TX Rainy Day Fund Proposal

texas_financeTexas Comptroller Glenn Hegar proposed last month significant shifts in management of Texas’ Rainy Day Fund, and it’s all shockingly sensible.

I say shockingly not as a diss against Hegar, but rather because my usual stance with respect to fiscal prudence among government leaders is an exasperated shrug. It’s usually “Oh, they went and did THAT again?” Pffft!! Gah!

For Hegar, however, all I can offer is a congratulatory fistbump and an ‘attaboy.’ He’s applying prudent principles of financial management. It’s almost enough to make a financial cynic believe in, like, good fiscal leadership.

Three simple financial rules – as true for individuals as they are for governments – come into play with the Economic Stabilization Fund (ESF) in Texas, the so-called Rainy Day Fund.

First, automated savings plans are the best savings plans. Second, long-term money should earn a higher rate of return than cash, through riskier investments. Finally, setting aside money during surplus times can make an extraordinary difference in the future, when the lean times inevitably come.

Following these principles – setting aside money automatically, investing for a higher return, and delaying spending until its needed – is notoriously difficult for both individuals and governments to do. I’d say especially governments, because competing financial needs – right now – always seem so compelling. And in a democratically elected system, being responsive to citizens is sometimes hard to square with fiscal prudence.

Legislators created the ESF in 1988 to be automatically funded mostly by excess oil and gas extraction-tax revenue. The fund didn’t amount to much throughout the 1990s, until the revival of the industry after 2006 – via fracking – began to fill up the ESF’s bucket. The neat thing about the ESF, from my perspective, is the automatic nature of the savings. With a savings plan you should try to make a rule and then try not to think about savings as they build up. That benign neglect is the key to success.

A rule written long-ago, automating savings for the state, suddenly brought in a kind of savings windfall. Ten years into the fracking revolution, Texas has the high-class problem of about $10 billion in the ESF. That’s quite a nice “set it and forget it” savings plan.

glenn_hegar_rainy_dayRegarding investments in higher-risk, higher-yielding opportunities, the ESF has until now always erred on the side of caution and low returns. Historically, the vast majority of ESF funds have earned little more than cash, not even keeping pace with inflation. With a balance above $10 billion, however, Hegar’s proposal sensibly calls for dedicating a portion of the ESF to higher-return investing. Every billion in the ESF that could earn an extra, say, 4 percent annually, would mean $40 million in additional government revenue. The state’s legislative budget board estimates a net gain for the state of more than $82 million by August 2019 if this bill passes

Earning an extra $40 million per year by following a prudent reallocation seems like a good plan to me.

Regarding spending the gains from investment, Hegar proposes a Texas Legacy Fund from which future legislatures could vote specifically for long-term, fiscally prudent, projects. If big public pensions suffer a short-fall in the future, something he and I both worry about, funds from the Legacy Fund could plug the hole. Relatively small amounts now, applied steadily to public pensions, could stave off big problems in the future.

So given how sensible this is, will it actually pass this legislative session?
Ah, representative democracy. So much potential, and yet, so frustrating!

Ready for a rainy day

Hegar’s proposed changes to the ESF came relatively late in the Texas legislative session, through HB 855. The enemy of the bill may not be any particular opponent, but rather the limited time remaining in the legislative session. Changes to the ESF cannot be made without a vote in the Texas House and Senate.

As of this writing, HB 855 had passed out of the House committee, but the state Senate still needed to hear and opine on the proposal.

Setting fiscal prudence aside and thinking more about my needs, I mentioned to Hegar last week that Alaska has a similar ESF fund, but that Alaska makes an annual distribution of close to $1,000 per year to every resident. I think of that money as hardship pay for living through those winter months up North.

I’m originally from Massachusetts and I feel like living in Texas in July and August is worth at least $1,000 per citizen. So I tried on the phone to goad Hegar into agreeing to simply distribute ESF funds to all citizens of Texas every year in the form of a hardship dividend, given our summer heat.

