The post Pension Reform News: ESG blueprint, Arizona’s pre-funding, and more appeared first on Reason Foundation.
]]>In This Issue:
Articles, Research & Spotlights
News in Brief
Quotable Quotes on Pension Reform
Articles, Research & Spotlights
Reason’s New Blueprint for ESG-related Legislation
Reason Foundation’s Pension Integrity Project has developed an ESG Blueprint to help policymakers seeking sound and effective policies for managing public funds, particularly public pension funds. The website provides an overview of what ESG is, its potential impacts on public pension systems, and model legislation to strengthen the boundaries of fiduciary responsibility, ensuring that policymakers keep public funds out of political influence campaigns. Reason’s ESG blueprint is available here, and our full archive of ESG-related analysis is here. Recent pieces include:
Arizona Creates Prefunding Program for State Retirement System
Many state-run public pensions are multi-employer plans, meaning local cities and counties participate and contribute to a single fund and share liabilities. This allows smaller governments to reap the investment benefits of a larger asset-pooled plan, but it can also mean less flexibility in paying down the unfunded pension liabilities that are impacting annual budgets. State legislators in Arizona recently passed a bill that aims to improve this flexibility for employers participating in the Arizona State Retirement System (ASRS). As outlined by Reason’s Ryan Frost and Truong Bui, Senate Bill 1082 offers a vehicle for local governments to apply extra payments to a separate account, which can be used to offset rising contributions at a later time. This is an innovation that other state-run multi-employer plans should consider employing.
Is Texas’ Definition of an “Actuarially Sound” Public Pension System Outdated?
With high inflation continuing to degrade the value of fixed pension benefits, there is significant attention being placed on the cost-of-living adjustment policies that are supposed to cushion the blow from retirees’ losses of purchasing power. In Texas, there is a strict hurdle set in law that must be achieved before giving retired public workers a so-called “13th check.” The state must be able to demonstrate that it is “actuarially sound.” Reason’s Steven Gassenberger explains the current understanding of this hurdle, noting that it would be prudent to adjust this standard with shorter debt-payment requirements.
More Portable Retirement Plans Would Help Public Employers Attract and Keep Workers
Increased rates of resignation in the post-pandemic world are a continuation of a decades-long evolution in the modern workforce, with the current generation of workers switching jobs at much higher rates. This phenomenon is even more pronounced among public workers and teachers. Examining some of the latest shifts in public employee retention, Reason’s Jen Sidorova offers ways that policymakers can shape retirement benefits to better fit today’s workers, including shorter vesting requirements and increased portability.
The U.K.’s Margin Call Offers Warning Signs for Public Pension Funds in the U.S.
A sharp increase in bond yields recently put United Kingdom pensions in a difficult position where they needed to sell off assets, resulting in what was called a ‘doom loop’ scenario that prompted intervention from the Bank of England. Reason’s Swaroop Bhagavatula looks at how this market scare was associated with liability-driven investing (LDI), which is a strategy not often used by pensions in the United States. Still, there are some valuable lessons that can be applied, namely avoiding over-leveraging and maintaining adequate levels of cash to manage any major market shocks.
News in Brief
Paper Rediscounts Public Pension Liabilities
A paper from economics professors Oliver Giesecke and Joshua Rauh of Stanford University asserts that public pension liabilities should be discounted in a way that reflects the guaranteed nature of these promised benefits, which would mean using zero-risk rates based on treasury yields. Their analysis of 647 state and local pension plans in 2021 finds that, while these plans report unfunded liabilities of just over $1 trillion and an aggregated funded ratio of 82.5%, rediscounting the same plans to the proposed specifications would mean unfunded liabilities of $6.5 trillion and a funded ratio of 43.8%. The full paper is available here, and an interactive dashboard of its results is available here.
New Survey Asks Public Employees How The Current Market Has Impacted Their Retirement
MissionSquare Research Institute has published results from a survey of 1,003 state and local government workers focusing on how current market turbulence has impacted the perception of retirement security as well as saving behavior. The survey indicates that most (84%) of respondents feel anxious about their personal financial security. Nearly half (48%) have reduced the amount they save for retirement, naming high inflation as the cause. Over half (58%) of the polled public workers indicated that the retirement plan offered to them was a factor in their decision to stay in the job, while 33% said that this made no difference. The full report is available here.
Quotable Quotes on Pension Reform
“In some cases, the [midterm election] campaign rhetoric not only dismissed the danger of climate change, it went so far as to mischaracterize a strategy we believe in strongly: examining the risk factors of the environment, of social inequality, and of good governance […] But let’s be clear: Applying the lens of ESG is not a mandate for how to invest. Nor is it an endorsement of a political position or ideology. Those who say otherwise are actually advocating for investors like CalPERS to put on blinders…to ignore information and data that might otherwise help build on the retirement security of our 2 million members.”
—CalPERS CEO Marcie Frost quoted in “CalPERS CEO Pushes Back Against Politicization ESG Investing,” Pensions & Investments, Nov. 16, 2022
“Regardless of your view on climate change or inclusion or human rights, Mississippi’s pension system, taxpayer dollars, and college savings programs are the wrong place to experiment with investment strategies that push balance sheets to the side. Moreover, many of the policies ESG promotes tie directly to higher costs for consumers, a weaker Mississippi job market, increased inflation, and smaller investment returns – all while undermining the free market and our economic liberty.”
—Mississippi Treasurer David McRae in “Guest Column: Protecting Mississippi’s Finances,” The Vicksburg Post, Nov. 2, 2022
“It does limit us…We, I believe, have been successful in trying to minimize any kind of cost that might bring to you, but eventually, it’s going to bite us in the butt if we continue. So we just have to be careful and prudent about it…Our bank list is getting short.”
—Lamont Financial Services Founder Bob Lamb on Louisiana Treasurer John Schroder pulling the state’s investments from BlackRock over their ESG approach in “Pulling Louisiana’s Investments Could ‘Bite Us in the Butt,’ Adviser Tells Treasurer,” Louisiana Illuminator, Oct. 18, 2022
Contact the Pension Reform Help Desk
Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.
Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.
The post Pension Reform News: ESG blueprint, Arizona’s pre-funding, and more appeared first on Reason Foundation.
]]>The post Is Texas’ definition of an actuarially sound public pension system outdated? appeared first on Reason Foundation.
]]>With the challenge of inflation likely to continue to be at the forefront of all of the state’s major financial discussions when the Texas legislature reconvenes in January 2023, it is essential to understand how the state government determines the health of its public pension funds and how policymakers can protect public retirees from the degradation effects of inflation.
In the Sept. 8 hearing, members of the Texas House Appropriations Committee explored the importance of being “actuarially sound” in response to the numerous calls by lawmakers and retired educators to follow up on 2019’s 13th check by issuing more inflation relief to provide cost-of-living adjustments to retirees during the next legislative session.
Rep. Carl Sherman (D-Desoto) asked Teachers Retirement System of Texas (TRS) Executive Director Brian Guthrie about the health of the state’s largest public pension plan. In posing his question, Rep. Sherman focused on the term “actuarially sound” specifically. Guthrie noted that Texas currently defines “actuarially sound” as taking less than 31 years to amortize, or fully fund, every pension dollar earned by members of the pension plan. That definition is set in statute and applies to all the state’s major public pension systems. You can watch Guthrie’s full response on being actuarially sound and the timeline for paying off the state’s unfunded liabilities below.
This technical issue is on the minds of retirees because the Teacher Retirement System (TRS) of Texas and the legislature can only issue a cost-of-living adjustment or a 13th check if the pension fund is determined to be “actuarially sound.” As Guthrie noted, this is currently defined as the pension fund’s amortization period not exceeding 31 years.
With this year’s high inflation rates hitting retirees living on fixed incomes the hardest, it is not surprising that retiree groups and their allies are advocating for a cost-of-living adjustment in the next legislative session. But just as was the case in 2019, when the state legislature opted to issue a 13th check to make up for the past decade’s inflation instead of adding liabilities to the fund, giving a permanent cost-of-living benefit increase next session would attach future obligations to the state and taxpayer in perpetuity. These obligations should be fully prepaid to limit their impact on the long-term financial health of the pension system. If state policymakers want to address the issue once and for all, they should look at launching a new TRS tier for new hires that includes a predictable cost-of-living adjustment as a core benefit in retirement.
To be “actuarially sound” is less of a universal definition or number than a collection of policies reflecting short and intermediate timeframes. Policymakers would do well to listen to Teacher Retirement System’s Guthrie and talk to other actuaries and the Texas Pension Review Board about a more contemporary idea of how the state should judge the financial stability of its public pension systems. For example, Guthrie notes that other groups, including the Society of Actuaries, recommend public pension amortization periods be no longer than 15-to-20 years. Setting an amortization period and allowing rates to adjust—the policy the Employees Retirement Plan (ERS) recently adopted—is also more actuarially sound than the current TRS policy of setting rates and allowing amortization periods to adjust.
Teacher Retirement System actuaries have now built the increased contributions from 2019’s pension reform, Senate Bill 12, into the plan’s funding valuation. The effect was a shorter amortization period calculation, from 87 years to 29 years, if TRS manages to do something it’s never done: meet all of its actuarial predictions, like investment returns and mortality rate, 100% accurately.
After the market turmoil in 2020 and then record-breaking investment returns in 2021, TRS actuaries are now reporting a 26-year calculation, which is about where the system stood in 2013. The impact of the 2022 investment year, likely well below the pension system’s long-term expectations, has yet to be reported. But the low-to-negative investment returns expected are bound to bring that amortization figure closer to, if not beyond, the 31-year mark.
If retirees and budget managers want predictable inflation relief that protects the value of pension benefits in a financially prudent manner, updating the state’s definition of “actuarially sound” to align with the Society of Actuaries’ recommendations would be a good first step.
The post Is Texas’ definition of an actuarially sound public pension system outdated? appeared first on Reason Foundation.
]]>The post Pension Reform News: Join our ESG webinar, best practices for addressing inflation, and more appeared first on Reason Foundation.
