Pension Vocabulary: What Does
“Smoothing” Mean?
One of the elements of the addition of a Tier III in the new
law for latest hires in Illinois is a change in how state government calculates
the amount of money TRS and other programs will receive from the state
government in Illinois for the years going forward: 2018, etc.
Making common sense of how one might determine what would
constitute a required annual contribution is a bit complicated, because that
contribution by the State of Illinois to TRS is dependent upon the fluctuating
rates of investment returns in the reserves into which we (teachers) all
pay.
Confused? Believe me,
as a retired Language Arts teacher, me too.
But think of it this way:
If the investments in TRS do better than the funds assume
(predict) in a current year, the state and local governments can fund pensions
with much less tax money, which could be in turn used for services,
infrastructure, or citizen benefits.
However, if the investment returns do poorly, the required annual
contributions by the state will need to
increase to meet the needs; and that will crowd out the same programs – the
services, infrastructure programs, and citizen benefits mentioned above.
With me so far?
So…if TRS is down 5% this year in investment returns, the
state picks up the additional 5% of contribution. Or if the investment returns are up 3% this
year, then the state is able to lessen its payment by the corresponding amount. Right?
Yes, that is, until a little actuarial gimmick called smoothing is applied to the mathematical
reality.
According to one economist, smoothing is a “actuarial camouflage,” a method to dampen on-book
asset volatility.” The practice is meant
to protect the payer from the shocks of sudden changes in market returns (or
volatility) in gains and losses during a single year. So, why not spread the damages or gains over
five, or ten, or twenty years to artificially reduce asset volatility?
Analogy: I’ll meet
with my Doctor later next month. He’ll
be checking my weight carefully again as he does every six months. Let’s just say that I have a deep and abiding
love for good food and paired wines. And
my weight has fluctuated during those times we have met.
Me: Yes, you know, Doctor, I think we should smooth the last five years of our
appointments. I calculate an overall average
loss of a single pound over our ten meetings.
That’s a hopeful indicator, don’t you think?
Doctor: Does that make
you feel better?
When the smoothing
is done, it is more likely that the underfunding of pensions will continue as
it artificially reduces asset volatility and reduces funding pressures in the
short run. In my case, my assets may
look better than they are (pun intended), and the same is true of this
engineered value of pension assets and returns.
According to the Rockefeller Institute study on Public Pension
Funding Practices, “Funding policies and practices that take a long time to
repay shortfalls protect current taxpayers and beneficiaries of government
services from sharp and possibly unaffordable changes. But they create risk that the pension plan
will become deeply underfunded and that future taxpayers who never benefitted
from past services will have to pay for them.
This is particularly true of the plan suffers a series of shortfalls
over several years.”
Welcome to Illinois.
According to TRS, the original state contribution for TRS
expected in fiscal year 2018 – $4.65 billion – will be recalculated.
“TRS must retroactively “smooth” the fiscal effect of any
changes made in the TRS assumed rate of investment return over a period of five
years. The “smoothing” applies to
assumption changes from 2012 on. Up until
now, the fiscal impact change in the assumed was totally absorbed at one
time. For example, in 2016 TRS reduced
its rate of investment return from 7.5% and the result was a $402 million
increase in the fiscal year 2018 state contribution to TRS. Under this new law, that $402 million increase
would be phased in over a five-year period.“
The only way it could get any more slippery or worse is if
Illinois found a way to short the funding even more.
They did:
According to Mr. Richard Ingram, the executive director of
Illinois’ TRS, “Over the last several years state government has taken its
responsibilities to TRS very seriously and has paid its legal obligation in
full. Still, the legal state contribution for the last several years has been
insufficient to improve the System’s long–term finances. State government’s
annual contribution is set artificially by law. It is not an actuarial
calculation.
As it
does every year, for FY 2017 the TRS Board asked its actuaries to calculate two
state contributions — the payment calculated under state law and the payment
calculated under actuarial practices. Under standard actuarial practices, the
state’s annual contribution for FY 2017 should be $6.07 billion.
The
calculations set in state law artificially lower the state’s annual funding
level. For instance, state law:
•
Requires
pension costs to be calculated on a 50–year timetable instead of the standard
30 years
•
Establishes
a 90 percent funding target instead of the standard 100 percent goal
•
Requires
the debt payments on state pension bonds to be deducted from the total
contribution.
Illinois
teachers have always paid their required share and are counting on their
pensions to sustain them in retirement. The state has never paid its full
share.
The annual
contribution is the amount of money required by state law to fund TRS pensions
during the coming year, as well as a payment on the System’s unfunded
liability, which currently stands at $71.4 billion.”
The
inclusion of another Tier by the General Assembly as a laurel to Republicans
and Rauner does not fix the hole nearly 80 years of underfunding has excavated. It provides some relief (like SB7 did) to
borrow to pay off debts, once again on the backs of those who paid into their
pensions as demanded each and every paycheck.
Does that make you feel better?
Nope.
Illinois adopted asset smoothing (Senate Bill 1292 in 2011) to determine the actuarial value of its plan assets. The asset smoothing method uses expected returns on the asset mix and averages both past and anticipated asset values, generally over a period of five years.
ReplyDeleteConsider the State of Illinois’ consistent underfunding of its annually-required contributions to the pension plans, the transferring of the state’s “normal costs” to the public pensions, the inadequate revenue growth for the long-term costs of public pension benefits, the unfunded pension liabilities and funded ratios, the historical rates of return, amortization periods, discount rates and inflation rates, and the state’s current flat-rate tax system and budget practices, to name just a few. They still need to be addressed.
Consider that the long-term consequences of legislative policy decisions are also based upon preferred and changeable data, that public pensions carry liabilities into perpetuity, and that the immediate effects of any legislation passed will affect primarily middle-class citizens who are victims of an imperfect fact-finding and decision-making processes.
We would agree that claims are considered effective when supported by sufficient, accurate, and relevant evidence; however, will Illinois legislators and the governor agree about evidence and solutions for the state’s public pensions’ unfunded and future liabilities? The answer is NO. The governor and legislators of the State of Illinois will not focus upon solving the state’s revenue and debt problems so that they can decisively commit to a responsible funding for all of the state’s debts.
From the Teachers Retirement System of Illinois, October 2016:
ReplyDelete“‘By any measure, $4.56 billion is a lot of money, but that amount is a direct product of the perpetual underfunding of TRS by state government over the last 76 years,’ said TRS Executive Director Dick Ingram. ‘Illinois is reaping what it sowed. Decades of inadequate contributions for TRS mean that now – when investment returns are not robust – big contributions must be made to secure the retirement promises made to generations of teachers.’
“Of the $4.56 billion state contribution for FY 2018, only $974 million is needed to pay the anticipated annual cost of TRS pensions during the year. The remaining $3.59 billion in the contribution is dedicated to help pay off the System’s $71.4 billion unfunded liability.
“‘Most of the FY 2018 contribution is a self-inflicted wound,’ Ingram added. ‘That money could be spent on other priorities today if the State of Illinois had fully met its obligations in the past.’”