Hegar countered that the good people of Houston might have a stronger claim to summer hardship payments because of humidity rather than the ‘dry heat’ of San Antonio. Dry heat? I thought to myself. I have three words for Hegar: What. Ev. Er.

texas_heatMy proposal is that we get a distribution chart from the Comptroller for every city in

Texas determining which people in the state get the best ‘dividend.’ Can we settle who has the worst summer heat? I feel like my city deserves it the most and there’s potentially a lot of money at stake.

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Teachers and Their Retirement Problems

Public School Teachers are the Glengarry Leads

A majority of people struggle to prepare financially for their retirement, but public school teachers and employees face a particularly difficult set of circumstances.

I’m enough of a fiscally hard-assed finance guy to think that every public school teacher should self-fund his or her retirement to supplement their pension plan, which for people in my state is the Teachers Retirement System of Texas (TRS).  Unfortunately, there’s the grim reality facing many teachers about how hard this is to actually do. I learned a lot recently from my teacher friends about why that’s so.

My friend Dina Toland has worked as a public school teacher in Texas for 23 years and described the typical way she and her colleagues obtain their “retirement advice.”

First, a representative salesperson for an insurance or investment management company gets invited, for some unclear reason, to a faculty and staff meeting, where they have a captive audience from which they can collect email sales leads by offering raffles or some other minor incentive.

The salespeople then attempt to schedule one-on-one teacher meetings using these leads, at which the pitch usually involves scaring teachers about their insecure retirement and the need for certain specific investment products. Thus made anxious, teachers are often urged to invest in variable annuities, which I consider one of the four horsemen of your personal financial apocalypse because of their high fees, illiquidity, low returns, and generous sales commissions for these same salespeople.

TRSDina was convinced to buy into this mess when she was a young teacher just starting out. Ironically, the salesperson herself was so inexperienced that she convinced Dina and her cohort of similarly clueless young teachers to take out too much money from their paychecks, such that they all had trouble paying their bills in subsequent months. Besides taking too much money, they all bought into these terrible variable annuities. As Dina says, how would they have known any better?

This problem afflicting teacher retirement planning isn’t limited to Texas. The New York Times ran an excellent 6-part series last year with provocative and true headlines like “Think Your Retirement Plan is Bad? Talk To A Teacher” and “An Annuity for the Teacher – And the Broker” about precisely these difficulties, featuring public school teachers in Connecticut who were sold products with this combination of high fees, low returns, illiquidity, and hefty commissions for insurance salespeople.

My friend David Nungaray, in his 6th year of teaching and administration in public schools in Texas, has a similarly discouraging story.

Early in his career, a representative salesperson of an insurance company was invited to speak to new teachers like him, at which he was of course urged to purchase an annuity. He did, to my chagrin when I later learned what had happened. This year he resolved to open up his 403(b) employee-sponsored retirement account, the next big option for self-funding one’s retirement.

Helping my friend David set up his 403b account was anything but easy and straightforward. David is himself extremely competent. But we agree this would never have gotten done without both of us working hard to do it.  As a first step, David asked six of his colleagues in the public school system – chosen by David for their seeming prudence and likelihood to have a 403(b) account – if they had any advice for him. Only one of the six had ever signed up for a 403b account. Not an auspicious start. David then contacted his school district to look for help. Could David get any investment advice from his school district? No. The human resources department at his school district referred David to TCG Group, which administers all employees’ 403b plans for his school district, as well as many others in the state. The TCG Group website provides a list of 51 approved annuity and investment firms, with links to contact them.

“Shit Sandwich”

David had no idea which investment firm to pick. Could TCG Group help? No, that’s not their job. They are 403(b) plan administrators only.

As a side note, I tried for three days to have a substantive conversation with folks at TCG Group, for the purposes of this post. Let’s just say they were as helpful and open with me as they were with David.

