Texas Comptroller Glenn Hegar says the time for action on the state’s Employee Retirement System is now. “There is no question that something has to be done,” Hegar recently told Equable. “This won’t go away … I’ve been trying to say to both parties that you’ve got to take a step.”
According to a recent report, the pension fund for Texas state agency employees only had 48 cents on the dollar for promised retiree benefits. On top of a state constitutional cap on the amount money that the state can put into the pension system in a year, there are three main problems with the ERS that, left unchanged, will likely cause the fund to run out of money in the next 20-30 years.
“You could do something for new members and that might be fine, but it doesn’t make the [pension] debt go away,” Hegar told Equable. “That has to be dealt with by this legislature.”
He’s right, and it should be a bipartisan effort. Here’s how the state should address those problems to put Texas ERS on the path toward long-term sustainability and provide better benefits for the state’s retirees.
Reduce Texas ERS’s Assumed Rate of Return
More than half of Texas ERS’s pension debt is because of underperforming investments, a problem the fund faced even before the economic downturn caused by the Covid-19 pandemic. And despite the stock market’s resurgence in recent weeks, Texas still has an unrealistic assumed rate of return of return that is going to continue leading to future unfunded liabilities.
The Texas ERS board took a good first step when it lowered the investment assumption from 7.5% to 7% in May 2020, but given today’s low interest rates and the overall investment climate, it’s unreasonable to expect these kind of returns on average going forward.
The state should aim for something closer to a 6% assumed rate of return, or possibly lower. Making this change now will give Texas legislators a realistic picture of ERS’s pension debt.
Put More Money into Texas ERS
Paying off pension debt is like paying off a credit card — paying less than the interest only makes the problem worse. Right now, Texas’ pension fund contributions are too low and in many years the interest on the system’s pension debt has grown faster than contributions flowing into it.
To combat this, the state should make a large lump-sum contribution into ERS. This could be money from the state’s rainy day fund, resources from a future Covid-19 relief bill, or even a low-priced pension obligation bond.
Whatever the source, enough money should be injected into the system to get the overall contribution rate down well below 20% of payroll. This will prevent the state from needing to increase member contributions and keep the state under the 10% of payroll constitutional cap on contributions. The more one-time money that can be injected to lower the long-term projected contribution rate, the more flexibility there will be in the future for the next major financial hit to the U.S. and Texas economy.
Improve Retirement Benefits for Future Employees
Existing retirement benefits are not particularly well-aligned with the needs of the state’s workforce. Additionally, roughly two-thirds of those who join a state agency covered by ERS are expected to leave within five years of employment — meaning they never really accumulate any meaningful benefit that can help them on their path to retirement security.
Texas should close the existing plan and offer future hires different retirement benefit options. This would stop adding new members to a struggling system, and it would let the state think about what retirement plans work best for their workforce goals in the 21st century.
The state could still offer the option of pension, just better designed with risk-sharing features like strong plans offered in Wisconsin and South Dakota. It could also offer portable options like a Defined Contribution Plan or a Hybrid Plan Or even a plan that balances portability and guarantees like a Guaranteed Return plan plan — which many city and county workers in Texas have access to.
Improving the retirement benefit design for ERS won’t immediately fix the funding problem. But it can help with ensuring Texas can build an effective 21st century workforce and reduce some long-term risks of pension debt continuing to pile up.