and addresses the sources of debt growth and risk.  Without the necessary changes, further growth in unfunded liabilities and long-term costs jeopardizes retirement security for teachers and crowds out funding for other public services taxpayers rely on.

The post Proposed Reforms to Georgia’s Teacher Pension System Missed the Mark appeared first on Reason Foundation.

Any time annual investment returns fall below the assumed rate of return (ARR), a plan must find ways to make up the shortfall between expected and actual assets. Sustained experience below a plan’s ARR results in growing pension debt, which has been a significant contributor to the funding shortfalls in public pension plans across the nation.

In response to decades of investment performance below expectations, most public pension plans have been gradually adjusting their assumed rates of return down to more realistic levels.

This map (click to zoom) shows the changes in assumed rates of return held by state pension systems from 2001 to 2018, along with the national average rate for comparative purposes. And this visualization highlights the different ways states have responded to the ubiquitous challenge of lower long-term returns. [Note: for cases of states with multiple public pension plans, the analysis uses each plan’s accrued liability to weight the state’s combined assumed rate of return.]

As an example, North Carolina lowered its ARR well before most other states. As a result, they experienced fewer unexpected costs over the studied timeframe, which helped them become one of the nation’s healthiest states in pension funding — with a 90 percent funded ratio at this time.

Colorado, on the other hand, was slow to adjust its ARR. Market returns below the state’s expectations were the largest contributor to Colorado’s pension debt over the past two decades, adding $8.4 billion in unexpected costs. Now, the state only has 60 percent of the funding needed to cover the retirement promises already made to its public servants.

States have been lowering their assumed rates of return across the board, but most maintain assumptions that are still too high. Many financial advisors believe that investors can expect to see continued overall investment performance that is below the levels experienced in the past. With this in mind—and the unignorably turbulent market results as of late—state policymakers should consider reducing the risk of future pension debt accrual by lowering their ARR even further.

The sooner government pension plans adopt more conservative return assumptions, the better off they will be down the road. More importantly, acting early can help ensure that promised pension benefits will be available for their public workers.

Map: State Pension Plans’ Assumed Rates of Return 2001-2018 (png)

Map: State Pension Plans’ Assumed Rates of Return 2001-2018 

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In This Issue:

Articles, Research & Spotlights 

• North Carolina’s Pension System Is Strong, But Risks Loom
• Analyzing Proposed Changes to Georgia’s Teacher Retirement System
• Changes to Improve New Mexico’s Pension Board 
• Ohio Considers a Freeze on Cost-of-Living Adjustments
• When Governments Go Under, Who’s Responsible for Pension Debts?

News in Brief

Quotable Quotes on Pension Reform

Featured Graph

Contact the Pension Reform Help Desk

Articles, Research & Spotlights 

North Carolina Teachers’ and State Employees’ Retirement System: A Pension Solvency Analysis

North Carolina’s largest pension plan, the Teachers’ and State Employees’ Retirement System (TSERS), is one of the best-funded plans in the country boasting a nearly 90 percent funded ratio, but even some of the better-funded pension systems are showing signs of trouble. While TSERS enjoys funding above the national average, the system’s unfunded liabilities have grown significantly over the past two decades. This policy study, by the Pension Integrity Project at Reason Foundation and the John Locke Foundation, takes an in-depth look into North Carolina’s pension system, identifying the primary causes of the current $9.6 billion in unfunded liabilities, risks facing the system and potential solutions to ensure the long-term retirement security of their members.

» FULL ARTICLE

The Impacts of Proposed Changes to Georgia’s Teacher Retirement System

This legislative session the Georgia legislature has been evaluating two major reforms proposed for the state’s underfunded Teachers Retirement System (TRS). The first, House Bill 662, would lower the retirement system’s assumed rate of return, while the second, House Bill 667, would accelerate the state’s payment of TRS pension debt by scheduling all additional unfunded liabilities to be paid within 15 years instead of the current 30-year plan. In this analysis, Reason’s Jen Sidorova and Leonard Gilroy use actuarial forecasts to evaluate the fiscal impact of these proposed changes. They find that both reforms would result in a more stable future for TRS, with more predictable contributions and a higher chance of reaching full funding. However, absent additional reforms that are designed to improve solvency, the proposed reforms will likely be diminished by the continued accumulation of unfunded—but earned and legally protected—benefits. 

