Securities and Exchange Commission Fraud Charges Against the State of Illinois

Issue: On March 11, 2013, the State of Illinois agreed to settle securities fraud charges brought by the U.S. Securities and Exchange Commission which alleged that between 2005 and 2009 state officials misled bond investors about the size and nature of the unfunded liabilities facing TRS and the state’s other pension systems.

Discussion: State officials settled the securities fraud charges by making changes to the way the state reports the finances of its pension systems. Since 2009 TRS has worked with the Governor’s Office of Management and Budget on ways to improve the reporting of pension system finances. In settling the charges, the state neither admitted nor denied any guilt. Illinois did not have to pay a fine or a penalty.

Teachers’ Retirement System is not and was never under investigation by the Securities and Exchange Commission (SEC). In a November 29, 2010 letter to TRS, the SEC said, “This investigation has been completed as to the Teachers Retirement System of the State of Illinois, against whom we do not intend to recommend any enforcement action by the Commission.”

TRS cannot sell bonds, so the System cannot be the subject of this inquiry by the SEC. The inquiry has not and will not affect the status of any TRS member’s pension.

The SEC continues to look into the activities of various states that have sold bonds in recent years. The SEC inquiries look into the use of state government financial information during the sale of the bonds. Specifically, did any state use false, misleading or incorrect information to make their pension systems appear to be more financially sound than they really are in order to sell bonds. In other words – did the state mislead potential bond buyers with false information?

In the early fall of 2010, the SEC asked TRS and the other Illinois public pension systems for basic financial information. This data was swiftly provided by TRS to the SEC.

In 2010 the SEC charged the State of New Jersey with using false information in the sale of pension bonds. The SEC and New Jersey reached a settlement agreement and the state paid a penalty to the federal government.

Illinois Policy Institute Questions on TRS Investments

Issue: In February of 2013, the Illinois Policy Institute’s director of health policy and pension reform, Jonathan Ingram, distributed statewide an email that raised several questions about investment practices and decisions at Teachers’ Retirement System. The positions and questions raised by the IPI were repeated in various publications across Illinois.

Discussion: The IPI email contained several inaccuracies, misunderstandings of fact and contradictions. In response to the email, TRS has identified each of the problems in the email and corrected the record.

Have you ever wondered what investments politicians have made using teachers’ retirement savings? (1)

(1) Incorrect. “Politicians” do not control the investments decisions at Teachers’ Retirement System. No statewide elected official or member of the General Assembly or the General Assembly as a whole makes any investment decision concerning TRS funds once those funds are under the control of the System. TRS was created by the State of Illinois as an independent fiduciary with legal responsibility over the administration of money that TRS members and taxpayers set aside for the retirement annuities of the System’s members.

That’s because the politicians want the state government, and by extension, your tax dollars, to financially guarantee the state pension funds (2)

(2) The Illinois Policy Institute apparently is unaware that the payment of teacher pensions from TRS has been guaranteed by the state for years. By law, pension payments are an obligation of state government. The statute is found at 40 ILCS 5/16-158 (c): “Payment of the required State contributions and of all pensions, retirement annuities, death benefits, refunds, and other benefits granted under or assumed by this System, and all expenses in connection with the administration and operation thereof, are obligations of the state.”

As the report illustrates, taxpayers aren’t being asked to back safe investments such as government bonds. (3) Instead, they’re being asked to bail out riskier investment strategies (4) if and when they fail to bring in the promised investment returns. (5)

(3) This statement leaves the incorrect impression that TRS does not invest its assets in “government bonds.” What the Institute does not say is that on pages 61 and 62 of the Comprehensive Annual Financial Report for fiscal year 2012, cited by the Institute, it is clearly stated that TRS during the year held investments in government bonds totaling $1.8 billion.

TRS is required by Illinois law, 40 ILCS 5/1-109(c) to prudently diversify its investments across an appropriate number of asset classes.

(4) The “risk” incurred by TRS investments falls within established parameters set by the TRS Board of Trustees. Compared to its peers, the System’s risk is lower than the median risk of the pension plans used in the comparison. Over the last 30 years, TRS investment strategies have resulted in a rate of return of 9.6 percent against a long-term target of 8.5 percent. (5) This statement is incorrect and reveals a basic misunderstanding by the Institute of how pensions are funded by state government. The amount of money state government allocates to TRS every year is determined predominantly by the projected cost of pensions in the future and not by investment returns, either positive or negative.

For example, in the wake of the 2009 worldwide financial meltdown and the last recorded investment loss for TRS, state government’s contribution in 2010 increased by $63 million. In 2012, a year after TRS’s investment return was an unprecedented 23.6 percent, the state’s annual contribution increased by $237 million.

The System’s investment strategies are within acceptable risk parameters and have been successful over the long-term. “If and when they fail” is a contradictory phrase that says, at the same time, that something “may” happen and “will” happen.

