Updated: Oct. 1, 2017
Issue: Public pension systems like TRS must set a forward-looking “assumed long-term rate of investment return” periodically in order to help complete critical financial calculations for the future, such as how much state government must contribute to the System in a year.
There has been a debate over the size of the long-term assumed rates set by Illinois pension systems and TRS since 2011, when the Chicago Tribune published an editorial about the assumed rates of return. The Tribune referred to public pension systems as “Pollyannas” because most public pension systems at the time assumed that investments would return an 8 percent or greater “profit” over an extended period of time. The Tribune said that rate of return was too high.
The Tribune said it believed that pension systems like TRS should set their assumed rate of return much lower – at around 2 percent or 3 percent. A rate that low effectively would tie the assumed rate of return to the return rate of U.S. Treasury bonds. Those bonds are considered to have “zero risk” in the financial and investment world.
Discussion: The Tribune’s call for a “zero risk” rate of return is not based on any historical data about investment returns or economic projections of future income, but rather on a simple fear that a bad economy will keep investment earnings low. If investment earnings are low, then state government must step in with a greater amount of money in each year to fund pension obligations. However, any reduction in the assumed rate of return will increase the amount of money that state government must contribute to its pension plans.
Pension systems like TRS have a fiduciary responsibility to their members to set a long-term assumed rate that accurately reflects the best analysis of what financial conditions and expected returns may be in the future. The goal is to make sure that current taxpayers are not over-charged or under-charged for their share of teacher pension costs. If the assumed rate proves to be too low over time, then current taxpayers are paying more than they should. If the assumed rate is too high, then current taxpayers are not paying enough.
Despite the unpredictability of the international economy and the investment markets, the current projected 7 percent TRS rate of return is right on target with the System’s historical long-term rate of return. The TRS assumed rate of return was set at 7 percent in August of 2016. By contrast, the TRS investment rate of return during the last 30-year period through fiscal year 2017 was 8.1 percent. The TRS assumed rate was 8.5 percent between 1997 and 2012, 8 percent between 2012 and 2014 and 7.5 percent between 2014 and 2016.
By law TRS must study and recalculate its assumed rate of return at least every five years. Due to the current unpredictability of the world economy, the Board of Trustees has determined that the assumed rate should be reviewed annually, and more often than that, if necessary.
There is no economic rationale for lowering the TRS rate of return to 2 percent or 3 percent. The suggestion to reduce the target rate of return to as low as 2 percent would unfairly burden current taxpayers with higher costs by undercutting the actual investment returns of the fund to the present day’s benefits.
In fiscal year 2017, 114 of 127 public pension funds studied by the National Association of State Retirement Administrators had an assumed rate of return set at between 7 percent and 8 percent. Only three had an assumed rate of return greater than 8 percent and 10 had an assumed rate lower than 7 percent.
In FY 2017, the TRS rate of return calculated for the last 10-year period, net of fees, was 4.8 percent. The rate for the last five-year period was 9.2 percent and the rate for the last three-year period was 5.4 percent. Because the national and world economies are facing many challenges, TRS recorded an investment rate of return of 13.3 percent gross of fees and a 12.6 percent return net of fees during FY 2017.