» FULL ARTICLE

Restructuring New Mexico’s PERA Board Would Improve Expertise, Balance Representation Long-Term

In addition to the major contribution rate changes recently enacted in Senate Bill 72, New Mexico legislators considered, but did not enact, legislation that would have restructured the state’s Public Employees Retirement Association (PERA) pension governing board via Senate Bill 201. The reform would have reduced the overall size of the board and improved the representational balance between the pension system’s various stakeholders. In this commentary, Reason’s Anil Niraula, Steven Gassenberger and Leonard Gilroy evaluate the proposal and explain why a new board structure could improve the overall financial expertise and stakeholder representation of the governing body.

» FULL ARTICLE

How Ohio’s Proposed Cost-of-Living Adjustments Would Impact OPERS’ Unfunded Liabilities

Managers of the Ohio Public Employees Retirement System (OPERS) are considering a temporary freeze on cost-of-living adjustments as a way to reduce costs and slow the growth of the $24.4 billion shortfall in funding needed to pay for promised pension benefits. OPERS has yet to release a report on the fiscal impact of such a freeze, but the savings are not expected to be a complete fix to the state’s underfunding struggles. In this commentary, Reason’s Marc Joffe and Anil Niraula detail the likely fiscal impacts of the proposed change and examine why OPERS’ shortfalls, as given in official reports, are likely understated due to overly optimistic investment return assumptions. As a result, the state likely needs much more comprehensive reforms if it wants to resolve its growing pension-related challenges. 

» FULL ARTICLE

When Governments Go Insolvent, Should Others Absorb Their Retirement Plans’ Costs and Risks?

A San Francisco ballot measure, on the city’s March 3 ballot, asks voters if the city can absorb the retirement plans and promises of an insolvent housing authority. If passed, the city would take on the responsibility of funding retirement promises that were made and guaranteed by the now-nonexistent government authority. Reason’s Marc Joffe notes that while the actual impact of this decision is likely relatively minor due to the small number of pension accounts being transferred, the issue does raise important questions about the fairness of larger government —and taxpayers— taking on the pension obligations of struggling smaller government entities.

»FULL ARTICLE

News in Brief

Calm Amid the Chaos: Wisconsin’s Pension System and the 2008 Financial Crisis: 
The 2008 financial crisis had a detrimental effect on the funded levels of many state and local pension plans. Many public pension plans were forced to initiate reforms in order to recover from the impact of the financial crisis and recession. Anthony Randazzo and Scott Alexander of the Equable Institute have written a paper examining the steps Wisconsin took in order to reach full funding. They detail how Wisconsin implemented a number of important reforms, such as mandatory funding, to fully meet actuarial standards, as well as structuring the board in ways that help insulate it from politics. The paper can be found here. 

An Introduction to Police and Fire Pensions:
Local governments are generally held responsible for providing police and fire-fighting services. However, the fiscal stress of hiring personnel has risen due to the growing price of providing public retirement plans. Jean-Pierre Aubrey and Kevin Wandrei of the Center for Retirement Research at Boston College have released their latest brief on providing for retirements for these workers. They find that while public safety retirement plans are more costly than other workers due to early retirements, the plans are generally significantly smaller than general employee plans and do not make up a majority of local government spending. The brief can be found here. 

The Pension Debt Levels of Illinois’ State and Local Governments:
The Illinois state government, and local governments across the state, are not contributing enough to their pension plans, according to a white paper by the Institute for Illinois Public Finance. The author, Kenneth Kriz, director of the institute, concludes “current contributions are insufficient to pay off their unfunded liability debt in the timeframe that Illinois law requires.” He also argues that the assumptions built into the actuarial analyses are overly optimistic. The white paper can be found here. 

Quotable Quotes

 “A stable and solvent PERA matters to all New Mexico taxpayers. We must make changes now – the alternative is to saddle New Mexicans with unacceptable risk. I want to thank senators of both parties for recognizing the essential nature of this reform and the shared sacrifice required to ensure New Mexico’s pension plan remains the finest in the country.”

—New Mexico Gov. Michelle Lujan-Grisham, quoted in a press release, Feb. 12, 2020.

“It’s a great year and it helps absolutely, but it doesn’t solve the problem.  Market returns alone aren’t going to improve pension funding significantly.”

—Karen Carraher, executive director of Ohio Public Employees Retirement System (OPERS), commenting on the system’s 2019 returns in “Your OPERS benefit cuts questions answered,” The Columbus Dispatch, Jan. 16, 2020.

