A pension plan’s financial status also can be gauged by its funding period, the time required for the plan to become fully funded based on characteristics such as contribution rates and benefits offered. In fiscal 2016, the funding period was 35 years. At present, the ERS plan’s funding period is “never” – meaning that, based on current actuarial assumptions and contribution rates, it will never have enough money to pay for the current and future retirement benefits it owes.⁹

Challenges Facing ERS

Several factors are making the ERS pension fund’s future viability uncertain, including:

• unrealistic investment return assumptions. ERS’ investment return assumption remained at 8.0 percent from 1994 to 2016; it was lowered to 7.5 percent in 2017 to more accurately reflect expected long-term returns. Even so, over time the ERS’ actual investment returns averaged 5.5 percent for the last 10 years and 6.4 percent for the last 20 years.¹⁰
  
  The updated return assumption, however, will further reduce the ERS plan’s funded ratio and, if future state and employee contributions continue at their current level, completely deplete the fund by 2084.¹¹
• inadequate state and employee contributions. Since 2016, the state has contributed an amount equal to 10 percent of payroll to the ERS plan annually (including a 0.5 percent contribution from individual state agencies), while employees contribute 9.5 percent of their salaries (Exhibit 3).¹² The Texas Constitution limits the state’s contribution to 10 percent, well below the national median of 12.95 percent. Conversely, the employee contribution rate is well above the national median of 6 percent (for state pension plans with members who also are enrolled in Social Security).¹³
  
  In all but one year since 1998, moreover, the state has failed to make the actuarially sound contribution (ASC) — that is, the contribution needed to fund the cost of future benefits and eliminate the UAAL over a finite period.¹⁴
• demographic pressures. In the last two decades, the number of active contributing members in the ERS plan has fallen by 10 percent, while the number of retirees and survivor beneficiaries (such as spouses) has risen by 64 percent. Thus, fewer active members are contributing toward the plan while an increasing number of members draw benefits without contributions from salary.¹⁵ Longer lives are increasing this fiscal pressure; the average U.S. life expectancy rose by nearly 10 years from 1960 to 2016.¹⁶

EXHIBIT 3: ACTUAL CONTRIBUTION RATE COMPONENTS, 2005 to 2018

Actual Contribution Rate Components,
2005 to 2018

Year	Agency	State	Employee	Total Contribution
2005	0.00%	6.00%	6.00%	12.00%
2006	0.00%	6.45%	6.00%	12.45%
2007	0.00%	6.45%	6.00%	12.45%
2008	0.00%	6.45%	6.00%	12.45%
2009	0.00%	6.45%	6.00%	12.45%
2010	0.00%	6.78%	6.48%	13.26%
2011	0.00%	6.95%	6.50%	13.45%
2012	0.00%	6.00%	6.50%	12.50%
2013	0.00%	6.50%	6.50%	13.00%
2014	0.50%	7.50%	6.60%	14.60%
2015	0.50%	7.50%	6.90%	14.90%
2016	0.50%	9.50%	9.50%	19.50%
2017	0.50%	9.50%	9.50%	19.50%
2018	0.50%	9.50%	9.50%	19.50%

Source: Employees Retirement System of Texas

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Legislative Actions

From 2009 to 2015, the Texas Legislature passed various laws addressing the ERS plan’s growing unfunded liability by increasing employee contributions (in 2009 and 2015); raising the minimum retirement age (in 2009); increasing the length of the service period used to determine the final average salary, and thus the pension payment (in 2009 and 2013); and making other adjustments.¹⁷

The most recent legislation concerning ERS operations — Senate Bill 301, approved in 2017 — strengthens the ERS board’s oversight of “alternative investments,” such as private equities, private real estate or hedge funds. In recent years, these alternatives (as opposed to more traditional public equities) have represented a rapidly increasing share of ERS’ investments. The new law also requires the ERS board of trustees to approve any individual alternative investment above $100 million and requires a vote to be taken in public. Finally, the law requires ERS to study and adopt new actuarial assumptions once every four years, rather than every five.¹⁸

Policy Options

Despite recent legislation, the financial health of the ERS plan continues to decline. Any change to government pension plans can involve significant challenges and may have unforeseen consequences.

Proposed options to improve the funding status of the ERS plan include:

• increasing contributions. Increasing member contributions would improve the ERS fund’s financial health, but would not be popular with enrollees. Increasing the state contribution rate requires a constitutional change unless the governor declares an emergency.¹⁹
• making a one-time payment. In the absence of further plan changes or major economic disruption, a substantial appropriation to the fund could significantly reduce the ERS plan’s unfunded liability and establish a desirable funding period. Such a one-time payment also would help the fund earn higher returns. It would not, however, prevent the UAAL from rising again in subsequent years if the state does not begin meeting the ASC.²⁰ A lump-sum payment, moreover, might be limited by the spending cap of 10 percent of payroll.
• dedicating an additional, ongoing state revenue source to the ERS plan. An additional revenue stream diverted to the ERS plan could help address its increasing unfunded liability.
• reducing benefits offered to current and/or future hires. Options include increasing the retirement age; raising the number of working years required to become pension-eligible (currently, at least five or 10 years of service depending on the initial hiring date); or reducing the multiplier that determines the size of annuities. As already noted, the Legislature has taken similar actions several times in the last decade.
  
  Although such actions would help stabilize the plan, they might cause high-performing workers to seek employment elsewhere, thereby reducing the overall quality of the workforce. They also could cause a “rush to retirement” among those at or near retirement age, which would reduce contributions and damage the plan’s solvency.²¹
• changing the ERS plan to a defined contribution or hybrid plan. Most private employers offer defined contribution plans (DCPs), such as 401(k) plans, generally contributing a specific amount to employee retirement without guaranteeing a specific payment at retirement. The employee is at least partly responsible for managing the investment, if only by selecting among various retirement investment plans offered.²² In recent years, at least 10 states have adopted hybrid plans.²³ These plans typically involve mandatory contributions to both a DBP and a DCP, distributing the risk between employee and employer. The DBP component provides a guaranteed monthly annuity, while the DCP component provides employees some control over their investment portfolios.²⁴

Related:

• Texas State Government and Long-Term Obligations (March 2017)
• 2017 Legislative Wrap-Up (September 2017)
• The Fiscal Noting Process (January 2017)
• Hurricane Harvey and the Texas Economy: Economic Impact (February 2018)