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The Texas Teacher Retirement System (TRS) has been making the headlines lately, and TRS members may be wondering just what’s going on over there. Though some issues are of the system’s own doing, TRS is also having to implement state and federal policies, both positive and negative. Here’s an explanation of the issues making the news.

Let’s start with the current status – how’s TRS looking right now? The TRS fund has grown to more than $112 billion, making it the seventh largest pension fund in the country.

Over the past year, the fund earned more than 14% in investment gains, well over the 8% needed to meet its actuarial benchmark. This, combined with the gains of the previous several years and the increase in the state’s TRS contribution rate, ensures that the fund is actuarially sound and has pulled out of the slump caused by the poor economy and investment losses of the early 2000s.

TRS Board members received good news from the latest valuation of the fund, learning from the system’s actuaries that even after the 13th check is paid out the fund is under the 31-year benchmark funding period for the first time in several years. If the trend continues, additional benefit increases could be affordable in the next legislative session (the Legislature must initiate and approve any benefit changes). See page 17 for more information on the 2007 fund valuation and the 13th check.

Is it true that TRS is going to be investing in hedge funds and other risky ventures?

Yes. But it’s important to understand the details of the new investment strategy. TRS will be investing in new categories that are considered to be riskier. The stated goal is to find specific investments that will actually decrease risk to the fund overall by providing a better balance to the fund’s portfolio.

Currently, the TRS fund is heavy in domestic equity (the kind of investments you may think of when you hear references to “the stock market” – primarily stock shares in U.S. companies). As a result, TRS Executive Director Ronnie Jung is fond of pointing out that TRS “is,” in effect, the stock market. With more than 60% of the fund invested in U.S. stocks and bonds, TRS investment return rates essentially mirror the stock market returns. In good times that works just fine, but the plummeting economy of 2001 and 2002 served as a lesson on the risks of that approach.

Though U.S. stocks might be considered generally less risky than other investments, having a large portion of the portfolio invested in similar types of stocks increases the risk to the fund. TRS now proposes to expand its portfolio to reduce the reliance on domestic equity.

Investments in alternative investments (real estate, hedge funds and private equity) could climb to as much as 29% of the portfolio in the coming years. By law, however, TRS is limited to investing no more than 5% in hedge funds. Though some perceive hedge funds as a high-risk investment, other experts worry that the 5% limit prevents TRS from using hedge funds correctly to balance the fund, maintaining that hedge fund investments can be less risky than other private equities.

An important component of the revised investment strategy is risk management. In conjunction with the new strategy, the TRS Board has devised new risk parameters that are designed to lower the overall risk to the fund, despite the potentially higher risk represented by individual investments under consideration.

If the fund is in such great shape, why are they making dramatic changes?

As noted above, the current structure of the fund leaves it vulnerable to the ups and downs of the economy. The new strategy is designed to diversify the portfolio in a way that reduces the risk to the fund and hopefully avoids the previous situation where market downturn affected the fund for years. With legislators choosing not to make a significant cash infusion, the losses of 2001-02 effectively prevented any increase in retiree benefits for six years, and prompted Texas lawmakers to reduce future benefits for active employees.

When the TRS fund’s previous chief investment officer (CIO) resigned to take a position at Texas Christian University in 2006, the board turned to Britt Harris, an industry professional specializing in alternative investments. The new investment strategy and the accompanying compensation structure for TRS investment staff were the brainchild of Harris and were supported by a majority of TRS Board members.

I’ve heard that staff will be able to make some of these tricky investments without board approval. As part of the revised strategy, staff was granted more flexibility to make alternative investments without preapproval from the board. TRS staff maintained that high quality opportunities have been missed because of the time constraints involved in waiting for a board meeting to get formal approval. Under the approved plan, deals of up to $500 million (less than 1/2 of 1% of the fund) would be allowed without a direct board vote, though an external consultant must approve the investment. Staff have been quick to reassure that board members are still notified ahead of time about every potential investment opportunity, and would have the ability to question and place any individual deal on the next board agenda for consideration.

Are TRS staffers really going to be making salaries of over $900,000?

The total compensation (salary plus bonuses) that could be paid to the CIO, Britt Harris, could reach just over $900,000 if all benchmarks were reached, but this will be very difficult to achieve. His actual salary is reported to be around $402,000.

The new investment strategy is going to require some staff changes at TRS, and fund officials and the TRS Board are actively recruiting investment experts from across the country. As we so often argue in the education profession, recruiting the best people requires competitive salaries, and investment officers in the private sector are earning considerably more than the amounts proposed for TRS staff.

