The Teachers' Retirement System of Illinois Cost of Living Adjustment

“‘...In the 21 years from 1969 through 1989 there was only one year that inflation was less than 3.3% and the average annual rate of inflation was just over 6.2%.  In making the decision in 1989 to change our annual increase from three percent simple to three percent compounded, the members of the General Assembly made what they felt was a reasonable assumption that inflation would continue and that it would grow at the rate that it had been for more than 20 years.  Since state pensions had not kept up with inflation they would provide a necessary increase, but they did not ask anyone to pay for it because they assumed it would not really be expensive.  The change would cost the state, but they assumed it would still run behind inflation. And growing inflation would mean the state would collect more tax revenue’ (Bob Lyons, former Trustee for the Teachers’ Retirement System of Illinois).

“Anticipating further elevated inflation rates, the General Assembly granted a change from 3% simple to 3% compounded COLA in 1990 to the retirees in TRS. 

“Since 1990, (high of 4.1% in 2007 and low of .1 in 2008) the average inflation rate for the country has been overall 2.4%.   As Mr. Lyons writes, ‘The reality is that the change from 3% simple to 3% compounded did just what it was supposed to do and it has more than protected us from inflation.’

“And he’s right.  On average, thus far, we are looking back nearly 30 years with a .6% positive break.  And in our current media environment of people turning on each other rather than to each other, this COLA correction seems unacceptable to those who criticize the Illinois ‘Pension Problem’ as simply an issue of too many benefits. The finger pointing by the Tribune and other anti-union organizations ignore the truth: the cost of pension would not be so overwhelming if there were no debt payment as a result of decades of avoiding payments.  

“Eric Madiar, the former Chief Legal Counsel for Senate Leader John Cullerton and author of a thorough exegesis ‘Is Welching on Public Pension Promises an Option for Illinois?' speaking before the City Club of Chicago, once reminded his audience: ‘Our current pension disaster cannot be blamed on salary or pension cost increases.  Between 1985 and 2014, pension funding liabilities grew by $97 billion.  Benefit increase only counted for 8%, or $8 billion of that growth.  Pay increases were actually less than actuaries had assumed they would be. And the actually helped bring down the unfunded liability by $1.3 billion.  The state's failure to fund the system accounts for 49 or 47% of that growth.  So simply out, the main reason we are in this mess is for insufficient pension contributions’ (City Club of Chicago). 

“But like any Zen Balance question, we are all awash in what may decidedly come again in another inevitable wave.  Okay, so now maybe we are .6 ahead.  Now.  But in the 15 years before the 3% compounded (1975-1989), we were battling an average of 6.7% inflation – or a 3.6% disadvantage even if pensioners had compounded COLA’s.  

“Maybe the General Assembly didn't foresee a lessening of inflation or the Great Recession, but they understood what continued rampant inflation was doing to state retirees.  

“And, it’s not pensioners that created the fiscal problems at the state or municipal levels; it is and will always be the avoidance of funding the pensions that now comprise the interest-laden debt which must be serviced yearly.  As Bob Lyons also wisely points out, ‘The truth is that this year 76% of the 8.5 billion going to pensions is to make up for the continuous past underfunding of the five systems.  If Illinois pensions were fully funded, all it would take to fund the pensions for all current employees would be just a little more than two billion dollars. The so-called pension problem in Illinois has in reality not been caused by the cost of our pensions, but by the failure to fully fund them’…” (For the complete article by John Dillon, click here).

Commentary:

On May 8, 2015, the Illinois Supreme Court delivered the judgment of the court, with opinion. All seven justices concurred in the judgment and opinion (Doris Heaton et al., Appellees v. Pat Quinn, Governor, State of Illinois, et al., Appellants)]. There are two interesting footnotes in the judgment on pension reform litigation regarding COLA: "By way of comparison, data published by the Social Security Administration show that Social Security increases, which are tied to the cost of living, averaged 3.98%, nearly a percentage point more than under the Illinois formula, between 1975 and 2014 (page 4)." (http://www.ssa.gov/OACT/COLA/colaseries.html.). "While the automatic annual increases have sometimes exceeded changes in the cost of living, these judgments are not cost of living adjustments, and as indicated earlier in this disposition, the increases have actually lagged the average increases granted by the Social Security Administration, which are tied to the cost of living" (page 27). 

