Reduce For This Biennium State Contributions to the Major Retirement Systems

The Legislature should reduce the state s contributions for the next biennium to the Employees Retirement System, the Teacher Retirement System and the Optional Retirement Program.


Background
The State of Texas sponsors three major public employee retirement systems: the Employees Retirement System of Texas (ERS), the Teacher Retirement System of Texas (TRS) and the Optional Retirement Program (ORP). ERS administers a defined-benefit pension pl an for state employees and elected officials. TRS administers a defined-benefit pens ion plan for employees of public schools, the Texas Education Agency, public junior and senior colleges, medical schools and other education-related state agencies. ORP is a defined-contribution plan that serves as an alternative to TRS for faculty members and top administrators of public colleges and universities and administrative staff of other education-related state agencies.

Defined-Benefit Pension Plans (ERS and TRS)
In defined-benefit plans, the State of Texas, acting as plan sponsor, commits itself to pay a specific annuity to a retiree. A retiree s benefit or annuity is based on a formula that considers the member s years of service, a benefit rate of 2 percent for each year of service and the member s salary level. For example, state employees r etiring with 30 years of service receive a monthly annuity payment equal to 60 percent (30 years of service x 2 percent) of their average monthly salary during their three years of highest earnings.

Members must contribute a percentage of their salary to the retirement system. The state in turn provides contributions sufficient to fund the promised level of benefits on an actuarially sound basis. As long as the amortization period remains within the statutory 31-year limit, variances in the state s contribution rate do not affect retirement benefits under defined-benefit plans.

The state contribution rates to ERS and TRS generally consist of the following two elements:
The state s share of the normal cost the percentage of the system s total payroll necessary to pay estimated retirement benefits for the average newly hired employee.
An additional layer of funding to amortize the system s unfunded actuarial accrued liability (UAAL) the excess of the actuarial accrued liability over the actuarial value of assets of a pension plan.
These factors are recalculated each year.

Generally, funding for defined-benefit plans is considered actuarially sound if it covers the normal cost and amortizes any unfunded actuarial accrued liability over a reasonable pe riod of years. In Texas, state law limits the amortization period for ERS and TRS to 31 years; thus, the state may not increase benefits or reduce contribution rates if the change would increase either system s amortization period to a period exceeding 31 years, or further extend the amortization period if it is already 31 years or more. 1

Defined-Contribution Plans (ORP)
In ORP, as is the case for all defined-contribution plans, there is no formula for determining retirement benefits. Benefits are based on the accumulation of state and member contributions and interest earnings in each member s account.

Each ORP member establishes a retirement account with one of more than 100 private carriers. The carrier invests the money in fixed or variable income securities on the member s behalf. The member s benefit is completely dependent on the investment performance of the fund. Everything the state contributes to ORP goes to the member s benefit. Therefore, varying the state s contribution rate in a defined-contribution plan does affect retirement benefits.

ORP s primary purpose is to provide young, mobile faculty members and university administrators a portable retirement program, meaning that members can take all accumulated employer and employee contributions and earnings with them as they pursue their c areers from one campus to another. More than 700 public colleges and universities in 41 states and the District of Columbia offer ORP-type plans to their faculty and administrators. In 23 states, including Texas, ORP is offered as an alternative to the public retirement plan. The remaining states offer ORP-type plans either as a supplement to the state s retirement system or as the sole retirement plan. 2

The portability feature gives ORP members a significant benefit that is not available to members of TRS and ERS. ORP members who leave employment after only one year of service are fully vested in the entire balance in their retirement account, which includes both state and member contributions and inter est earnings. In contrast, a member of ERS or TRS who leaves state employment can withdraw only his or her own contributions (no state contributions) plus interest earned. To receive a vested benefit, a member of ERS or TRS must have at least five years of service. In lieu of receiving a refund of contributions, a vested member leaving the system may choose to receive the monthly annuity earned to date, with payment deferred until retirement age.

