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On Nov. 19, the Teacher’s Retirement System’s (TRS) Board of Trustees voted to continue to grant automatic cost of living adjustments (COLAs) to retired teachers instead of making the COLA optional. One good aspect of the controversy over this vote is that it has given everyone an opportunity to review how the retirement system works. The important role that the earnings of the fund play is probably the one fact that surprised everyone. The earnings of the fund normally total more than the employee and employer contributions.
Once again, here are some of the important facts about TRS:
• TRS is a defined benefit system. This means the plan pays benefits based on length of service and highest two years’ pay.
• TRS manages retirement accounts for 272,000 active employees, 75,000 retirees and survivors, and has an estimated FY09 retiree payroll of about $2.6 billion.
• Almost $1.1 billion of earnings are required just to meet the payroll of retirees currently for a year.
• Retirees receive COLAs of 1.5 percent once on Jan. 1 and again on July 1.
• The employee contribution rate is 5 percent of their salary; however in FY10, the contribution rate will increase to 5.25 percent.
• Employers (the state and school districts) contribute 9.28 percent of an employee’s salary to TRS. This contribution will increase to 9.74 percent in FY10.
• At the end of FY08, TRS had a “funded status” of 94.7 percent. This ratio of assets over liabilities is used to assess whether a pension system will be able to cover all of its liabilities over a 30 year time period.
Contribution is earnings — funding scenarios
Although a funded status of 94.7 percent indicates a strong pension system, in order to ensure that the pension system has sufficient funds to meet liabilities, TRS relies on three main sources of revenue: employee contributions, employer contributions and returns on investments.
The models used to assess funded status assume that TRS will make a 7.5 percent return on its investments, calculated on a 7 year rolling average basis. As of Sept. 28, TRS has lost 19 percent this year, or $9.6 billion. Although the pension system will smooth out its losses by averaging over seven years, large losses can have the effect of eroding the funded status of the system. When this happens, to maintain sufficient funding TRS can either increase contributions as it is doing in FY10, or it can reduce liabilities, such as reducing the COLAs.
It takes a billion in earnings to meet yearly payroll.
The math for the pension system is as follows: TRS estimates that it will have a retiree payroll of $2.6 billion in FY09. TRS also estimates that it will receive about $1.6 billion from employee and employer contributions. Ideally, the payroll should be covered from the assets paid into the system by the retirees in years earlier. The current employee and employer contributions are insufficient on their own to cover the current retiree payroll.
The balance must come from earnings
At a 7.5 percent return on investment, the fund will accumulate $3.8 billion in interest which would be sufficient to cover payroll and to build the value of the portfolio by $2.7 billion.
However, if investment returns turn down, over time TRS will end up dipping into the underlying assets of the fund that erodes the funds ability to meet future obligations. For instance:
• Even a 5 percent return on investment that would equal around $2.5 billion, would be insufficient to cover payroll by $90 million.
• If earnings were zero, the plan would post a net loss of $1.04 billion. Since employee and employer contributions are insufficient to cover the payroll, TRS would have to use its underlying assets to cover payroll.
• A 5 percent loss would equal negative $2.5 billion. After employee and employer contributions are used to cover part of the retiree payroll, TRS would post a net loss of about $3.6 billion in total.
So, earnings and earning strategies are extremely important. Retirees seem to be more aware of this fact today.
Given the current losses, the erosion of the funded status is a concern; however, in general, Georgia is doing well compared to other states. The TRS plan was 94.7 percent funded at the end of FY08. GAO notes that most experts consider the threshold for a sound pension system is 80 percent. The Pew Center on the States recently reviewed the pension systems across all the states in the country and cites Georgia throughout its report, “Promises with a Price: Public Sector Retirement Benefits,” as a state having one of the best managed retirement systems.
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