TRS Financial Matters and Investments
State Budget Stalemate
Updated: November 1, 2016
Issue: TRS pension payments will continue to be paid despite the fact that state government’s six–month “stop–gap” budget is scheduled to expire in December, 2016.
A balanced government budget approved by the General Assembly and the governor is required in order for the state to spend money on most services unless spending is ordered by a court or by law, or does not require a legislative appropriation.
After failing to develop and enact a full 12–month state budget for fiscal year 2016, Gov. Bruce Rauner, a Republican, and Democratic leaders of the General Assembly in July of 2016 enacted a temporary spending plan to authorize state expenditures through the end of calendar year 2016. The enactment of a full year’s budget is caught in a political dispute over the legislative consideration of the governor’s proposed “Turnaround Agenda” for Illinois.
- Current estimates indicate that spending authorizations in the six–month exceed available revenue by about $8 billion.
- Governor Rauner wants his agenda approved before considering long–term ways to balance the budget.
- House Speaker Michael Madigan and Senate President John Cullerton want to focus exclusively on the budget and not consider the governor’s agenda as part of a budget compromise.
Both sides have proposed ways to end the stalemate, but no agreement has been reached.
Discussion: Since all TRS benefits are funded by the TRS trust fund — not state government — TRS does not need to have a state budget in place in order to pay benefits. Operations at the TRS offices in Springfield and Lisle will continue uninterrupted. The top priority of TRS during the budget dispute is to ensure all benefits continue to be paid.
State Comptroller Leslie Geissler Munger said in June of 2015 that her office will pay all pensions beginning in July, even if no state budget is in place.
On July 7, a Cook County Circuit Court judge officially outlined the obligations and salaries the State of Illinois can pay and must pay even if state government does not have a comprehensive budget. The judge’s order said specifically that “all non–appropriated funds” must be paid by the state comptroller.
All TRS benefits are “non–appropriated funds,” so TRS does not need the permission of the General Assembly and the governor to spend money on benefits. The authority of TRS to spend money on benefits is perpetual and is never included in the state budget. All TRS benefits are funded by the TRS investment portfolio, which at the end of FY 2016 totaled $44.7 billion.
TRS will continue operations. All TRS staff salaries and operations are funded by the TRS trust fund, not by state government, so the System does not need legislative approval to pay salaries.
However, the potential exists that the budget dispute could hamper day–to–day TRS operations in the future.
TRS depends on other state agencies — the state comptroller, the state treasurer and the Department of Central Management Services — for some important services, such as the transfer of funds in the TRS investment portfolio and the writing of checks for salaries and obligations. The lack of a state budget could affect the ability of these agencies to do work for TRS in the future.
TRS will work closely with other state agencies to minimize any inconveniences.
TRS Investment Strategy during Stock Market Fluctuations
Updated: November 1, 2016
Issue: Periodically, the value of the U.S. stock markets will experience larger–than–normal fluctuations that reduce the individual value all investments, including the public equity investments of TRS. These fluctuations are reflected in the indexes which track the day–to–day value of the public equity markets.
TRS members worry what the effect of these sharp declines in value of the stock market will have on the TRS investment portfolio, and the viability of the System to pay retirement benefits.
For instance, during the last week of August, 2015, the Dow Jones Industrial Average and the Standard & Poor’s 500–stock Index, along with other public equity indexes, experienced six days of sharply falling values. On August 24 during trading, the Dow briefly dropped by 1,089 points before recovering 500 points by the end of the trading day to close with a loss of 588.4 points — the eighth worst one–day point decline in the history of the New York Stock Exchange.
Any time there are sharp declines in the value of the highly–publicized Dow and other stock market indicators, media coverage of the event is extensive, with an emphasis on the financial losses experienced by the owners of stocks. Since large institutional investors like TRS and other public pension systems are heavily involved in the stock market, part of the coverage of these fluctuations describes the losses seen by the members of these pension systems.
Discussion: TRS strives to protect the value of our members’ money through a long–term investment strategy designed to mitigate any losses in value that result from sharp fluctuations in the stock market or the economy in general.
Sharp declines in the value of the stock market have occurred throughout history at regular, yet unpredictable, intervals. As result, the TRS investment strategy anticipates that these fluctuations will occur in the future and plans for those events. The TRS investment portfolio is continually prepared to absorb value reductions when they happen.