“People are living longer and working longer and the minimum retirement age was set decades ago. The biggest recruiting issue for state employees I hear is pay, not benefits. Lowering the cost of the pension system will lower contribution rates for both taxpayers and employees, raising take-home pay.”

—Duey Stroebel, Wisconsin state senator, quoted in “Proposed bill would raise the retirement age for teachers, public workers,” WIProud, Jan. 31, 2020.

“A deputy with a $40,000 salary is an $80,000 employee… For a small county like us, it’s a huge deal. If you look at the primary property tax – we bring in about $2.8 million. A third of that’s going to just the excess state retirement payments.”

—Apache County Manager Ryan N. Patterson discussing the high cost of pension payments in “Pension woes haunt county, town budgets,” White Mountain Independent, Feb. 11, 2020.

Featured Chart

Each month we feature a pension-related chart or infographic of interest. This week we looked at the aggregate funded ratio and employer contribution for teacher pension plans across the country. 

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Since the fiscal impacts will likely drive the committee’s deliberation on these bills in the upcoming legislative session, understanding the bills’ short-term costs along with their potential long-term benefits is critical to fully evaluating these reforms. 

Actuarial modeling performed by Reason Foundation’s Pension Integrity Project—calibrated and confirmed by an internal short-term actuarial study prepared for Georgia’s House Retirement Committee—provides some insight into the long-term impact of the proposed legislative changes.

The two bills address TRS’ challenges in different ways:

• HB 662 would lower the assumed rate of return (ARR) for TRS from 7.25 percent to 6.75 percent.
• HB 667 would require all current legacy unfunded liabilities to be paid off by 2037, and put all new unfunded pension liabilities accrued in any given year on a 15-year amortization (e.g., “pay-down”) schedule instead of the current 30 years. 
• Both bills would accelerate the frequency of internal TRS actuarial experience studies from the current every five-year review to a lookback every three years.

Both changes would result in higher annual contributions into the system in the short-run, but for that cost Georgians would enjoy a more stable retirement system, both in future contributions and overall retirement security for members.

Figure 1 shows how HB 662 would impact employer contributions once the ARR is reduced by 0.5 percent. The forecast indicates the pension reform would result in an additional $17.7 billion in contributions over the next 30 years.

The act of lowering a pension fund’s assumed rate of return has the effect of reducing expected contributions resulting from investment gains, which means the system will need higher annual contributions from taxpayers and/or its members to maintain its current funding trajectory.

[Note: The yellow “baseline” trend line in each figure that follows reflects the current forecasted employer contribution rates for TRS.] 

Figure 1. Projected Employer Contributions with Reduced Return Assumption (HB 662)

Source: Pension Integrity Project actuarial forecast of Georgia TRS under HB 662. 

Figure 2 illustrates that under HB 667—modifying the amortization schedules for both legacy and future unfunded liabilities—the plan would pay off legacy unfunded liabilities by 2039. Without this reform, TRS expects to take until 2049 to pay off these debts.

The forecast analysis indicates that shortening the debt-payment schedule by a decade would result in modest increases in contribution rates in the near-term but would reduce total 30-year employer contributions by almost $7 billion dollars when compared to the current baseline trajectory. 

The total long-term cost of amortizing both legacy and any future unfunded liabilities would be lower under this proposal, mainly because pension debt would not accumulate as much interest if it is paid off sooner. Because accrued pension liabilities grow at the plan’s discount rate—in this case 7.25 percent annually—the sooner one pays down unfunded pension liabilities the less expensive it will be.

Figure 2. Projected Employer Contributions with Reduced Return Assumption and Shorter Amortization Schedule (HB 667)

Source: Pension Integrity Project actuarial forecast of Georgia TRS under HB 667. 

Figure 3 forecasts the system’s unfunded liabilities under HB 662 and HB 667, respectively, if one or the other were to become law. Assuming investment returns match the plan’s expectations, the two reforms are likely to make significant changes to the system’s funding status.

HB 662 would increase the amount of recognized unfunded liabilities in the mid-term, but will gradually line up with the current trajectory while HB 667 accelerates pension debt payments, so it understandably decreases unfunded liabilities much faster and eliminates the current $22 billion shortfall by 2040. 

Figure 3. Effects of HB 662 and HB 667 on TRS Pension Debt

Source: Pension Integrity Project actuarial forecast of Georgia TRS using HB 662 and HB 667. 