Over the last 30 years, TRS investments have recorded a positive 9.6 percent rate of return, compared to a target rate-of-return of 8.5 percent. The average rate of return for the last three years is 12 percent. For all of calendar year 2012, TRS investments returned 13.9 percent.

Take a look at TRS’s investment portfolio: roughly 43% of teachers’ retirement savings are invested in equities, which by their nature are very risky. (6) Another 12% is invested in real estate — the last few years have shown us all exactly how risky that type of investment can be. (7)

(6) TRS investments in stocks are not “very risky.” All investments carry some risk, but the fiduciary duty of the TRS Board requires it to set an acceptable risk tolerance and to prudently maximize TRS assets through investments. Together, the TRS investments in U.S. and international stocks have returned a positive 17.2 percent over the last 10 years.

Based on the sheer volume of investments in equities, the reward from investing in stocks has been greater than the risk incurred. Worldwide 1.2 billion people invest in equity markets. The international stock market at the end of 2012 was worth $54.6 trillion.

In addition, the vast majority of 401(k) plans owned by Americans are invested in stocks and bonds. Fidelity Investments alone administers 12 million 401(k) accounts in the United States on behalf of clients.

Also, the Institute ignores the fact that over decades, the value of stocks has increased greatly and therefore is a benefit to TRS members. Between 1900 and 2012, the average total return per year from U.S. stocks was 9.4 percent. Created in 1939, TRS is a perpetual entity without a “life span” and its members benefit from the long-term increase in the value of stocks as the value of retirement investments increase. TRS is required by law to fund teacher pensions forever.

(7) Incorrect. At the end of fiscal year 2012, TRS real estate investments generated a positive return of 9.9 percent after all investment fees had been paid. Over the last 10 years, TRS real estate investments generated a 7 percent positive return after fees.

But it doesn’t stop there. TRS is dumping money into fancier investments with less transparency, including complex derivatives, private equity and foreign currency bets. (8)

(8) The ill-defined term “less transparency” does not describe the decision process used by TRS to determine where assets are invested. All investment allocations are made by the Board of Trustees in open, public meetings. The System’s CAFR includes a tremendous amount of detail about where TRS assets are invested. TRS complies with quarterly investment reporting laws. The System is subject to the Illinois Freedom of Information Act and routinely provides detailed descriptions of various system investments to the public. Also, TRS finances and investment reports are reviewed annually by an independent accounting firm selected by the Illinois Auditor General. Annual actuarial valuations are reviewed by the Illinois State Actuary.

The subjective term “bet” implies that TRS is gambling with its members’ money. That is incorrect. Since 1990, prudent investments by TRS have generated a total of $35.9 billion in investment income, or an average of $1.6 billion per year.

All large institutional investors like TRS allocate money to derivatives, private equity and foreign currency as part of the process of portfolio diversification. These investments are not unusual.

The world derivatives market is valued in excess of $600 trillion. All TRS derivative investments are secured by collateral. During the 2008-2099 worldwide financial crash, some investors got into trouble by investing in derivatives that were not backed up by collateral.

The private equity investment market worldwide is valued at $2 trillion. TRS investments in private equity have been very successful, generating a 17.8 percent return for the System since 1982.
Foreign currency transactions are a prudent aspect of portfolio diversification. Every day, worldwide foreign currency transactions total in excess of $4 trillion.

TRS has more than $1 billion invested in bonds that Moody’s Investors Service or S&P Ratings Services rate as below investment grade. That’s the rating given to bond issuers who they don’t have the capacity to meet their financial commitments. They’re commonly called junk bonds. More than 14% of the TRS bond portfolio is tied up in junk bonds. (9)

(9) The Institute’s estimate of “more than 14 percent” of TRS bond investments in high-yield “junk” bonds falls way short of maximum limits on high-yield bond investments set by publicly available 401(k) plans and mutual funds that are registered with the Securities and Exchange Commission. In 2012, the average allowable limit for high-yield bonds held by 1,641 public and private investment funds was 35 percent of a total bond portfolio.

Overall, $1.07 billion in high-yield “junk bonds” represents just 2.8 percent of the System’s $38 billion investment portfolio. In fiscal year 2012, almost half of the bonds held by TRS – 46.2 percent – were rated as “Aaa,” by Moody’s Investors Service, the highest quality rating possible.
Since 2010, all TRS bond investments have returned 10.38 percent.

And higher risks can mean bigger losses for government workers’ retirement savings. (10)

(10) A completely speculative statement with no basis in fact. Compared to its peers, the TRS risk is lower than the median risk of other comparable pension plans. Between 1990 and 2012, the TRS investment portfolio has grown from $8 billion to $38 billion. In that time period, TRS investment income averaged $1.6 billion per year.