The next step was to pick an investment firm and to open an account. I helped him do that. Having done that, he returned to TCG Group to give them instructions to have 403b contributions deducted from his paycheck. Of course, then he needed to select an investment, or series of investments, at his chosen investment firm. That’s easy for me to help him with, so I did.  But this hand-holding happened over the course of four weeks, with many barriers along the way. The barriers would have deterred a less determined employee, especially one without a friend willing to do it, in a non-conflicted way, for free.

Of course any of the investment firms could have “helped” him too, but he might have ended up with terrible annuity-like products totally inappropriate for the retirement account of a teacher still in his twenties. I’m all for self-funding and self-reliance as a theory, but I’ve become concerned about the reality of doing this well, for most teachers.

The stakes are high because most public school teachers in Texas – like those in many other states – can not count on Social Security in retirement, as 95 percent of school districts opt out of the federal system. So teachers fall back on the TRS and do little else.

If you are one of the over 1.5 million Texans who are members of the TRS, you should ask at least two big questions about your retirement. First, as my main safety net, is TRS financially strong? Second, will payments from TRS be enough to cover my needs in retirement, personally?

If you are not a member of the TRS, then as a citizen and taxpayer you should hope that state leadership is also asking important questions and having a good dialogue around these challenges and solutions. In a subsequent post I’ll talk about the finances of TRS, and that dialogue.


A version of this post ran in the San Antonio Express News and Houston Chronicle


Please see related post:


Public Policy Debate on Teachers Retirement in Texas (upcoming)


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Public Pensions – The Big Four In TX

the_bigger_they_comeA key reason why I started a discussion of public pension funds in Texas by saying “Don’t Panic” is because 88% of Texans covered by a public pension plan are participants in one of just four plans, and the good news is that none of these four are in distress. Right now.

 The largest four pension plans – Teachers Retirement and Employee Retirement System (TRS), Employees Retirement System of Texas (ERS), Texas County and District Retirement System (TCDRS) and Texas Municipal Retirement System (TMRS) – cover over 2 million Texans. So no distress means you can stay calm.

On the other hand, if you had a worrying kind of paranoid view of public pensions – like I kind of do – you would notice that size should inversely correlate with complacency. The bigger they come, the harder they fall, as Jimmy Cliff and others point out.

The problem of size

If the Teachers’ pension system goes poorly – or any of these four go poorly – we can’t rely solely on my three rules of thumb to alert us.

We need an additional layer of scrutiny because the absolute scale of the problem is what we should worry about. The bailout for miscalculating on this scale might swamp the state budget.

This is what people in California worried about in the aftermath of the Great Recession in 2010, or what people in Illinois this year worry about. Namely, might the entire state of Illinois have to seek bankruptcy (or its legal equivalent) as a result of unfunded pensions?

Review of the Big Four

Four state pension plans dominate the Texas public pension scene, with over 2 million Texans participating.

texas_teachers_retirementOf these, the Teachers’ Retirement System (TRS) is the big gorilla, about six times as big as the next biggest pension system, with about 1.5 million members and over 150 billion in assets, as of its 2015 report.

The funded ratio of the TRS – the ratio between estimated assets and estimated liabilities, stands at 80.2 percent – or just at the point where reasonable observers feel comfortable most of the time. Remember, 100 percent means fully funded, but many funds do just fine running in perpetuity in the 80 to 90 percent region.

Meanwhile, the time to amortization – the estimated number of years it will take to fully fund teachers’ pensions – stands at 33 years, which is a bit on the high side. The Pension Review Board would prefer 15 to 20 years, but according to the state legislature, 40 years is the panic point, statutorialy speaking.

Finally, TRS estimates investment returns of 8% going forward, which seems too high to me, roughly in the top quartile of estimates. It’s not totally out of line with other pensions nationally, but it’s not a conservative estimate either.