TRS has been successful over the last 25 years in expanding the size of TRS member assets, despite the ups–and–downs of the world economy and insufficient funding from the Illinois General Assembly. Since 1990, TRS assets have grown by 464 percent, from $8.079 billion to $45.5 billion.
Here is an overview of the TRS investment strategy:
Long–term emphasis: As a perpetual entity, TRS will always stress a long–term view of investment results rather than emphasize short–term gains or losses. The media may get fixated on single–day returns, but TRS understands that its relationships with most of its members will last decades. Steady, positive returns over 10, 20 or 30 years are more important to people with a long–term stake in TRS. At the end of fiscal year 2016, the 30–year TRS investment return was a positive 8.1 percent, which exceeded the System’s assumed 30–year rate of return for that fiscal year of 7.5 percent.
Diverse investments: TRS maintains a highly–diversified investment portfolio set up to mitigate sharp drops in the value of the stock market or any other segment of the economy. In other words, not all of the eggs are in one basket.
A diverse portfolio safeguards TRS assets because sections of the worldwide economy do not grow or shrink in unison. Throughout history, as a rule of thumb, when stock values are expanding, bonds slow down. But when stocks slow down, bonds pick up speed. Real estate, as an investment market, is not tightly connected to the movements of stocks so real estate can make money when stocks lose. Other markets TRS invests in — private equity, hedge funds and commodities – also are not influenced greatly by the equity markets.
When the stock markets experience a sharp drop in value, other TRS investments in real estate, private companies and commodities, for example, hold their own. They may make money, or not lose as much money as the stocks lose.
Public Equity Markets: Since the U.S. stock exchanges are the most visible parts of the U.S. economy many people, including members of the media, have advised TRS to place its entire $45.59 billion portfolio in “index funds.” Index funds are designed to track the average value of the public equity markets on a day–to–day basis and not to “better” the average value. This advice is especially prevalent in a “bull” market where stock values are climbing regularly.
But the value of index fund investments also drop accordingly when the value of the markets drop, so when the market loses 500 points in a day, those investors lose 500 points in that day. Index funds match the volatility of the market.
With stocks, both in U.S. markets and overseas markets, TRS invests money to be actively managed so returns, it is hoped, beat the market averages. With this strategy, TRS has been successful over the long term. At the end of fiscal year 2016, TRS investments in domestic stocks returned a positive 7.62 percent, gross of fees, over the last 20 years. International stocks returned a positive 5.62 percent return, gross of fees, in that time period.
Currently, TRS has 36.5 percent of its total investment portfolio in stocks, or $16.3 billion. The public stock markets over time, remain the most efficient money maker. Over the last 115 years, the average total return per year from U.S. stocks is a positive 9.4 percent.
Fixed Income: Also known as the bond market, TRS currently invests 18.7 percent of the total portfolio, or $8.4 billion, in fixed income securities around the world. At the end of FY 2016, over the last 20 years the Fixed Income portfolio returned a positive 6.62 percent.
Real Estate: TRS currently invests 15.5 percent of the total portfolio, or $6.9 billion, in properties of all types throughout the world — office buildings, hotels, apartment complexes, retail and industrial. Over the 20 years concluding at the end of FY 2016, real estate investments generated returns of a positive 10 percent.
Private Equity: These direct investments in privately–held companies around the world generated a 20–year return at the end of FY 2016 of 16.9 percent. TRS currently invests $5.5 billion in this strategy, which is 12.3 percent of the entire portfolio.
Hedge Funds: Also known as “absolute return” investments. These allocations, as the name of the portfolio implies, are designed to provide steady positive returns regardless of the state of the world economy. In other words, these investments “hedge” the risk that is present in other investment strategies. TRS currently invests $3.2 billion in hedge funds. Since this is a relatively new strategy for TRS, the System does not have a 20–year return number. But over the last five years ending in FY 2016, hedge funds returned a positive 6.6 percent.
Real Return: This relatively new strategy also focuses on protecting TRS assets from the fluctuations or downturns of the economy. These investments include various commodities and inflation–linked securities. TRS curre:ntly invests $3.5 billion in this strategy, or 7.8 percent of the total portfolio. At the end of FY 2016, the strategy’s five–year returns were a positive 2.33 percent.