]]>In This Issue:
Articles, Research & Spotlights
News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk
Articles, Research & Spotlights
Webinar: What Does ESG Mean for Public Pension Systems and Taxpayers?
Environmental, social, and governance (ESG) trends are impacting public pension systems, retirees, and taxpayers. Join former SEC Commissioner Paul Atkins, former CKE Restaurants CEO Andy Puzder, and Reason Foundation’s Leonard Gilroy for a webinar on September 20 at 1 pm ET to discuss how ESG policies and politicized public investments may impact investment returns and saddle taxpayers with additional costs. The panel discussion will also examine if legislators pushing broad anti-ESG laws could unleash unintended negative consequences and will explore potential reforms that would help keep politics out of public pensions.
Best Practices for Cost-of-Living Adjustment Designs in Public Pension Systems
Extended periods of high inflation can be particularly challenging for pensioners, whose promised benefits usually come in the form of fixed payments. To protect retirees from losing too much purchasing power, many public employers provide a cost-of-living adjustment (COLA) benefit. Like any other retirement benefit, this brings additional costs and requires appropriate funding and limitations. A new report from the Pension Integrity Project identifies a set of best practices that policymakers should consider when structuring or reforming the COLA benefits offered to public retirees. Among those principles are the recommendations that COLAs should be pre-funded and aligned with explicit retirement plan objectives.
The Public Pension Systems Signing on to Politicized ESG Investment Efforts
Several state and local public pension systems have signed on to global climate change accords and/or formally joined activist investment groups focused on reducing climate change. This interactive map by Reason’s Jordan Campbell shows the state and local pension plans, treasurers, and investment boards taking such actions to date.
Policy Brief: The Impact of Cash Flow on Public Pensions
Because public pension plans are designed to combine annual contributions with investment returns to fulfill retirement promises, it is crucial to monitor the money flowing in and out—also known as the cash flow—of public systems. In this new policy brief, Reason’s Truong Bui uses the Montana Public Employee Retirement System (PERS) as a case study to examine the impact of cash flow, both historically and in long-term forecasts. The analysis demonstrates some of the risks that can arise when a plan has more money leaving its fund than going in.
How Alaska’s Defined Contribution Plan and Supplemental Annuity Plan Compare to the Gold Standard
Alaska’s defined contribution and supplemental annuity plans are the primary retirement offerings to the state’s public workers. In this analysis, Reason’s Richard Hiller and Rod Crane partner with the Alaska Policy Forum to evaluate these plans according to best practices for defined contribution plans. They find that the plans fulfill some of the best practices of well-structured retirement plans, while also finding that there is still room for improvement in areas such as a formal statement of plan objectives and contribution adequacy for both teachers and public safety workers.
Texas Dangerously Inserts Politics into Pension Investing
In accordance with Senate Bill 13 from the 2021 legislative session, the Texas Comptroller of Public Accounts recently released a new list identifying 10 financial firms and 348 investment funds that Texas claims are boycotting the fossil fuel industry. This means the state’s public pension funds must remove them from their investment portfolios. Reason’s Marc Joffe highlights some of the implications of this new policy and considers how this reaction to ESG investing also elevates politicized investments over core fiduciary decision-making and risks higher costs for taxpayers.
Policymakers Should Focus on Improving Participation Rates in Retirement Plans
Recent reporting from the National Institute on Retirement Security (NIRS) identifies economic inequities caused by tax incentives in retirement savings, but this analysis overlooks some key facets of how the laws promoting savings operate. Reason’s Rod Crane asserts that tax incentives are working exactly as they are meant to by benefiting those who are closer to retirement. Instead of focusing on retirement benefit inequities between the upper- and middle-classes, policymakers should simply seek to maximize the number of employees that are participating in retirement saving programs.
News in Brief
New Report Underscores Volatility for State Pensions
A new paper published by the Center for Retirement Research looks at the impact of declining stock market returns and rising inflation on pension funds. The paper shows that, despite the market drop, pension funds have still seen a net increase in funded ratios by one percentage point between 2020 and 2022. The paper goes into more depth as to how this affects amortization payments and overall contribution rates. Regarding inflation, the only types of COLA plan offered by pension plans affected by inflation are CPI (Consumer Price Index) linked. Other types, such as ad-hoc and invested-based COLAs, are unaffected. CPI-linked COLAs typically have caps of around 3.5%. Due to these caps, increases in amortization payments from inflation will be relatively limited (estimated to be between 0.4% to 1.6% of payroll). The full brief is available here.
Paper Examines Purpose and Effectiveness of ESG ratings
A new working paper from the Rock Center for Corporate Governance at Stanford University reviews the stated purpose of ESG ratings and how effective they are at achieving these goals. The paper identifies the shortcomings that exist in both the objectives and execution of current methods in grading the nonfinancial impact of companies. It also asks if the motivations of fund managers are aligned to produce accurate and reliable reports, which are crucial for calibrating ESG ratings that the market can confidently apply to decision-making. The working paper is available here.
Quotable Quotes on Pension Reform
“Starting in FY 2024, the budget will start reflecting the impact of adverse financial market conditions on pension returns.”
—New York City Comptroller Brad Lander cited in “NYC Will Need to Chip in an Extra $6 Billion to Shore up Pension Funds — Comptroller” in Pensions & Investments, September 7, 2022
“For a while, ESG looked like a good bet, and values seemed cheap. In a down market, though, ESG’s true cost is starting to reveal itself—and in a more volatile, energy-scarce market, it will only get more expensive. Politics aside, few people or fund managers will tolerate funds that underperform, and this may be the real reason ESG funds have peaked.”
—Manhattan Institute Senior Fellow Allison Schrager in “The ESG Bubble Is Bursting” in City Journal, August 30, 2022
“The concern for most investors now is ‘how do I find exposures that are going to help me stabilize the portfolio vs. investing with my values?’”
—Managing Director at FLX Networks Jill DelSignore cited in “The ESG Crown Is Slipping, and It’s Mostly the Fund Industry’s Own Fault” in Bloomberg, September 2, 2022
Data Highlight
Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell created an interactive map showing the state and local government pension plans that have signed on with the Ceres Investor Network on Climate Risk and Sustainability and Climate Action 100+. You can access the map here.
Contact the Pension Reform Help Desk
Reason Foundation’s Pension Reform Help Desk provides technical assistance for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.
Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.
The post Pension Reform News: Join our ESG webinar, best practices for addressing inflation, and more appeared first on Reason Foundation.
]]>The post Texas dangerously inserts politics into pension investing appeared first on Reason Foundation.
]]>It is understandable for state policymakers to want to push back against an environmental governance social investment (ESG) movement that they view as threatening to Texas’ oil and gas industry, but just as some progressive states are wrongly telling their public pension funds not to invest in specific sectors, Texas Senate Bill 13 threatens the cost-effective stewardship of taxpayer funds.
Texas SB 13 instructs the Comptroller to identify financial firms that are:
“…refusing to deal with, terminating business activities with, or otherwise taking any action that is intended to penalize, inflict economic harm on, or limit commercial relations with a company because the company … engages in the exploration, production, utilization, transportation, sale, or manufacturing of fossil fuel-based energy and does not commit or pledge to meet environmental standards beyond applicable federal and state law.”
The Comptroller’s list includes nine European companies and BlackRock, the world’s largest asset management firm. Disinvesting in BlackRock could impose special challenges for Texas pension funds because it is included in the Standard & Poor’s 500 stock index. Thus, in simple terms, any exchange-traded fund (ETF) or index fund that is based on the S&P 500 holds some shares in BlackRock.
Fortunately, SB 13 appears to provide some flexibility for state agencies that have exposure to blacklisted firms through indirect means—like holding them through mutual funds or ETFs. Specifically, SB 13 states:
A state governmental entity is not required to divest from any indirect holdings in actively or passively managed investment funds or private equity funds. The state governmental entity shall submit letters to the managers of each investment fund containing listed financial companies requesting that they remove those financial companies from the fund or create a similar actively or passively managed fund with indirect holdings devoid of listed financial companies.
So, according to the law’s text, a Texas pension fund or government agency can continue to hold an S&P 500 fund—as long as it asks the fund manager to drop BlackRock from its portfolio. It is doubtful that an S&P 500 fund would follow through and eject BlackRock for various reasons, including because it would introduce a tracking error—a divergence between the index fund’s performance and its underlying index.
Among the mutual funds on the Comptroller’s blocked list are six vehicles that invest in most S&P 500 stocks. Texas is targeting them because the state claims they explicitly exclude companies in the fossil fuel industry and those with low ESG scores. These blocked funds would also diverge from the S&P 500’s performance, but it is possible that ESG-focused investors holding these funds may be more likely to accept any discrepancy. It remains to be seen whether a fund provider could attract sufficient interest in an investment product that mostly tracks the S&P 500 while excluding ESG-oriented firms such as BlackRock.
The European firms on Texas’ blacklist include three institutions—BNP Paribas, Credit Suisse, and UBS—that rank among the 50 largest banks worldwide. The Texas Employees Retirement System or the Texas Teacher Retirement System may hold securities issued by these entities, but this cannot be readily confirmed because neither system publishes a detailed list of investments on their respective websites.
Although SB 13 is relatively clear that pension funds do not need to liquidate mutual funds that include the blacklisted companies, it is less clear whether the Texas pension funds can invest additional, new money in such vehicles going forward.
Most importantly, while the law includes provisions that try to reduce its impact on the state’s pension funds, Texas Senate Bill 13 sets a dangerous precedent for inserting politics and legislating into investment decisions.
It’s also part of a troubling bipartisan trend. In 2021, Maine passed a law requiring the state’s pension system to divest from fossil fuel investments. And similar divestment bills have been proposed in Massachusetts, New York, and New Jersey.
State policymakers and legislators should not limit the flexibility of pension fund managers to maximize risk-adjusted returns. Public pension fund managers should focus on optimizing their portfolios on a risk/return basis, so the pension systems have funding to pay for pension benefits promised to workers.
