The Teachers’ Retirement Fund’s

Pension Stabilization Fund

A Trust Fund Insuring Indiana’s Commitments

 

Executive Summary

 

Mark D. Brown

 

This Indiana Fiscal Policy Institute Report reviews the current condition of the Teachers’ Retirement Fund (TRF) and the Pension Stabilization Fund (PSF).  We review the actions taken by the General Assembly, the impact of those actions on the TRF’s fiscal condition, and examine the actuarial status of both the pre-1996 account (Closed Plan) and the 1996 account (New Plan) in the TRF.  Finally, we will provide policy recommendations that will keep the state on the far-sighted and fiscally responsible road chosen by the Indiana General Assembly in 1989, 1993, and 1995.

 

The Indiana Fiscal Policy Institute, in December, 1988 produced a report entitled “Financing Teacher Retirement in Indiana,” in which we called attention to the very serious unfunded liability of the TRF, which was then estimated at over $3.4 billion.  We identified policy options that incorporated a generally accepted public finance principle of recognizing the true current cost of pension benefits and not shifting those costs across generations.  The principles underlying those options:

 

• The State of Indiana will recognize and meet its obligation to retired and subsequently retiring teachers.
• The State of Indiana will act to limit the impact on the General Fund budget by dedicating current resources to reduce the growth of the General Fund obligation from the New Plan.
• The State of Indiana will move, over time, from a “pay as you go” teachers’ pension system to an actuarially sound and funded system that recognizes the true current cost of the teachers’ retirement benefits.

 

In 1993, the General Assembly enacted legislation that closed the “old” teachers’ pay-as-you-go pension plan and created an actuarially funded new plan in which all newly hired teachers would be members. Then, in 1995, the Pension Stabilization Fund was created.  It would receive $30 million annually, beginning in FY 1996, from the Lottery, $25 million annually, beginning in FY 1996, from the General Fund, and $425 million of employer reserves from the Old Plan.  The legislation also limited increases in General Fund payments to 6% per year, beginning in FY 2006.

 

Estimates during the period prior to and during the 2003 budget-writing session of the General Assembly suggested that the PSF had accumulated greater funding than was necessary to meet its original obligations.  These estimates ignored the increasing unfunded liability in the New Plan, which was a result of transfers from the Old Plan to the New Plan.   Reacting to the severity of the recession’s impact, the budget for fiscal years 2004 and 2005 called for $190 million to be transferred each year from the PSF.  In addition, the budget also stopped the deposit of $30 million of Lottery proceeds into the PSF and used that money to subsidize employer contributions in the New Plan.   

 

A total of 8,901 members have transferred from the Old Plan the New Plan since its inception.  As of June 30, 2004, the unfunded liability of the New Plan totals $683 million.  To actuarially fund the New Plan, an actuarial determination of the employer contribution rate is done each year.  The Teachers’ Retirement Fund Board has consistently set the employer contribution rates lower than the actuarially determined rate necessary to fully fund the New Plan. 

 

Since 1994, cost of living adjustments (COLAs) have been granted in every year except 2002, or 11 COLAs in the last 12 years, with actuarial funding of those COLAs occurring in only three of those years.  Without advance funding, COLAs add to both the Old and the New Plan’s unfunded liabilities.  A prudent approach to long term TRF budget planning would include an assumption including some form of COLA. It is also worth noting that the impact on the retiree of not enacting COLAs is striking, over time.  Assuming 2% inflation, retirees will lose eighteen percent of the purchasing power of the monthly pension benefit in the first 10 years and nearly 40% over 25 years.   

 

Findings:

 

1. Due to the actions of state policy makers, good investment returns, and the transfer of a portion of the unfunded liability from the Old Plan to the New Plan, analysis indicated that the Pension Stabilization Fund was, in six short years, in a fiscally sound enough position to meet the expectations set forth in the 1995 legislation creating it.
2. Due in part to transfers from the Old Plan to the New Plan, the estimated benefit payouts from the Old Plan have decreased over the last 8 years (from 1996 to 2004).
3. 8,901 TRF members have transferred from the Old Plan to the New Plan.
4. The cumulative impact of those 8,901 transfers is the development of $683 million of unfunded liability in the New Plan.
5. Without changing recent and current practices, the Teachers’ Retirement Fund’s New Plan is in danger of developing an unfunded liability similar in scope to the Old Plan.
6. COLAs have been granted in 11 of the past 12 years, with those granted in eight of the years not being actuarially funded, thereby adding to unfunded liabilities in both the Old Plan and the New Plan.

 

Recommendations:

 

1. Make no further dollar transfers from the Pension Stabilization Fund other than those set forth by the Pension Stabilization Percentage triggering mechanism. 
2. Immediately, in fiscal year 2006, resume the transfer of $30.0 million from Lottery proceeds to the Pension Stabilization Fund.
3. For budgeting and policy analysis purposes, actuarial estimates of future benefit payouts and unfunded liabilities should include an assumption of the granting of annual COLAs.
4. Permanently separate the Old Plan’s unfunded liability from the New Plan by:
   1. Stopping the transfer of members, and their accompanying unfunded liability, from the Old Plan to the New Plan and
   2. Dedicating $683 million of Pension Stabilization Fund assets to the New Plan, thereby eliminating the unfunded liability in the New Plan that is a result of transfers from the Old Plan (An alternative would move the transfers, and the associated unfunded liability, from the New Plan back to the Old Plan.  Either would accomplish the same result).
5. Require that the Teachers’ Retirement Fund Board set the employer contribution percentage for the New Plan at a level sufficient to cover all normal costs and COLAs.
6. Consider reducing the Pension Stabilization Percentage to 105%, which is more in line with recent revenue growth activity and with near term revenue forecasts.

 

Concluding Remarks:

 

In order to continue on the road to prudent fiscal management of retired teacher pensions and the State’s budget, the General Assembly must return to the original guiding principles that led to the sound public policy enacted nearly 10 years ago.  Policymakers recognized then, and need to recognize now, that each generation should shoulder the costs it incurs. 

 

There is more at stake than whether teachers’ will receive their pensions.  Indiana must maintain its ability to provide adequate services to all Hoosiers and make necessary investments toward a future that has a variety of challenges and uncertainties.  Our ability to do so depends on thoughtful, prudent fiscal management that does not pass the current generations’ pension obligations to future generations of taxpayers.

 

Short term budgetary and political pressures often detour policies based on sound public finance principles.  Policymakers should keep their hands on the wheel and their eyes on Indiana’s future.  Generations of Indiana’s teachers and taxpayers are counting on it.