It’s quite another to force upon them the high-risk choices made in Springfield. (11)

(11) This analysis is not supported by the facts. Compared to its peers, the TRS risk is lower than the median risk of other comparable pension plans. Between 1990 and 2012, the TRS investment portfolio has grown from $8 billion to $38 billion. In that time period, TRS investment income averaged $1.6 billion per year. The System’s 30-year rate-of-return is 9.6 percent.

It’s time to expand a program that already exists for workers at Illinois’ community colleges and public universities. Today, more than 10,000 government workers in Illinois participate in 401(k)-style plans that put them — not politicians — in charge of their retirement. (12)

(12) Actually, at the end of fiscal year 2012, State Universities Retirement System had 16,684 members enrolled in its Self-Managed Plan, not 10,000. Those 16,000 members represent just 14.6 percent of the 114,000 active and retired SURS members. In addition, all 114,000 SURS members, including the 16,000 that participate in the supplemental 401(k)-style plan, benefit or will benefit from a defined benefit pension plan that is very similar to the TRS pension plan.

In championing 401(k) plans, the Institute contradicts its position that pension funds should not invest money in stocks, which it describes as “very risky.” The vast majority of 401(k) plans owned by Americans are invested in stocks and bonds. Of the SURS members enrolled in the Self-Managed Plan, over the last 10 years 71.2 percent of money dedicated to the SMP was invested in stocks and 28.6 percent in bonds. The average SMP account balance at SURS was $57,500 in FY 2012.

Also, Fidelity Investments alone administers 12 million 401(k) accounts in the United States. According to Fidelity, the average 401(k) account balance of its clients at the end of 2012 was $77,300. Distributed equally over a 20-year period of retirement, $77,300 would create an annual payment of $3,865 on which to live.

More than 1,600 401(k) plans and other investment funds regulated by the federal government set the maximum limit for high-yield bonds at an average of 35 percent of their total bond investments.

Union leaders and politicians want you to guarantee the high-risk investment decisions made by the politician-controlled pension systems. (13) If and when these risky investments fail, (14) they’re coming for your wallet so they can dump even more money into the failed pension systems.

(13) See Number 1, Number 2 and Number 6, above. The state already has guaranteed public pensions in state law. TRS is not controlled by “politicians.” The investment decisions made by TRS are not high-risk.

(14) “If and when they fail” is a contradictory phrase that says that something “may” happen and “will” happen at the same time.

But providing a taxpayer guarantee for the high-risk investment decisions made by politician-controlled pension systems only guarantees one thing: disaster. (15)

(15) See Number 1, above. The state already guarantees public pension payments in state law.

Illinois Pension Problem is “Unfixable” – Civic Committee of Chicago Statement

Issue: On November 14, the Civic Committee of the Commercial Club of Chicago, which leads the effort to overhaul Teachers’ Retirement System and the state’s other pension systems, sent a letter to Governor Quinn that said that there is no solution to fixing the long-term financial problems facing TRS and the other systems. This is a quote from the letter: “Our latest sobering analysis has led us to conclude… that under current circumstances the pension system is unfixable.”

Despite the finality of this statement, the Civic Committee nonetheless proposed a series of changes they said would “minimize the long-term damage.”

• “Eliminate all cost-of-living increases”
• “Institute a pensionable salary cap”
• “Increase the retirement age to 67”
• “Shift annual costs to local employers over 12 years or more”
• “Before undertaking these reforms, it is critical that the pension funds immediately lower their discount rate (investment return) assumptions… Moody’s has suggested the high grade long-term corporate bond index rate, which was 5.5% for 2010 and 2011.”

Discussion: The Civic Committee’s statement is fundamentally untrue. The long-term TRS financial problem can be fixed. In fact, if current state law is left unchanged, in 34 years TRS will be 90 percent funded. This path, however, does require tough choices and regular and increased funding from state government and TRS members.

The Civic Committee’s statement never gives any evidence that the pensions systems are “unfixable,” but only that in the future the state will pay more every year for public pensions than the Civic Committee says it wants the state to pay.

The Civic Committee has always been clear that it wants less tax money spent on pensions so the funds can be spent on other priorities. They also have pointed out for years that the majority of citizens do not enjoy a public pension. These are quotes from the statement:

“It’s crushing our ability to educate students, ensure adequate public safety and provide health care and social services to those who are most in need.”

“But moreover, it’s a slap in the face to the 95% of Illinois residents who do not participate in these pension systems.”

While the Civic Committee’s statement leaves an impression that there will not be enough money to pay for pensions in the future, in reality the opposite is true. Sufficient money is there to pay for pensions. The problem for legislators is deciding how to spend the available money and how much should be devoted to TRS and the other pension systems in order to ensure financial stability in the future.