The post Texas dangerously inserts politics into pension investing appeared first on Reason Foundation.
]]>The post Projecting the funded ratios of state-managed pension plans 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.
The post Projecting the funded ratios of state-managed pension plans appeared first on Reason Foundation.
]]>The post Unfunded public pension liabilities are forecast to rise to $1.3 trillion in 2022 appeared first on Reason Foundation.
]]>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.
Unfunded Pension Liabilities (in $ billions) | Funded Ratio | |||||
---|---|---|---|---|---|---|
2021 | 2022 (if -6% return) | 2022 (if -12% return) | 2021 | 2022 (if -6% return) | 2022 (if -12% return) | |
Alabama | $13.03 | $19.02 | $21.72 | 78% | 69% | 64% |
Alaska | $4.48 | $6.67 | $7.77 | 81% | 72% | 67% |
Arizona | $22.85 | $30.72 | $34.44 | 73% | 65% | 61% |
Arkansas | $1.60 | $5.67 | $7.64 | 95% | 84% | 79% |
California | $131.57 | $232.98 | $285.57 | 87% | 78% | 73% |
Colorado | $22.37 | $29.64 | $33.07 | 72% | 64% | 60% |
Connecticut | $37.60 | $42.34 | $44.89 | 53% | 48% | 45% |
Delaware | ($1.17) | $0.29 | $1.06 | 110% | 98% | 91% |
Florida | $7.55 | $31.86 | $43.77 | 96% | 85% | 80% |
Georgia | $10.79 | $24.80 | $31.83 | 92% | 81% | 76% |
Hawaii | $11.94 | $14.81 | $16.13 | 65% | 58% | 55% |
Idaho | ($0.02) | $2.58 | $3.87 | 100% | 89% | 83% |
Illinois | $121.25 | $142.68 | $152.70 | 58% | 52% | 49% |
Indiana | $10.11 | $12.75 | $14.50 | 74% | 68% | 64% |
Iowa | ($0.12) | $5.41 | $8.14 | 100% | 89% | 83% |
Kansas | $5.70 | $8.65 | $10.15 | 82% | 73% | 68% |
Kentucky | $36.22 | $42.11 | $44.54 | 53% | 47% | 44% |
Louisiana | $11.57 | $17.55 | $20.75 | 82% | 74% | 69% |
Maine | $1.46 | $3.49 | $4.60 | 93% | 83% | 78% |
Maryland | $12.97 | $20.31 | $24.10 | 83% | 74% | 70% |
Massachusetts | $31.68 | $41.27 | $45.57 | 70% | 62% | 58% |
Michigan | $39.41 | $48.78 | $53.68 | 68% | 61% | 57% |
Minnesota | $0.68 | $11.31 | $16.36 | 99% | 87% | 82% |
Mississippi | $14.99 | $19.73 | $21.80 | 70% | 62% | 58% |
Missouri | $7.79 | $17.43 | $22.17 | 91% | 81% | 76% |
Montana | $2.67 | $4.22 | $4.95 | 82% | 73% | 68% |
Nebraska | ($0.88) | $0.98 | $1.88 | 106% | 93% | 87% |
Nevada | $9.12 | $17.71 | $21.15 | 87% | 75% | 70% |
New Hampshire | $4.54 | $5.90 | $6.59 | 72% | 65% | 60% |
New Jersey | $80.50 | $92.28 | $98.04 | 55% | 49% | 46% |
New Mexico | $12.13 | $16.48 | $18.50 | 74% | 65% | 61% |
New York | ($46.11) | $2.19 | $26.22 | 113% | 99% | 93% |
North Carolina | $0.09 | $12.95 | $20.29 | 100% | 90% | 84% |
North Dakota | $2.10 | $2.99 | $3.42 | 78% | 69% | 65% |
Ohio | $34.83 | $63.10 | $76.52 | 87% | 77% | 72% |
Oklahoma | $4.14 | $8.82 | $11.24 | 91% | 81% | 76% |
Oregon | $7.85 | $18.96 | $23.91 | 91% | 80% | 75% |
Pennsylvania | $56.19 | $68.43 | $75.13 | 67% | 60% | 56% |
Rhode Island | $4.29 | $5.35 | $5.93 | 70% | 63% | 59% |
South Carolina | $24.01 | $28.93 | $31.29 | 62% | 56% | 52% |
South Dakota | ($0.77) | $0.95 | $1.82 | 106% | 93% | 87% |
Tennessee | $10.22 | $16.59 | $19.32 | 82% | 72% | 67% |
Texas | $44.48 | $83.65 | $102.30 | 88% | 78% | 73% |
Utah | $1.11 | $5.72 | $7.90 | 97% | 85% | 80% |
Vermont | $2.72 | $3.40 | $3.74 | 68% | 62% | 58% |
Virginia | $5.97 | $17.08 | $22.94 | 94% | 84% | 79% |
Washington | ($19.60) | ($7.21) | ($0.56) | 122% | 107% | 101% |
West Virginia | $0.27 | $2.44 | $3.54 | 99% | 87% | 82% |
Wisconsin | ($15.32) | $0.52 | $8.38 | 113% | 100% | 93% |
Wyoming | $2.00 | $3.06 | $3.58 | 81% | 72% | 68% |
Total | $782.81 | $1,308.32 | $1,568.83 |
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:
The post Unfunded public pension liabilities are forecast to rise to $1.3 trillion in 2022 appeared first on Reason Foundation.
]]>The post The Teacher Retirement System of Texas needs to adjust its investment return assumptions appeared first on Reason Foundation.
]]>The turbulence across financial markets to this point in 2022, with virtually all U.S. companies in the S&P 500 index in the red, means TRS will likely be among the public pension plans missing annual investment return targets this year. Just as strong, double-digit investment returns in 2021 greatly enhanced TRS’ funded status, this year’s investment losses are expected to lower the plan’s funding level.
This dramatic up and down following the COVID-19 pandemic illustrates the folly of reading too much into pension funding measurements based on a single year of reported returns. Prudent public pension plan managers need to maintain a longer perspective and continue lowering investment return assumptions to accurately reflect what most market prognosticators expect to see over the next 10-to-15 years.
Maintaining an overly optimistic investment return assumption is costly. Doing so raises the risk of significant growth in pension funds’ unfunded liabilities, which historically tend to spiral into colossal costs for taxpayers and take decades to remedy.
The Teachers Retirement System of Texas is a perfect example of this. The plan has accrued $47.6 billion in pension debt since 2002, and most of it, around $25 billion, came from investment returns falling below the plan’s assumptions (displayed in Figure 1 as “Underperforming Investments”). The primary contributor to this was TRS maintaining an unrealistic 8.0% rate of return assumption until 2018, well past the time most other pension plans had started adjusting their return rate targets downward in reaction to a lower yield return environment on financial markets. Policymakers’ failure to be nimble with return assumptions ended up contributing to the system’s current funding challenges, and it would be wise to not repeat that mistake.
It is critical for Texas policymakers to consider improving the TRS contribution policy by changing “statutorily-set” to “actuarially determined” rates. As the Pension Integrity Project has covered, annual contributions capped by statutory rates have generated significant funding challenges for the system. Since 2004, contributions have routinely fallen below the interest accrued on TRS’ unfunded liability that year (a situation called negative amortization). This has led to the Teachers Retirement System falling further behind in its ability to pay for promised obligations.
An adjustment of the assumed rate of return down to 7.0% means the plan will recalculate pension debt upwards in 2023, but will also be better positioned to avoid future debt growth over the longer run. The forecast in Figure 2 compares the growth of TRS’ unfunded liabilities under three scenarios:
With this actuarial modeling of the system, it is clear that statutorily limited contributions will continue to pose funding risks for TRS that will be borne by Texas taxpayers. A proposed 7.0% assumed return will readjust 2023 unfunded liabilities upwards by $6.5 billion, but the plan will suffer fewer investment losses over the next 30 years when the plan inevitably experiences returns that diverge from expectations. TRS’ unfunded liabilities will remain elevated under the rigid statutorily-set contributions. If, however, TRS was to transition to Actuarially Determined Employer Contributions (ADEC) each year, then even by recognizing higher 2023 debt (under a 7.0% assumption) TRS could shave billions off its unfunded liabilities by 2052 ($74.7 billion down from $81.3 billion with current 7.25% assumption).
The lower return target should improve TRS’ ability to withstand turbulent market periods like we are seeing today.
A switch to an actuarial (or ADEC) contribution policy is what lawmakers did with the state’s other major pension plan—the Employees Retirement System of Texas (ERS)—just last year in a landmark pension reform. Unlike rigid contributions set in statute, actuarial contributions adjust and respond according to needs. This means that in situations of volatile market conditions (as tested and confirmed in the analysis above) contributions adjust automatically to ensure that the state’s unfunded obligations do not get out of control. This change in the ERS contribution policy is projected to save state taxpayers billions in long-term costs, and now would be a good time to consider similar reforms to how the state funds TRS.
Seeing the obvious reduction in funding risks through actuarial modeling, it is clear that lowering the Teachers Retirement System’s assumed rate of return is a step in the right direction to safeguard the pensions for the state’s teachers. In addition to heeding the advice of the pension system’s actuaries, Texas policymakers should also consider addressing the rigid statutory contribution policies, which currently prevent Texas from meaningfully cutting down existing unfunded liabilities and curbing future pension debt. At a time when market results appear to be extremely unpredictable and volatile, the state’s teachers and taxpayers need to ensure that TRS is positioned to weather whatever storms may come.
The post The Teacher Retirement System of Texas needs to adjust its investment return assumptions appeared first on Reason Foundation.
]]>The post Examining the Teachers Retirement System of Texas after the pension reforms of 2019 appeared first on Reason Foundation.
]]>The post Examining the Teachers Retirement System of Texas after the pension reforms of 2019 appeared first on Reason Foundation.
]]>The post Pension Reform News: Hybrid pension proposal falls short in Louisiana, shortcomings of ESG scores, and more appeared first on Reason Foundation.