The Annual State Contribution to TRS for Fiscal Year 2017
Updated: November 1, 2016
Issue: The Teachers’ Retirement System Board of Trustees in October, 2016 set state government’s funding contribution to TRS for fiscal year 2017 at $ 3.986 billion. The state’s pension contribution for the previous fiscal year was $3.742 billion
Discussion: The state contribution for FY 2017, however, falls short of the amount of money needed to fully fund TRS over the next 30 years. TRS faces the real risk of future insolvency because of an unfunded liability created by 75 years of insufficient state contributions.
TRS absolutely will be able to meet its benefit obligations to retired teachers in the near future, but we cannot guarantee retirement security for future generations of teachers unless the state’s future annual contributions meet an actuarial standard for full funding.
The FY 2016 state contribution falls $2.08 billion short of the amount of money that would be required to fully fund pension benefits in FY 2017 under standard actuarial calculations.
TRS earned a positive 0.69 percent, gross of fees, on its investments during FY 2016, compared with a positive 4.6 percent, gross of fees, in FY 2015.
Over the last several years state government has taken its responsibilities to TRS very seriously and has paid its legal obligation in full. Still, the legal state contribution for the last several years has been insufficient to improve the System’s long–term finances. State government’s annual contribution is set artificially by law. It is not an actuarial calculation.
As it does every year, for FY 2017 the TRS Board asked its actuaries to calculate two state contributions — the payment calculated under state law and the payment calculated under actuarial practices. Under standard actuarial practices, the state’s annual contribution for FY 2017 should be $6.07 billion.
The calculations set in state law artificially lower the state’s annual funding level. For instance, state law:
- Requires pension costs to be calculated on a 50–year timetable instead of the standard 30 years
- Establishes a 90 percent funding target instead of the standard 100 percent goal
- Requires the debt payments on state pension bonds to be deducted from the total contribution.
Illinois teachers have always paid their required share and are counting on their pensions to sustain them in retirement. The state has never paid its full share.
The annual contribution is the amount of money required by state law to fund TRS pensions during the coming year, as well as a payment on the System’s unfunded liability, which currently stands at $71.4 billion.
The state’s annual contribution to TRS is scheduled to be paid in 12 installments during the fiscal year. Each year before November, the TRS Board of Trustees is required by law to calculate and certify the state’s contribution for the next fiscal year. These calculations are then reviewed by the Illinois State Actuary, Cheiron, of McLean, Virginia
Fiscal Year 2016 Investment Returns
Updated: November 1, 2016
Issue: Teachers’ Retirement System investments generated a positive 0.69 percent rate of return, gross of fees, (0.01 percent net of fees) during fiscal year 2016. The investment return in FY 2015 gross net of fees was 4.57 percent and 3.95 percent net of fees.
TRS ended FY 2016 on June 30 with $44.7 billion in assets, which places the System among the top 40 largest pension funds in the United States.
Discussion: The rate of return for FY 2016 validates the investment strategy of the TRS Board of Trustees to maintain a widely diversified portfolio, which combats volatility in the world financial markets. By diversifying the System’s assets across a wide range of investment opportunities, any losses in one particular investment class are balanced by gains in other sectors. The goal is to achieve steady growth over the long–term.
TRS maintains approximately 36.5 percent of its investments in publicly–held companies around the world, approximately 18.7 percent in bonds and other fixed–income securities, approximately 15.5 percent in real estate worldwide, approximately 12.3 percent in private equity opportunities and the remainder in various alternative investments, including hedge funds and commodities.
The TRS investment strategy does not focus on a single year’s worth of investment returns and will always take a long–term view of investment returns because the System is a perpetual entity that must be in place for retired members and active members for decades to come. During the 30–year period that ended in 2015, TRS investments earned 9.4 percent net of fees against a long–term target of 7.5 percent.
The 4.57 percent rate of return gross of fees for FY 2015 matched the System’s 4.57 percent custom benchmark for the fiscal year. Since 2000, TRS has recorded positive investment returns in 12 fiscal years.
New Financial Reporting Standards for School Districts to Include TRS Debt
Updated: November 1, 2016
Issue: Beginning with their official financial reports from the 2014–2015 school year, all Illinois public school districts are now expected annually to report their “share” of the current $71.4 billion unfunded liability being carried by Teachers’ Retirement System.
