The “assumed rate of return” is the single most important assumption that pension systems make to ensure they have enough funding to pay benefits promised.

To determine the amount of required contributions that should flow into the pension fund, the Teachers’ Retirement System of Georgia (TRSGA) board and its actuaries make educated guesses about how much they think they can earn by investing those contributions. That educated guess is called the assumed rate of return.

Why does this matter for Georgia?

The primary reason that TRSGA currently has $22 billion in pension debt, is because the assumed rate of return for the pension plan has been wrong in most years over the past two decades.[1]

Pension funds depend on investment returns to build assets that can be used to pay promised benefits. When the actual returns for a pension fund are less than expected, that means there is a shortfall. Pension funds hope that over the long-term they will have more good years than bad years. But in the case of TRSGA, the goal of averaging 7.5% investment returns a year has turned out to be too optimistic.

In 2004, TRSGA had a 100% funded ratio. Since then, the actual return on investments for Georgia’s teacher pension fund has been 7%. However, up until 2019, ASRS was assuming a 7.5% return. In some years the actual returns exceeded this, but in most years it was less. As a result, of the $22 billion in pension debt, roughly $15 billion is related to investment returns being less than expected.[1]

How does pension debt affect public workers and taxpayers?

The primary reason for Georgia’s current pension debt problems has been an overly optimistic assumed rate of return, and that pension debt is requiring extra payments. For TRSGA, those payments have doubled since 2010.

Employees have had fairly consistent contribution rates over the past few decades. The amount of money contributed per paycheck has increased from 5% to 6% since the Financial Crisis of 2008-09. But the rate is otherwise stable.

By contrast, school districts and other public education employers have experienced a sharp increase in contributions. Between 2001 and 2010, the required money from employers was around 9% of teacher payroll. But that rate has steadily increased each year, to 20.9% of payroll this year.

That’s more than just an increase in taxpayer contributions. That is less money available for education budgets — which can be used to raise teacher salaries and help kids learn.

Ultimately, the assumed rate of return matters because getting it right or wrong can be the difference in pension debt levels and required contribution rates.

How does the assumed rate of return work?

The TRSGA pension board meets at least once a year to discuss how well investments are performing, compared to their assumption. For most of the past two decades they kept the assumed rate of return at 7.5%. Investment advisors and actuaries told the pension board this was reasonable, even if it was optimistic.

This past year, the TRSGA board collectively decided that it was no longer reasonable to keep this assumption, so they lowered the assumed rate of return to 7.25%. The pension board thinks there is around a 50/50 chance that future investment returns will match this assumption.

Actuaries then figure out how much should be contributed into the pension fund each year, assuming there will be future investment returns to help pay for promised benefits.

The higher the assumed rate of return, the fewer contributions teachers and their employers have to make. The lower the assumed rate of return, the higher contributions need to be in order to pay for the benefits promised.

Do historic returns matter?

For the most part, the historic returns of a pension fund have no influence on future investment returns. Over the past 10 years TRSGA has earned 7.4%, and over the last 20 years brought in a 6.1% return. But these numbers are virtually irrelevant when it comes to predicting future investments and setting an assumed rate of return.

The assumed return is an estimate about the future, and how markets will perform. But markets today are very different than in the 1980s and 1990s. Back then, interest rates were high, which meant borrowing money, including mortgages, was more expensive than today. It also meant pension funds could buy bonds and get good yields without taking much risk.

Today interest rates are at historic lows, meaning TRSGA has to take on a lot of risk to earn its currently adopted assumed rate of return.

Want to read more?


[1] As with almost anything in pension finance, breaking down the causes of the current pension debt is complicated. Of the current “unfunded liabilities,” $8 billion is because actual investment returns were less than expected. $7 billion was related to something called “interest rate smoothing,” which in short was a way of trying to tweak the assumed rate of return so that TRSGA could become better funded, but the idea backfired. After trying this interest rate smoothing idea from 2011 to 2018, the TRSGA board voted to get rid of it. The rest of the unfunded liabilities have been created by other demographic issues — but it is important to note that the Georgia government has not taken money out of the pension fund for uses other than to pay promised benefits.