Annual State Contribution to TRS for Fiscal 2014

Issue: The Teachers’ Retirement System Board of Trustees on October 26 set state government’s funding contribution to TRS for fiscal year 2014 at $ 3.438 billion, a 27.2 percent increase over last year’s contribution.

Discussion: The $3.4 billion contribution for FY 2014, however, once again falls short of the amount needed to fully fund TRS over the next 30 years. TRS faces the real risk of future insolvency because of insufficient state funding over the last 30 years.

TRS absolutely will be able to meet its obligations to retired teachers in the near future, but we cannot guarantee retirement security for future generations of teachers unless the state meets its total obligations.

The FY 2014 state contribution falls $941.9 million short of the amount of money that would be required to fund the System in FY 2014 under standard actuarial calculations.

The System’s long-term funded ratio declined from 46.5 percent in FY 2011 to 42.1 percent at the end of June, 2012. This funding shortfall is due primarily to years of insufficient state funding coupled with an uncertain economy in the last year that depressed the System’s investment earnings. TRS earned 0.76 percent on its investments during FY 2012, compared with 23.6 percent in FY 2011.

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 FY 2014, and for the last several years, has not been enough to improve the System’s long-term finances. The contribution is set artificially by state law. It’s not an actuarial calculation.

For FY 2014, the TRS Board asked its actuaries, Buck Consultants of Chicago, to calculate both numbers – the state contribution under state law and under normal actuarial practices. Under standard actuarial practices, the state’s annual contribution for the coming year should be $4.38 billion.

The calculations set in state law artificially lower the state’s annual funding level. State law, for instance:

• 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 $53.5 billion. The unfunded liability in FY 2011 was $43.5 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.

Fiscal Year 2012 Investment Returns

Issue: Teachers’ Retirement System investments generated a positive 0.76 percent rate of return during fiscal year 2012, a sharp decline from the 23.6 percent return of the previous year. TRS ended FY 2012 on June 30 with $36.3 billion in assets, which places the System among the top 40 largest pension funds in the United States.

Discussion: The sharp decline in the rate of return for FY 2012 underscores the uncertainty and volatility in the world economy over the last year. TRS managed to hold its own because its investment strategy stressing diversification balanced any losses in particular investments with gains in other sectors.

TRS 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 has to be there for our retired members and our active members for decades to come. During the 30-year period that ended in 2012, TRS investments earned 9.6 percent against the previous target of 8.5 percent.

TRS trustees and officials did not get overly excited about 23.6 percent return in FY 2011 and are not crying over a 0.76 percent return this year. It is the long-term results that matter.

In September the TRS Board of Trustees revised its long-term investment target to 8 percent from 8.5 percent largely because of the uncertainty facing the world economy, especially in Europe. The long-term rate of return target is an estimate that looks 30 years into the future.

The 0.76 percent rate of return for TRS in FY 2012 falls in line with the investment returns for FY 2012 being reported by other large public pension systems across the country. Many saw their investment returns drop from more than 20 percent to less than 4 percent in a year’s time.

The difficult and unpredictable nature of the world economy at the present time can be illustrated by the drastic turnaround in preliminary TRS investment results through September.

• Between April and June, TRS investments recorded a negative 1.52 percent return. However, between July and September, TRS investments saw a positive 4.8 percent return.
• While the TRS investment return was 0.76 percent for the 12-month period that ended in June, for the 12-month period ending on September 30, the TRS rate of return was a positive 16.4 percent.

In the last 10 years, TRS investments have recorded positive returns in eight years, with the two years of negative returns seen during the worldwide financial meltdown of 2008 and 2009.

During FY 2012, TRS realized its strongest gains from its investments in real estate, which returned +9.91 percent. Positive returns were also recorded from the System’s investments in:

• Bonds (+5.68 percent)
• Private Equity (+3.76 percent)
• Hedge Funds (+2.62 percent)
• Real Return Securities (+2.54 percent)
• Stock held in United States companies (+0.96 percent)

TRS investments in international stocks recorded a negative 11.71 percent rate of return, which pulled down the positive gains in the other six investment categories.

All of the return rates were calculated after all investment fees had been subtracted from the total assets in each portfolio.