While school districts must now report their share of the TRS debt on their financial statements, school districts do not have to pay the amount reported.
This disclosure of a district’s share of the total TRS unfunded debt is a new national reporting standard adopted by the Government Accounting Standards Board
Discussion: Because this is a new report on each school district’s official financial statements, TRS members, the public and the media could be confused by what this reported debt is – and what it isn’t. The public should not jump to an incorrect conclusion that school districts have to pay the amount that is listed in their financial statements as their share of the TRS debt.
School districts do not have to pay their share of the TRS debt because the Illinois Pension Code clearly says that state government is responsible for paying the majority of the TRS debt. By law, school districts are responsible only for a small amount of the debt. Districts annually pay 0.58 percent of their total TRS member salaries to the System to help pay for pensions and to help retire this debt. This is not changing.
Almost all school districts in Illinois would find it impossible to pay their “share” of the $71.4 billion TRS debt if called on to do so. School districts are responsible for using the numbers developed by TRS when they complete their annual financial reports. A report listing each school district’s share of the TRS unfunded debt for the 2014–2015 school year was released in August, 2015 by the Illinois Auditor General. TRS was responsible for developing the statistics in the report. For example, a small district in Adams County reported that its share of the TRS unfunded debt in the 2014–2015 school year was $952,963. The district has a population of 1,019; has one elementary school and one junior/senior high school; 531 students and 53 total staff.
This district would find it very difficult to pay its share of the TRS debt if it was required to do so. The school board would have to cut the district’s instructional budget by an estimated 35 percent in order to make such a payment. The district’s share of the TRS unfunded debt equals 12.9 percent of the district’s total $7.4 million budget.
Most districts would be in a similar, if not worse, position. In their annual financial reports for the 2014–1015 school year, 43 districts throughout Illinois reported that their share of the TRS debt exceeded $10 million. The Illinois State Board of Education reported its share of the debt was $57 million.
Background: The rationale behind this new GASB standard is to improve the transparency of all local government financial reporting and help taxpayers better understand the operation of their governments. Prior to this new standard, local governments were not required to show their “share” of any unfunded pension debt on their financial reports.
This new national reporting standard is aimed more at local governments that run their own pension systems or are responsible for funding a pension system than at Illinois public school districts. Public schools in Illinois do not run their own pension systems and are not responsible for paying off the TRS debt. Nonetheless, they still are under an obligation to adhere to this new standard.
A government’s debt is an important indicator of its financial health, especially when a government has the ability to sell bonds. Potential bond buyers want to know if a government selling bonds has the ability and the resources necessary to pay the bonds off.
In the case of Illinois school districts, however, their share of TRS debt reported on their financial statements really does not have any effect on their fiscal health, including their viability in selling bonds. Under Illinois law, school districts are only responsible for paying a small share of the TRS debt. Illinois school districts pay an annual contribution toward TRS that is defined in state law. Further, the law says that state government is solely responsible for paying off the TRS unfunded liability.
The Government Accounting Standards Board is an independent national organization that sets guidelines for government financial practices to help ensure that all public fiscal policies and reports are consistent and standardized. In this case, the new standard is commonly referred to as “GASB 68” because it was promulgated in the Board’s “Statement 68,” Accounting and Financial Reporting for Pensions.
GASB does not issue “rules” or “requirements,” that must be followed, but “standards and “guidelines” that should be followed as “best practices.” No public body violates the law by not following GASB standards, but not complying with GASB throws a government’s financial practices into doubt.
Teachers' Retirement System is Not Going Out of Business in 2018
Updated: November 1, 2016
Issue: Beginning in 2009, a story posted on Yahoo! Finance and subsequently on other websites predicted that TRS would go bankrupt in 2018 because of growing unfunded pension liabilities and the inability of the state to cover those future liabilities
Discussion: TRS is not going out of business in 2018 and all pension checks this year and in the foreseeable future will be honored.
This prediction has been discredited repeatedly by financial experts and pension officials from around the country, and proven incorrect by up–to–date information collected over the last six years since 2009. The U.S. Government Accountability Office looked at the academic exercise that prompted the story and concluded: “The projected exhaustion dates are thus not realistic estimates of when the funds might actually run out of money.”