]]>In This Issue:
Articles, Research & Spotlights
News in Brief
Quotable Quotes on Pension Reform
Data Highlight
Contact the Pension Reform Help Desk
Articles, Research & Spotlights
Evaluating the Potential Impacts of Louisiana Senate Bill 438
Recognizing the need to better accommodate an increasingly mobile workforce, Louisiana legislators are considering a proposal to create a hybrid pension plan for new workers in the Louisiana State Employees’ Retirement System (LASERS). Senate Bill 438 would place all new hires into a plan that combines a risk-reducing individual investment account with a defined benefit pension structure. Despite the bill’s intentions, Reason’s analysis and testimony find that the structure of the new plan would offer little risk mitigation, add costs, and be a poor fit for the modern worker.
The Difficulties of Assigning ESG Ratings
Despite concerns with fiduciary priorities, an increasing number of public pension plans are applying environmental, social, and corporate governance (ESG) policies to their investment strategies. A major part of this trend is the emergence of ESG ratings that attempt to quantify the environmental impact of companies. In an examination of this scoring, Reason’s Jordan Campbell finds companies with a higher market capitalization tend to receive better ratings, raising some questions about the validity of ESG scoring. Do bigger companies truly have a lower impact on the environment, or are they just better equipped to comply with demanding reporting requirements?
Why Paying Down New Hampshire Pension Debt Faster Would Be a Win for Taxpayers
New Hampshire’s state government holds over $800 million in unfunded pension obligations to public workers and retirees, but lawmakers have an opportunity to significantly reduce this costly debt. With state government revenues currently $382 million above expectations, policymakers should consider using this surplus to close the funding gap of its retirement system to reduce long-term costs and risks to taxpayers. The Pension Integrity Project’s new one-page explainer outlines the benefits of paying down New Hampshire’s pension debt sooner rather than later.
Texas policymakers have adopted several major reforms to improve funding and reduce runaway costs associated with the state’s pension plans in recent years. Most notably, 2021 legislation adopted an improved funding policy and established a risk-managed retirement plan for all new workers in the Employee Retirement System (ERS). Now, as Reason’s Steven Gassenberger testified to the State Senate Committee on Finance, Texas policymakers need to make similar reforms to the Teacher Retirement System (TRS), which is still chronically underfunded and remains very vulnerable to overly optimistic market assumptions. TRS benefit offerings also need to expand to better serve the mobile nature of educators today.
California Should Learn from Past Mistakes Made with Unfunded Pension Benefit Increases
California Senate Bill 868 would increase pension benefits for teachers who retired over 20 years ago. The bill aims to counteract the degrading effects that inflation has had on retirees’ pension benefits, but as Reason’s Marc Joffe warns, this benefit increase would come with a high price tag. The pension plan’s actuaries indicate that the move would cost the state $592 million, but this estimation could be too low because it depends on the plan achieving optimistic returns over the next few decades. The proposal would also add to California’s unfortunate history of giving out pension benefit increases without properly funding them, which has generated significant unexpected costs to public employers and taxpayers.
News in Brief
Forensic Analysis of Pension Funding: A tool for Policymakers
A new study conducted by Boston College’s Center for Retirement Research (CRR) looks at the role legacy debt plays in the solvency of pension plans in Illinois, Massachusetts, Pennsylvania, Ohio, and Rhode Island. The inception of many public pensions occurred in the early to mid 1900s and there were not the same established norms in funding practices that we see today. Many pension plans had a “pay-go” system where the funding for benefits was not saved in advance. Even those that used an actuarial funding method approached unfunded liabilities very differently, not always including legacy debt as part of the calculation for required contributions. These old funding policies, combined with underperforming investment returns and benefit increases during the 1980s and 1990s, have resulted in several plans holding significant unfunded liabilities that accrued more than half a century ago. On average, CRR reports that legacy debt is 40% of total unfunded liabilities for the five focus states, with some as high as 74% in the case of Ohio. The full brief is available here.
Quotable Quotes on Pension Reform
“We have a lot of counties and cities that are struggling right now with inflationary costs, and every time the plan doesn’t perform, they have to put in more money.”
— North Carolina Treasurer Dale Folwell in “Pensions’ Bad Year Poised to Get Worse,” The Wall Street Journal, May 10, 2022
“Ultimately at a fiduciary level, if a pension fund’s total worst-case exposure to all earnings and income derived from autocratic nations is an insignificant fraction of its total portfolio, the composite risk is probably not worth losing sleep over, on purely financial grounds. But politics could still enter the theater stage for pension boards that ignore this issue”
– Former GASB board member and ICMA Retirement Corp. President Girard Miller in “Public Pensions’ New Quandary: Coping With Geopolitical Turmoil,” Governing, May 10, 2022
Data Highlight
Each month we feature a pension-related chart or infographic of interest generated by our team of Pension Integrity Project analysts. This month, analyst Jordan Campbell created a visualization of ESG risk ratings for the nation’s largest companies, showing the difference between the S&P 500 and the Russel 2000.
Contact the Pension Reform Help Desk
Reason Foundation’s Pension Reform Help Desk provides information on Reason’s work on pension reform and resources for those wishing to pursue pension reform in their states, counties, and cities. Feel free to contact the Reason Pension Reform Help Desk by e-mail at pensionhelpdesk@reason.org.
Follow the discussion on pensions and other governmental reforms at Reason Foundation’s website and on Twitter @ReasonPensions. As we continually strive to improve the publication, please feel free to send your questions, comments, and suggestions to zachary.christensen@reason.org.
The post Pension Reform News: Hybrid pension proposal falls short in Louisiana, shortcomings of ESG scores, and more appeared first on Reason Foundation.
]]>The post Testimony: Teacher Retirement System of Texas can improve funding policies to benefit taxpayers, employees appeared first on Reason Foundation.
]]>Chair Huffman and members of the committee:
Thank you for the opportunity to offer our brief perspective on the three interim charges before you today as they pertain to the state’s public pensions.
My name is Steven Gassenberger, and I serve as a policy analyst for the Pension Integrity Project at Reason Foundation. Our team conducts quantitative public pension research and offers pro-bono technical assistance to officials and stakeholders aiming to improve pension resiliency and advance retirement security for public servants in a financially responsible way. Our work in Texas includes actuarial modeling and technical analysis related to the state’s most recent and impactful reforms, Senate Bill 12 of 2019 and SB 321 of 2021. These public pension reforms represent critical initial steps toward making the state’s pension systems as strong and effective as possible.
Increasing contributions to the Teacher Retirement System of Texas (TRS) and modernizing the Employees Retirement System of Texas (ERS) benefit have taken two public pension systems that were on a financially unsustainable path and have redirected them toward long-term solvency. However, the interim charges being discussed today show us there is still an opportunity to improve on how the state and taxpayers offer retirement security to public employees. These improvements can be secured without taking on the risks of unfunded liabilities and surprise cost overruns borne by taxpayers.
Between 2000 and 2019, ERS went from having an $867 million surplus to having $14.7 billion in unfunded pension obligations. By 2019, 64% of new hires under 35 were expected to leave public employment within five years, forfeiting their contributions made on their behalf by their ERS employer. Only 14% were expected to reach a full-career, un-reduced retirement benefit. For many years the state contributed a fixed percentage of payroll toward ERS that fell far short of what actuaries calculated was necessary every year to properly fund the plan. Worse, investment markets also shifted away from high-yielding fixed assets over that period, with many public pension systems opting to increasingly rely on less transparent—and generally higher risk—alternative asset investments to achieve expected returns.
In short, Texas was structurally underfunding a retirement plan designed to address a shrinking cohort of public employees’ needs while taking on more investment risk in an unsuccessful effort to stop the problem.
During the 2021 regular session, Senate Bill 321 tackled these problems head-on. It established a debt payoff plan and a date for when all ERS’ unfunded liabilities must be fully funded. It also provided a new, risk-managed retirement option for new hires that will help ensure that state workers of the past, present, and future can rely on a strong and sustainable ERS system. These solutions also minimize taxpayer exposure to severe long-term financial risks.
Unfortunately, many of the elements that plagued ERS at that time continue to plague TRS today. Although additional state contributions and historic market returns have improved the fiscal posture of TRS on paper, outdated assumptions, funding policies, and benefit offerings make it less likely that the increased contribution levels set by SB 12 in 2019 will ever fully fund all earned benefits going forward or meet the needs of modern educators.
Actuaries advising the TRS board recently warned members about a critical element underpinning the future solvency of the system that needs updating: the current 7.25% investment return assumption. By showing how TRS uses one of the highest investment return assumptions among major public systems—the national average has fallen to 7% over the years, with major plans like CalPERS now lowering assumptions into the 6-7% range—plan actuaries offered legislators a hint of what is in store for the retirement system over the next two decades. Investment revenue is expected to underperform in the next decade relative to expectations, which combined with contribution rates being artificially capped through statute creates the conditions for unfunded liabilities to steadily accrue over the next decade—just as it has done over the last two.
Obviously, lowering investment revenue expectations will mean actuarial cost projections will reveal previously unrecognized costs. Other states have used surplus funds or large investment gains to cover the actuarial cost of using a lower investment return assumption to avoid accruing debt. That method of minimizing risk may be particularly interesting to lawmakers looking for ways to effectively use supplemental surplus revenue without growing government, as well as retirees who depend on the plan being on the path to full funding in order to receive a cost-of-living adjustment (COLA).
Our team will be sharing actuarial modeling throughout the legislative interim that covers both ERS and TRS, highlighting areas of opportunity from a technical perspective. We hope this will help facilitate productive dialogue among stakeholders.
Finally, nearly every lawmaker has heard at least one call for Texas to invest in or divest from one particular asset or another. Sometimes—like the recent calls by some pension systems to divest from Russian companies in the wake of the Ukraine invasion—geopolitics and other national security concerns may dictate certain shifts in investment strategy. Most investment or divestment calls, however, do not involve national security, but rather narrow political interests of various factions.