One of the next biggest, the Employees Retirement System of Texas (ERS) resembles TRS in the sense of a 76.3 percent funded ratio, as well as a 33-year amortization, or time to pay down its unfunded liabilities. Back in 2014, the ERS reported an “infinite” amortization time period, essentially meaning it would never pay off its debts. So while 33 years is uncomfortably long, it also represents a step in the right direction from the previous years. The ERS also assumes an 8% return, which again isn’t conservative.

The two other big pension systems right now appear in healthier shape than either TRS or ERS. The Texas Municipal Retirement Systems (TMRS) scores higher than the first two, with a funded ratio of 85.8 percent, and an easier 17-year amortization. It’s 7 percent return assumption also means it has more room for error in its model, in case markets do not cooperate over the coming decades.

Meanwhile, the Texas County and District Retirement System (TCDRS) has a pretty comfortable 90.5 percent funded ratio, meaning estimated assets cover nine-tenths of estimated liabilities. In related news, actuaries estimate it will take only 9 years to amortize its debts. These levels for the TCDRS look good enough that the 8 percent return assumption feels less threatening.

texas_pensionTaken as a whole, these four systems indicate acceptable levels of risk as of now. They also mostly compare favorably with pension systems in other states.

A little panic

Ok, do you want to be a little bit scared? Fine, I’ll help you.

Josh McGee, Chairman of the Texas Pension Review Board, points out that these four big pension plans in general, and the Teachers Retirement System in particular, run an additional risk beyond the normal risk – simply based on their massive sizes.

“You want to see something really scary?”

You see, if a small pension plan goes bust, a responsible government entity has a problem of filling in the hole, but the hole might be, and hopefully is, manageable through belt-tightening, cutting future benefits, and higher taxes.

But the TRS, with an unfunded future liability a little more than $33 billion, is too big to fix, if something goes terribly wrong.

Just to attach a sense of scale to the $33 billion figure, the state of Texas spent about $112 billion on everything last year, so it’s not like a $33 billion hole can be solved by any reasonable measures. TRS looks fine-ish right now, but failure is too big a financial risk for the state to run, so extra caution is needed.

I still say “Don’t Panic” but I’d also say don’t get too comfortable either. A little bit afraid might be just right.

A version of this post ran in the San Antonio Express News


Please see related posts:

Public Pensions – Don’t Panic, Use Heuristics

Public Pensions – Dallas Police and Fire Pension System Clusterfck

Public Pensions – Houston Might Have a Problem



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Public Pension System Heuristics

dont_panicDouglas Adams’ Hitchhikers Guide To The Galaxy famously advised us on the book cover “Don’t Panic,” and I think that’s a useful starting point for discussing public pensions in Texas.

You see, I started by wondering “should we panic?” when I began a personal project of studying public pensions, for a variety of reasonable suspicions, which I’ll share. After sharing my suspicions, I’ll tell you what I think the informed citizen – that’s you and me! – should worry about, and monitor, with respect to Texas pensions. Next week I’ll tell you specifically more about the biggest public pension plans in Texas.

The stakes for these multi-decade math models are particularly high for cities and counties that offer pension plans to employees.

Just ask the folks of Central Falls, Rhode Island (2011), both Stockton and San Bernardino, California (2012), and Detroit (2013), where insufficiently-funded and/or overly generous pensions sent those governments into bankruptcy protection. The City of Chicago is currently engaged in a multi-year game of chicken over its pension benefits. Some see bankruptcy as the future for Chicago, or possibly its public school district.

My suspicions

My first suspicion began because we’re in an environment of extremely – historically significant – low returns from bonds, such as 1 to 2 percent over the next ten to thirty years. Meanwhile, almost all public pension plans in Texas routinely model a 7 to 8 percent annual return over decades. That assumed annual return matters because with even a moderate allocation to bonds, risky assets like stocks have to make up the difference. Stocks and other things in the pension investment portfolios – like private equity and real estate – have to return 10 percent or more on average – every year for decades – just to make up the high returns that bonds can’t. That seems like an uncomfortable assumption over the next few decades. That made me suspicious.

On top of the current market environment, pension plans always represent some of the most complex financial systems in the universe. Complexity makes me suspicious too.