Teachers' Retirement System is Not Going Out of Business in 2018

Issue: A story that has been posted on Yahoo Finance and other websites that say TRS will 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 good. The story has been discredited repeatedly by financial experts and pension officials from around the country, as well up-to-date information collected since the original prediction was made in 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, an associate professor of finance at Northwestern University. Rauh conducted an academic study to determine how long the state’s 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. By dividing total assets by total 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, in a March, 2012 blog post, Rauh toned down his 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 runout 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. This situation has not happened in the past and has not happened in the years since the study.

In the last completed fiscal year, 2011, TRS distributed $4.2 billion in pensions and benefits. Total TRS revenue for the year was $10.4 billion - $155 million from school districts, $909 million from members, $2.1 billion from the state and $7.2 billion in investment income. TRS ended the year with $37.8 in assets.

In the last completed fiscal year, 2012, TRS distributed $4.5 billion in pensions and benefits. Total TRS revenue for the year for the last three years was $20.9 billion - $481 million from school districts, $2.7 billion from members, $6.7 billion from the state and $11.1 billion in investment income. TRS ended the year with $36.3 in assets.

Rauh’s assumed 3 percent rate of return is unrealistic. The agency's current target rate of return is 8 percent. In the last year, the agency's actual rate of return over the last 30 years ending in fiscal year 2012 it is 9.6 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.

Rauh's prediction will only come true if TRS does not earn another dime in investment income or receive any state contribution over the next eight years. That scenario is not only unlikely, it is impossible.

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Teacher Pensions are too “Generous”

Issue: The guaranteed benefits of retired teachers and other public employees are too high and are out of synch 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 cuts in other public services.

Discussion: The average annual retirement benefit for an Illinois teacher is $46,452. 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 monetary lifeline for retired teachers, but they stimulate local economies across Illinois. The pensions and benefits paid annually to retired teachers living in Illinois create more than $4 billion in economic activity, including more than 30,000 full-time jobs that mean $2.3 billion in wages for non-teachers.

TRS benefits are not responsible for one-half of the unfunded liability problem at TRS. TRS actuarial reports show that 66 percent of the unfunded liability over the last 15 years is caused by lower-than-needed contributions from state government; 27 percent is the result of unrealized investment profits due to the lower-than-needed contributions, the cost of issuing pension bonds and other miscellaneous factors. Only 7 percent is the result of benefit increases to members. According to the group “Illinois is Broke,” over the last 15 years 50 percent of the TRS unfunded liability is the result of lower-than-needed state payments, 25 percent from pension bond costs and miscellaneous items, 21 percent from unrealized investment profits and only 4 percent from benefit increases.

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Teachers Do Not Contribute Enough to Pay for Their Entire TRS Benefit

Issue: Some critics of public pensions maintain that the current 9.4 percent paycheck contribution made by 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 the state constitution was written with its pension protection clause.

Discussion: Contributions from Illinois teachers fund a majority of the total cost of TRS benefits.

From the beginning of TRS, teacher contributions were never intended to fund a member’s entire retirement annuity. The benefit has always been a shared responsibility of teachers, school districts, state government and investment income generated by TRS.

The total annual cost of benefits to retired TRS members in fiscal year 2012 is $1.7 billion, or 17.8 percent of the total $9.9 billion in salaries to be earned by Illinois teachers. Of the total cost of benefits, teacher contributions fund more than half of those benefits, 9.4 percent, or $939.6 million. The remainder of the total cost is funded by the state, school districts and investment income.

The 9.4 percent paycheck contribution rate in Illinois is among the highest rates in the nation. In 2010, only teachers in Kentucky, Missouri, Nevada, Ohio, Rhode Island and Vermont 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 9.4 percent, a 135 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.

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State of Illinois Bankruptcy

Issue: There has been talk in Washington, D.C. about Congress approving a federal law that would allow states to declare bankruptcy as a way for cash-strapped states like Illinois to dissolve debts and lower pensions, pay and benefits for teachers and public employees.

Discussion: Illinois officials consistently say the state isn’t about to declare bankruptcy because there is no law allowing a state to declare bankruptcy and even if there was, state officials would not use it.

The claim is the result of a front-page story in the January 21st New York Times describing how some legislators in Washington are seriously discussing legislation to allow states to declare bankruptcy. But despite the talk, this proposal has no immediate effect on TRS pensions. Right now this idea is just that – an idea. There is no legislation – nothing in writing – pending before Congress.

A proposal like this faces 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, if at all.

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 restructures the 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” by the U.S. Constitution and cannot be sued.

