Texas Takes Next Steps Towards Improving Teachers Retirement System Sustainability

Key Takeaways:

• The passage of SB12 over the Memorial Day weekend was a positive step towards ensuring long-term solvency for the Teachers Retirement System of Texas.
• The“funding period” has been reduced from more than 8 decades to around 3 decades.
• More work needs to be done to ensure TRS long-term sustainability in the face of lower trending investment returns.
• And many Texas educators are not getting the kind of retirement security that they need, either because they’ve only earned partial pensions or they don’t have a permanent COLA. Solving this challenge should be on the agenda for the next legislative session.

The Texas legislature has taken a positive step towards ensuring the long-term solvency of its Teachers’ Retirement System(TRS). Over the Memorial Day weekend, as the biannual legislative session wound to a close, Senate Bill 12 was adopted in sweeping bipartisan fashion. More legislative and administrative actions will be needed in the coming years to ensure long-term TRS sustainability and retirement security for TRS members. But for 2019, SB12 was a responsible balance of competing priorities.

Why SB12 Was Needed
The main challenge that Texas legislators were trying to solve with SB12 is the lack of appropriate funding for the TRS pension fund. Over the last 15 years, the Texas legislature had only paid the full actuarially required bill for TRS twice. (What is the actuarially required bill? See footnote 1.) This failure of the legislature to authorize appropriate funding was one of the key reasons that TRS has accumulated $46.2 billion in pension debt.

Going into the 2019 legislative session, TRS asked for an additional 1.8% of payroll in contributions (equal to around $1.3 billion over the next two years), on top of already planned payments. Total contributions from the state, school districts, and employees have been the equivalent of 15.4% of total TRS payroll for the last few years. And this request would mean bumping that total amount up to 17.2% of payroll.

What SB12 Does to Help
SB12 gets to the goal of increased contributions in stages. Current contribution rates into the fund will grow in gradual steps between the next fiscal year, 2020 or “FY’20,” and the year 2025. The rates different stakeholders pay will change too:

• The state of Texas will increase the amount it pays into TRS from 6.8% of payroll to 7.5% during the next two fiscal years (FY’20 & FY’21), and then scale up to 8.25% of payroll by FY’24.
• School districts pay a supplemental amount into TRS too. This will be ramped up from 1.5% of payroll to 2% of payroll between FY’21 and FY’25. (The details on how this works are kind of complicated. See footnote 2.)
• Finally, employees will see the amount they contribute towards their benefits grow from 7.7% to 8% in FY’22, and then jump again to 8.25% in FY’24.

In total, Texas is adding contributions of 2.5% of payroll contributions through a six year ramp up. By FY’25, the total amount going into TRS will be 18.5% of payroll — which is actually a bit more than TRS originally requested in the long-run. That additional amount is to make up for the reality that, based on this contribution rate schedule, the legislature will still not be paying the full actuarially required amount that TRS needs for at least the next two years.

The ramp up of contributions strikes a balance between the goal of TRS sustainability and the many other ways that Texas could spend money for pension contributions this biennium. Whether it’s the most appropriate balance is somewhat politically subjective — South Carolina is in the midst of a seven year ramp, Colorado launched a three year ramp last year.

What is important is that the legislature didn’t completely punt its responsibility towards TRS members this session:

• Before SB12 was adopted the Equable Institute research team estimated it would take between 85 and 90 years for TRS to pay off its $46.2 billion in pension debt (assuming the TRS 7.25% long-term rate of return). And TRS itself estimated it would take roughly 86 years to pay off the pension debt.
• Under this new ramp up in contributions, we now estimate it will take between 26 and 30 years to get the TRS pension debt paid off. Assuming, of course, that all of the TRS actuarial assumptions are correct.

Why SB12 is Not the Final Step toward Sustainability
Failures to pay the full actuarial cost into TRS was only part of the reason why Texas needed to ramp up contributions in the first place. A larger cause of TRS pension debt has been investment returns performing worse than expected.

TRS uses an “assumed rate of return” to help it estimate how much money should be paid into the system this year, in order to have enough to pay benefits in the future. (Note: The assumed rate of return is not a fixed amount that TRS will definitely earn. And the assumed rate of return does not dictate the amount of pension benefits that will be paid. It is simply one of the many assumptions that pension plans make when figuring out what contribution rates should be.)

In 2018, the board of trustees for TRS took a good first step towards improving sustainability by lowering the assumed rate of return from 8% to 7.25%. According to TRS estimates, there is now around a 50% chance they can meet the investment expectation, up from the roughly 40% chance of earning 8% returns.

Of course even a 50% chance, basically a coin flip, is risky. It is likely that in the next five years that TRS will need to lower its assumed return again. Or, if they don’t, there is at least a 1 in 2 chance that more pension debt will accrue. This is one reason why we believe that Texas has more to do to improve the sustainability of TRS.

What Texas Needs to Address Next: Retirement Security for All
Another important item on the TRS “to-do” list is figuring out a way to expand retirement security to more Texas educators.

