April 17, 2015
“OREA Member Action Lessens Threat to TRS Funding”
First there were the denials, then the reluctant admissions, and finally a strong legislative backlash against the threat to dedicated funding for the Teachers’ Retirement System.
In recent weeks, OREA has advised members and the political community at large of the potential for a legislative diversion of dedicated funding away from TRS to other functions of state government. The reason for the possible diversion: a massive $611 million budget deficit facing the legislature for the fiscal year beginning July 1, 2015.
As we have previously reported, TRS depends on a 5% slice of the state’s personal and corporate income, sales and use taxes for much of its annual operating revenues. The money from these dedicated taxes amounted last fiscal year to approximately 30% of an overall $1 billion retirement system budget. Without it, the progress that TRS is now making toward 100% funding by the year 2025 would be impossible – and could even be reversed.
The legislature does not get its hands on dedicated funding. When collected by the Oklahoma Tax Commission, 5% of the tax receipts go automatically (“off the top”) to TRS. Several key functions of state government receive dedicated funding, such as transportation, education, college scholarships, retirement and more.
Information gathered in recent weeks from a variety of House and Senate members revealed there really was a plan – highly developed or not – to divert as much as $60 million for next year’s budget from dedicated TRS funding to help solve the shortfall.
More than a hundred OREA member-lobbyists, working at the Capitol April 7, visited with lawmakers of all stripes – Republicans, Democrats, leaders, rank and file – to determine the sources and substance of the diversion rumor. In the process, they uncovered a solid bed of legislative opposition to a diversion plan. Many legislators gave assurances they were not part of a plan, would not support it, and further said they did not believe it could succeed.
In the following days, hundreds of other OREA members, working from their hometowns, continued to contact legislators on the issue. Most got the same assurances a diversion plan would not be carried out.
This week, Rep. Randy McDaniel (R, Edmond), chair of the House Business, Labor and Retirement Laws Committee, weighed in on the subject in a newspaper op-ed, strongly opposing a possible diversion of TRS dedicated funding. Among a number of good points, he argued to allow reforms made in recent years to strengthen state retirement systems – particularly TRS – to continue to work. As the recognized leader on retirement issues in the legislature, his views should go a long way toward mitigating any diversion efforts.
The threat to TRS dedicated funding is not over. It won’t be over until the legislature reaches final adjournment in late May. Even then, it won’t be completely over, because there will be future budget shortfalls and plenty of wild ideas to solve them.
In the meantime, give yourself a pat on the back, OREA members and friends. Good work.
The National Institute on Retirement Security (NIRS) says three states that switched from defined benefit pension plans to defined contribution plans in the last two decades wound up getting the opposite of what they were seeking.
In a report released in recent weeks, NIRS explains that the three states – Alaska, Michigan, and West Virginia – closed out defined benefit (DB) pension plans in favor of defined contribution (DC) plans in order to save money and reduce pension fund liabilities. Instead, they did not save money and in fact saw their liabilities rise.
“Case Studies of State Pension Plans that Switched to Defined Contribution Plans” presents summaries of pension changes in the three states. The case studies examined key issues that impacted the pension plans, including demographic changes, the cost of providing benefits, actuarially required contributions (ARC), plan funding levels and employee retirement security.
Based on the studies, NIRS researchers drew the conclusion that the best way for a state to address a pension underfunding issue is to maintain its DB plan, implement a responsible funding policy (including making full annual actuarially required contributions), evaluate plan assumptions and funding policies over time, and make adjustments when and where appropriate. In the long run, a disciplined and responsible approach toward management of a DB plan will prove smarter than succumbing to the lure of a DC plan.
NIRS reports that in Alaska legislation was enacted in 2005 that moved all employees hired after July 1, 2006, into DC accounts. At the time, the state faced a combined unfunded liability of $5.7 billion for its two DB pension plans and a retiree health care trust. The unfunded liability was the result of the state’s previous failure to adequately fund pensions over time, stock market declines and actuarial errors. Although the DC switch was sold as a way to slow down the increasing unfunded liability of the residual DB pension systems, the total unfunded liability more than doubled under the DC plan, ballooning to $12.4 billion by 2014. In 2014, the state made a $3 billion contribution to reduce the underfunding, and legislation was introduced to move employees back to a DB pension plan.
In Michigan, that state’s DB pension plan was overfunded at 109% in 1997, when the decision was made to close the plan to new state employees, who were instead offered DC accounts. State leaders thought they would save money with the switch, but the residual DB plan amassed a significant unfunded liability following its closure. By 2012, the funded status dropped to about 60%, with $6.2 billion in unfunded liabilities. In recent years, Michigan has become more disciplined in the funding of its plan, making nearly 80% of the actuarial required contribution (ARC) from 2008 to 2013.
In West Virginia, the state closed the teacher retirement system in 1991 to new employees in the hopes it would address underfunding caused by failure of the state and school boards to make adequate contributions to the pension in previous decades. After closure, the pension’s funded status continued to deteriorate, while retirement insecurity increased for teachers with the new DC accounts.
After a study found that providing equivalent benefits would be less expensive in a DB plan, legislation was enacted to move new educators into such a plan, while providing the option for educators with DC accounts to also make the switch. By 2008, new teachers were again covered by a traditional DB pension plan, along with most of the former DC account holders.
After reopening the DB pension, the state was disciplined about catching up on past contributions, and the plan funding level has significantly improved since 2005. It is expected to reach 100% funding by 2034.
(Note: The foregoing article is a summary prepared by OREA of key points from a 2015 study by the National Institute on Retirement Security, a non-partisan, non-profit research institute based in Washington, D.C. It was founded in 2007 by the Council of Institutional Investors, the National Association of State Retirement Administrators, and the National Council on Teacher Retirement.)
According to the National Institute for Retirement Security, traditional defined benefit retirement plans - like the Oklahoma Teachers' Retirement System - are better than the individual accounts provided by defined contribution 401 (k)-style plans now being pushed aggressively across the country by some leading politicians and many leaders of the financial industry.
A recent NIRS study found that traditional defined benefit plans are 48 percent less expensive to provide the same modest retirement benefit offered by a defined contribution plan. Stated differently, it means that, for the same amount of money going into the plan, a sponsor (i.e., the state of Oklahoma) can benefit from significant savings, and the eventual retiree (i.e., the Oklahoma retired teacher) can enjoy much more money in his/her pocket. It means lifetime financial security, and not outliving your money.
More specifically, NIRS says that traditional pension plans enjoy higher investment returns and lower fees than individual accounts, generating a 27 percent cost savings.
Unlike individual investors who generally enjoy high-risk, high-reward investment strategies when they're young, but switch to lower-risk portfolios that yield far lower returns as they age, traditional pension plans can maintain a balanced portfolio that yields consistently high returns, generating an 11 percent cost savings.
Traditional pension plans pool longevity risk, meaning that they only have to save for the average life expectancy of a group of individuals. Workers in a 401(k)-style defined contribution plan need an investment strategy that provides for the event that they live longer than average life. Longevity risk pooling generates a 10 percent cost savings.
Add up the savings, and it's 48 percent. If the Oklahoma Teachers' Retirement System, as it is currently structured, is less costly to administer, and retirees get more money to last them a lifetime, why would we want to do anything else?
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