Actuaries, the poor souls charged with solving the math problems to figure out whether pensions will support public workers in old age – or conversely drive governments into bankruptcy – have a lot to keep track of.

Tracking the money going into a pension may at first seem relatively straightforward, depending as it does on employee headcount, employee salaries and contributions, and employer contributions. It gets a little trickier when you have to make assumptions about long-term investment gains – for the next thirty years.

Money paid out of a pension plan, however, really increases the complexity. The easy part of the equation here are the costs of administering a plan. The hard part comes from the fact that payouts generally continue for the life of workers. We don’t know exactly when people will die, so actuaries have to accurately model the expected length of the lives of workers. They also have to estimate when workers will separate from employment, and when they will claim benefits, and how much those benefits will be. On top of that, they have to model such things as dependent-spousal benefits, as well as rates of disability, both of which increase benefit payouts.

Ideally, these actuarial estimates need to work over long time periods. Contributions made to support a thirty year-old worker today may need to fund payouts for that worker fifty years from now. That’s a long time to estimate anything.

It seems analogous to those scientists at the Southwest Research Institute in San Antonio who planned the science behind the New Horizons space probe of Pluto launched in 2006 who then waited for a few seconds of planetary flyby in deep space in 2015. I picture these scientists sort of praying at launch ten years ago, like, “I hope our math works?”

No, pensions are easier (although in some ways harder!) than that Pluto mission, because there’s a political component to public pensions. If the teacher’s or policeman’s fund runs out in ten years, they don’t just throw up their hands and say “whoops, don’t worry about it.” Instead taxpayers – that’s you and me – will pay one way or another to honor previous public pension commitments, even if generally future retirees after that take a hit as well.

So how do we make sure public pensions are on the level, despite their complexity, and despite historically low returns from bonds?

One answer is first, not panicking. And then, vigilance. That’s what former Texas State Comptroller Susan Combs urged through her office with the publication of the 2014 report “Your Money and Pension Obligations,” and the creation of a searchable pensions database.

But how to you continue vigilance in the face of all the complex moving parts of public pensions?

I’m a big fan of that Texas Transparency site. You can see important data online, and I’m here to tell you the three things to look for in that public data.


My frequent answer to complexity: Heuristics! (I love that word.)

I mean, rules of thumb. Here are the three main rules of thumb that pension board members use to figure out whether their plans are healthy or in trouble.

First: Are liabilities (future payouts) at least 80 percent covered by money already in the pension plan? This is called the “Funded Ratio.” If you’re at 80 percent, then you’re pretty good. It doesn’t have to be 100 percent. Less than 60 percent and you’ve got a potential problem.

Second: If you have a shortfall – meaning your future payouts are less than 100 percent funded – then how quickly can you pay down your debts? Is the estimated time to pay off any pension shortfalls between 15 and 25 years? If yes, then according to the Texas Pension Review Board (PRB) you’re probably good. State law (HB 3310) and PRB Guidelines sets up a maximum of 40 years or else they start to get all up in your pension’s grill with reporting requirements and restrictions on benefits.

Third: Are the return assumptions over the next thirty years reasonable?

Reasonable right now means something kind of within the range of what other pension plans assume. NASRA – The National Association of State Retirement Administrators, but you probably already knew that – reports the average return assumption nationally as 7.62%.

As I’ll mention in a follow-up story on Texas’ Big Four Pension plans, three out of four of the state’s biggest pension plans assume annual returns above that average, with an assumed annual rate of return of 8 percent. Sadly, we can’t expect Texas to be the financial equivalent of Lake Woebegone, where all the market returns are above average. I wouldn’t conservatively plan on anybody consistently being able to earn an 8 percent return over the coming decades, especially when bonds return 1 to 2 percent. And even small “misses” on that measure, compounded over decades, can cause huge headaches down the line.

So yeah, I’m worried about that measure for millions of public employee retirees, and then I’m worried for all the taxpayers acting as unwitting backstops to those pension plans.