As the Pension Integrity Project’s fiscal 2018 analysis of TRS suggested, the main contributor to the system’s declining fiscal health has been low investment returns. Although the TRS governing board took an important step last year towards reducing the system’s risk by lowering the ARR to 7.25 percent from 7.5 percent, this is a small reduction relative to what is likely needed given diminished capital market expectations for investment returns over the next decade or two. It would be prudent to consider lowering the ARR even further as proposed in HB 662 given the system’s financial future relies heavily on the accuracy of this assumption. 

A TRS investment portfolio analysis using various capital market forecasts issued by leading global financial institutions suggests that TRS is more likely to achieve lower-than-assumed returns, potentially in the five-to-six percent range in the next 10-15 years—a timeframe used due to the uncertainty of investment market forecast extending more than two decades into the future.

In what follows, Reason Foundation’s Pension Integrity Project examines the possible impacts on the Teachers Retirement System (TRS) of Georgia’s unfunded liability over the next 30 years using a six percent investment return scenario. 

As shown in Figures 4 and 5, projected unfunded liabilities can still vary greatly depending on the plan’s long-term market experience. A long-term investment return of six percent leads to unfunded liabilities growing to as high as $39 billion under HB 662 and $29 billion under HB 667. Both outcomes are better than the status quo, where a six percent average return would drive unfunded liabilities as high as $43 billion.

It should also be noted that under both reform scenarios, unfunded liabilities would not grow as much or as fast then they would under the status quo. 

Figure 4. Sensitivity of Pension Debt After HB 662

Source: Pension Integrity Project actuarial forecast of Georgia TRS using HB 662. 

Figure 5. Sensitivity of Pension Debt After HB 667

Source: Pension Integrity Project actuarial forecast of Georgia TRS using HB 667. 

Figure 6 presents the results of a combination scenario in which both bills are assumed to be enacted. While the reduction in risk would expose otherwise unaccounted liabilities in the short-term, TRS’ unfunded liabilities would be eliminated five years earlier if both reforms were enacted, assuming expected returns are realized. 

Figure 6. Sensitivity of Pension Debt after Both HB 662 and HB 667 pass

Source: Pension Integrity Project actuarial forecast of Georgia TRS using HB 662 and HB 667. 

Perhaps more striking in terms of conveying the potential risk mitigation benefits of the proposed reforms is that in the case of an underperforming market environment—a hypothetical, but realistic, six percent average investment return—the plan accumulates a significantly higher unfunded liability over time, nearly double the current level as shown by the dotted yellow line in Figure 6.

By contrast, if both bills were to pass and TRS experienced an average six percent investment return, unfunded liabilities would not be entirely eliminated but would fall to less than half the current level, demonstrating a clear risk reduction benefit. 

Conclusion

Both HB 662 and HB 667 would reflect important steps towards putting the plan on track for long-term solvency and be fiscally prudent steps to take in the process of shoring up TRS for future educators. HB 662 would lower the assumed investment return to a more realistic level, while HB 667 would establish a shorter amortization schedule more in line with guidance from the Society of Actuaries, using larger contributions upfront to reduce long-term costs. 

That said, even taking such important steps would not obviate the need to continue seeking additional reforms down the road. For example, while HB 662 would represent a positive step by adopting a more conservative investment return assumption, continuing reductions would further reduce the risk of future underfunding. The assumed rate of return is just one assumption among many that impact TRS.

Analysis of the causes of TRS pension debt reveals other important factors that led to the decline in the fiscal health of the plan, the most important of them being missed demographic assumptions. 

Unfortunately, neither proposal would address the chronic problems and additional costs driven by missed demographic assumptions, nor would they expand retirement security options offered to retirees unwilling to commit 30-plus years of their careers to government service upon being newly hired. The current structure generally benefits those who stay in the system their entire career, leaving those who switch to a different career or relocate to a different state with little to no retirement savings. Providing additional options could better serve a larger range of teachers and accommodate a modern workforce that tends to value more flexibility and portability when considering retirement.

There is a range of options and trade-offs to consider before policymakers decide how to move forward with reforms to improve TRS and its long term solvency. Finding effective ways of managing existing pension debt while reducing future risks the plan could face should be the primary focus.