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. They could, in theory, reduce payments to every entity that is owed money. This is what happens when a municipality files for bankruptcy. Municipalities, like private corporations, are legal creations of the state.

But there are legal questions about this kind of proposal that would generate lengthy lawsuits: A bankruptcy law would change a state’s sovereign immunity status, so does that mean anyone can now sue a state? How would a federal bankruptcy law affect the pension protections in the Illinois Constitution?

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 the court. In other words, 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 that kind of broad control to a court.

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The TRS Assumed Rate of Return on Investments

Issue: On October 17, 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 assume that investments will return an 8 percent profit over an extended period of time. The Tribune says that rate of return is too high.

The Tribune believes that pension systems like TRS should set their assumed rate of return much lower – 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 the more tax money is not 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, 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 to fund pension obligations.

At Teachers’ Retirement System, the investment rate of return during the last 30-year period through fiscal year 2012 is 9.6 percent. The assumed rate of return is currently 8 percent. It was set at 8 percent in September of 2012. It was 8.5 percent between 1997 and 2012.

By law TRS must study and recalculate its assumed rate of return 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 for fiscal year 2015.

The projected TRS rate of return is right on target with the actual 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.

The projected TRS rate of return is right on target with the actual 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.

In 2011, 79 of 126 public pension funds studied by the National Association of State Retirement Administrators had an assumed rate of return of 8 percent or higher. The rest had set an assumed rate of between 7 percent and 8 percent.

The average TRS rate of return calculated for the last 10-year period, or the last five-year period, is lower than the 8 percent target rate, due exclusively to the financial crisis of 2008-2009. The TRS rate of return for the last 10-year period is 6.4 percent. The rate of return for the last 5-year period is 0.67 percent. But low average investment returns over the last five or 10 years were not exclusive to pension systems. Almost every large institutional investor, as well as millions of individual investors, lost a lot of money during the economic downturn.

Even though the national and world economy is facing many challenges, TRS recorded an investment rate of return of 0.76 percent during fiscal year 2012, but a 23.6 percent during fiscal year 2011. Here is the TRS actual rate of return for the last 10 fiscal years:

• 2012: + 0.76%
• 2011: +24.0%
• 2010: +13.5%
• 2009: -22.3%
• 2008: -   4.5%
• 2007: +19.6%
• 2006: +12.2%
• 2005: +11.1%
• 2004: +16.8%
• 2003: +  5.2%
• 2002: -   2.9%

75 percent of TRS investments currently are comprised of stocks, bonds and real estate, which cannot be described as a “risky” portfolio.

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"Risky" Investments

Issue: A Northwestern University study from March 2010 concludes TRS has the “fourth riskiest” pension system in the country, with 81.5 percent of investments classified as “risky.”

Discussion: The “study” merely totals the assets that TRS and 24 other public pension systems have that are not held in cash or invested in fixed income securities, and labels these investments as “risky.” No valuations or comparisons are assigned to any of the thousands of individual investments held by TRS, so the study does not rank how risky the TRS portfolio is compared to any other public pension system. For instance, the study did not determine whether an investment in Microsoft is more risky than an investment in American Airlines. TRS is required to maximize the resources available for retired teachers. All investments carry some element of risk. Without its investment portfolio, TRS could not keep pace with the resources needed for pension and benefit checks. Forty-nine percent of a TRS pension check comes from investment income. Check out the “study” at www.npr.org/templates/story/story.php?storyId=125059110.

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TRS is “Mismanaged”

Issue: 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 two years TRS has not made any substantial changes in its investment philosophy, and the overall $37.7 billion portfolio recorded a 24 percent rate of return during fiscal year 2011. The target rate of return for TRS is 8.5 percent. Total TRS assets have increased by $9.2 billion two years since the worldwide financial crisis.

(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.)

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Derivatives

Issue: 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 to reduce risk in a large portfolio and to make some hard-to-acquire investments available at a lower cost.

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.

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Unfunded Liabilities

Issue:TRS, like many other pension systems throughout the United States, carries an “unfunded liability,” which currently is $53.5 billion, out of a total liability of $91.5 billion.

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 1953 and 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 58.5 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 2012, TRS paid out $4.5 billion in benefits, but in the last three years collected $21 billion in revenue.

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. In FY 2012, two-thirds of the state’s $2.4 billion contribution to TRS was dedicated to paying off a portion of the unfunded liability, and only one-third dedicated to the year’s pension obligations.

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