The incorrect 2018 doomsday prediction was made by Joshua Rauh, who currently is a professor at Stanford University. Rauh conducted an academic study to determine how long Illinois’ public pension systems could pay pensions if the System’s revenue streams were drastically reduced. At the time the study was written, TRS had $28 billion in assets and spent $3.6 billion in benefits in a year. By dividing total assets at the time by annual benefits, Rauh came up with an answer of 7.7 years.
In February of 2011, Rauh told a Congressional subcommittee: “Many pension systems are approaching a day of reckoning. Even assuming 8 percent returns, the assets of the systems in seven states and six big cities would be insufficient to pay for today’s already–promised benefits past 2020.”
However, Rauh's prediction only comes true if TRS does not earn another dime in investment income or receive any state contributions. Using the latest financial information from fiscal year 2016, TRS had $44.7 billion in assets and during that year distributed more than $5.8 billion in benefits. If you update Rauh’s simple calculation using 2016 numbers, you find that TRS has 7.6 years of assets available to pay benefits if all funding sources are cut off. Rauh’s “day of reckoning” has been pushed off from 2018 to 2023 or 2024.
In a March, 2012 blog post, Rauh toned down his doomsday language and clarified the purpose of his academic exercise. He said the study only shows what would happen if Illinois and other states do not make “adjustments” to the current way pensions are funded. “Those ‘adjustments’ are costly/painful for someone, which is the point of the exercise,” Rauh wrote. “The run out dates are what happens without adjustments that are costly to some party – public employees, beneficiaries, taxpayers or recipients of public services.”
In any event, the academic exercise completely disregards the historical pattern of TRS revenues. Rauh’s prediction is based on TRS earning only a 3 percent rate of return on its investments and collecting nothing in legally–required contributions from TRS members, school districts and state government in the future. This situation has not happened in the past, has not happened in the years since the study and will not happen in the future.
Rauh’s assumed 3 percent rate of return is unrealistic. The agency's current target rate of return is 7 percent. In the last year, the agency's actual rate of return over the last 30 years ending in fiscal year 2016 was 8.1 percent. It also is unrealistic to assume that members, school districts and Illinois state government will not be contributing much to TRS in the future.
In the last completed fiscal year, 2016, TRS distributed more than $5.8 billion in pensions and benefits. Total TRS revenue for FY 2016 was $4.8 billion — $148 million from school districts, $951.8 million from members and $3.7 billion from state government. Investment returns remained relatively flat with a loss of $44 million. TRS ended the year with $44.7 billion in assets.
In the first seven years since Rauh’s study was published, TRS distributed $33.9 billion in pensions and benefits. Total TRS revenue for the seven years was $46.3 billion — $1.09 billion from school districts, $6.46 billion from members, $23.9 billion from the state and $24.2 billion in investment income. Total TRS assets increased by 42.8 percent during that time.
Nonetheless, the unfunded liability carried by TRS at the end of FY 2016 — $71.4 billion — remains troubling. TRS has less than 40 cents on hand for every dollar owned to TRS members over the next 30 years. If the unfunded liability is allowed to grow, TRS may have insufficient funds within the next 50 years. But the imminent collapse of TRS is impossible.
Teacher Pensions are too “Generous”
Updated: November 1, 2016
Issue: Critics of defined benefit pension plans like TRS say the guaranteed benefits of retired teachers and other public employees are too high and are out of sync with retirement benefits found in the private sector. The rising costs of maintaining these pensions should be scaled back in order to avoid tax increases and to allow more state tax revenues to be spent on other government priorities.
Critics also charge that retirement benefits are the major cause of the System’s unfunded liability, which was $71.4 billion at the end of fiscal year 2016.
Critics also charge that retirement benefits are the major cause of the System’s unfunded liability, which was $71.4 billion at the end of fiscal year 2016
Discussion: The average annual pension for a retired Illinois teacher in fiscal year 2016 was $54,252. When you consider that Illinois educators do not pay into or collect Social Security for their teaching years, the TRS benefit cannot qualify as “too generous.” Not only are TRS benefits many times the sole source of revenue for retired teachers, but TRS benefits stimulate local economies across Illinois. The pensions and benefits paid annually to retired teachers living in Illinois create more than $5.6 billion in economic activity, including more than 41,700 full–time jobs that mean more than $1.5 billion in wages for non–teachers.
