TRS – A Texas Pension Too Big To Fail

TRSTexas State Senator Paul Bettencourt, (R-Houston) poked the bear when he filed Senate Bills 1750 and 1751, which would allow the Teachers Retirement System of Texas (TRS) and Employee Retirement System of Texas (ERS) to study, and possibly implement, changes in their public pensions. Change would mean moving – in an as-yet unspecified way – from a traditional “defined benefit” to a more 401K-style “defined contribution” plan. The effect would be to shift the burden of paying for retirement, somewhat, from taxpayers to employees. The bills as written specifically would only affect newly hired employees, not existing employees or retirees.

The bear he poked, of course, is public school teachers.

Public school teachers in Texas face steeper challenges planning their retirement than other professionals, in part because the vast majority cannot participate in Social Security, in part because of modest pay increases throughout a full career of service, and in part due to barriers to good retirement advice.

I don’t blame teachers, their union, and groups like the Texas Public Employees Association and Texas Retired Teachers Association (TRTA) that have come out in opposition to the bills. Tim Lee, Executive Director of TRTA, told me that an estimated 120 thousand text messages had been sent to legislators regarding changes toward a hybrid plan, such as suggested in SB 1751. Lee regards a shift to a hybrid system – even for only new hires – as undermining the strength of the entire TRS. A change caused by these bills would cause his organization to rethink their strategic approach to everything, including whether to advocate for joining the Social Security system. They don’t currently, but might in the future if they thought a hybrid system weakened TRS.

And yet, (and here’s where I become a target for the next 10,000 angry text messages from teachers) Bettencourt has an important point to make, by filing these bills. “Long term, what I hope to do is start a discussion about the real cost of pensions,” Bettencourt told me.

paul_bettencourtAs a finance guy, I want my public officials staying up late worried about public pensions, seeking ways to reduce their systemic risks. TRS has more than 1.5 million members, more than $130 billion in net assets, and represents the ultimate “Too Big To Fail” public pension in Texas.

Reasonable people can disagree on the following, but on the four biggest measurements of a pension plan’s health, the TRS according to its 2016 audit is worse off than we’d wish for, although maybe still within acceptable bounds.

  1. We want at least an 80 percent “Funded Ratio” – the percent of money owed to pensioners that’s covered by money already in the investment portfolio. TRS is now at 79.7 percent. Too low.
  2. We want less than 30 years to “amortize” or pay down, pension debts, and would prefer 15 to 20 years. TRS is at 33 years. Too long.
  3. We would prefer a low, or conservative, annual return assumption, compared to a national average of 7.47 percent annual return assumption in pension plans. The TRS assumes an optimistic 8 percent return. Too high.
  4. Finally, the unfunded liability part of the pension – money owed to retirees but not yet paid for – has grown from zero in the year 2000 to approximately $35 billion this year. Too big.

None is this spells catastrophe today, in my view. It just means the TRS is not, currently, building in room for error. As a teacher, if TRS is my main safety net, these numbers do not make me comfortable.

Actually, let me restate: Were I a young teacher, or a prospective teacher facing a new career, I would be livid about those TRS numbers. Older teachers – those close to retirement or already retired – are probably fine, and realistically won’t get benefits chopped to make up any future shortfalls. Rule changes in pensions always hurt the young ones.

In fact, one of the main flaws of the TRS design is this “generational inequity” in favor of older teachers rather than younger teachers, according to Josh McGee, who is both a pension-plan economist for the John Arnold Foundation and the Chairman of the Texas Pension Review Board. McGee has written extensively about how traditional pensions like TRS strongly favor veterans over younger teachers, especially those who change jobs or leave the system at any point in their career.

Defined benefit plans are most generous to veterans of over 20 years, but McGee cites figures that only 28 percent of teachers nationwide stay for that long. The early-departing teachers lose many of their hard-earned retirement rewards.

A defined contribution plan or hybrid plan theoretically could allow teachers the chance to self-fund part of their retirement, which could accompany them to another career or another location.

Then there’s the issue of pension plan solvency.

“When you look around the state, the Dallas [Police and Fire] Pension is a smoking crater at this point in time. Houston is not far behind,” Senator Bettencourt notes, referencing existing problems in public employee pensions in the state’s largest municipalities.

The following are my words, not Sen. Bettencourt’s, but I regard public pension plans as ticking time bombs. Not because the managers of TRS are bad, or because anyone is doing anything particularly wrong. It’s just that small decisions to underfund a public pension can, over decades, compound into giant problems. Make a few wrong assumptions – the 8 percent return assumption seems way high to me for example – and you end up with a big fiscal hole in the state.

A safer approach for teachers and taxpayers might in fact be to shift, over time, some of the risks away from taxpayers. Currently 13 states have a version of a hybrid system of the type that Bettencourt’s bill would allow, while 38 states continue with a “defined benefit” plan like Texas’ current TRS.

It’s a debate worth having now, before anything bad happens.

 

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

Please see related post:

Teachers and the struggle to get good financial advice

I Finally Say How To Invest

Interview with Mint: I give ALL the answers

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Teachers and Their Retirement Problems

teachers_financial_advice
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.

shark_sandwich
“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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Houston We’ve Got a (Pensions) Problem

danger_will_robinsonHouston’s three public pensions may not be in total distress today, but some of the instrument panels are beginning to flash orange.