The impact investment returns have on both the cost and effectiveness of retirement benefits makes placing political constraints on pension fund investments a dangerous proposition. Not only does it make the goal of fully funding earned pension benefits harder for administrators, but it rarely achieves the intended political impact. Instead of preferential treatment for certain industries, an across-the-board update of the rules and expectations set for public pension fiduciaries and enhanced reporting requirements would improve governance and give stakeholders even more confidence in their system for future generations.
The Texas state legislature has been a national leader in updating public retirement design options that empower public employees to choose the best retirement path for themselves and their families. But there is more work to do. We look forward to following up with more technical analysis and exploring these issues in greater detail throughout the interim.
The post Testimony: Teacher Retirement System of Texas can improve funding policies to benefit taxpayers, employees appeared first on Reason Foundation.
]]>The post Keeping politics out of public pension investing appeared first on Reason Foundation.
]]>The post Follow up analysis of the Texas Sunset Advisory Committee’s recommendations for the Texas Teacher Retirement System appeared first on Reason Foundation.
]]>Quick Facts—Sunset Commission Findings and Recommendations:
Where Do the Sunset Review Commission’s Concerns Regarding Alternative Assets Come From?
From the 1950s through the early 2000s, TRS was mostly invested in relatively safe fixed-income and large U.S. equity assets. Through the 1990s and up until the 2008 financial crisis, TRS was able to maintain a fully funded status and consistent contribution rates. However, with declining interest rates and the lasting impact of the financial crisis, TRS has struggled to maintain its funding levels, resulting in its funded status dropping below 80% and requiring higher contribution rates. To address those rising costs, TRS turned to investment managers to increase the performance of its investment portfolio. These investment managers have moved away from safe, reliable, yet low return fixed assets and towards potentially higher-yielding—and more volatile—alternative assets to increase revenue from investments. International equities, hedge funds, private equities and other alternative investment categories now make up the majority of assets upon which TRS relies to fund their pension benefit obligations.
According to the 2021 Sunset Commission staff report, TRS has increased the allocation of its alternative investments from 20% in the fiscal year 2009-10 to 46% in the fiscal year 2019-20. Because asset managers often charge high fees, it is likely that this shift to alternative investments has drastically increased TRS’ investment costs.
Figure 1: TRS Asset Allocation from 2001 to 2021
Despite this transition to high risk, lower transparency assets, TRS continued to accumulate unfunded liabilities as a result of returns routinely falling below expectation over the last decade. The plan returned only 6.5% on assets between 2015 and 2020, according to Sunset staff, which fell short of the plan’s 7.25% assumed rate of return. It wasn’t until last year’s historic one-year return on investments that TRS saw any meaningful increase in its funding.
What are Alternative Assets?
Alternative assets are investments that fall outside traditional cash, publicly traded stocks, and bonds. Commonly, alternative investments take the form of shares in limited partnerships, as with private equity funds. As a statutorily protected fund worth over $165 billion, TRS is one of the largest institutional investors globally and along with other Texas and state-level pension systems across the country is considered a major source of capital for alternative investment providers.
Many of the TRS assets deemed alternative are classified as “Level 3” under fair value accounting rules promulgated by the Financial Accounting Standards Board. Level 3 assets are the most challenging to value, requiring assumptions to be made about future cash flows and valuation multiples that could be obtained during a future sale.
When public pension boards choose to engage in alternative asset investing, they must manage these investments either in-house or via hired investment consultants paid to manage the planning and execution of the board’s stated investment goal. When contracted, these services often involve fees decoupled from the portfolio’s performance. These service providers are tasked with helping the board determine where to invest, making them important appropriators of retiree and taxpayer dollars. The limited partnerships managing the alternative asset enjoy the standard “2 and 20” compensation package where managers take 2% of all assets being managed and 20% of all returns.
The Challenge with “Alternative Assets” & Importance of Transparency
Despite alternative assets being a type of security, they are usually exempt from registration and disclosure rules set by the Securities and Exchange Commission (SEC). Because these alternative assets provide limited reporting, they are hard to value. This can create a circumstance where it is possible that TRS will experience unexpected losses when their alternative assets are liquidated due to previous valuations of those assets being too optimistic. In many cases, TRS is a limited partner in an investment vehicle operated by a private equity firm, which acts as the general partner. Only when a partnership is liquidated, typically over 10 to 12 years, can the true value of the investment be determined; however, annual valuations of TRS are conducted and subsequent policies based on those valuations are developed on an annual basis, creating a lag between data and policy decisions.
Although it may not be possible for the public to value holdings within private equity and other alternative investment funds, knowing which funds TRS participates in would allow external observers to follow TRS alternative investments by knowing the identity of the general partner.
Despite the challenges in valuing and assessing the performance of private equity funds, increased transparency through a basic disclosure of the assets, funds committed, and investment costs would provide independent observers a better opportunity to assess TRS’ investment policies and results.
How to Strengthen Sunset Commission Staff Recommendations
The issues highlighted by the Sunset Commission staff recommendation 3.3 reflect how the last two decades have changed the funding landscape for large pension systems like TRS. As treasury bond yields remain low and policymakers remain sensitive to unexpected contribution increases, funds like TRS will continue to meet the needs of their members by attempting to secure the highest investment returns possible. If traditional fiduciary standards are used to determine the usefulness of alternative investment to TRS, then investment advisors and board members should feel free to engage in those opportunities. However, without increased transparency and reporting on these assets, the capability of underwriters (taxpayers) to achieve any oversight is drastically limited.
TRS and its membership, as well as every other state-sponsored public pension member and system in Texas, would benefit from two annual reports regarding the system’s alternative investment holdings. Both suggested reports below are currently produced by comparable state-sponsored pension systems outside Texas and would not require any additional appropriation from the legislature.
Suggested Report #1: Private Equity Portfolio Performance
The Private Equity Portfolio Performance report would publicize specific information regarding the private equity holdings of TRS for third-party monitoring and evaluation. The report takes the form of a simple six-column table populated with the following data points per holding:
This level of transparency is provided by other similar-sized public pension systems like the California State Teachers’ Retirement System (CalSTRS). CalSTRS’s publishes a report, which can be found on CalSTRS’s website, that lists these data points in a stakeholder-friendly format. CalSTRS’s private equity performance report, including the internal rate of return, is maintained internally by CalSTRS and published annually.
Suggested Report #2: Annual Investment Cost Report
Shifting to alternative assets usually involves higher costs, as actively managed private equity and hedge funds tend to demand higher fees for the services relative to passively managed assets like index funds. A 2018 report by the Pew Charitable Trusts found pension plans spend at least $2 billion a year on investment fees alone, and TRS is no exception to this trend.
Last year, TRS administrators set the system on a five-year plan to reduce fees by over $1.4 billion through increased in-house investment management. However, unreported fees such as carried interest (i.e. performance fees) are not addressed in the recent operational changes set in motion by TRS. Performance fees for private equity investments are typically far higher than the ordinary management fees for those assets, and most public pension funds—including TRS—do not report those performance fees.
An Investment Cost Report directly addresses the issue of opaque fee reporting by directly outlining the fees and other expenses a pension system incurs in the process of managing its portfolio. Again, CalSTRS offers a model, producing a report showing investment costs by type and asset category. An example report can be viewed directly from CalSTRS.
This report is designed to provide stakeholders with detailed fee data and trends over a four-year period for each asset class and investment strategy. Reporting this ratio analysis to show the cost-effectiveness of the total fund, asset classes, and strategies over time provides a quantitative metric to compare costs against the returns generated from those costs.
The benefits of TRS members are paid from net returns and not from gross returns. Since increased investment costs reduce net returns, fees and expenses should be consistently monitored and managers held accountable for the costs and benefits of investments relative to the overall growth and resiliency of TRS as a long-term provider of pension benefits to Texas educators.
Contact Information:
Marc Joffe (Marc.Joffe@reason.org), Senior Policy Analyst
Steven Gassenberger (Steven.Gassenberger@reason.org) Policy Analyst
The post Follow up analysis of the Texas Sunset Advisory Committee’s recommendations for the Texas Teacher Retirement System appeared first on Reason Foundation.
]]>The post Houston firefighter pension plan makes a bold move into cryptocurrency investing appeared first on Reason Foundation.
]]>The Houston Firefighters’ Relief & Retirement Fund’s $25 million cryptocurrency investment amounts to about 0.5% of the pension fund’s total assets under management, so the risk to the overall portfolio is limited. That said, if the fund significantly increases its exposure to this risky asset class, there could be cause for concern.
Cryptocurrencies have been highly volatile since their inception, and they are not income-producing assets. Unlike bonds, whose interest coupons can be applied to pension benefits, cryptocurrency holdings must be partially liquidated to provide income to beneficiaries.
Cryptocurrencies also come with some unique risks. Individuals and organizations that manage their own cryptocurrency holdings (often in the form of a USB drive containing a digital wallet) might forget or lose the password used to secure them. In January 2021, a San Francisco programmer told The New York Times that he could not remember the password for his digital wallet and stood to lose 7,000 Bitcoins (then worth $220 million).
Those who store their Bitcoins with an exchange have also suffered losses due to fraud. Clients of the Japan-based Mt. Gox exchange lost Bitcoin now worth billions of dollars after the intermediary was hacked in 2011 and collapsed in 2014. In October, a majority of investors did accept a corporate rehabilitation plan for Mt. Gox under which they will recover a large portion of their lost Bitcoin. In 2019, investors lost $135 million of cryptocurrency when QuadrigaCX, Canada’s largest cryptocurrency exchange, collapsed in the aftermath of the CEO’s apparent death.
Recent developments for crypto promise a higher degree of investor security. Coinbase, the largest US crypto exchange, went public in April. As a NASDAQ-listed company, Coinbase will face a greater level of scrutiny from regulators and equity investors than earlier exchanges. In October, ProShares introduced the Bitcoin Strategy ETF, an exchange-traded mutual fund that aims to track Bitcoin’s performance by investing in Bitcoin futures. Individual investors can hold shares in the ETF in their brokerage accounts.
