Risky investments further compromise IL TRS pension fund

December 30, 2011

According to a recent report by the Illinois Policy Institute, John Tillman, CEO, Still leaving Illinois: An exodus of people and money, Illinois residents are fleeing the state and taking their purchasing power, entrepreneurial activity and taxable income with them. Pension reform was noted in the report as one of three changes that must take place in Illinois to turn the state around.

 llinois legislators made a stab at pension reform in 2011, but reforms enacted only applied to new hires, while promised generous benefits that are out of proportion to private sector benefits and employee contributions were not affected.

The Pew Center on the States, a Washington, D.C. think tank, on April 25, 2011, released a series of annual studies on the financial status of state public pension plans, including the TRS (Teachers Retirement System).  Noted in the report is that Illinois continues to have the “worst funded” pension systems in the country.  http://www.pewcenteronthestates.org/uploadedFiles/Pew_pensions_reti..
The Illinois TRS $40 billion unfunded liability is part of the total $77 billion liability that the TRS owes current retired teachers and all active teachers who have yet to retire.  Because active teachers cannot collect what they are owed until they retire, the deficit in the TRS fund appears less critical as the total liability never comes due at one point in time.
The devastating state of the Illinois pension system was hammered home to me by Marc Levine of the Illinois Policy Institute in his article, Two sides of the pension debate.  http://illinoisissues.uis,edu/archives/2011/10/levine.html

Although much has been written about the detrimental impact of Illinois’ unfunded pension systems, Marc Levine links Illinois’ default risk as the result of Illinois’ insolvent state pension system.

On average, full-time teachers earn $84,000 as they near retirement.  Upon retirement, their initial $63,000 annual pension income grows 3 percent annually and, given teachers and state workers can retire as early as age 55, they enjoy this growing income for decades (actuaries estimate about 30 years).  It is fundamentally unfair for Illinois’ private sector citizens, already worried they will outlive their own savings, to pay higher taxes for the lavish retirement packages of teachers and government workers.”

It is easy and convenient to place blame upon legislatures for Illinois having the largest unfunded pension liability, when for years legislatures have failed to make sufficient contributions to the state’s pension systems despite a 1994 state law mandating contributions by the state.  Accordingly, the funded ratio for the TRS pension has continued to slide, hovering below the 50% mark for the past two years.

But what about the politicians from both parties who promise generous benefits that are out of proportion to private sector benefits and employee contributions, as well as IEA union representatives who negotiate with school districts across the state for huge teacher salaries and pension benefits?

Only consider my Lake Forest School District #115.  Out of 169 full time and part-time administrators and teachers employed by District 115, 89 of them earn more than $100,000 a year and another twenty-one earn salaries of $90,000 to $100,000 with no obligation to contribute to their pensions.  Dr. Harry Griffith, superintendent of Lake Forest District 67 (4 schools) and District 115 (high school) was the second highest paid superintendent in the state of Illinois in 2009-10 at $358,540.  Dr. Griffith’s retirement package upon retirement in June of 2012 will be over-the-top in value (“Gouging Taxpayers in the Chicago Suburbs”  http://www.americanthinker.com/printpage/&url=http://www.americant. . . by N. Thorner).

In light of the TRS $40 billion unfunded liability, I was appalled after reading a June 10, 2010 report titled, Illinois pension fund uses OTC derivatives to recoup returns, jeopardized pensions, by Alexandra Harris, in which Harris writes about the TRS using OTC derivatives to recoup returns.  Alexandra Harris writes:  “In addition to writing swaptions, TRS is also selling credit default swaps on corporations like MetLife, Inc. and Ford Motor Co., as well as the debt of Brazil, Germany, China and Panama.”

Dale Rosenthal, the now University of Illinois-Chicago assistant professor of finance, after examining a seven-page list of derivatives positions held by the Illinois Teacher Retirement System obtained by Medill News Service through a Freedom of Information Act request, found that the Illinois TRS fund lost $4.4 billion on investments in fiscal year 2009 (22% or the fifth-largest loss in the U.S.) and 5% on investments in fiscal year 2008.