Judging by the variety of challenges facing TRS, it is unlikely that any single change in policy (either HB 662 and HB 667) would achieve long-term fiscal solvency goals. In that light, both bills offer serious policy options to start—but not end—a process of reform to ensure that Georgia teachers and taxpayers will be able to depend on the long-term financial stability of TRS.

Below we present a breakdown of how well HB 662 and HB 667 meet the Pension Integrity Project’s reform objectives: 

Assessing the Impacts of Proposed Changes to Georgia’s Teacher Pension System – House Bill 662

Assessing the Impacts of Proposed Changes to Georgia’s Teacher Retirement System – House Bill 667

The post The Impacts of Proposed Changes to Georgia’s Teacher Retirement System appeared first on Reason Foundation.

Public pensions in the U.S. are underfunded anywhere from $1.6 trillion to $5.96 trillion, depending on the methods used to discount the pension promises made to past and current workers. As The Economist points out, colossal pension debt burdens in many jurisdictions, with cities in Illinois serving as a notable example, are imposing tremendous budgetary pressure on governments and taxpayers.

Another example is the Kentucky Retirement Systems, which combined were around 120 percent funded in 2001, with employers contributing just 1.9 percent of their payroll. Fast-forward to 2018, the state’s retirement system was less than 60 percent funded—meaning the system has 60 percent of the money to pay for benefits already promised to workers— on average, while employers contribute 41 percent of payroll costs to the system.

The Arizona State Retirement System and Georgia’s Teachers Retirement System are other examples where outdated assumptions about investment return and funding practices have helped generate billions in pension system shortfalls.

As the Pension Integrity Project has highlighted previously (here, here, and here), the main culprits of the public pension shortfalls are investment returns failing to meet overly optimistic expectations and insufficient pension contributions from employees and employers. 

Furthermore, with actual payrolls growing slower than plan actuaries have assumed (partly due to shorter careers and a slow post-recession recovery by state and local governments), and many public workers living longer than estimated, the key assumptions that pension plans have relied on to predict their future costs have often been out of sync with the changing reality. 

One piece of the puzzle is the loose actuarial rules on assumptions and funding mechanisms, which vary significantly between private and public-sector retirement systems. For example, under the federal Employee Retirement Income Security Act of 1974 (ERISA) law enacted to help protect the solvency of private-sector pension plans, the discount rate used by private plans must be based on the cost of debt, which is the yield on AA-rated corporate bonds. Thus, by law, corporate pension systems tend to recognize the higher costs of pension promises by applying less risky, lower discount rates, which are the rates pension systems use to put a value on the current cost of their future pension obligations.

That is why, for example, faced with a $22.4 billion shortfall, General Electric recently froze pension benefits for 20,000 employees. Similarly, FedEx, facing $4 billion in pension debt, recently decided to discontinue its traditional pension plans for new hires. FedEx says it will be offering a higher 401(k) plan contribution match for new and current employees starting in 2021.

These different accounting approaches might lead one to erroneously infer that it is cheaper to fund a public-sector pension than a private-sector one. But in fact, it all comes down to the way pension costs are accounted for.

In reality, the American public-sector pension deficit is likely closer to the $4.4 trillion estimated by Moody’s Investors Service than some of the other lower estimates.  For context, $4.4 trillion is equivalent to the economy of Germany.

The Economist’s article is yet another reminder that the public-sector pension crisis requires an honest reexamination on the actuarial cost of public pension promises. States and cities need concrete reforms (like those enacted in Michigan and Arizona) that promote a “shared sacrifice” mentality, reduce insolvency risks, and make pension funding more resilient to economic turbulence.

Comprehensive reforms that address all of the causes of the current pension debt are needed not only to protect taxpayers from unchecked growth in costs but also to ensure the retirement security of teachers, public safety personnel and other public employees around the country who are expecting the pension benefits they’ve been promised to be there when they retire.

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The pension system—currently only 80.2 percent funded with a whopping $18.6 billion in unfunded liabilities (based on a market value of assets)—is long overdue for changes, and it might seem like any fix would be helpful in this situation. But the question must be asked, are these proposed adjustments enough to guarantee long-term fiscal solvency, or are they merely a band-aid on an open wound?

Summary of GDAA Report No. 18-11: Recommendations to Improve TRS Solvency

The first report responded to a legislative request on various aspects of Georgia’s state-run pension plans, including a review of reform options that could decrease employer contributions and risk while maintaining TRS’s structure as a defined-benefit plan. The report recommends a number of changes that vary in fiscal impact, as viewed through the lens of the near-term future (fiscal years 2021-2025).