The Houston Firefighters’ Relief & Retirement Fund is using NYDIG to hold its cryptocurrency investment. The company, a subsidiary of alternative asset manager Stone Ridge, claims to “meet the industry’s highest regulatory, audit, and governance standards”.
But with the risk comes large potential rewards. Since the beginning of 2010, the value of one Bitcoin rose from a fraction of a penny to over $55,000. Much of Bitcoin’s appreciation has been recent, with its price almost doubling between January 1 and December 1, 2021.
Fiscal and monetary policy under both the Trump and Biden administrations has been very expansionary, and the results are now showing up in the form of increased inflation. During this recent inflationary period, gold has not performed its traditional role as an inflation hedge. The precious metal recently traded below the level at which it opened in 2021. Established cryptocurrencies, which have limited supply, could be supplanting gold as an inflation hedge. Thus, they may be a reasonable alternative for portfolio managers concerned about the risk of the federal government and Federal Reserve being unable or unwilling to control inflation.
So, for U.S. public pension systems that are tasked with delivering returns in excess of risk-free interest rates, cryptocurrency is an attractive alternative to public and private equity. According to the firefighter system’s most recent Investment Returns and Assumptions Report to the Texas Pension Review Board, HFRRF has an assumed rate of return of 7.25%, more than 500 basis points above risk-free long term Treasuries and slightly above the 7% median return assumption for large plans.
Lowering the plan’s assumed rate of return on investments and thus increasing actuarially determined pension contributions would reduce pressure on investment managers to embrace risky assets such as Bitcoin and Ethereum in the search for higher yields.
The post Houston firefighter pension plan makes a bold move into cryptocurrency investing appeared first on Reason Foundation.
]]>The post The Teacher Retirement System of Texas Is in Need of Serious Reform appeared first on Reason Foundation.
]]>Dueling versions of the proposed one-time retiree payment took only hours to receive their first vote after Texas Gov. Greg Abbott released his special session agenda and the state legislature began the first of what is expected to be two special sessions in 2021. House Bill 85 and Senate Bill 7 would both give retired educators and support staff in the Teacher Retirement System of Texas (TRS) an ad hoc, one-time supplemental payment in lieu of a cost-of-living adjustment (COLA). This payment can be colloquially referred to as a 13th check. It is calculated the extra benefit payment would cost the state nearly $700 million, but notably, only Senate Bill 7 would require the payment actually be funded in advance—before being handed out to retirees (instead of just being paid out of the pension fund directly out of the asset pool).
This distinction is critical to note because if there is no accompanying legislative appropriation to cover the full cost of this 13th check. Plan actuaries estimate the initial $700 million costs of House Bill 85 would add more than $4.3 billion to the Teacher Retirement System’s already sizable $50 billion in unfunded liabilities because the cost of the 13th check would effectively be financed, with brutal compounding interest, over many decades. At least Senate Bill 7 avoids those long-term financing costs by requiring the exact cost of the 13th check to be appropriated before any of the checks are sent out to retirees.
That said, both state bills ultimately ignore the systemic issues that require COLAs to be issued under such extraordinary circumstances as a legislative special session in the first place.
Texas legislators may have been surprised last week when, in testimony before the Senate Finance Committee, several TRS retirees characterized the one-time benefit increase as underwhelming and instead urged the state legislature to establish a permanent and predictable COLA.
The frustration felt by a committee room filled with union members and their representatives is a sign that Texas TRS has a flawed benefit design. TRS is sub-optimizing teacher benefits and doesn’t offer members a path to a retirement benefit adjustment without the state legislature making a special appropriation.
Fiscal hawks in Texas would be right to question the financial wisdom of granting a supplemental benefit payment in a broken, structurally underfunded teacher pension system without officially addressing the pension system’s declining health and exposure to volatile global investment markets. While this is likely to be a great year for investment returns, one good year will not make up for decades of structural underfunding of public pension systems like TRS.
If a 13th check sounds familiar to legislators, it might be because just two years ago during the 2019 legislative session, TRS retirees were given the 13th check after not seeing a benefit increase for over a decade. The reason for the wait was because, prior to Senate Bill 12 of 2019, TRS did not have the funds on hand at the time, nor did it expect future contributions to be sufficient enough to return the TRS system to full funding over the next 30 years, as required under Texas law. The 2019 legislation increased how much both teachers and employers (read: taxpayers) are required to contribute to TRS—allowing the plan to technically meet the threshold for granting a 13th check. However, the bill did nothing to address the systemic issues that sunk TRS into debt in the first place and made the 13th check threshold unachievable for so long.
In short, the 2019 session’s efforts to make TRS “actuarially sound” began and ended with meeting the requirements to issue retirees a long-awaited 13th check. To call this an unhealthy way to handle retiree benefit adjustments in a large pension system would be an understatement. Retirees are forced to ask for benefit increases every legislative session—inevitably politicizing something that in many pension systems is automated, built-in and routine. This in turn leads to increased risk of legislative decisions that drive bad fiscal outcomes for taxpayers through unanticipated costs in the future.
Both the 2019 process and the current special session discussion highlight the opportunity to reform the Teacher Retirement System further to allow for regular, predictable, and properly-funded cost-of-living adjustments. It is possible to implement a COLA in a way that doesn’t expose the system to the kinds of financial risks inherent in ad hoc benefit increases granted arbitrarily by legislators.
In most years since 2000, on an actuarial basis, the costs to service TRS benefits have exceeded the contributions made annually by the state. This has driven a large portion of TRS’s structural underfunding since 2000. This same dynamic was driving the Employees Retirement System of Texas (ERS) to insolvency until Senate Bill 321 was enacted in June 2021. That public pension reform promises to address structural underfunding and finally moves the state to a rational funding policy.
By contrast, analysis of SB 12 from 2019 revealed the contribution rate increases contained within the measure would result in improvements—assuming the plan’s investments perform 100 percent in line with expectations. However, if the plan averaged just 100 basis points lower than assumed—a 6.25 percent average return instead of the assumed 7.25 percent return—then TRS’s current $50 billion in unfunded liabilities would more than double to over $100 billion, according to actuarial models. This demonstrates strongly that TRS is a fragile pension plan that cannot handle stress.
Despite the contribution increases SB 12 requires over the next few years, TRS lacks a sustainable funding policy that will tackle unfunded liabilities and prevent future debt. Given the significant lingering risks facing TRS, Texas legislators should continue to seek out solutions for issues not addressed in SB 12 or any of the bills introduced so far during this current special session. Paying off the system’s pension debt quicker, adopting an actuarially determined contribution rate to avoid future underpayments into the system, and adopting alternative benefit packages to better address the retirement security needs of a shifting workforce would be significant steps to addressing the ongoing challenges to TRS.
Until SB 321 was signed into law earlier this year, the Employees Retirement System of Texas suffered from many of the same issues driving TRS’s unfunded liabilities. Texas stakeholders and lawmakers would be wise to use the momentum of the recent ERS reforms to build more effective, affordable, and sustainable retirement solutions that work for the state’s educators and taxpayers.
Appropriating more funding for another ad hoc 13th check, while certainly important to retirees, does not address the $50 billion in TRS debt, and depending on the legislature’s commitment to pre-funding this particular 13th check, may in fact make it worse.
A non-negotiable reality is that the longer the Teacher Retirement System’s $50 billion in pension debt is left unaddressed, the more long-term costs for TRS will continue to grow. As the recent experience with ERS shows—along with similar experiences in other states like Michigan, Arizona, and New Mexico,—public pension systems like TRS can be reformed in a cost-controlled way that conforms to a range of designs stakeholders choose, while also providing a sustainable and predictable COLA.
From the employee and retiree perspective, one thing should be clear: ad hoc pension benefit increases subject to the whims of politicians are not optimal for ensuring a secure retirement. Prior to 2019, retired educators went a decade without a benefit adjustment, which highlights one of a number of suboptimal aspects of the current TRS pension design. And for future teachers, it would be far better to offer them an updated, sustainable retirement plan design that incorporates a predictable cost-of-living adjustment instead of continuing to place them in a flawed and massively underfunded pension system lacking such a mechanism.
The post The Teacher Retirement System of Texas Is in Need of Serious Reform appeared first on Reason Foundation.
]]>The post These States Are Leading the Way on Pension Reform appeared first on Reason Foundation.
]]>That debt is ultimately borne by taxpayers, and like any debt, when unfunded pension liabilities rise, so do the costs of servicing it. As pension debt payments start to siphon money away from other government priorities, such as education and infrastructure, some lawmakers are now pushing for much-needed reforms.
In Texas, the state Legislature passed a major pension reform that tackles the Employees Retirement System of Texas’ nearly $15 billion in pension debt. The ERS serves more than 300,000 current and retired Texas government workers. But driven largely by rosy investment-return assumptions and a history of underfunding by the state, the system’s unfunded liabilities have skyrocketed. The ERS’s consulting actuary says the plan will be insolvent by 2061 even if it meets its lofty long-term investment return goals, and as early as 2047 if it doesn’t.
The reform legislation commits Texas to paying the bill for retirement benefits promised to workers by shifting the ERS to actuarially based funding and a fixed payoff schedule. The new law also enters all future employees into a new low-risk “cash balance” retirement plan that provides a guaranteed minimum 4% return on investment along with the portability of a 401(k). In short, the reforms would enable Texas to keep the promises made to current and retired workers but would stop making unsustainable pension promises to workers in the future.
The pension reform bill will become law this weekend if Gov. Greg Abbott doesn’t veto it, which he hasn’t indicated he will do. Texas will then join a growing list of states—including Michigan, Arizona, Pennsylvania and Colorado—that have created or expanded retirement plans that reduce financial risks for governments and can help avoid burdening future taxpayers with more unfunded liabilities.