The fiscal year 2013 state budget is $53 billion, not counting federal money. The total state contribution for TRS and the state pension systems in FY 2013 is $7.5 billion. There is enough money. The question is, as it has always been: where will that $53 billion be spent?

For TRS, the state’s contribution in FY 2013 is $2.7 billion, which is 5 percent of the entire state budget.

Left alone under current state law, the pension systems get fixed over the next 34 years – but this fix is expensive, will take a long time and carries serious consequences. The fix works if the state continues to pay its entire annual contribution – which is a lot of money every year – and if Tier II members continue to subsidize the system – which is fundamentally unfair to them.

Under current state law, Tier II members pay the same contribution to the state from every paycheck that Tier I members pay – 9.4 percent. However, because the Tier II member benefit costs less than the Tier I member benefit, the Tier II members are paying the entire cost of their benefit and a little extra. About 36 percent of the Tier II member’s 9.4 percent salary contribution is a subsidy that offsets the costs of Tier I benefits.

Between 2012 and 2038, the number of Tier II members paying into TRS will continue to grow and eventually will eclipse the number of Tier I members paying contributions, so the Tier II subsidy will continue to grow.

In fiscal year 2038, TRS estimates show that the System will be 68 percent funded and by 2046 will be 90 percent funded. The Tier II subsidy will be so large that by FY 2038 the state’s annual contribution will be devoted to paying off the unfunded liability. The entire annual cost of pensions after 2038 is paid for by members. According to estimates, the state’s annual contribution in FY 2038 is $9.1 billion and tops out at $10.2 billion in FY 2045, but in the next year drops substantially to $1.3 billion.

Finally, the Civic Committee’s latest suggestions to reform the pension code are contradictory and will not, taken together, lower the state’s costs.

While the first three suggestions drastically reduce benefits for retired members and therefore the overall cost, these savings are wiped out by the Committee’s fifth proposal – to have TRS and the pension systems “immediately” lower their assumed rates of investment return to 5.5 percent.

The current TRS assumed rate of return is 8 percent. Lowering the rate of 8 percent to 5.5 percent will automatically increase the state’s cost every year by billions of dollars. When you assume that TRS will be earning less from investments, the state must pay more to meet the total cost of pensions because total contributions from members and school districts is a revenue stream set by state law.

For FY 2014, TRS lowered its assumed rate of return from 8.5 percent to 8 percent. That 0.5 percentage point reduction alone added $473 million to the state’s annual contribution.

The Committee’s fourth suggestion – shifting the annual cost of pensions to local governments – does nothing to lower costs for taxpayers. The proposal is just a transfer of responsibility from a larger group of taxpayers to a smaller group of taxpayers. The cost of the pensions remains the same. For TRS, the shift means that the annual cost of a pension for a school district’s teachers will not be spread out statewide among millions of taxpayers, but only spread among thousands of people who live in that school district, much like the way municipalities pay for the pension costs for police and firefighters.

Better Government Association Report on TRS Investment Fees – April 18, 2012

Issue: The Chicago Sun-Times and WBBM-TV published a report written by the Chicago-based Better Government Association that compared Teachers’ Retirement System investment results between 2001 and 2010 with fees paid to external money managers hired to invest our members’ money. The report said that during this decade, TRS spent $1.3 billion on fees, yet the average investment rate of return for the decade was 3.7 percent, well below the System’s target of 8.5 percent.

Discussion: While the numbers are true, the comparison does not provide an accurate picture of TRS investments. It’s like comparing apples and oranges. The real comparison is between fees paid and investment revenue earned. Those statistics tell a different story:

Between 2001 and 2010, Teachers’ Retirement System generated $10 in investment revenue for every $1 paid in fees to outside investment managers. While fees totaled $1.3 billion between 2001 and 2010, investment revenues totaled $10.937 billion.

The BGA arbitrarily chose to study a decade that included an unprecedented world-wide financial downturn in 2008-2009. That crisis, you will recall, caused all large investors, including TRS, to lose money, as well as a lingering recession. Other arbitrary measures of time produce different investment results for TRS against the System’s target return of 8.5 percent:

• Between 1981 and 2011, investment returns averaged 9.3 percent.
• Between April of 2009 and March of 2012, investment returns averaged 14.8 percent.
• Between 2003 and 2007, investment returns averaged 12.64 percent.

In fiscal year 2011, TRS recorded a 23.6 percent rate of return after all fees had been subtracted and generated $7.2 billion in investment income. At the end of March 2012, total TRS assets stood at $37 billion.

TRS’s investment management fees are competitive, and often superior, to public pension plans of a similar size. In the 10-year period being studied by the BGA, TRS assets available for investment averaged $33.6 billion per year. A total of $1.3 billion in fees equates to an average annual fee of 39 basis points over the period.