Regarding the Cost-of Living Adjustment (COLA) of the Illinois Teachers’ Retirement System: 
 

Illinois Pension Code: 40 ILCS 5/16-133.1) (from Ch. 108 1/2, par. 16-133.1) Sec. 16-133. (Automatic annual increase in annuity):

(a) Each member with creditable service and retiring on or after August 26, 1969 is entitled to the automatic annual increases in annuity provided under this Section while receiving a retirement annuity or disability retirement annuity from the system. An annuitant shall first be entitled to an initial increase under this Section on the January 1 next following the first anniversary of retirement, or January 1 of the year next following attainment of age 61, whichever is later. At such time, the system shall pay an initial increase determined as follows:

(1) 1.5% of the originally granted retirement annuity or disability retirement annuity multiplied by the number of years elapsed, if any, from the date of retirement until January 1, 1972, plus

(2) 2% of the originally granted annuity multiplied by the number of years elapsed, if any, from the date of retirement or January 1, 1972, whichever is later, until January 1, 1978, plus

(3) 3% of the originally granted annuity multiplied by the number of years elapsed from the date of retirement or January 1, 1978, whichever is later, until the effective date of the initial increase. However, the initial annual increase calculated under this Section for the recipient of a disability retirement annuity granted under Section 16-149.2 shall be reduced by an amount equal to the total of all increases in that annuity received under Section 16-149.5 (but not exceeding 100% of the amount of the initial increase otherwise provided under this Section).

Following the initial increase, automatic annual increases in annuity shall be payable on each January 1 thereafter during the lifetime of the annuitant, determined as a percentage of the originally-granted retirement annuity or disability retirement annuity for increases granted prior to January 1, 1990, and calculated as a percentage of the total amount of annuity, including previous increases under this Section, for increases granted on or after January 1, 1990, as follows: 1.5% for periods prior to January 1, 1972, 2% for periods after December 31, 1971 and prior to January 1, 1978, and 3% for periods after December 31, 1977.

(b) The automatic annual increases in annuity provided under this Section shall not be applicable unless a member has made contributions toward such increases for a period equivalent to one full year of creditable service. If a member contributes for service performed after August 26, 1969 but the member becomes an annuitant before such contributions amount to one full year's contributions based on the salary at the date of retirement, he or she may pay the necessary balance of the contributions to the system and be eligible for the automatic annual increases in annuity provided under this Section. 

c) Each member shall make contributions toward the cost of the automatic annual increases in annuity as provided under Section 16-152.

(d) An annuitant receiving a retirement annuity or disability retirement annuity on July 1, 1969, who subsequently reenters service as a teacher is eligible for the automatic annual increases in annuity provided under this Section if he or she renders at least one year of creditable service following the latest re-entry.

(e) In addition to the automatic annual increases in annuity provided under this Section, an annuitant who meets the service requirements of this Section and whose retirement annuity or disability retirement annuity began on or before January 1, 1971 shall receive, on January 1, 1981, an increase in the annuity then being paid of one dollar per month for each year of creditable service. On January 1, 1982, an annuitant whose retirement annuity or disability retirement annuity began on or before January 1, 1977 shall receive an increase in the annuity then being paid of one dollar per month for each year of creditable service. On January 1, 1987, any annuitant whose retirement annuity began on or before January 1, 1977, shall receive an increase in the monthly retirement annuity equal to 8¢ per year of creditable service times the number of years that have elapsed since the annuity began.

Source: Illinois Pension Code

A Letter from Bob Lyons

“[Bob Lyons] was recently asked, ‘who pays for our pensions; where does the money come from?’ [Lyons] asked Kathleen Farney, the research analyst of the Teachers Retirement System of Illinois, for the calculation of the past 20 years.

“Over the past 20 years, the percentage from investment earned is 46%; the percentage from the state's contribution is 35%; the percentage from the contributions of active teachers is 17%; the percentage from school districts is two percent.

“For most of those 20 years, active teachers have contributed 9.4% of their salary, but now it is reduced to 9.0% after the early retirement option ended. Individual school districts contributed .58% of teachers' salary and 10.1% for federally-paid teachers.

“The goal for the state's contributions is the one established by the state in 1995; the state was supposed to contribute enough money over 50 years so that in 2045 the five state pensions (TRS, SURS, SERS, GARS, and JRS) would be 90% funded.  

“Ideally, that would have called for 50 years of equal payments, but the subsequent annual payments would have been more expensive than the legislators were willing to pay, despite being the least expensive option for the total 50 years.  

“Instead, the state used a 15-year ramp to gradually increase the payments, with balloon payments in each of the last five years from 2040 to 2045. Of course, the state had a partial pension holiday in ‘06 and ‘07, and the state also lowered the expected rate of return [and TRS had to retroactively ‘smooth’ the fiscal effect of any changes made in the assumed rate of investment return over a period of five years. The ‘smoothing’ applied to any assumption changes from 2012].

