Testimony: Texas Employee Pension System Considers Funding Change

Testimony submitted to the Texas House of Representatives Committee on Pensions, Investments and Financial Services, March 31st, 2021.

Chairman Anchia, committee members, thank you for the opportunity to offer a brief technical assessment of House Bill 3397 and the implications of the state adopting an actuarially determined employer contribution funding policy—commonly referred to as the ADEC rate—to address the state’s worsening public pension underfunding and put the Employees Retirement System of Texas (ERS) on a sustainable fiscal trajectory.

My name is Steven Gassenberger and I’m a Houston resident serving as a policy analyst with the Pension Integrity Project at Reason Foundation.

Over the last 20 years, ERS has gone from 105% funded and holding a surplus of $867 million to holding over $14.7 billion in earned, yet unfunded, pension obligations that are implicitly protected by both the state and federal constitutions.

Over $4.46 billion of that $14.7 billion in ERS pension debt—nearly a third—can be attributed to the way the state systematically underfunds its public employee pension system, according to annual public reports published by ERS. In their most recent report, ERS actuaries determined that the state needed to contribute 15.98% of payroll to put the plan on the path to full funding. However, the statutory contribution rate established in state law is only 10% of payroll, shorting ERS the 5.98% needed to get back on track to full funding.

The consistent practice of setting lower than required ERS contribution rates in state law instead of paying the amount actuaries calculate is needed each year to stay on track to meet promises has consistently shorted the system of expected revenue. Almost every single year for the last 18 years (2003-2020) the state’s statutory rate has been below the actuarially determined ERS employer contribution rate.

The reason the current ERS funding policy is broken is simple. By statutorily setting contribution rates below the ADEC rate policymakers ensure expected revenue will never make it into the fund to be invested, and thus will never earn a return.

Credit rating agencies routinely evaluate pension solvency as they make credit rating determinations, generally taking a dim view of pension underfunding and demonstrating a willingness to issue improved forecasts or even credit rating upgrades in states like Michigan and Colorado that have recently enacted similar pension funding policy reforms designed to pay down pension debt faster.

The increases needed now to meet the ADEC rate will pale in comparison to maintaining the structural underfunding of today and the ever-compounding accumulation of pension debt. ADEC funding alone will not guarantee the plan reaches full funding, nor will it address the systemic risk inherent in making assumptions about future investment returns and demographic changes. However, shifting to the use of an actuarially determined contribution rate for ERS would be a prudent funding policy step to ensure that today’s missed contributions do not become the financial burden of tomorrow’s Texans.