TRS benefits are not responsible for the majority of the unfunded liability at TRS. TRS actuarial reports show that 66 percent of the unfunded liability over the last 15 years was caused by contributions from state government that failed to meet the “full funding” levels set by actuaries. For instance, between FY 2004 and FY 2016, the state’s total contributions fell $10 billion.
In addition, the chronic lack of proper funding from state government means TRS does not have that money to invest, and those “unrealized” investment returns over time account for 27 percent of the TRS unfunded liability, along with the cost of issuing pension bonds and other miscellaneous factors. Of the $578 million increase in the state’s annual contribution to TRS for fiscal year 2018, only 4.7 percent is attributable to benefit increases. According to the group “Illinois is Broke,” over the last 15 years 50 percent of the TRS unfunded liability is the result of underfunding by state government, 25 percent from pension bond costs and miscellaneous items, 21 percent from unrealized investment profits and only 4 percent from benefit increases.
Teachers do not Contribute Enough to Pay for their Entire Benefit
Updated: November 1, 2016
Issue: Some critics of public pensions maintain that the current 9 percent paycheck contribution made by active TRS members does not “pay for” the member’s entire benefit when he or she retires. In particular, critics say that teacher contributions did not increase to correspond with and offset all of the benefit increases approved by the General Assembly since 1970, when a pension protection clause was added to the Illinois Constitution.
Discussion: In fiscal year 2016, active TRS members actually will pay slightly more for the actual annual cost of TRS pensions and benefits than will state government.
From the beginning of TRS in 1939, teacher contributions were never intended to fund 100 percent of a member’s retirement annuity. As in all defined benefit retirement plans, the benefits have always been a shared responsibility of the members and the employers, which in the case of TRS are school districts and state government. TRS is responsible for investing these contributions and adding all investment returns to the trust fund to enhance its ability to pay member benefits. The state, by law, assumes the lion’s share of the employer’s cost because state government requires all active public school teachers outside of the city of Chicago to be TRS members. Also, all public school districts are creations of state government.
Here’s how it breaks down: The state’s total annual contribution for TRS in fiscal year 2016 was $3.742 billion, or 33.6 percent of the total $10.6 billion in salaries earned by all TRS members. That $3.742 billion was composed of $992 million to cover the actual annual cost of pensions in FY 2016 and $2.89 billion dedicated to help pay off the System’s unfunded liability.
By contrast, under state law active TRS members contribute 9 percent of total salaries to the actual cost of their benefits, or $996 million in FY 2016. The total member contributions for the actual annual cost of TRS pensions this year were 0.4 percent higher than the share paid by state government.
The only reason state government’s total out–of–pocket expenses exceeded $3.742 billion in 2016 is because for the last 76 years the state has never allocated to TRS an annual contribution that actuaries would determine is “full funding.” The state always has underfunded TRS. The $2.89 billion is the cost – plus interest – of not paying enough in the past.
The 9 percent TRS paycheck contribution rate in Illinois is among the highest rates in the nation. In 2016, only teachers in Arizona, Kentucky, Massachusetts, Missouri, Nebraska, Nevada, New Jersey, North Dakota, Ohio, paid higher rates. Illinois teachers and those in Kentucky, Missouri and Ohio do not participate in Social Security.
Since the founding of TRS in 1939, the teacher contribution rate to the System has more than doubled, from the original 4 percent to the current 9 percent, a 125 percent increase. Under state law, the majority of the contribution – 7.5 percent – funds retirement benefits, with the rest funding benefits for survivors, annual cost of living adjustments and an early retirement program.
State of Illinois Bankruptcy
Updated: November 1, 2015
Issue: There has been talk in Washington, D.C. about Congress considering a federal law that would allow financially troubled states like Illinois to declare bankruptcy as a way to help balance spending and revenues. Bankruptcy would allow a state government to reduce its debts and, theoretically, enable them to cut pay, benefits and pensions for teachers and public employees despite contractual protections. This discussion intensified in 2012 when the City of Detroit formally filed for bankruptcy protection in court. In 2014 a federal bankruptcy court and Detroit officials finalized a restructuring of the city’s debts over 10 years that included reductions in pension benefits to help balance revenues and spending.
Discussion: Illinois officials consistently say that despite its deep financial problems, the state isn’t going to declare bankruptcy because there is no law allowing a state to declare bankruptcy. Even if there was such a law, state officials say they would not use it.