One of the warning signs is the hit to the city’s credit-ratings earlier this year, as

Moody’s Investors Service downgraded the City of Houston’s debt on March 16 2016.

You might guess that the main problem with the City of Houston’s credit rating is the slowdown in the oil services business, and that’s certainly a short-term issue.

But Moody’s specifically cited large unfunded pension liabilities as one of the four main reasons to downgrade city debt to Aa3 and keep it on “negative outlook,” calling the liabilities “among the highest in the nation.” Lacking a plan to address the pensions, Moodys wrote in March, could lead to a further downgrade in the city’s bond rating.

moodys_houstonLet’s review some statistics on the pensions for firefighters (acronym: HFRRF), police officers (acronym: HPOPS), and municipal employees (acronym: HMEPS).

Things to monitor

Remember, the first two things to monitor, with respect to the health of a pension plan, are the funded ratio – roughly how much of future payments are already covered by investments – and years to amortization, otherwise known as the time needed to pay down debts. I’ve previously said that an 80 percent funded ratio is considered ok, although closer to 100 percent would be preferred. For years to amortization, a 15 to 20 year time frame seems manageable, while 40 years to infinity invites state monitoring and restrictions.

So what do we worry about the Houston plans in particular when we see the funded ratio and the years to amortization?

Here are the two measurables on the three Houston pension plans:

HFRRF – 86.6 percent funded ratio, 30 years amortization

HMEPS – 54 percent funded ratio, 32 years amortization

HPOPS – 79.8 percent funded ratio, 23 years amortization

Honestly, using just those measurements, only the HMEPS funded ratio makes me worried. If you’re not frightened by the first two measurements of funded ratio and amortization – and when I look at them I don’t personally get panicked – the next thing to monitor gets trickier.

You see, the firefighters’ and municipal workers’ plans assume an 8.5% annual return on investments, while the police plan assumes an 8% return. Not only do all three assumptions seem too high, but the first two plans are complete outliers. In a survey done by the National Association of State Retirement Administrators in early 2016, only 1 out of 127 plans assumed an 8.5% return. So, Houston firefighters and muni workers have an aggressive – actually my preferred word would be unrealistic – set of assumptions.

Last Fall, the Chairman of the HFRRF Todd Clark defended their outlier return assumptions in the Wall Street Journal, saying “We strongly believe, and past history shows, we can continue to achieve the 8.5% long term.” Clark resigned in July. HFRRF Executive Director Ralph Marsh declined to comment on my questions about the assumed return, or others posed about their pension fund.

houston_we_have_a_problemThe last 20 years’ average pension returns were 7.47 percent, according to the Wall Street Journal.

As a finance guy, I wish I could intuitively explain to the non-finance reader the uncomfortable tingly feeling in my toes that I get about that math. The effects of being wrong by just 1 percent, compounded over decades in a pension plan, are huge. We can see some of the scary implications from a presentation done by the Houston plans for the Texas legislature in June.

In that presentation, they showed that if you shift the return assumptions on Houston’s police and municipal employees down by 1 percent, suddenly the police pension plan only has a 54.6 percent funded ratio, while the municipal employees plan goes to a 49 percent funded ratio. So, like, only half the money needed to pay out retirees is currently available in the plans. Ugh. The instrument control panel not only shows blinking green lights turning into red lights, but sparks are starting to shoot out of the dials. Danger Will Robinson!

Now you start to get a sense for why Moodys downgraded the City of Houston in March, and why the Chairman of the Pension Review Board is trying to sound the alarm on Houston pensions.

City Budget Constraints

You see, the next big problem is that fixing pension shortfalls begin to eat into city budgets, a process already underway in Houston.

Josh McGee, who serves as both the Vice President of the Laura and John Arnold Foundation – a Houston think-tank focused on public finance, as well as the Chairman of the Texas Pension Review Board – points to a worrisome trend for Houston’s city budget.

houston_pensionIn 2001, required pension contributions made up just 6.7 percent of general fund revenue, or the amount of money in the city budget not otherwise allocated to specific purposes. By 2015, the required pension contributions have climbed to 19.2 percent of the general fund.  The trend here, tracked by McGee, has been steadily upward.

McGee compares Houston’s situation today with Chicago’s situation a decade ago. In Chicago, the comparable pension payment to the general fund rose from 19 percent to a stunning, and devastating, 54 percent today.

That means city leaders can’t decide to pay for stuff in a city without dedicating half their discretionary budget to fill in holes in pension plans – money already owed to workers, for work already performed. You have to rob Peter to pay Paul. Chicago is in a terrible bind today, and McGee openly worries Houston will follow down that path without a course correction.

So what happens if these plans stay in trouble? Realistically, political leaders don’t just say “Whoops” and send a shrugging emoji to pensioners. They especially don’t do this with politically sensitive pensioners like police, fire and city employees.

No. Instead, they fund the plan, and then taxes go up. Or they fund the plan, and other discretionary city services go way down.

The only other fix is to significantly reduce benefits for future employees.

Either way, residents previously blissfully unaware of such boring actuarial minutia as funded ratios, amortization schedules and actuarial unfunded liabilities unhappily begin to care, deeply and late, about such problems.

 

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

 

Please see related posts

The Dallas Police and Fire Pension Mess

Pension Plan Heuristics

The Big Four Texas Pensions

 

 

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