Arizona and Michigan have enacted more than a dozen substantive pension reform bills over the past five years. Credit-rating agencies and national retirement experts have cited Arizona’s public-safety pension reforms. Moody’s Investors Service gave Michigan’s teacher retirement reform a “credit positive” review because the state and participating local governments “will no longer carry the entire burden of investment performance risk for new employee pensions.”
Pension reform need not be partisan. After gaining input and buy-in from unions for police officers, firefighters and other public employees, New Mexico Gov. Michelle Lujan Grisham, a Democrat, overhauled her state’s public-employee pension plan for workers who aren’t teachers. “We must make changes now—the alternative is to saddle New Mexicans with unacceptable risk,” Ms. Grisham said, urging fellow Democrats to pass reforms. In 2018, Colorado legislators bridged their differences in a divided government to pass comprehensive reforms that increased employee and employer contributions, reduced cost-of-living adjustments, raised the retirement age, and expanded the use of defined-contribution plans for future employees to address the chronic structural underfunding of the state’s main public pension system.
Public pension reforms aren’t politically easy. With Republicans in control of Florida’s state government and the Florida Retirement System $36 billion in debt, the state Senate passed a bill that would have closed the state pension plan to new hires. But the bill died in the House because lawmakers couldn’t agree on how to pay down the state’s pension debt.
Meaningful pension reforms are difficult to accomplish but will be increasingly necessary as state and municipal pension debt service eats up larger chunks of government budgets. State and local leaders seeking to make lasting improvements to government finances should look to Texas, Arizona and Michigan. These states are showing that it’s possible to create resilient retirement systems that can promote long-term financial security for taxpayers and public employees alike.
A version of this column originally appeared in The Wall Street Journal.
The post These States Are Leading the Way on Pension Reform appeared first on Reason Foundation.
]]>The post Landmark Texas Pension Reform Law Tackles Funding Issues, Secures Employees’ Retirement Benefits appeared first on Reason Foundation.
]]>The reform—Senate Bill 321 (SB 321)—was the result of a bipartisan, collaborative effort to addresses many of the major challenges facing the Employees Retirement System. The law, signed by Texas Gov. Greg Abbott on June 18, includes two major changes: committing the state to make annual contributions that will fully fund the retirement promises already made to public workers and introducing a cash balance plan for future hires that will manage any further unexpected costs to taxpayers.
We’re proud to say the Pension Integrity Project at Reason Foundation played a key role in the collaborative effort that drove this successful ERS reform, providing technical assistance, policy analysis, and educational outreach on ERS reform to a wide range of policymakers and stakeholders throughout the reform process, including bill sponsor State Sen. Joan Huffman and many individual legislators. Dating back to 2020, we provided independent actuarial modeling related to ERS reform concepts and offered advice on design concepts and fiscal implications to legislative leaders, governmental stakeholders, and a diverse array of non-governmental partners including the Texas Public Employees Association, Department of Public Safety Officers Association, Texas 2036, Americans for Tax Reform, Americans for Prosperity-Texas, Equable Institute, and Texas Public Policy Foundation.
With Senate Bill 321 signed into law, Texas joins the growing list of states taking bold action to tackle persistent public pension underfunding in recent years, including Michigan, Colorado, New Mexico, Arizona, Pennsylvania, and others.
However, in true “everything’s bigger in Texas” form, the Lone Star State deserves special acknowledgment for doing what few states have yet been able to do—embrace, in one legislative package, a comprehensive reform effort that both offers a realistic policy to fully pay off all current unfunded liabilities while simultaneously modernizing the retirement benefit for new hires to avoid new unfunded liabilities and still ensure strong, guaranteed retirement security for future state workers. The holistic nature of Texas’ approach should serve as a model for structural pension reforms in other states facing similar underfunding challenges.
1. The Problems
Over the last two decades, the Employees Retirement System—which provides retirement benefits to most state public employees and sworn law enforcement personnel—has gone from fully funded to holding $14.7 billion in unfunded pension obligations. ERS was, prior to Senate Bill 321, trending toward complete insolvency over the next 20 to 30 years—absent significant legislative changes.
Figure 1: History of ERS Solvency (2001-2020)
There are several reasons for these growing unfunded liabilities. According to ERS reports, over $8 billion in pension debt is the result of overly optimistic investment return assumptions and investment returns underperforming what plan actuaries expected. Another $4.5 billion of this debt is the result of the state government systematically underfunding its public pension systems.
Figure 2: Causes of ERS Pension Debt (2001-2020)
The current reform effort comes after years of warnings from ERS administrators and actuaries that the pension system would never reach full funding if nothing dramatic changes, nor will the current funding method—based on legislatively chosen (not actuarially determined) contribution rates that are too low and structurally underfunding the ERS system—ever pay down the $14.7 billion pension debt.
Worse, this structural underfunding is happening despite the fact that relatively few Texas workers—less than 14 percent of those hired under age 35 by the state—actually work long enough to receive a full unreduced retirement benefit. A whopping 64 percent of Texas state workers work for the government for less than five years, the point of “initial vesting” at which they would start to be eligible to tap some portion of the employer contributions made on their behalf if they left state service.
Figure 3: Probability of Members Remaining in ERS (Hired at Age 25)
In short, Texas has been structurally underfunding a retirement plan designed to address the needs of a small cohort of public employees. Public pension costs and debt continue to rise rapidly even though benefits haven’t changed.
2. The Reform: Summary of Senate Bill 321
Senate Bill 321 provides a holistic solution to the challenges associated with ERS using two distinct and complementary approaches:
What Is a Cash Balance Plan?
A standard cash balance plan design blends positive attributes of both traditional pensions and more portable defined contribution plan designs into a unique type of retirement benefit that, like a pension, offers some guaranteed lifetime income to employees, but, like a defined contribution plan, does so in a framework designed to minimize taxpayer cost and risk.
Cash balance plans provide members with their own individual retirement accounts within which they contribute a portion of their salary along with their employer, who adds an additional predetermined matching interest credit. Texas’ new cash balance plan will have employees contribute 6 percent of their pay into their accounts, and employers will add an amount equal to 9 percent of pay.
The funds of law enforcement and corrections officers—who have earlier retirement and thus need larger annual contributions—will get an additional 2 percent from employees and 6 percent from employers.
A cash balance plan defines a member’s benefit as a constantly growing account balance. In this case, ERS will have a 4 percent minimum annual investment return rate. The plan also takes any market earnings between 4 percent and 7 percent and splits it evenly between both parties; any investment returns exceeding 7 percent would be retained by the cash balance plan to offset potential future year losses.
A traditional pension plan like the legacy ERS benefit defines a member’s benefit using an accrual formula based on salary and years of service. Table 1 below shows how Texas’ new cash balance plan will credit a member’s account each year with a “pay credit” (percent of pay) and a guaranteed return “interest credit rate.”
The decision to establish a cash balance retirement plan to new hires leans heavily on the experience of municipal governments in Texas, many of which rely on one of two large cash balance plans—the Texas Municipal Retirement System and the Texas County and District Retirement System—which have offered a guaranteed return to members on a fiscally sustainable basis for employers despite decades of market volatility. Table 1 provides a comparison of the major benefit provisions of these two systems relative to the new ERS benefit under SB321.
Table 1: Comparing ERS’ New Cash Balance Plan to Texas’ County and Municipal Cash Balance Plans
Cash balance plans have several advantages over traditional pensions, both for employees and employers. For the new ERS members who will be enrolled in the cash balance plan, they will enjoy a more portable and flexible retirement fund, which can move with them as they transition to other employment options. They will also enjoy a 4 percent return guarantee, which places a floor on annual earnings their account will accrue, but at a much more achievable and realistic level than the 7 percent return guaranteed by the legacy ERS pension system.
For employers, the cash balance plan places limits on unexpected long-term costs. Instead of having to cover any returns below the Employees Retirement System’s 7 percent assumed rate of return, the state will only be obligated to pay for any returns below the guaranteed 4 percent. And retaining a portion of returns above the 4 percent guaranteed rate will help the system fund future market downturns. All in all, the new cash balance plan means a much lower level of long-term financial risk for the state.
What Is Actuarially Determined Pension Contribution Policy?
Historically, the Texas legislature has set its own annual contributions with no deference to the actual funding needs expressed by ERS actuaries. Adding another layer of complexity to the issue, Texas has had a constitutional limit on how much they are allowed to pay into their public pension plans. The result of these policies was an inflexible annual contribution to the pension funds, and as the actual costs of funding promised benefits rose, state contributions were systemically underfunding these benefits (see Figure 4). Since these benefits must eventually be paid, and funding shortfalls mean less money to accrue annual market returns, this structural underfunding has come at a tremendous cost to the taxpayer.
Using actuarially determined employer contribution (ADEC) policy will mean that the state is essentially committing to fully fund pension obligations. The actual costs of funding a defined benefit retirement plan can vary significantly from year to year depending on how accurately a plan predicts market, demographic, and payroll trends. Every year a plan’s actuary calculates how much money is needed today to eventually provide an earned benefit.
Figure 4: ERS Statutory vs. ADEC Contributions (1998-2020)
With the implementation of SB 321, the state will shed its failing statutory contribution policy and begin making annual payments based on ADEC requirements. That will mean higher, but now sufficient, payments into the ERS fund to fully fund pension promises made to Texas workers over a 30 year period. Instead of an annual, fixed contribution of 10 percent of the state’s total payroll—a policy that has created significant unfunded liabilities for the state—the state will be making more dynamic payments that adjust according to experience.
The result of this policy adjustment makes a marked difference in the outlook of ERS over the next 30 years, as shown in Figure 5.
Figure 5: Comparing ERS Funding Forecasts (Status Quo vs. SB 321)
Switching to an actuarially determined employer contribution policy makes an unmistakable difference in the outlook of the ERS’ fiscal future and completely changes the financial trajectory, for the better. Whereas the plan was on an unsustainable path before (deteriorating funding and insolvency within a few decades), the increased contributions from SB321 would reverse the decline in the plan’s funding and ensure that ERS nears full funding within the projected 30-year timeframe.