For comparison, the average public pension fund paid fees of 48.5 basis points in fiscal year 2010. Pension systems with more than $20 billion in assets had average investment manager fees of 55.2 basis points in fiscal year 2009. A “basis point” is a standard measurement in investing - one-hundredth of 1 percent. 

The BGA and CBS 2 report warned that their findings are not good news at a time when TRS is facing a $44 billion unfunded liability and the very real prospect that the General Assembly will not appropriate to TRS its entire annual payment as required by law. The truth, however, is that without strong investment returns over the last 30 years, and especially in the last two years, the TRS financial picture would be much worse. You cannot properly analyze TRS finances in 2012 using only statistics from 2001 to 2010.

The $44 billion TRS unfunded liability was caused by legislators not appropriating sufficient funds to TRS every year for the last 60 years.

Crain’s Chicago Business Story of December 19, 2011

Issue: Crain’s Chicago Business published an article on December 19, 2011 that questions the investment practices and decisions at Teachers’ Retirement System regarding the use of “alternative” investments.

• Crain’s said that a recent increase in the size of TRS investments in “alternatives” was an attempt to try and earn money more quickly to cover the System’s $43.5 billion long-term unfunded liability.
• Crain’s also cast doubt on whether TRS investments in alternatives are a good use of members’ retirement funds because the investment rate of return on these investments in the last few years has not been as high as the rate of return for the stock market. In other words, would the System’s members have been better off if the System had put the money into traditional investments instead of alternatives?

Discussion: To the first question, it is financially impossible for TRS to quickly retire a $43.5 billion debt by safely investing $37 billion. It would take decades for investments alone to raise that kind of money. For that to happen, the stock market would grow in value every year. Also, the total TRS liability would have to be frozen to create a fixed target, and not gradually increase in size, as it does every year.

To the second question, the alternative investment classes were added to TRS as a way to diversify the total portfolio and provide some insurance against the volatile ups-and-downs of the stock market – not to make quick profits or compete with other investments.

• All large institutional investors have money in alternatives, including mutual funds that anyone can buy. The alternative investment market is the largest in the world – more than $700 trillion. It’s larger than the stock market and the bond market combined.
• “Alternatives” are investments not made in the stock market or the bond market:
  • Real Estate
  • “Absolute Return” - hedge funds
  • “Real Return” - a variety of investments, such as inflation-linked bonds and agricultural commodities, where value is tied to inflation
  • “Private Equity” - direct investments in private companies that do not sell stock on a public exchange such as the New York Stock Exchange or NASDAQ.

For fiscal year 2011, which ended on June 30, TRS investments posted a positive 23.6 percent rate of return after all fees for outside investment managers have been subtracted. That rate of return translated into $7.2 billion in investment income, the highest one-year total for TRS in the last 21 years. By contrast, expenses for the last two fiscal years totaled $8.3 billion, with the majority of that spending, $8.1 billion dedicated to pensions and benefits paid to TRS members. The target rate of return for TRS investments is 8.5 percent. Total TRS assets increased during the year from $31.323 billion to $37.769 billion. Over the last 30 years, TRS investments have averaged a 9.9 percent rate of return after fees are subtracted against the target of 8.5 percent. Here are total TRS revenues, by source, from fiscal year 2010 and fiscal year 2011:

During the financial crisis of 2008-2009, TRS took money out of the stock market and invested it in alternatives and lost less money than if that money had had stayed in the stock market. During 2008-2009 practically all investments lost value. The goal was to limit losses as much as possible. During the worldwide financial crisis, these portfolios did not lose as much money as stocks, which protected TRS assets. Here is a comparison with today:

The vast majority of TRS assets are allocated to “traditional” investments. Here is the allocation of TRS assets to the current investment categories and the percentage of those allocations in the total $37 billion investment portfolio as of June 30, 2011.

Compared to other pension funds as large as TRS, the System’s risk is lower than the median risk of the pension plans used in the comparison, and the System’s investment returns are higher than the median returns of the other pension plans.

A recent risk analysis conducted by TRS shows that, as of September 30, 2011, 84 percent of TRS portfolio risk came from the 43 percent allocation to domestic and international stocks while all other asset classes served to moderate risk. Specifically, the Absolute Return portfolio accounted for 1.49 percent of total risk compared to its 4.58 percent portfolio weight.

All institutional investors like TRS invest in derivatives, primarily as a form of “insurance” against a drop in the value of other assets. TRS has been successfully trading in derivatives since 1986 without harming the fiscal health of the System. Derivatives 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.

TRS, like many other pension systems throughout the United States, carries an “unfunded liability,” which on June 30, 2011 was $43.5 billion, out of a total liability of $81.3 billion. The TRS unfunded liability is a long-term concern – think decades – and should not be confused with the annual obligations of the System. 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 2011, TRS paid out $4.2 billion in benefits, but collected $10.5 billion in revenue.