In arguing for the new salary/bonus plan, staff and board members noted that the fund had experienced unusual turnover in recent years. TRS has had four CIOs since 1997, with much of the turnover attributed to salary issues. Harris maintained that a revised compensation plan was essential to attracting individuals with the talent and experience needed to fill key slots on the investment team.

The compensation plan approved by the TRS Board in September would allow Harris to earn just over $900,000 if all available bonuses were paid out. A few other top employees could earn more than $500,000. Achieving that goal, though, will be difficult. For any investment staff employee to earn the highest possible bonus, the fund would have to outperform benchmarks by at least a percentage point, outperform every other peer pension fund in the country, and achieve the highest ratings on an internal qualitative review. For the fund as a whole, outperforming benchmarks by a percentage point would increase the value of the fund by more than $1 billion over the predicted returns – making six-figure bonuses seem almost insignificant in comparison.

One point that has been virtually overlooked, though, is that the bonuses will still be available even in a poor economy. In other words, if the TRS fund is down, but is down less than other funds, investment staff could still be eligible for hefty bonuses (though those bonuses would be delayed by a year). While arguably fair, this scenario could cause some raised eyebrows should it come to pass in the future.

How could they give these bonuses before giving retirees a 13th check? We agree that the timing was insensitive, but the two events are unrelated. The determination of whether the 13th check would be distributed was based on the August 31 valuation of the fund. Though the bonus plan was adopted before the 13th check was formally approved in November, the first staff bonuses would not be earned until 2008, and would not be paid until February 2009.

OTHER TRS ISSUES

The following information is excerpted from a recent TCTA eUpdate; if you are a TCTA member and would like to receive the most up-to-date information in future eUpdates, send your e-mail address to the membership department and we’ll add you to the list.

403(b) regulations

Most school districts offer employees the option to defer a portion of their salary into a 403(b) plan approved by the district. New state and federal regulations have changed some aspects of 403(b) plan administration, affecting both employers and employees.

Until recently employees could transfer their 403(b) money into a different plan, an option typically used when an employee changed employers. New federal regulations that became effective Sept. 25, 2007, are imposing additional requirements on school districts, requiring the disclosure of more information and development of a written policy before transfers from one 403(b) plan to another would be allowed. Your school district must establish a written 403(b) plan by Dec. 31, 2008; the plan may prohibit transfers or allow them under certain conditions.

The most immediate implication for employees is that transferring funds from your 403(b) into another plan may be prohibited by your district for some time, or even permanently. Thus, initial investment in a 403(b) plan should be made with even more care than usual, since those decisions may be irreversible.

Have you named someone besides your spouse as a TRS beneficiary?

If your named TRS beneficiary is someone other than your spouse, your TRS benefit options may be limited if you retire after Dec. 31, 2007. New federal laws will restrict your ability to choose lifetime benefit payments for a non-spouse beneficiary who is significantly younger than you.

In lieu of receiving the standard annuity, retirees have five payment options. The alternatives reduce the annuity paid to the retiree, but provide payments to a beneficiary after the retiree’s death, either for life or for a guaranteed period of time.

  • Option 1 – Beneficiary receives 100% of the retiree’s reduced annuity throughout his/her lifetime
  • Option 2 – Similar to Option 1, but beneficiary receives 50% of the reduced annuity through lifetime
  • Option 3 – Benefit is paid for a minimum guaranteed period of five years; if retiree dies before the five years is up, the beneficiary receives the same benefit for the remainder of that period
  • Option 4 – Similar to Option 3, but a guaranteed period of 10 years
  • Option 5 – Similar to Options 1 and 2, but a 75% payout

Beginning with retirements effective after Dec. 31, 2007, certain plan option/beneficiary combinations will be limited.

The most notable change will be in the selection of Options 1 and 5, which allow the highest payout to beneficiaries (100% and 75 %, respectively). According to TRS, retirees will not be allowed to utilize Option 1 with a beneficiary who is at least 10 years younger than the retiree, or Option 5 with a beneficiary who is at least 19 years younger.

In unusual circumstances, Options 3 and 4 might also be limited – TRS notes that neither option would be allowed for an employee who is older than 92 at retirement (if you know of any teachers that stayed in the classroom that long, let us know, they deserve an award!); and that Option 3 would be prohibited with a beneficiary who is older than 91.

Web posted: 11/29/07 from The Classroom Teacher, Winter 2007