Interest Rate on Employee Contributions

TRS credits members’ accounts with 4.5 percent interest on employee contributions. When members leave prior to retirement, they receive the interest accrued on the contributions. The interest credited is a risk-free return on members contributions and ranges from 0 to 6 percent in other states. Reducing the interest rate to either 2 percent or 3 percent would result in a decrease in total employer contributions ranging from $6 to $13 million annually, depending on the magnitude of reduction.

Benefit Formula and Retirement Age

Currently, members are eligible to retire at the age of 60 with at least 10 years of service or at any age with 25 years of service. The monthly pension benefits are calculated as:

(Years of service) x (2 percent) x (the member’s average annual compensation during the two consecutive years producing the highest average).

Proposed changes include lowering the benefit multiplier (from 2.0 percent to 1.9 percent) and using a five-year average salary instead of the current two-year average. This could reduce the annual employer contributions anywhere from $38 million to $45 million a year, according to the report. Increasing retirement age by two years, in turn, could produce savings between $48 million and $50 million, depending on a fiscal year.

COLA

TRS beneficiaries receive a cost-of-living-adjustment (COLA) of 1.5 percent every six months, as long as there is an increase in Consumer Price Index (CPI). As noted in the report, in the past 21 to 26 years TRS’s COLA has outpaced inflation. After 20 years of retirement, fully-vested retirees in TRS receive a COLA that is 49 percent higher than the minimum needed to maintain equal purchasing power.

There are six different scenarios outlined in the report. Proposed changes to COLA are the most impactful changes for the system. The magnitude of changes varies from reducing COLA and the frequency of its adjustment, to ending it for new hires only and making it payable starting at a later age (65 or 70). The contribution savings could range from $17 million to $685 million a year depending on the changes. The analysis also shows that eliminating the COLA for all new hires would save the state around $200 million annually.

Although taking a critical look at the TRS plan structure and evaluating the impact of various possible changes is a good step towards starting the conversation, none of the incremental changes proposed in the report would, by themselves, put the plan on the path to near-term full-funding —assuming no other changes to the contribution rate or plan’s assumptions.

We have previously discussed various causes of TRS’s fiscal solvency crisis. Driving factors behind the system’s problems include underperforming investment returns, unmet demographic assumptions and negative amortization (annual interest on pension debt exceeding annual contributions toward amortizing unfunded liabilities). Long-term solvency can hardly be achieved without making changes focused on these key areas.

Underperforming investments alone are responsible for $9.7 billion in unfunded pension liability since 1998. According to our calculations, which take into account the plan’s investment portfolio structure, investment returns are likely to vary anywhere between 5 percent and 6 percent in the foreseeable future, far lower than the plan’s assumed 7 percent return. A 6 percent long-term average return would require an additional $21 billion in employer contributions over the next 30 years to cover the shortfall. A return of 5 percent would require an additional $34.5 billion. It’s important to note that low investment returns alone can generate far greater liability then any one of the measures proposed in the report can reduce.

Other main contributors to the existing pension debt — unmet demographic assumptions and negative amortization— are responsible for $7.4 billion and $3.1 billion in unfunded liabilities respectively. These problems aren’t likely to go away unless specifically addressed.

Revisiting the components of the plan that are its greatest contributors to unfunded liability, as discussed above, would likely be a more prudent path to take relative to the more incremental changes proposed in the report.

Summary of GDAA Report No. 18-11A on TRS Pension Contributions

The second report, released in February, reviews the process of calculating the USG’s contributions to TRS and the Optional Retirement Plan (ORP), the defined-contribution retirement plan offered to higher education employees. It is reported that USG has failed to appropriately fund ORP’s portion of TRS on several instances, which results in higher employer contributions charged to TRS. The findings of the report can be summarized as follows:

• USG has not made unfunded liability amortization payments it owed TRS from 2008 to 2019; an estimated $600 to $660 million for years 2008 to 2018, plus an additional $170 million for fiscal year 2019 is what is owed to TRS, according to the report.
• In 2001, actuarial valuation of TRS projected that the ORP unfunded liability portion would be fully funded so USG stopped payments. And, although as of 2008, there was an unfunded liability, USG did not resume payments that it stopped seven years ago.
• USG has received an additional $250 million in state appropriations for the required unfunded liability payments that should have been made to TRS, according to the report. Since the payments were never received by TRS, the report suggests that the current budget process is reviewed in order to determine if USG received an appropriate amount of such payments.
• Normal cost rate payments from USG to TRS for its ORP members has never been determined (or paid) since the plan’s creation in 1990.[1] The report recommends that the appropriate value of these normal cost amounts is calculated by an actuary and fulfilled by USG.