Contribution Rates for ERS and TRS
According to a 1991 sur vey of state and local public retirement systems, ERS and TRS retirement benefits are slightly above national averages. For example, the 2-percent benefit rate used by ERS and TRS exceeds an average benefit rate of 1.9 percent for general state and local e mployees and 1.8 percent for teachers and school employees. 4

Contribution rates for ERS and TRS are set by statute. The statute sets member contribution rates at 6 percent of salary for ERS and 6.4 percent of salary for TRS. Statutory state contribution r ates are 7.4 percent of payroll for ERS and 8 percent of payroll for TRS. The Texas Constitution requires that state contribution rates for ERS and TRS range from 6 to 10 percent.

On the other hand, temporary rates have been adopted by the Legislature since 1983 to fund short-term budget demands. These rates generally have been set so that temporary rates set for the biennium and the statutory rates, which take effect thereafter, would be sufficient to liquidate the unfunded actuarial accrued liability over a period not to exceed 31 years.

Some states follow Texas approach in setting fixed pension-fund contribution rates in statute, but vary the amortization period. Others fix the amortization period in statute, as with Texas 31-year limit, but vary the contribution rate to fund pension liabilities at the statutory amortization period, which is generally in the range of 20 to 40 years. 3

Contribution Rates for ORP
Contribution rates for ORP are set in statute at 6.65 percent for members and 8.5 percent for the state. During the 1992-93 biennium, the state contribution rate for ORP was set at the TRS contribution rate of 7.31 percent of payroll, while the member contribution rate was maintained at 6.65 percent. Institutions and agencies with employees par ticipating in ORP are allowed to supplement the state s contribution rate in order to provide an employer contribution of 8.5 percent of payroll. This, in effect, kept members benefits whole.

The state contribution rate for ORP moved in tandem with the TRS rate until 1983, when the TRS rate was reduced from 8.5 percent to 7.1 percent. After 1983, the ORP state contribution rate remained at 8.5 percent until the 1992-93 biennium, when it was reduced to match the TRS rate of 7.31 percent. 5


Recommendations
A. The Legislature should set the state s contribution rates for Employees Retirement System (ERS) and Teacher Retirement System (TRS) during the 1994-95 biennium at the 30-year rate necessary to fund the retirement systems in an actuarially sound manner. The Legislature should make appropriations accordingly.

According to estimates prepared by the actuarial firm Milliman & Robertson, Inc., the state contribution rates required to amortize the unfunded actuarial accrued liability over a period of 30 years from September 1, 1991, are 6.35 percent for ERS and 7.2 5 percent for TRS. 6 These 30-year rates should be revised to reflect the incremental cost of any benefit changes adopted by the Legislature.

B. The Legislature should set the state contribution rate for ORP at the recommended TRS rate of 7.25 percent, and allow institutions of higher education to supplement this up to 8.5 percent.


Implications
The state s method of funding retirement contributions at an arbitrary rate set in statute makes it difficult to measure the cost of benefit increases. For example, reserves accumulate within the retirement funds as a result of arbitrarily set state contri bution rates. These reserves serve as a hidden funding source for benefit increases, as the systems funding period can be extended up to a maximum of 31 years to pay for the proposed benefit increases. As a result, the Legislature can adopt benefit increases without having to increase its contribution rates to the systems. If the recommended poli cy is adopted, every benefit increase would require an increase in the base 30-year contribution rate. Thus the cost of benefit increases would be measured against other needs of the state.

Funding state retirement contributions at the 30-year rate for t he 1994-95 biennium would establish a clear direction for the future. Savings would be achieved without reducing existing defined benefits or harming the actuarial soundness of the pension funds. When pension funds are overfunded, or funded at a level high er than required to fund current benefits, it is only prudent to question and adjust the allocation of state resources. The recommendation strikes a balance between the pre-funding of long-term pension liabilities and the current needs of the state, its ta xpayers and the recipients of its services.


Fiscal Impact
The estimated savings from implementing the recommendation are summarized in the following tables. The estimates assume the 30-year rates will be continued by future legislative action.

