(September 7, 2012) – Switching to a defined contribution structure would do nothing to solve the Teachers Retirement System of Texas’ (TRS) $24.1 billion funding shortfall, according to a major study by the pension.
In fact, closing the defined benefit plan would only make things worse.
In 2011, the Texas Legislature insisted that the $107.4 billion fund investigate major structural changes in order to address its unfunded liabilities. TRS recently released its results, including an exploration of shuttering the defined benefit plan to new members, shifting new retirees to a defined contribution scheme. In total, TRS personnel and the fund’s actuary modeled five alternative plan structures: a defined benefit/defined contribution hybrid, capped hybrid, cash balance, self-directed defined contribution, and pooled defined contribution.
The findings, presented in a 58-page report, could be summed up on a post-it: Bad Idea.
TRS spent a few more words on its summary for legislators, but not many:
1. While the TRS pension fund can pay currently projected benefits through 2075, the State needs to begin addressing the unfunded liability. Delays will only increase costs.
2. The value of the retirement benefit available to TRS members is 36% less than the average benefits available to members of peer systems.
3. The defined benefit plan provides current benefits at a lower cost than alternative plans.
4. The majority of TRS members will do significantly worse investing on their own in a plan with a defined‐contribution component.
5. Alternative plan structures carry differing levels of risk for the State and TRS members.
6. Other systems changing structures have lowered benefits to realize savings.
7. Moving new hires to an alternative plan will not eliminate existing liabilities.
8. Approximately, 95% of public school TRS members do not participate in Social Security, leaving the TRS benefit as their only lifetime annuity.
According to the pension’s models, switching new members to either a self-directed or pooled defined contribution plan would increase unfunded liabilities by $14.7 billion, or 61%. “It is important to understand why the alternative plans modeled by TRS are more expensive than the current defined benefit plan to provide the same level of benefits,” TRS authors explained in the report. “The main reason for the expense difference is that most alternative plans do not generate the same level of investment returns as the defined benefit plan.” Actuarial models estimated over 90% of members would do significantly worse managing their own money compared to TRS’ investment team, which returned 15.5% last year and 4% over the last five years. This disparity would be due primarily to “access to fewer asset classes, demonstrated behavioral tendencies, and potential payment of higher fees.” Over the last three years, for instance, TRS earned an annualized 18.5% return on its private equity allocation—an asset class closed to individual investors.
As the study points out numerous times, relative to other public mega-funds, TRS isn’t in bad shape at 82.7% funded. The Texas Legislature’s demand for the study may or may not have been influenced by ideology and politics. But the report’s conclusion makes it clear that a major structural change to the pension has implications far beyond the financial:
“Ultimately, if members retire without adequate income or if retirees experience a drastic reduction in their savings post-retirement, then state and local governments may face growing demands on programs such as food stamps, Medicaid, and other social services. This potential outcome shifts some of the investment and longevity risk back to the State and taxpayers. The fiscal and social costs resulting from retirees who lack retirement self-sufficiency are beyond the scope of this study to assess but could be significant.”