The discussion about states declaring bankruptcy stems from a front–page story in the January 21, 2013 New York Times describing how some legislators in Washington were seriously discussing legislation to allow states to declare bankruptcy. The idea has not progressed beyond the discussion stage.
A bankruptcy provision for the states would face a difficult road to become law. There are constitutional questions and legal questions, and the public can expect strong opposition from organized labor, retirees, bondholders and service providers for the states. It is unlikely that a proposal like this would be enacted very quickly.
Bankruptcy protection, essentially, prevents a creditor from suing you to recover debts that are not being paid. Under current federal law, individuals, businesses and municipalities can file for bankruptcy. In return for not getting sued by creditors, a federal bankruptcy court can relieve you of that debt or restructure the unpaid debt to make it easier to repay as much of it as can be paid, either over time or by selling off assets.
State governments currently cannot file for bankruptcy – and do not have to – because they are granted “sovereign immunity” under the U.S. Constitution and cannot be sued for unpaid debts.
Some in Congress are pushing the idea of a state bankruptcy law because in theory bankruptcy would allow a state to renegotiate union contracts, pension agreements, the repayment of bonds and contracts with service providers like hospitals. With this power, state leaders could, in theory, reduce payments to every entity that is owed money. This is what happens when a municipality files for bankruptcy. Municipalities such as Detroit, like private corporations, are legal creations of the state and can declare bankruptcy.
But there are legal questions about this kind of proposal that would generate lengthy lawsuits: For instance, a bankruptcy law would change a state’s sovereign immunity status, so would that mean anyone could then be able to sue a state? How would a federal bankruptcy law affect the pension protections in the Illinois Constitution that were upheld in 2015 by the Illinois Supreme Court?It’s not even a sure bet that any state would want to declare bankruptcy. No entity can be forced into bankruptcy, not even municipalities. Right now, any person, company or local government that declares bankruptcy forfeits certain rights about what they can spend to a court. It would be no different for a state. The governor of an officially bankrupt state might have to get the approval of a federal judge in order to spend any tax dollars. It’s very unlikely that a governor would want to give up that kind of broad control to a court.
The TRS Assumed Rate of Return on Investments
Updated: November 1, 2016
Issue: In 2011, the Chicago Tribune published an editorial about the rates of return public pension systems like TRS predict their investments will earn over a long period of time. The Tribune referred to public pension systems as “Pollyannas” because most public pension systems at the time assumed that investments would return an 8 percent or greater “profit” over an extended period of time. The Tribune said that rate of return was too high.
The Tribune said it believed that pension systems like TRS should set their assumed rate of return much lower – at around 2 percent or 3 percent. A rate that low effectively would tie the assumed rate of return to the return rate of U.S. Treasury bonds. Those bonds are considered to have “zero risk” in the financial world.
Instead of putting more state tax money into pensions, the Tribune argues a better course of action is to reduce pensions, so that “risk–free” investments can pay for benefits and more tax money would not be needed by the pension systems.
Discussion: The Tribune’s call for a “zero–risk” rate of return is not based on any historical data or economic projections of investment income, but rather on a simple fear that a bad economy will keep investment earnings low. If investment earnings are low, then state government must step in with a greater amount of money in each year to fund pension obligations.
At Teachers’ Retirement System, the investment rate of return during the last 30–year period through fiscal year 2016 is 8.1 percent. The assumed rate of return is currently 7 percent. It was set set at 7 percent in August of 2016. The TRS assumed rate was 8.5 percent between 1997 and 2012, 8 percent between 2012 and 2014 and 7.5 percent between 2014 and 2016.
By law TRS must study and recalculate its assumed rate of return at least every five years. Due to the unpredictability of the world economy, the Board of Trustees has set the next review of the assumed rate of return more frequently.
Despite the unpredictability of the international economy and the investment markets, the projected 7 percent TRS rate of return is right on target with the System’s actual long–term rate of return. There is no economic rationale for lowering the TRS rate of return to 2 percent or 3 percent. The suggestion to reduce the target rate of return to as low as 2 percent would unfairly burden current taxpayers with higher costs by undercutting the actual investment returns of the fund to the present day’s benefits.