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“Pensions vs. Schools” – Illinois Policy Institute Study

Issue: The Illinois Policy Institute published a study in January 2012 which estimates that by 2029 the state’s annual contribution for Teachers’ Retirement System - $6.796 billion – will be larger than the state’s appropriation for suburban and downstate schools - $6.555 billion.

Discussion: The IPI manipulated the numbers to create this “tipping point” in 2029. They artificially reduced the amount of state funding for K-12 education and artificially increased the amount for “retirement costs." In reality, this “tipping point” may never happen.

While the IPI says that in fiscal year 2012 “aid to schools” is $5.639 billion and “retirement spending” is $3.432 billion, in reality the total budget of the Illinois State Board of Education for the entire state in FY 2012 is $10.265 billion while the state’s annual contribution for TRS is $2.406 billion.

Here’s how the IPI calculated the numbers:

• They only include funds directed to suburban and downstate schools, not all funds for all schools throughout Illinois.
• They included appropriations for retired teachers’ health care, which is not part of the TRS funding mix.
• They included the debt service cost of retiring the pension obligations bonds issued since 2000 to pay the state’s annual contribution.

Even if the state’s budget for K-12 education were to stay level at $10.265 billion in every year until 2046, the state’s annual pension contribution is expected to never be higher than $7.644 billion in any one year.

The IPI’s analysis also fails to keep in mind that the annual allocation for teacher pensions is part of the overall compensation package for educators, so it is money dedicated to the education of children. Without a teacher, a classroom is just four walls and a bunch of kids.

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Private Organization Employees in TRS

Issue: An October 2011 article in the Chicago Tribune highlighted the fact that some TRS members who go to work for statewide or national education organizations, including organized labor unions, retain their memberships in TRS and when they retire they are eligible to use their union salaries and service time in the pension calculations. In 2007, two employees of the Illinois Federation of Teachers who had no previous teaching experience used a temporary state law that has since expired to join TRS and claim all previous service time with the IFT toward their pensions by working a single day as substitute teachers.

Discussion:In January, 2012, Governor Quinn signed House Bill 3813 to address concerns about private organization employees in TRS, especially those who had not been teachers previously but used a state law to claim past employment service toward their TRS pensions. The law is Public Act 97-0651.

The law forbids these members from including any service time with the IFT prior to joining TRS in the calculations to determine their TRS pensions. They will be able to receive a TRS pension based on IFT service and salary after they became members of the System.

It was not a TRS decision to open membership to the employees of education unions or organizations. For decades, state law has allowed certain people who are not currently working in a public school system to be TRS members. Employees of the Illinois Association of School Boards have been allowed to participate in TRS since the 1940s. Employees of organized labor unions have been allowed to participate in TRS since 1987.

In 2011 there were 56 active or inactive members and 60 retired members in TRS who fell into this category. Out of 362,000 members, 116 members did not and do not affect the cost of the System to members and taxpayers, even though the average pension for these particular retired members was $100,089. The average pension for all 90,967 retired TRS members is $46,000.

Also, under current state law, these members must adhere to the rules that apply to all other TRS members:

• They must be certified by the State Board of Education.
• They must have established creditable service with TRS prior to taking a job with a union.
• They must pay the teacher contribution of 9.4 percent.
• If they receive an annual raise of more than 6 percent, and that salary is used in the calculation of their average salary, the employing organization must pay the added cost of the pension, just like a school district.
• Post-retirement employment in a TRS-covered position is restricted, just as it is for other TRS members.

The union or outside organization pays more in contributions to TRS than school districts pay. The union must pay the entire “employer’s normal cost” of the member’s pension, which is comprised of the organization’s share and the state’s share. For all members employed by a school district, the district pays 0.58 percent of the normal cost and the state pays the remainder.

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Criminal Trial of William F. Cellini, Sr.

Issue: Springfield Businessman William Cellini, Sr. was indicted in 2008 by U.S. Attorney Patrick Fitzgerald of the Northern District of Illinois with attempting to extort a $1.5 million campaign contribution for former Gov. Rod Blagojevich from Thomas Rosenberg, a principal partner in Capri Capital Management. Capri, at the time, was seeking a $220 million real estate investment from Teachers’ Retirement System for Capri. The indictment alleges that Cellini and others told Rosenberg that without the contribution, Capri would not get investment funds from TRS.

Discussion: Cellini was convicted on two of the three counts against him on November 1, 2011 and sentenced on October 4, 2012 to 366 days in prison.

Neither TRS nor any of its current board members or staff has been indicted or charged as part of this case. TRS did not lose any money and the alleged incident did not affect any TRS investments or any member’s pension. The alleged scheme did not involve any TRS funds.