Although it is important to precisely determine the share of the TRS bill that is USG’s responsibility, even when fully executed, these payments from one large employer will not eliminate the total amount of unfunded liabilities held by the retirement system. The report primarily deals with explaining the rationale behind the above mentioned discrepancies, which were a result partially of the turnover of TRS and USG staff and board members throughout the past 29 years (since the inception of the ORP) and partially of the lack of clear rules and regulations of the particular funding process. Nonetheless, it is important to understand that following through with the recommendations of this audit would not fundamentally change underlying TRS assumptions, which are a primary cause of the growing unfunded liability.

Conclusion

Fixing TRS’s problems will require a wide mix of policy changes, and there are a range of options and trade-offs to consider. First and foremost, Georgia policymakers need to consider reforms which provide more effective ways to manage the existing debt while de-risking the plan for the future to avoid accruing new unfunded liabilities. Georgia teachers depend on TRS’s long-term stability, and a comprehensive approach is needed to achieve this.

The implementation of the fixes proposed by the reports may generate political action, but they are unlikely to improve the plan’s fiscal situation to the point where it can sustainably guarantee future benefits. Without a comprehensive approach, Georgia might be back to revisiting reform options for its teachers’ pension plan just a few short years after implementing any of these incremental changes. Legislators need to consider the trade-offs between long-term solutions and short-term fixes.

[1] USG is required to remit payment to TRS if the normal cost rate increases due to the absence of members who have joined ORP. This is designed to mitigate any increased costs results from USG payment joining ORP instead of TRS.

The post Two State Reports Suggest Fixes for Georgia TRS, But Are They Enough? appeared first on Reason Foundation.

As of today, public education employees have been promised $25 billion more in pension benefits than Georgia is expected to have available to fully pay its obligations. Each year, a certain amount of money needs to be contributed to the pension fund in order to pay promised benefits. The required contributions has been steadily increasing – reaching 21 percent of total payroll as budgeted for 2020 – escalating the pressure on school finances and siphoning education dollars away from the classroom.

Undoubtedly and understandably, retirement benefits are a major source of post-employment income for Georgia’s public education professionals. The Teachers Retirement System (TRS) of Georgia’s mission is to serve teachers by administering their retirement benefits and protecting the system’s long-term financial solvency. However, TRS is facing some major risks that could harm not only retirees, but also current students and teachers.

Realistically, contributions are likely to increase even more in the event of investment underperformance or a recession.

Unfortunately, the primary driver of the increase in costs is the “unfunded liability” for TRS, i.e. the gap between how much money should be on hand to pay promised teacher pension benefits over the long term and what the retirement system actually has.

To sustainably deliver all the promised pension benefits to teachers, TRS needs to be fully funded at all times. All the actuarial assumptions that went into creating the pension plan – the educated guesses on the “what ifs?” about what happens in the future with regard to markets, demographic trends, and more – need to be correct.

But consider the performance of investment returns against the educated guesses that Georgia’s TRS has been using. For the past two decades, TRS has assumed it would earn a 7.5 percent investment return but only averaged 5.5 percent between 2001 and 2017 – a result of a “new normal” of low asset returns for most institutional investors, not just TRS. And, although some years were better than others in terms of the investment returns, the overall underperformance has created $9.7 billion of the current unfunded liabilities.

Missed demographic assumptions and negative amortization – an increase in the pension debt simply because total contributions are less than the interest accruing on that debt – were other major factors driving today’s $25 billion unfunded liability.

Going forward, the funding deficit is likely to continue driving higher state and school district pension contributions and crowding out spending that could otherwise be directed toward classrooms and students.

School district contributions to teacher pensions represented less than 10 percent of payroll costs until 2011. If future investment returns average just 6.5 percent, annual payments would grow to 22 percent of payroll by FY2040. If investment returns continue to average 5.5 percent, annual taxpayer contributions to the TRS would increase to 27 percent of payroll.

That means that for every dollar paid in salary to current teachers, a quarter needs to be added to the pensions system – money that could have otherwise gone towards their benefits or compensation.

What does this potentially mean for teachers and students?