In fiscal year 2015, 116 of 127 public pension funds studied by the National Association of State Retirement Administrators had an assumed rate of return set at between 7 percent and 8 percent. Only four had an assumed rate of return greater than 8 percent and only seven had an assumed rate lower than 7 percent.
In FY 2016, the TRS rate of return calculated for the last 10–year period, gross of fees, was 6 percent. The rate for the last five–year period was 7.42 percent and the rate for the last three–year period was 7.53 percent.Because the national and world economies are facing many challenges, TRS recorded an investment rate of return of 0.69 percent gross of fees during fiscal year 2016.
TRS is “Mismanaged”
Updated: November 1, 2016
Issue: Critics charge TRS is endangering teacher pensions by seeking to make a fast buck through “risky” trades in securities known as derivatives – attempting to recoup $4.4 billion in investments that were lost during the world financial crisis in fiscal year 2009.
Discussion:TRS did lose $4.4 billion during 2008–2009, but almost every large institutional investor around the world lost money. The losses stemmed from a worldwide economic downturn in the value of stocks, bonds and real estate, not because of mismanagement or trading in derivatives. For the last five years TRS has not made any substantial changes in its investment philosophy, and the overall $45.6 billion portfolio recorded a 30–year investment rate of return of 8.8 percent, gross of fees, at the end of fiscal year 2016. Total TRS assets have increased by $17 billion since 2009.
Updated: November 1, 2015
Issue: Critics say TRS needlessly risks members’ assets on investments in “derivatives” in order to make a lot of money quickly. The media point a negative finger at derivatives because many financial experts and commentators blame unregulated derivative trading for contributing to the 2009 worldwide economic crisis.
Discussion: TRS has been successfully trading in derivatives since 1986 without harming the fiscal health of the System. In reality, for institutional investors like TRS, derivatives serve a greater purpose. They are never used to make quick profits, but used to reduce risk in the rest of the portfolio.
A derivative is essentially a “side bet” in the world of investing that is not regulated by any government oversight body. It is a privately–created and privately–traded transaction between two parties that is based on the value of an actual stock or bond or a bundled group of real stocks or bonds. The difference is with derivatives, the investors do not actually “own” the stocks or bonds. Investors make or lose money by predicting the performance of the individual instrument or the entire bundle of securities.
At TRS, derivatives are used essentially as “insurance” against a potential drop in the value of an investment. At TRS, a derivative investment is only created and traded in conjunction with a direct TRS investment in assets that are part of the bundled package. The value of a particular stock or bond, on its own, may vary over a period of time. But coupled with other investments in a bundle, the average value of the entire package does not vary as much because the combined investments play off of each other — as one falls, another rises. If the value of the “real” investment increases, TRS gets a profit. If the value of the “real” investment does drop, the System’s loss is reduced or mitigated by the investment in the derivative that contains the “real” investment.
Despite the negative image of derivatives in the media, all large pension funds and institutional investors trade in derivatives. Derivatives comprise the largest investment market in the world, with a value of $650 trillion.
Updated: November 1, 2016
Issue: TRS, like many other pension systems throughout the United States, carries an “unfunded liability,” which at the end of fiscal year 2016 was $71.4 billion. Because of this unfunded liability, TRS currently has less than 40 cents in the bank for every dollar owed to members.
Discussion: The TRS unfunded liability is a long–term concern — think decades — and should not be confused with the annual obligations of the System. It would be like confusing a family’s “mortgage” with the “mortgage payment.” TRS has carried an unfunded liability since 1939 and yet has never missed a pension payment to any member because of the unfunded liability.
If all of TRS obligations for current retirees and active teachers were called due today, the System could not meet 60 percent of those outstanding pensions and benefits. But that can never happen because not all teachers will retire at the same time. By law, active teachers cannot collect retirement benefits, so TRS must pay out only what is owed to benefit recipients in that year. In fiscal year 2016, TRS paid out $5.8 billion in benefits and collected $4.8 billion in total revenue. Over the last five years, benefits paid totaled $25.9 billion while revenue collected totaled $34.4 billion.
The unfunded liability is a concern for state officials because the higher the unfunded liability gets the more money the state must contribute each year to TRS and the other public pension funds. High contributions drain money away from other state services. For FY 2016, 78.7 percent of the state’s $ 4.6 billion contribution to TRS was dedicated to paying off a portion of the unfunded liability, and only 21.3 percent dedicated to the year’s pension obligation.