Capri continues to manage investment properties for TRS. As of March, 2012 the firm administered 21 percent of the TRS real estate portfolio, or $785 million in properties. TRS also had an investment relationship with Commonwealth Realty Advisors, a property management firm that Cellini founded and used to own. TRS severed its relationships with Commonwealth in 2009.

The alleged extortion scheme was developed with former TRS Board Member Stuart Levine, who was convicted of various crimes as a result of the overall Blagojevich scandal. Levine has not served on the TRS Board since 2004.

The incident of Cellini resulted in a legislative overhaul of top TRS management and Board of Trustees. The General Assembly approved legislation that expanded the TRS Board to 13 members and increased the number of gubernatorial appointments to six. The overall Blagojevich scandal resulted in numerous state laws that tightened ethics and business reporting requirements for state government agencies, including TRS.

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School Districts “Picking Up” Members’ TRS Contributions

Issue: The Illinois Policy Institute on October 13, 2011 released a study of the school districts in Illinois that “pick up” or pay the 9.4 percent teacher contribution for their TRS-covered employees. IPI research indicated that about half of the 867 school districts in Illinois “pick up” all or part of the teacher contribution. The IPI concluded that when districts pick up all or part of the teacher contributions, that means teachers are not paying the contribution. The IPI says this amounts to $400 million “extra” that taxpayers must pay every year to TRS that teachers should be paying.

Discussion: This is an incorrect view of how teacher contributions are paid by TRS members. Illinois taxpayers are not paying an “extra” $400 million for teacher pensions and teachers are not being spared the responsibility of paying $400 million in contributions.

Teacher contributions to TRS are deferred income. The TRS contributions are part of a teacher’s overall compensation package along with their take-home pay. The TRS contribution is designed to come back to the teacher later in life as a retirement benefit.

When a school district “picks up” the contribution, the money still comes from the teacher’s total compensation package. The “pick up” is in reality only a difference of when the district deducts the contribution from the teacher’s salary – either before taxes are deducted or after taxes are deducted. Teacher unions for years have negotiated this point with school boards as part of overall salary and benefit packages for teachers. There is an income tax savings for teachers if the contribution is deducted pretax.

In practical terms, no teacher writes TRS a check every month and mails it, so no teacher in Illinois directly “pays” TRS. All contributions from every teacher in every school district are deducted from paychecks by the school districts and sent to TRS in one lump sum. Member contributions to TRS in fiscal year 2012 totaled $917.6 million.

The IPI conclusion that taxpayers are paying “extra” for the pick-up rings false because, in the end, taxpayers pay for everything in a school district, including all teacher salaries. There is no “extra” $400 million.

If you carry the IPI’s conclusion about TRS contributions to other examples you’ll realize that everyone who participates in Social Security hasn’t paid their share of federal Social Security taxes because their employer is paying the tax for them. No one writes a check to Social Security when they get paid. The FICA tax is deducted from the paycheck. It’s the same thing for TRS contributions. One of the reasons Illinois teachers don’t contribute to Social Security or get a Social Security benefit is because they make the same type of paycheck contribution to TRS.

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Pew Center on the States 2011 Pension Report “The Widening Gap”

Issue: The Pew Center on the States, a Washington D.C. think tank, on June 18, 2012 released the latest in a series of annual studies on the financial status of state public pension plans, including TRS and other Illinois systems. The report notes that Illinois continues to have the “worst funded” pension systems in the country. The study shows that combined, the state’s public pension systems only have 45 percent of their long-term obligations secured with assets, which creates an “unfunded” liability of 55 percent of assets. Illinois’ long-term funding level fails to meet the target level of obligations that should be secured by assets. Actuaries and accountants say that level should be at least 80 percent. In all, 34 states fail to meet this standard.

Discussion: The Illinois unfunded liability identified in the report in no way will affect pension checks for TRS members during 2012 or into the future. The unfunded liability does not affect the System’s ability to pay annuitants or benefit recipients.

The current $53.5 billion TRS unfunded liability is part of the total $91.5 billion liability that the System owes current retired teachers and all active teachers who have yet to retire. Because active teachers cannot collect what they are owed, the total liability never comes due at one point in time.

The numbers that members should focus on are the amounts TRS pays out in pensions and benefits in a year. During the last three fiscal years, TRS paid out $12.8 billion in benefits, but collected $21 billion in revenue, more than enough to meet those obligations.

Because the Pew study uses 2011 statistics, it actually is an out-of-date snapshot in time.

Even though the Pew report does not have financial data for Illinois from fiscal year 2012, the General Assembly’s Commission of Governmental Forecasting and Accountability has released this information to the public. The COGFA report shows that the state’s total funded pension liability shrank from 43.3 percent in 2011 to 39 percent in 2012. For TRS, the Auditor General reports that the TRS funded liability shrank from 46.7 percent in 2011 to 42.1 percent in 2012.