The estimated savings from reducing the state contribution rate for TRS to 7.25 percent are shown below. Projected contributions to TRS at the statutory rate of 8 percent are based on the TRS legislative appropriation request for the 1994-95 biennium. The estimates assume a payroll growth rate of 6.5 percent per year for TRS.

Estimated Savings - TRS Contributions

Projected TRS Projected TRS
Contributions Contributions
Fiscal at the Statutory at the 30-year Rate Total Change
Year Rate of 8.00% of 7.25% Savings in FTEs

1994 $1,046,780,000 $ 945,738,000 $101,042,000 0
1995 1,116,836,000 1,009,226,000 107,610,000 0
1996 1,191,445,000 1,076,841,000 114,604,000 0
1997 1,270,904,000 1,148,850,000 122,054,000 0
1998 1,355,528,000 1,225,541,000 129,987,000 0


The estimated savings from reducing the ERS contribution rate to 6.35 percent follow. Projected contributions to ERS at the statutory rate of 7.4 percent are based on the ERS Request for Legislative Appropriations for the 1994-1995 biennium. The projection s assume a payroll growth rate of 3 percent per year for ERS.

Estimated Savings - ERS Contributions

Projected ERS Projected ERS
Contributions Contributions
Fiscal at the Statutory at the 30-year Rate Total Change
Year Rate of 7.4% of 6.35% Savings in FTEs

1994 $242,226,000 $207,856,000 $34,370,000 0
1995 249,486,000 214,086,000 35,400,000 0
1996 256,971,000 220,509,000 36,462,000 0
1997 264,680,000 227,124,000 37,556,000 0
1998 272,621,000 233,938,000 38,683,000 0


The estimated savings of reducing the state contributions for ORP to the TRS rate of 7.25 percent follow. These estimates are based on actual 1992 ORP expenditures as of November 19, 1992, as reported by the Comptroller s office. The estimates assume a payroll growth rate of 5 percent per year for ORP.

Estimated Savings - ORP Contributions

Projected ORP Projected ORP
Contributions Contributions
Fiscal at the Statutory at the TRS Rate Total Change
Year Rate of 8.5% of 7.25% Savings in FTEs

1994 $154,043,000 $131,390,000 $22,653,000 0
1995 161,745,000 137,959,000 23,786,000 0
1996 169,833,000 144,857,000 24,976,000 0
1997 178,324,000 152,100,000 26,224,000 0
1998 187,240,000 159,705,000 27,535,000 0


The final table summarizes the total savings by fund of reduced state contribution rates to TRS, ERS and ORP. State retirement contributions for TRS and ORP are made entirely from the General Revenue Fund. It is assumed that about 59 percent of the ERS budget for st ate retirement contributions is appropriated out of general revenue related funds.

Summary of Total Cost Savings By Fund

Savings to the Savings to
Fiscal General Revenue Other Dedicated Total Savings Change
Year Fund 001 Accounts or Funds All Funds in FTEs

1994 $144,042,000 $14,023,000 $158,065,000 0
1995 152,353,000 14,443,000 166,796,000 0
1996 161,166,000 14,876,000 176,042,000 0
1997 170,511,000 15,323,000 185,834,000 0
1998 180,422,000 15,783,000 196,205,000 0


Endnotes
1 Tex. Govt. Code Ann. Sec. 811.006 and Sec. 821.006 (Vernon 1992).
2 Interview with Sharon L. Beardman and Kevin C. Brown, Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF), Austin, Texas, November 12, 1992.
3 Paul Zorn, Survey of State and Local Government Employee Retirement Systems (Chicago: Public Pension Coordinating Council, November 1991), p. 55.
4 Ibid., pp. 27, 31.
5 State Pension Review Board, Pension Legislation, 72nd Legislature, First Called Session, Austin, Texas, August 1991, p. 4.
6 Telephone interview with Thomas P. Bleakney, Milliman & Robertson, Inc., Seattle, Washington, November 17, 1992.