“This year the state is paying more than $4 billion into TRS, though it really should be over $6 billion, but since more than 25% of this year’s state budget is going into the pensions, the state cannot afford to do what is actuarially necessary. 

“If TRS was currently funded at 100%, the necessary ‘normal cost’ to fund the current active teachers would be just over $1 billion.  Three-fourths of what the state pays TRS is what they owe.  Furthermore, no actuarial study was done in 1989 when the state made the decision to change a three percent simple COLA to a three percent compounded COLA.

“The COLA is our most significant benefit, and no one was asked to pay for it: not teachers, not school districts, or the state were required to increase their payments to pay for the benefit. 

“The old joke that a legislator can only look as far as the next election is more accurate than it is funny. If the State of Illinois had paid for our pensions as we had earned them, it would have cost them less money, and even more of our pensions would be coming from the profits of the TRS’ investments.”

“Please remember that this is not official. I cannot speak for the TRS board when I was on it, and I certainly cannot speak for it when I am no longer on the board—Bob Lyons.”

Cullerton's Senate Bill 17: So-called "Pension Reform"

Issue Background Memo: Pension Reform  

Eliminates the General Assembly Retirement System for future lawmakers. Upon being signed into law, new lawmakers taking office on or after that date would have no pension.

Public Pension Reform:

Savings would be recognized by giving Tier 1 public sector employees a choice of benefits related to raises they may receive in their careers and the annual cost of living adjustments to their pensions in retirement.

Estimated savings: Potentially $700 million to $1 billion annually.

Who’s covered?

Tier 1 employees covered by SURS (university employees), TRS (public school teachers), GARS (General Assembly members) and CTPF (Chicago teachers).

Who’s not covered?

All retirees.

SERS (state employees). State employees are excluded because of ongoing legal action

regarding the lack of a contract at this time.

Judges.

How it works:

Tier 1 employees (those employed prior to Jan. 1, 2011) are asked to give up the 3 percent compounding COLA increase they would be eligible to receive each year in retirement.

It would be replaced with the COLA plan for Tier 2 employees (those employed after Jan. 1, 2011). The Tier 2 COLA rate is 3 percent non-compounding or half the rate of inflation, whichever is lower.

They would also be asked to delay Tier 2 COLA increases until either 5 years into retirement or at age 67, whichever comes first.

Those who agree to the lower, delayed cost of living retirement adjustments this would get three things in return:

1.  A constitutional guarantee that future raises would count toward their pensions.

2.  A lump sum refund worth 10 percent of their contributions to the pension systems so far.

3.  A 10 percent reduction in what they pay toward their pensions going forward.

For those who do not agree to accept the COLA change, the 3 percent compounded COLA remains unchanged in retirement. However, future pay raises will not count as pensionable income. Those employees’ pensions would be based on what they make now.

For example, if a Tier 1 employee makes $50,000 today and rejects the deal, but later receives a $5,000 salary increase, then the employee’s salary for calculating pensions when he later plans for retirement is frozen at $50,000, not $55,000.

Other provisions:

·      Voluntary 401K-style retirement option: Instead of paying toward a pension plan, Tier 1 employees would have a choice of investment options. Employees who go this route would have their pension benefits frozen where they are now and would utilize this new retirement plan going forward. Would be open to a maximum of 5 percent of active Tier 1 employees.

·      Pension Spiking: Change the current 6 percent limit on end of career pay to a cap based on the rate of inflation.

•        High Salary Cost Shift: Any employee whose salary is higher than the salary set for the governor ($177,412) the employer (school district, university) shall pay the state’s pension contribution for the portion that exceeds the governor’s pay. 

Read previous post for commentary: Click Here.

The Teachers Retirement System of Illinois: Data and Information for Fiscal Year 2016

     

TRS Summary:

•      Fiscal Year 2016 Assets - $44.8 billion (down 3.6%)

•      Benefits Paid in FY 2016 - $5.9 billion (up 7.3%)

•      Investment Return in FY 2016 – 0.8%

•      Benefit Recipients – 116,582 (up 1.4%)