Other than accurately reflecting history, the Pew report adds nothing new to the discussion over public pensions. It’s been true for some time that Illinois has the largest unfunded pension liability in the nation and that the unfunded liability was caused by years of insufficient contributions from state government.

What the report does not say is that in the last three years Illinois state government has kept its promise and has made its required contribution to the pension systems and that elected leaders are committed to correcting the mistakes of the past. Last spring the legislature approved a $2.7 billion contribution to TRS for fiscal year 2013. For fiscal years 2011 and 2012, TRS received its total required contributions from state government, or $4.58 billion.

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Chicago Tribune Article of March 23, 2011

Issue: The Chicago Tribune published a front-page story on March 23, 2011 that used selective facts to say that Teachers’ Retirement System is “$40 billion short of what’s needed to cover future benefits.”

Discussion: The Tribune story is misleading because it never explains that the $40 billion “shortfall” is a long-term deficit that never comes due at one point in time. The “shortfall” was the unfunded portion of the System’s total liability at the time of $77 billion.

TRS will have enough money to pay pensions this year and for many decades to come. TRS has carried an unfunded liability since at least 1953 and has always paid retired teachers on time. TRS has never missed a pension check. The current total TRS liability is $91 billion and the unfunded liability is $53.5 billion.

The main problem with the story is that it confuses the total TRS “mortgage” - $91 billion – with the “mortgage payment” – what the System needs in any one year to meet its pension and benefits obligation. This year the mortgage payment is $4.5 billion. Like any homeowner, TRS can’t pay the mortgage off at one time, but it can make the mortgage payment.

In fiscal years 2011 and 2012 combined, the TRS “mortgage payment” was $8.9 billion and our total revenue was $17.3 billion. TRS had more than enough money to cover those expenditures.

The total liability never comes due because active teachers cannot collect their pension. Only retired teachers can collect a pension. For the total liability to come due at one point in time all teachers would have to be retired and school districts would have to be out of business.

The story says that Illinois teacher pensions “get higher benefits, on average, than government retirees in most pension plans.” The national average benefit at the time of the story was $30,642. The average TRS benefit at the time was $40,798. While factually correct, that is true in part because retired teachers in Illinois don’t receive Social Security. The story compares Illinois retirement benefits with benefits in states where teachers do receive Social Security. When Social Security benefits are factored in, Illinois benefits are comparable with most other states. No one can consider $40,798 as an “extravagant” pension. Illinois teachers contribute more to their retirements than teachers in all but six other states.

The TRS unfunded liability was created by state officials who since the 1950s decided not to give TRS all of the money required to cover current and future pension obligations. As a result, TRS has never been given the opportunity to function as it was designed to function.

A system that has been properly funded can expect to have investment earnings pay for 60 percent to 65 percent of benefits. It is estimated that the state has held back more than $15 billion in funding from TRS since 1970. Because TRS has not had this money to invest, the difference has to be made up with higher contributions from taxpayers. Although TRS has exceeded its investment target over the last 25 years, investment income only pays for 49 percent of TRS benefits.

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“Illinois is Broke” Video on Teacher Pensions

Issue: In October of 2011, the organization “Illinois Is Broke” posted on their website a 2:30 minute video of a middle-aged woman in a classroom talking about teacher pensions in Illinois. In short, the video’s message is that TRS is running out of money and that there will not be enough money in TRS to pay active teachers once they are set to retire. The action requested is to contact legislators to get them to vote for Senate Bill 512, the Civic Committee’s pension reform proposal.

Discussion: The video’s script does not accurately describe the finances of Teachers’ Retirement System. TRS is not going broke and will have enough money to pay pensions for decades.

The video’s script says: “This is how much money we have in the fund,” and a graphic showing “$31 billion” pops up. That number reflects the assets held by TRS last year. The current assets, thanks to a 23.6 percent return on investment for fiscal year 2011, total $37 billion.

The script says: “This is how much we need to pay our current retirees.” A graphic of “$49 billion” pops up. This is an incomplete statement. What’s not said is that the $49 billion is the estimate of what’s needed to pay “current retirees” every year for the next 30 years. The actual cost of teacher pensions this year is $4.5 billion.

The script then says: “This is how much we need to pay people like you.” A graphic of “$27 billion” pops up. Again, what’s not said is that this number reflects a 30-year estimate for teachers who are not even eligible for a benefit.

The script barely mentions current revenues collected by TRS. Over the last two years, TRS revenue totaled $17.3 billion, from teachers, school districts, state government and investments. TRS benefit checks in the last two years totaled $8 billion.

TRS currently carries an unfunded liability of $53.5 billion, but this is a number that never comes due at one point in time because only current retirees are eligible to be paid. TRS has carried an unfunded liability since at least 1953 and has never missed a pension check.

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