Using an ADEC policy will also improve the plan’s ability to navigate continued market volatility. To apply stress testing to the system’s funding, we apply a “crisis simulation” to ERS, which uses 6 percent year-to-year returns and 2008-like recessions in 2021 and 2036. Before the reform, ERS responded very poorly to the introduced market stress, seeing major drops in funding levels and complete insolvency within 20 years. With the introduction of an ADEC contribution policy, ERS funding will continue to trend up, even applying crisis simulations.
3. Long-Term Cost Impact of SB 321
Initial analysis suggests that this change in contribution policy could mean annual contributions at least 6 percent higher than current rates, but ensuring the pension benefits are fully funded will mean significantly reduced costs in the long term. Pension Integrity Project actuarial modeling of Texas Senate Bill 321 shows that instead of a worsening funding trend, SB 321 would ensure that the Employees Retirement System ends up with an improved funding result while driving net savings of at least $15 billion in taxpayer costs over the next 30 years (see Table 2).
Essentially, the reform ensures that Texas taxpayers aren’t paying $20-$40 billion into the legacy ERS fund over the next 30 years and ending up in an even worse fiscal position, despite that sacrifice.
Table 2: Long-Term Costs (Status Quo vs. SB 321)
4. Grading SB 321
The Pension Integrity Project uses a rubric of seven objectives of good pension reform to evaluate bills. Our grading shows that Texas Senate Bill 321 represents significant improvements in nearly all facets of effective reform, including a better plan to keep promises made to public workers, improved retirement security, more predictability in future contributions, reduction of risk to the state, reducing long-term costs, and adding benefits that are attractive to a wider group of new members.
5. Reviewing the Process
The road to passage of Senate Bill 321 involved collaboration between many different interest groups and policymakers, which generally fostered an inclusive reform process with representation from all relevant stakeholders. This setting ensured a final product that works for everyone involved, which greatly improved the chances for success in the end.
That is not to say the process was without its challenges. After the bill’s passage in the Senate, the House of Representatives added a small, but ill-advised, technical amendment to the bill that was more of a hindrance than an improvement. In an attempt to allow long-tenured public employees to keep working longer, the amendment gives ERS members who are over age 60 and who have worked for their public employer for over 30 years the ability to stop accumulating and begin drawing on their public pension early—without actually retiring. The ill-advised amendment is expected to only impact about 35 of the most senior ERS members, according to the bill’s House sponsor, but those members include a handful of long-standing legislators.
Actuarially, the House amendment made no discernable difference to the funding or cost of ERS, but the legislative preferential treatment for certain members prompted understandable questions in the Senate and only hindered the bill’s ability to succeed. Based on that assessment, a plan was implemented to create a bicameral conference committee to approve a final version of the bill stripping the added language, but this plan was abandoned after a large contingent of House members staged a walk-out in the final hours of the legislative session in protest of election-related legislation under consideration, stopping all House action in its tracks and leaving dozens of bills to die due to the end of the legislative session.
With retiree benefits and billions in taxpayer money at risk, the State Senate quickly reversed its objection to the House amendment in an effort to save Senate Bill 321 from death by inaction before the legislative calendar ran out of time, in essence passing the House-approved version of SB 321, including the retire-in-place amendment.
It is our hope and understanding that key legislative leaders intend to resolve this outstanding issue with SB 321 in the special legislative sessions expected to be called this year. It is important to convey that this imprudent amendment does not weaken the overall importance and effectiveness of the reforms in Senate Bill 321. The bill, as passed in both chambers of the state legislature, still represents a major piece of comprehensive and lasting reform on one of Texas’ major pension plans.
6. Conclusions and Next Steps
Looking forward, stakeholders should continue to seek ways to reduce long-term costs. While SB 321 already commits the state to higher annual contributions, even more savings could come from additional supplemental payments to the significant debt of the legacy plan.
Texas policymakers should be on the lookout for opportunities to direct extra funds to accelerate the payment of the state’s pension debts. They should also consider adopting shorter amortization schedules, which would save the state even more in long-term costs. There is also still work that can be done to reduce the risk and volatility by adopting assumptions that are more certain to be achieved by ERS. This will involve lowering the plan’s unrealistic assumed rate of return.
Stakeholders should also apply their experiences with this reform to the state’s other major pension plan, the Teacher Retirement System of Texas (TRS), which faces many challenges and would benefit from a similar collaborative reform process.
Minor last-second challenges aside, Senate Bill 321 is an outstanding reform of the Employees Retirement System that effectively addresses the challenges facing Texas and the public pension plan. State policymakers and other parties involved in the process should be commended for fostering a collaborative process based on actuarial forecasting and for providing an outstanding pension reform model that many other states can follow.
The post Landmark Texas Pension Reform Law Tackles Funding Issues, Secures Employees’ Retirement Benefits appeared first on Reason Foundation.
]]>The post Cash Balance Retirement Plan Would Offer Texas Workers Guaranteed Retirement Benefits appeared first on Reason Foundation.
]]>What are the Benefits of Cash Balance Plans for Employees?
How Do Cash Balance Plans Invest Contributions?
How is Risk Managed in a Cash Balance Plan?
Proposed ERS Cash Balance Plan Offers Workers Guaranteed Benefits
The post Cash Balance Retirement Plan Would Offer Texas Workers Guaranteed Retirement Benefits appeared first on Reason Foundation.
]]>The post How Would Senate Bill 321 Effect Texas’ Public Employee Recruitment and Retention appeared first on Reason Foundation.
]]>How Does the Cash Balance Plan Compare to the Current ERS Benefit?
Senate Bill 321: Designing Retirement for Future Employees
The post How Would Senate Bill 321 Effect Texas’ Public Employee Recruitment and Retention appeared first on Reason Foundation.
]]>The post Texas Considers Much Needed Reforms to Employees Retirement System appeared first on Reason Foundation.
]]>Luckily, the Texas legislature is considering a bill that would make much-needed changes to the pension system. Senate Bill 321, sponsored by Sen. Joan Huffman (R-Houston), would reverse the Employee Retirement System’s (ERS) financial free-fall, improve retirement benefits for most workers, and save taxpayers billions of dollars in the long run.
Growing pension debt is a problem akin to an oil spill, and there is a simple two-part solution to the issue: Step one is to cap the spill, and step two is to clean up the damage. Senate Bill 321 tackles both problems with one comprehensive solution.
To ‘cap the spill,’ SB 321 would enter all new state employees and law enforcement officers into a modernized and financially sustainable pension system known as a cash balance plan. The retirement plan would be designed similar to the two large state retirement systems that have effectively and affordably served most local governments in Texas and their employees for decades.
Cash balance plans blend the guaranteed lifetime benefit aspect of traditional pensions—with strong guardrails built in to avoid the accrual of massive debts—and the portability of a traditional private sector 401(k)-style plan. This plan will improve retirement security for most people hired by the state today.
Approximately 64 percent of newly hired state workers leave employment with the state before five years of service, forfeiting the employer contributions made to their pension plan on their behalf. The remainder of Texas employees that stay in their jobs see their benefits accrue very slowly. The proposed cash balance plan would be an immediate improvement for most new employees who are poorly served by the current ERS design.
But sending new hires into a sustainable retirement plan alone is not sufficient. To ‘clean up the spill,’ the proposed legislation would adopt a new method of funding ERS pension promises and is designed to ensure the current pension debt of nearly $15 billion is paid off completely. Not only would SB 321 eventually eliminate this debt, but Reason Foundation’s Pension Integrity Project actuarial analysis shows that this policy could mean over $15 billion in taxpayer savings over the next 30 years due to the bill’s commitment to making higher contributions in the near term to aggressively pay off pension debt.
By capping the spill of pension debt and putting in place a solid method to clean up the unfunded liabilities accrued thus far, Senate Bill 321 would set ERS on a more sustainable trajectory, provide billions in savings for Texas taxpayers, and better meet the retirement needs of today’s public workforce.
Pension Reform Scorecard on Senate Bill 321
Update 5/19/2021: This post previously stated that 66 percent of new ERS members leave before five years of service. Corrections to our employee attrition calculations now show that 64 percent of new ERS members will leave employment before five years of service.
The post Texas Considers Much Needed Reforms to Employees Retirement System appeared first on Reason Foundation.
]]>The post Analysis of Texas Senate Bill 321 appeared first on Reason Foundation.
]]>Senate Bill 321 is a bold solution to two major challenges facing the Employees Retirement System of Texas.
The first of these challenges is the pension system’s debt. The plan currently has $14.7 billion in earned, yet unfunded, retirement benefits and is on track to become insolvent within the new few decades. To address this issue, Senate Bill 321 commits Texas to a pension contribution rate that guarantees benefits are fully funded. Our analysis shows that this funding change could mean upwards of $15 billion in savings over the next 30 years.
The hundreds of millions annually in additional funds allocated via Senate Bill 321 alone, however, does not address the second challenge facing the Employees Retirement System (ERS): The fact that fewer and fewer members are staying in public employment long enough to receive a retirement benefit.
According to the Employees Retirement System of Texas’ reports, 64 percent of new ERS members leave before five years of service. Another 19 percent of new members still working after five years will leave within the 25 years of service it takes to qualify for reduced ERS benefits—leaving the majority of those entering ERS without an optimal retirement plan.
The cash balance benefit offered in SB 321 modernizes the state’s retirement offering to public employees and meets the needs of today’s more mobile workforce. Future members would see less coming out of their paychecks and be able to retain their employer’s contributions to their cash balance accounts when they leave public service.
Our analysis shows that Senate Bill 321 would set the Employees Retirement System of Texas on a sustainable trajectory and meet the retirement needs of today’s public workforce.
Full Analysis of Texas Senate Bill 321
Update 5/19/2021: This post previously stated that 66 percent of new ERS members leave before five years of service. Corrections to our employee attrition calculations now show that 64 percent of new ERS members will leave employment before five years of service.
The post Analysis of Texas Senate Bill 321 appeared first on Reason Foundation.
]]>