Retired teachers in Texas have not received a regular cost-of-living adjustment (COLA) since the Enron scandal caused significant fund losses in 2002. A 13th check was paid in 2007, and a COLA check was paid in 2013, but consistent inflation adjustment has been suspended for most of the last two decades. Any teacher that retired in the early 2000s has effectively had their retirement benefit remain flat, with two exceptions, while inflation has steadily progressed. The ability for Texas to suspend retired teacher COLAs is because it was never originally funded along with the base pension benefit in the first place. Rather COLAs are authorized at the discretion of the legislature, and only if the retirement system is at least 80% funded.

The purpose of a cost-of-living adjustment is to protect pension benefits against inflation. So ideally, a COLA should be given at the rate of inflation, and it should be “pre-funded” during the working years of an pension plan participant. That is, money should be set aside (actuarially calculated contributions) for the base pension benefit and anticipated inflation adjustments to that benefit.

SB12 included yet another patch for this problem, authorizing a 13th check to be paid using money from the state’s rainy day fund. This up to $2,000 check certainly is welcome to retirees, but this isn’t a permanent fix.

Still, for retirees whose only problem is the COLA, things could be worse. An additional problem is that 80% of new teachers and other education staff entering the work force are not projected to work long enough to earn a full pension benefit.

The financial experts working for TRS have reviewed employment patterns for all educators and determined that roughly 50% of teachers and other public school workers leave within 8-years of being hired (long-enough to pass the 5-year vesting period for TRS). Of the half that remain, 65% leave before reaching the normal retirement age for a full pension. Which is a particularly troubling problem given that the vast majority of Texas public school staff are not enrolled in Social Security. This means there are tens of thousands of educators in Texas who are not accumulating adequate retirement savings.

Addressing this challenge and the lack of a permanent COLA are critical for ensuring that TRS is providing real retirement security for the 21st century.

SB12 Was a Balancing Act, Not the Perfect Bill
Improving retirement systems usually involves some trade-offs, and it’s uncommon for everyone to be happy with the outcome.

From the point of view of active teachers and other members of TRS, it isn’t pleasant to have a contribution rate increase from 7.7% to 8.25%. However, this is fortunately not going to kick in until 2020–2021, by which time the salary increases authorized this session will be in full effect. And a much lower percentage of the cost increases were placed on teachers this time than in previous years of increased contributions.

From the point of view of school districts, the specific provisions increasing their share of costs are disappointing. Districts only pay their supplemental payment on the statutory minimum salary, and districts are going to receive $6.5 billion more from a school financial bill also passed at the end of session. Still, superintendents find it frustrating to have a portion of their budget cut back to pay for pension debt.

From the point of view of taxpayers, SB12 requires paying more money today to reduce pension debt and responsibly fund promised benefits. This is a trade-off between putting those dollars towards other public goods (or tax relief) and avoiding having to pay even more money in the future if TRS was allowed to walk down a road towards insolvency.

Ultimately, the legislature had to strike a balance between TRS sustainability and these competing interests. The high degree of bipartisanship in reaching that balance — SB12 was adopted 31–0 in the Senate, and 145–1 in the House—suggest that it was likely a reasonable balance for the current political climate.

The Texas legislature should be commended for working towards a bipartisan solution to the need for more TRS funding. As a whole, SB12 is a solid piece of legislation that reflects serious thinking and positive political compromises.

For more about why Texas needed to adopt legislative changes to improve the sustainability of TRS, see our previous post here.

Check out the open letter to the legislature we wrote earlier this spring at PayTheBillTx.org.

To learn more about the Teacher Retirement System of Texas and current pension benefits, please visit Equable.org/Texas.

[1] The actuarially required bill is the amount that needs to be paid each year to both (a) save money that can be invested, with the balance then used to pay out guaranteed pension benefits in the future, and (b) pay down any accumulated pension debt. More specifically, financial experts (called actuaries) estimate how much in future promised pension benefits have been earned, then take an educated guess at what investment returns the state can make, and come up with an amount that should be paid this year so that the necessary money will be available to pay benefits when TRS members retire. In addition, those financial experts calculate how much has to be paid each year to ensure that any accumulated pension debt gets paid off. That estimated amount to “pre-fund” future benefits plus, an amount to “amortize” pension debt, is equal to the actuarially required contribution, aka the annual pension bill.

[2] The details on school district supplemental payments are based on the minimum statutorily established salary rate. The legislature has established this minimum schedule based on seniority, so the minimum rate scales up a bit for school districts that have more senior staff. But most school districts pay their staff wages above the minimum schedule. So when the state pays a contribution it is on total payroll, but when the school districts pay a contribution it is on minimum payroll. Additionally, up until SB12 there was an exemption for school districts that participate in Social Security (which is just a few in Texas, the largest of which are Austin and San Antonio). Under SB12, that exemption will go away, increasing the total amount that TRS collects from this supplemental payment.