Updated: September 1, 2018
Issue: A law enacted in July 2017 requires TRS to “smooth” or phase-in monetary changes caused by any alterations in actuarial assumptions that the System uses to calculate its finances. The result of this “smoothing” is to reduce the amount of money TRS will receive from state government in its annual contribution. The intent of the law is to help a cash-strapped state government balance its budget by lowering the annual contribution to TRS and the state’s other public pension systems.
Discussion: Every year, TRS actuaries conduct a review of the System’s finances to calculate the cost of retirement benefits and how much state government must contribute to TRS to cover that cost. This review can include a study of the System’s assumed rate of investment return. This rate is a measure of what TRS expects to earn from investments over the next 30 years. Along with the state’s annual contribution, investment returns help pay the cost of benefits.
The rate can change when the investment markets get stronger or weaker. When circumstances call for it, TRS changes its assumed rate of investment return.
The estimate of future returns, then, has a direct effect on the state’s annual contribution. If the estimated rate of return drops in a year, the state contribution must increase in order to cover the pension cost. If the assumed rate increases, the state contribution is lowered.
The 2017 “smoothing” law aims to prevent a large one-time increase in the state’s contribution any time TRS lowers the assumed rate. The new law requires TRS to “smooth” or phase in the effects of the lower assumed rate over a five year period.
TRS last changed its assumed rate of return in 2016. Using the 2016 change in the assumed rate as an example, if the “smoothing” law had been in place, instead of a one-time $402 million increase to the state contribution, the increase would have been $80.4 million in one year, or one-fifth of the total. In the second year, the increase from the 2016 rate change would have been $160.8 million, or another $80.4 million, and so on. The full effect of the lower rate would not be felt, in this example, until fiscal year 2021.
With that said, however, the “smoothing” law did affect the 2016 rate decrease. The law requires TRS to retroactively apply the phase-in to any changes in the assumed rate TRS made since 2012. TRS reduced its assumed rate in 2012 and 2014, as well as 2016. Since it has been five years since the 2012 reduction, the System did not have to smooth that increase. But the law affected the 2014 rate decrease. TRS is now five fiscal years into that rate change. And for the 2016 rate decrease, TRS is in the third year of the five-year phase-in.