The Teachers Retirement System (TRS) of Georgia alarmed legislators and stakeholders when it requested over $588 million in increased contributions in the 2017 and 2018 legislative sessions combined, largely the result of missed actuarial assumptions. Given such a steep rise, the relatively small $25 million budget increase requested for 2019 may have signaled to some that things might be turning around for the troubled pension plan. But this would be mistaken, according to a new report published by the Georgia Public Policy Foundation and the Pension Integrity Project at Reason Foundation that finds the Georgia TRS has several shortcomings that could further degrade its long-run solvency.
The pension system currently has $24.8 billion in unfunded pension liabilities according to its latest actuarial valuation, and since 2002, the growth in annual actuarially determined contributions required for Georgia TRS has far outpaced the growth of the state’s economy, with pension contributions having grown by 67 percent and Georgia’s GDP grown by 23 percent.
While it might be tempting to blame this experience on the Great Recession, it’s clear that the 2007-2008 financial crisis does not explain the trend. Since 2009, the leading financial indicators, such as the S&P 500 and the Dow Jones Industrial Average, have outperformed pre-crisis levels and risen to new heights, whereas the Georgia TRS’ unfunded liabilities have not returned to pre-crisis levels.
The reality is that the current unfunded liability may be only the tip of the iceberg of what is yet to come for Georgia TRS. The problems causing TRS’ pension debt are much deeper than a reaction to economic shocks or cyclical fluctuations. So what are Georgia TRS’s problems exactly?
For a pension plan to be fully funded and have no debt, the actuarial assumptions set ahead of time need to be correct, but that has not been the case for Georgia. The plan’s overly optimistic assumption about its investment return rate is the largest contributing driver of the growth in unfunded liability.
The TRS has assumed a 7.5 percent investment return on its assets since 2001, whereas its actual market returns have averaged 5.5 percent over that period. This alone created $9.7 billion in unfunded liabilities between 2001 and 2017. Other major contributors to the TRS growing debt are flawed demographic assumptions and negative amortization (which occurs when unfunded liability amortization payments are less than the interest accruing on the same pension debt).
Speaking of underperforming investments, it is worth mentioning the high investment returns of the past two years (12.5 percent in 2017 and 8.9 percent in 2018). Although they are indeed outperforming the plan’s target of 7.5 percent rate of return, it is important to understand that such high returns are likely to be rare in the foreseeable future. In fact, average returns in the next 10 to 20 years are likely to be less than those in the past 20 to 30 years, mainly due to the structural changes in the global and domestic economy.
So, how would future underperformance affect the budgetary outlays needed to keep TRS solvent? Our preliminary modeling shows that a 6.5 percent actual return would raise the employer contribution to 22 of payroll by FY2040, while a 5.5 percent average return could increase contributions as high as 27 percent of payroll. And that’s presuming that all other important economic and demographic assumptions are met; any variance in payroll growth, inflation, mortality, etc. relative to TRS’ current assumptions— some variance will certainly happen—will also influence the level of underfunding of TRS. And it’s important to remember that the more dollars dedicated to dealing with the consequences of underfunding, the fewer dollars available to dedicate to the classroom.
In order to fix the hard-hitting long-term consequences of the current pension plan structure, Georgia policymakers need to consider reforms to provide more effective ways to manage the existing debt while de-risking the plan for the future to avoid accruing new unfunded liabilities. The existing TRS debt is a sustainability threat to the active teachers, retirees and Georgia taxpayers. Growing unfunded pension liabilities could also eventually threaten the state’s credit rating, making future borrowing more expensive.
Tackling growing pension debt requires ever-increasing budget appropriations, which crowds out other education spending, including anything from teachers’ salaries to classroom supplies. The price that future generations will pay absent pension reform has to be measured not only by the dollar amount of the growing debt but also in forgone opportunities.
Read the full version of the paper, Georgia’s Teachers Retirement System: Historic Solvency Analysis And Prospects for the Future, here.