TRS Investment Results – Long-Range Target was 7.5% in FY 2016

               Time Period June 30, 2015      June 30, 2016

                             Fiscal Year           Fiscal Year

          1 Year             +  4.6%             +  0.8%

          3 Years           + 11.9%             +   7.6%

          5 Years           + 12.04%           +   7.4%

          10 Years         +  7.15%            +   6.0%

          30 Years         +  9.1%              +   8.8%

Total Portfolio: $44.8 billion, +0.8% Return

Global Fixed Income: $8.4 billion, 18.8% of total, +3.42% Return 
Domestic Equity: $7.9 billion, 17.7% of total, -1.26% Return 
International Equity: $8.4 billion, 18.9% of total, -9.13% Return 
Private Equity: $5.4 billion, 12.1% of total, +2.5% Return 
Real Return: $3.5 billion, 7.8% of total, -0.7% Return 
Real Estate: $6.9 billion, 15.5% of total, +14.2% Return 
Absolute Return: $3.2 billion, 7.3% of total, +0.4% Return 
Cash: $812.4 million, 1.8% of total.

TRS always focuses on long-term results more than on any one year because the System must be financially secure for all members, whether they’re 85, 65, 45 or 25.

The Board of Trustees reduced its long-range assumed rate of investment return to 7 percent from 7.5 percent on August 26, a move that reflects changes in the world economy that are expected to dampen investment results. The Board vote was 10-0, with 2 abstentions.

 

The reduction in the assumed rate of return does not affect most TRS pensions.

It's the third time in the last four years that TRS has reduced its assumed rate:

•      2012: 8.5 percent to 8 percent

•      2014: 8 percent to 7.5 percent

The assumed investment rate is a 30-year estimate of what, on average, TRS will earn from its investments. Currently, the actual TRS investment rate for the last 30 years is 8.8 percent, which beats the new assumed rate of 7 percent, as well as the old assumed rate of 7.5 percent and the rate in 2012, which was 8.5 percent.

 

The reduction in the TRS assumed rate of return will increase the amount of money state government will be required to contribute to TRS in fiscal year 2018 by $400 million to $500 million.

The State contribution in FY 2017 is $3.986 billion

The assumed rate is one of the factors plugged into the TRS funding formula, along with active member contributions, school district contributions and the contribution from state government.

The contributions from members and school districts are fixed by law.

The rate and the state contribution “float” and move in opposite directions.

The rate is tied to the economy and the productivity of the investment markets, so when it declines, the state must pay more in order to meet the pre-determined annual cost of benefits. When the rate increases, the state has to pay less.

Many economists explain that bonds are carrying interest rates at near-record lows and the stock market has been and will continue to be volatile, so the return expectations will be low.

Two measures in the House: House Bill 5625, sponsored by State Rep. Mike Fortner, R-West Chicago, and House Bill 4427, sponsored by State Rep. Mark Batinick, R-Plainfield:

Each bill allows TRS members to opt out of a lifetime pension for a one-time lump sum cash payment. Both bills will likely remain in the committee for study this year.

 

TRS Executive Director Dick Ingram told legislators in March that a “buyout” is a benefit cut that would “do little or nothing” to improve the financial health of TRS:

“…[I]t must be stated that any buyout – whether it be full or partial, at retirement or before, rolled over into an IRA or used to purchase an annuity – is a reduction in the guaranteed benefit that the member may have earned up to the point of the buyout. You won’t see any significant relief for the unfunded burden we already have created. In fact, the buyouts may actually serve to accelerate the state’s pension obligations.”

 

Both “buyout” plans are designed to reduce the state’s total pension liability and still provide retiring members with money for their retirements.

A reduction in the total pension liability, in theory, would reduce state government’s annual contribution and free up money for other spending priorities.

Largest unanswered question: The source of funding for the buyouts
 

TRS currently has less than 42 cents for every $1 owed to all 400,000 members, so TRS would be unable to fund any buyouts and pay the benefits of members that keep their pensions.

Gov. Bruce Rauner says he supports a proposal by Senate President John Cullerton that they argue would legally bypass the Illinois Constitution and reduce pension benefits for active Tier I members.

Option 1: Trade the current 3% compounded Tier I COLA for the Tier II COLA, which is half the rate of inflation. In return, all future salary increases will be “pensionable.”

Option 2: Keep the 3% COLA, but all future salary increases will be “non-pensionable.”

Supporters of the plan say it supersedes the Pension Protection Clause because active members will have a “choice.”

The attorneys that successfully challenged Senate Bill 1 disagree: “…[T]he Cullerton proposal would force upon pension system members a choice between two diminishments of their constitutionally protected pension rights. The fact that a 'choice' is offered does not matter. Either 'choice' would be a pension diminishment…”

The above information was from a power-point presentation at IEA Retired, Lombard, Sept. 1, 2016.