When school districts need to increase TRS contributions to pay down rising pension debt, this money needs to come from somewhere. Without some increases in the system’s revenue, districts would reroute education funds. That could force reductions to after-school programs, freezing teacher salaries, and/or cutting services from within the state’s education system.

Georgia’s public education system is the cornerstone in building the state’s future. Families of all walks of life rely on public schools. Redirecting resources from the classroom to the pension system means less money where it is supposed to be: in classrooms.

“The provision of an adequate public education for the citizens shall be a primary obligation of the State of Georgia,” Georgia’s Constitution states. Absent meaningful reform to reduce financial risk and improve the TRS’ solvency, the state will be increasingly unable to afford to invest in young Georgians’ education. Georgia’s political leaders owe it to parents and students to resolve the pension system’s solvency challenges.

Go here to read the Issue Analysis, “Georgia’s Teachers Retirement System: Historic Solvency Analysis And Prospects for the Future.” 

This column was originally published by the Georgia Public Policy Foundation.

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The pension system currently has $24.8 billion in unfunded pension liabilities according to its latest actuarial valuation, and since 2002, the growth in annual actuarially determined contributions required for Georgia TRS has far outpaced the growth of the state’s economy, with pension contributions having grown by 67 percent and Georgia’s GDP grown by 23 percent.

While it might be tempting to blame this experience on the Great Recession, it’s clear that the 2007-2008 financial crisis does not explain the trend. Since 2009, the leading financial indicators, such as the S&P 500 and the Dow Jones Industrial Average, have outperformed pre-crisis levels and risen to new heights, whereas the Georgia TRS’ unfunded liabilities have not returned to pre-crisis levels.

The reality is that the current unfunded liability may be only the tip of the iceberg of what is yet to come for Georgia TRS. The problems causing TRS’ pension debt are much deeper than a reaction to economic shocks or cyclical fluctuations. So what are Georgia TRS’s problems exactly?

For a pension plan to be fully funded and have no debt, the actuarial assumptions set ahead of time need to be correct, but that has not been the case for Georgia. The plan’s overly optimistic assumption about its investment return rate is the largest contributing driver of the growth in unfunded liability.

The TRS has assumed a 7.5 percent investment return on its assets since 2001, whereas its actual market returns have averaged 5.5 percent over that period. This alone created $9.7 billion in unfunded liabilities between 2001 and 2017. Other major contributors to the TRS growing debt are flawed demographic assumptions and negative amortization (which occurs when unfunded liability amortization payments are less than the interest accruing on the same pension debt).

Speaking of underperforming investments, it is worth mentioning the high investment returns of the past two years (12.5 percent in 2017 and 8.9 percent in 2018). Although they are indeed outperforming the plan’s target of 7.5 percent rate of return, it is important to understand that such high returns are likely to be rare in the foreseeable future. In fact, average returns in the next 10 to 20 years are likely to be less than those in the past 20 to 30 years, mainly due to the structural changes in the global and domestic economy.

So, how would future underperformance affect the budgetary outlays needed to keep TRS solvent? Our preliminary modeling shows that a 6.5 percent actual return would raise the employer contribution to 22 of payroll by FY2040, while a 5.5 percent average return could increase contributions as high as 27 percent of payroll. And that’s presuming that all other important economic and demographic assumptions are met; any variance in payroll growth, inflation, mortality, etc. relative to TRS’ current assumptions— some variance will certainly happen—will also influence the level of underfunding of TRS. And it’s important to remember that the more dollars dedicated to dealing with the consequences of underfunding, the fewer dollars available to dedicate to the classroom.

In order to fix the hard-hitting long-term consequences of the current pension plan structure, Georgia policymakers need to consider reforms to provide more effective ways to manage the existing debt while de-risking the plan for the future to avoid accruing new unfunded liabilities. The existing TRS debt is a sustainability threat to the active teachers, retirees and Georgia taxpayers. Growing unfunded pension liabilities could also eventually threaten the state’s credit rating, making future borrowing more expensive.

Tackling growing pension debt requires ever-increasing budget appropriations, which crowds out other education spending, including anything from teachers’ salaries to classroom supplies. The price that future generations will pay absent pension reform has to be measured not only by the dollar amount of the growing debt but also in forgone opportunities.

Read the full version of the paper, Georgia’s Teachers Retirement System: Historic Solvency Analysis And Prospects for the Future, here.

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