In the past two months, the Georgia Department of Audits and Accounts (GDAA) released two reports that are intended to improve the fiscal outlook of the state’s Teachers Retirement System (TRS). The first report, published in January, discusses options that would improve TRS’s financial viability while maintaining its status as a defined-benefit pension plan. The second report, posted in February, talks about the University System of Georgia’s (USG) unfunded liability payments to TRS.
The pension system—currently only 80.2 percent funded with a whopping $18.6 billion in unfunded liabilities (based on a market value of assets)—is long overdue for changes, and it might seem like any fix would be helpful in this situation. But the question must be asked, are these proposed adjustments enough to guarantee long-term fiscal solvency, or are they merely a band-aid on an open wound?
Summary of GDAA Report No. 18-11: Recommendations to Improve TRS Solvency
The first report responded to a legislative request on various aspects of Georgia’s state-run pension plans, including a review of reform options that could decrease employer contributions and risk while maintaining TRS’s structure as a defined-benefit plan. The report recommends a number of changes that vary in fiscal impact, as viewed through the lens of the near-term future (fiscal years 2021-2025).
Interest Rate on Employee Contributions
TRS credits members’ accounts with 4.5 percent interest on employee contributions. When members leave prior to retirement, they receive the interest accrued on the contributions. The interest credited is a risk-free return on members contributions and ranges from 0 to 6 percent in other states. Reducing the interest rate to either 2 percent or 3 percent would result in a decrease in total employer contributions ranging from $6 to $13 million annually, depending on the magnitude of reduction.
Benefit Formula and Retirement Age
Currently, members are eligible to retire at the age of 60 with at least 10 years of service or at any age with 25 years of service. The monthly pension benefits are calculated as:
(Years of service) x (2 percent) x (the member’s average annual compensation during the two consecutive years producing the highest average).
Proposed changes include lowering the benefit multiplier (from 2.0 percent to 1.9 percent) and using a five-year average salary instead of the current two-year average. This could reduce the annual employer contributions anywhere from $38 million to $45 million a year, according to the report. Increasing retirement age by two years, in turn, could produce savings between $48 million and $50 million, depending on a fiscal year.
TRS beneficiaries receive a cost-of-living-adjustment (COLA) of 1.5 percent every six months, as long as there is an increase in Consumer Price Index (CPI). As noted in the report, in the past 21 to 26 years TRS’s COLA has outpaced inflation. After 20 years of retirement, fully-vested retirees in TRS receive a COLA that is 49 percent higher than the minimum needed to maintain equal purchasing power.
There are six different scenarios outlined in the report. Proposed changes to COLA are the most impactful changes for the system. The magnitude of changes varies from reducing COLA and the frequency of its adjustment, to ending it for new hires only and making it payable starting at a later age (65 or 70). The contribution savings could range from $17 million to $685 million a year depending on the changes. The analysis also shows that eliminating the COLA for all new hires would save the state around $200 million annually.
Although taking a critical look at the TRS plan structure and evaluating the impact of various possible changes is a good step towards starting the conversation, none of the incremental changes proposed in the report would, by themselves, put the plan on the path to near-term full-funding —assuming no other changes to the contribution rate or plan’s assumptions.
We have previously discussed various causes of TRS’s fiscal solvency crisis. Driving factors behind the system’s problems include underperforming investment returns, unmet demographic assumptions and negative amortization (annual interest on pension debt exceeding annual contributions toward amortizing unfunded liabilities). Long-term solvency can hardly be achieved without making changes focused on these key areas.
Underperforming investments alone are responsible for $9.7 billion in unfunded pension liability since 1998. According to our calculations, which take into account the plan’s investment portfolio structure, investment returns are likely to vary anywhere between 5 percent and 6 percent in the foreseeable future, far lower than the plan’s assumed 7 percent return. A 6 percent long-term average return would require an additional $21 billion in employer contributions over the next 30 years to cover the shortfall. A return of 5 percent would require an additional $34.5 billion. It’s important to note that low investment returns alone can generate far greater liability then any one of the measures proposed in the report can reduce.
Other main contributors to the existing pension debt — unmet demographic assumptions and negative amortization— are responsible for $7.4 billion and $3.1 billion in unfunded liabilities respectively. These problems aren’t likely to go away unless specifically addressed.
Revisiting the components of the plan that are its greatest contributors to unfunded liability, as discussed above, would likely be a more prudent path to take relative to the more incremental changes proposed in the report.
Summary of GDAA Report No. 18-11A on TRS Pension Contributions
The second report, released in February, reviews the process of calculating the USG’s contributions to TRS and the Optional Retirement Plan (ORP), the defined-contribution retirement plan offered to higher education employees. It is reported that USG has failed to appropriately fund ORP’s portion of TRS on several instances, which results in higher employer contributions charged to TRS. The findings of the report can be summarized as follows:
- USG has not made unfunded liability amortization payments it owed TRS from 2008 to 2019; an estimated $600 to $660 million for years 2008 to 2018, plus an additional $170 million for fiscal year 2019 is what is owed to TRS, according to the report.
- In 2001, actuarial valuation of TRS projected that the ORP unfunded liability portion would be fully funded so USG stopped payments. And, although as of 2008, there was an unfunded liability, USG did not resume payments that it stopped seven years ago.
- USG has received an additional $250 million in state appropriations for the required unfunded liability payments that should have been made to TRS, according to the report. Since the payments were never received by TRS, the report suggests that the current budget process is reviewed in order to determine if USG received an appropriate amount of such payments.
- Normal cost rate payments from USG to TRS for its ORP members has never been determined (or paid) since the plan’s creation in 1990. The report recommends that the appropriate value of these normal cost amounts is calculated by an actuary and fulfilled by USG.
Although it is important to precisely determine the share of the TRS bill that is USG’s responsibility, even when fully executed, these payments from one large employer will not eliminate the total amount of unfunded liabilities held by the retirement system. The report primarily deals with explaining the rationale behind the above mentioned discrepancies, which were a result partially of the turnover of TRS and USG staff and board members throughout the past 29 years (since the inception of the ORP) and partially of the lack of clear rules and regulations of the particular funding process. Nonetheless, it is important to understand that following through with the recommendations of this audit would not fundamentally change underlying TRS assumptions, which are a primary cause of the growing unfunded liability.
Fixing TRS’s problems will require a wide mix of policy changes, and there are a range of options and trade-offs to consider. First and foremost, Georgia policymakers need to consider reforms which provide more effective ways to manage the existing debt while de-risking the plan for the future to avoid accruing new unfunded liabilities. Georgia teachers depend on TRS’s long-term stability, and a comprehensive approach is needed to achieve this.
The implementation of the fixes proposed by the reports may generate political action, but they are unlikely to improve the plan’s fiscal situation to the point where it can sustainably guarantee future benefits. Without a comprehensive approach, Georgia might be back to revisiting reform options for its teachers’ pension plan just a few short years after implementing any of these incremental changes. Legislators need to consider the trade-offs between long-term solutions and short-term fixes.
 USG is required to remit payment to TRS if the normal cost rate increases due to the absence of members who have joined ORP. This is designed to mitigate any increased costs results from USG payment joining ORP instead of TRS.