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The TRS Assumed Rate of Return on Investments

Updated: July 15, 2020

Issue: Public pension systems like TRS are required to set a forward-looking “assumed long-term rate of investment return” periodically in order to help complete critical financial calculations, such as how much state government must contribute to the System in a year.

The current TRS assumed rate of return is 7 percent.

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 TRS Board of Trustees has determined that the assumed rate should be reviewed annually, and more often than that, if necessary.

For several years, there has been a debate over the size of the long-term assumed rates set by TRS and other Illinois pension systems.

In 2011, for instance, the Chicago Tribune published an editorial about the assumed rates of return selected by TRS and other Illinois public pension systems. The Tribune said it believed that pension systems like TRS should set their assumed rate of return 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 at that time. Those bonds are considered to have “zero risk” in the financial and investment world.

Some academics that are critical of public pension systems have for years called on TRS and other public pension systems to lower their assumed rates to so-called “risk-free” levels.

Discussion: The 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 pessimistic view that investment income estimates should be as conservative as possible because the markets are so unpredictable. A bad economy will keep investment earnings low. Under federal law, private-sector pension systems must use a “risk-free” assumed rate of return.

However, for a government-sponsored plan, a low assumed rate forces taxpayers and the government to contribute more money in a year to cover the system’s costs.

Since 2011, the world economy and investment markets have grown more unpredictable. And while a large number of studies have indicated that it is prudent for public pension systems to adjust their assumed rates of return, none of the studies using historical data conclude that assumed return rates should be as low as 2 percent or 3 percent.

TRS trustees, the System’s investment staff, actuaries and investment consultants have said in recent years that all forecasts indicate it will be difficult to sustain investment returns over the next three decades that are higher than 7 percent. The most recent estimates of potential investment income conducted for TRS indicate that the probability that TRS will earn between 6 percent and 7 percent per year over the next 30 years is better than average.

There is no economic rationale for TRS to lower its assumed rate 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 paid through state government’s annual contribution to TRS.

Armed with these analyses, TRS has systematically lowered its assumed rate of return in recent years to match the expectation of the economic forecasts.

The TRS assumed rate of return was set at 7 percent in August of 2016. The assumed rate was 7.5 percent between 2014 and 2016; 8 percent between 2012 and 2014; and 8.5 percent between 1997 and 2012.

By contrast, the actual TRS investment rate of return during the last 40-year period through calendar year 2019 was 9.16 percent, net of fees. For FY 2019, TRS recorded an investment rate of return of 5.8 percent gross of fees and a 5.15 percent return net of fees.

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.

In fiscal year 2019, 106 of 128 public pension funds studied by the National Association of State Retirement Administrators had an assumed rate of return set between 7 percent and 8 percent. Only three had an assumed rate of return of 8 percent and 16 had an assumed rate lower than 7 percent.