As the session nears its end, the legislature faces the decision to either act responsibly and begin to repair the Teachers Retirement System’s (TRS) finances or to let the fund deteriorate more, leaving a bigger mess for future lawmakers.
TRS reports that Texas’ teachers have earned retirement benefits worth approximately $200 billion, but the retirement system only has $154 billion on hand to pay for those benefits. That means TRS is $46 billion short of what should be in the fund today.
For context, the value of all other state-level debt totals $53 billion.
Texas’ pension debt has continued to increase despite a decade-long bull market that saw the S&P 500 index increase by more than 300% from its bottom in 2009. It is clear TRS isn’t going to grow its way back to fiscal health.
TRS’s worsening funding situation is due to two primary causes: First, TRS has consistently underestimated benefits costs. And second, the legislature has failed to appropriate sufficient contributions.
Let’s start with TRS’s underestimation of cost. Despite interest rates falling steadily since the 1990s, TRS waited until the end of last year to lower its assumed investment return from 8% to 7.25%. Higher returns allow plans to rely less on annual contributions; but if realized returns are lower than assumed, costs can rise quickly because of the power of compounding.
Since 2001, when TRS reported being fully funded assuming an 8% return, the plan’s average annual investment return has been just 5.8%, falling 2.2% short of the target. That’s equivalent to $30 billion that should be in the fund today – money that will now need to be made up through higher contributions.
By keeping its assumed return at 8% for so long, TRS spent two decades undercounting the cost of benefits. We can’t definitively say that more realistic cost estimates would have resulted in better funding, but it certainly would have increased pressure on the legislature to appropriately fund teachers’ benefits.
Which leads to the second problem — only twice in the past 17 years has the Texas legislature paid the full bill owed to TRS. The state’s contribution rate is fixed in statute instead of being allowed to adjust to match actual benefits cost. In recent years, that fixed rate has fallen short of what was needed to fully fund benefits and the legislature has failed to bring cost and contributions back into alignment.
No matter how accurate TRS’s cost estimates, if the state refuses to pay the full bill, then the fund is destined to slowly dwindle until running out of money.
By lowering its return assumption, TRS has taken the first step toward providing the state with more accurate cost estimates. Now it’s time for the legislature to act and address the state’s underpayment of TRS.
The ideas in the House and Senate versions of SB12 would begin to fix the issue by ramping up contribution rates over the next few years. However, it’s likely that more will need to be done.
The Texas Pension Review Board has adopted guidelines for pension funding that recommend plan sponsors pay the full actuarially determined contribution each year, and that pension debt be paid off in 20-25 years. The contribution rates recommended by these guidelines would exceed the requirements of SB12, and it’s likely that TRS’s cost will increase in the coming years given that their consultants predict that the plan faces a 50/50 chance of achieving a 7% return.
Failing to address TRS’s funding challenges in this session will just make the bill bigger in two years, increasing the negative impact on teachers and taxpayers alike. State leadership should begin fixing the problem today so that they leave a more manageable situation for future policymakers. It’s the only fiscally responsible choice.
This piece originally appeared at Austin American-Statesman
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Josh B. McGee is a senior fellow at the Manhattan Institute. Follow him on Twitter here.
Anthony Randazzo is executive director of the Equable Institute.
This piece originally appeared in Austin American-Statesman