According to Joshua Rauh, associate professor, Northwestern University’s Kellogg School of Management, It’s clear the IRS portfolio is primed for speculation, because if the Illinois TRS were hedging or seeking to mitigate other risky investments, it would have been on the buy side of swaptions and CDSs, rather than selling one set of maturities while buying another.  http://news.medill.northwestern.edu/chicago/news.aspx?id-166746

Now fast forward to December 19, 2011 when a similar article was published by Lynne Marek in Crain’s Chicago Business.  Its title, Pension Peril.   http://trs.illinois.gov/Crain’s%20-%20TRS%20Story%20Annotated%20FIN…

According to Lynne Marek:  “The Illinois Teachers’ Retirement System — the worst-funded major pension plan in the U.S. — is pumping more of its assets into higher-risk investments while using accounting methods that some pension experts say understates its funding shortfall.

Uncovered by Crain’s after a four-month investigation of TRS holdings and practices was how TRS plans to allocate about a third of its $37.8 billion portfolio to alternative investments such as private-equitey and hedge funds.  Although these unconventional assets do typically dangle the potential for higher returns, it is only because they also carry greater risks and fees.

The TRS response to the Crain’s Chicago Business report of their investment practices was a resounding TRS denial which follows:

“From time to time, Teachers’ Retirement System gets questions from legislators, academics, members and others asking about the System’s investment decisions.  Specifically, there questions center on whether TRS is making risky investments in order to ‘overreach’ for investment returns that would help reduce our unfunded liability and whether the allocation of TRS assets to ‘alternative’ investments is a prudent move.   The answers are:  TRS does not invest with the goal of making up the System’s unfunded liability.  TRS investments in ‘alternatives’ are prudent and are designed more to reduce volatility in the overall portfolio.”

For point-by-point answers by the TRS to the accusations raised in Crain’s story by Lynne  Marek check out this link:  http://trs.illinois.gv/Crain’s%20Response%20Web%20-20121611.pdf

Although experts have claimed there is no language in the Illinois pension code that prohibits pension funds and retirement systems from buying or selling OTC derivatives as an investment method, does it make sense for the TRS’s portfolio to be invested in what might generate the highest returns as losses were already encountered through risky TRS investments from 2008 onward?  What about the possibility of even bigger losses further jeopardizing the pensions of 363,121 former and current teachers?

The TRS is counting on an 8.5% annual return this year which many portfolio managers and investors, including Berkshire Hathaway’s Warren Buffett, says is unrealistically high, even though two other IL public pension funds have lowered their forecasts to a 7.75% return.http://trs.illinois.gov/Crain’s%20-%20TRS%20Story%20Annotated%20FIN…  

It sounds much like going to Las Vegas in the hope that Lady Luck will substantially increase the amount of the 9.4% of each paycheck teachers have paid into their retirement fund.  Presently TRS liabilities amount to $17,562 per household.

Associate professor at Kellogg School of Management, Joshua Rauh, made this comment to Crain’s investigative report of December 19th:  “Taxpayers are, one way or the other, going to end up bearing a large portion of this burden.”

According to Marc Levine of the Illinois Policy Institute, “We cannot borrow our way out of the pension crisis; we must reform our way out.”

Will Illinois legislators in 2012 seriously tackle pension reform in a way that will help reduce the default risk Illinois is now facing due to having to pay the highest interest rate of any other state on borrowed money?

A good start was made last year when retirement age was increased to 67 from 55 along with reduced pension benefits for employees new to government pension systems.

The position of Dan Montgomery, President of the Illinois Federation of Teachers, must be vigorously challenged as to the constitutionality of making changes to the benefits employees receive who were in the IRS retirement plan before January 1, 2012.  Tyrone Fahner, a former Illinois attorney general and president of the Civic Committee of The Commercial Club of Chicago, is “absolutely convinced” that some pension changes would not violate the constitution. http://articles.chicagotribune.com/2011-03-22/news/ct-met-teacher-p…  (Illinois teacher pension system nearly $40 billion in the hole by Diane Rado)

Is it fair for taxpayers to have to pay for the generous salaries and pension teachers receive as a result of union negotiations, which have increased salaries and pensions far beyond those received by private sector employees.  Seventy-five percent of an educator’s average salary is used in retirement calculations.

Is sacrifice no longer a politically correct word when applied to doing what is best to save Illinois and to ease the burden on taxpayers in a challenged economy?


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