A version of this post appeared in the San Antonio Express News.

Please see related post:

Dallas Pension Plan – An Example Of What Can Go Wrong

The Big Four Texas Pensions

Houston Pensions – Worth Monitoring



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You Want To See Something Really Scary?

You want to see something really scary?

The headline is from The Twilight Zone movie, from when I was about 10 years old. As for the rest of the movie after that first moment, I experienced it as an audio-only event. I just stared down at my feet, too freaked out to look up above the seat in front of me.

I thought of the line this morning when I read an ordinary-seeming Wall Street Journal article about a legislative move to allow companies to continue to underfund their pensions.

Corporate pension-funding, analogous to long-term retirement planning or college funding for individuals, really comes down to small choices that we make today that have extraordinary consequences thirty years in the future.

This is the kind of thing which we – and our leaders – should worry about late at night.

Instead of course we focus on strategizing about which reality TV star ought to release a sex tape to revive her career, or which NFL player’s ongoing pattern of domestic abuse will cause a ‘distraction’ to his team during Sunday’s game.

I guess I’m just saying we’re typically not spending enough time worrying about the really scary things, like under-funded pension liabilities.

The WSJ article details that Congress passed, and Obama signed, a transportation bill that happens to contain a provision to allow companies temporary relief from fully funding their pension obligations. In the fine print of the article we learn that the pension-funding obligation comes from calculations of current interest rates, which are extraordinarily low. What companies wanted, and our leaders delivered, was a pension-funding formula that took into account interest rates of the last 25 years, rather than the last 2 years. This is a key difference.

unfunded_pension_liabilitiesHere’s how I assume it works: If you observe that prevailing interest rates of, say, 10 year bonds are at 2%, then you have to make the assumption that all money invested in bonds for the next ten years will return just 2% per year. That’s reasonable. And from there you can calculate how much money you’ll have in 10 years, using compound interest. (see how I always work in a link to that idea?)

The problem is that if you assume only a 2% return on your money, then you need to invest a lot more money today in order to actually have enough to meet the future obligations of your pension plan.

If you could instead assume a bond rate of return of 6% – because that was the average interest rate over the past 25 years – then you need a lot less money to fund your pension plan. Problem magically solved. Companies are happy. CEOs are happy. Workers who depend on pensions eventually are unhappy. But hey! As Meatloaf says, 2 out 3 ain’t bad.

As I’ve written previously, the low returns of bonds are a major drawback of a low interest rate environment, when you have to have enough money for the long run. Endowments and charities and pensions that previously depended on a healthy bond portfolio to kick out 5-6% returns every year are stuck either generating less money for the long run, or they’re going far out onto the risky end of the investment spectrum (over-allocating to stocks or more exotic risks) to make the numbers work.

Or, as we saw yesterday, just pretend you can get the returns on bonds that we got over the past 25 years. Ignore our actual historically low interest rates now with magical-thinking assumptions.

By the way, what happens when companies underfund their pensions?

If a company disappears or goes bust, the federal government (and therefore you and me, via taxes) picks up the unfunded pension liability through an agency known as the Pension Benefit Guaranty Corporation. Just as the FDIC guarantees bank deposits (up to a certain size) and insurance regulators guarantee insurance payouts (when an insurance company fails), so does the PBGC pick up pension obligations when a private company with a pension goes bust. In 2010 for example, 147 companies with pension failed, and the PBGC paid our $5.6 Billion in liabilities to pensioners.

A big factor in the GM and Chrysler bankruptcy and bailouts of 2008, for example, had to do with the government pension guaranties.

For some time before 2008, GM and Chrysler had morphed from car manufacturers with large pension plans into giant pension-liability companies that also happened to make some cars (that not enough people actually buy anymore.)

I can’t claim to know the details of the agreement signed into law yesterday, but using tricks like a 25 year average on historic interest rates, rather than current interest rates, should keep us up all night, rather frightened.

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