Texas TRS Finds Other Plans More Costly

September 4, 2012 (PLANSPONSOR.com) - A report for the Teachers Retirement System (TRS) of Texas shows a move from the current defined benefit plan will result in increased costs or decreased benefits, or both.

In conducting the study, TRS modeled the alternative plans using two different approaches: the “Targeted Benefit Approach” and “Targeted Contribution Approach.” The TRS benefit, as currently designed, replaces roughly 68% of a career employee’s pre-retirement income before a loss of purchasing power. Therefore, TRS modeled the plans in the “Targeted Benefit Approach,” to provide the same level of benefit as the current plan regardless of cost. The study found the alternative plans would be 12% to 138% more expensive than the current plan (not including the cost to pay off any unfunded liability) to provide the same level of benefit.  

Conversely, under the “Targeted Contribution Approach,” TRS modeled the alternative plans to cost the same as the current plan regardless of the benefit level provided. Under this approach, the study found the alternative plans would replace 27.7% to 59.7% of pre-retirement income for a career employee retiring at age 62.  

The study noted that in any plan with a self-directed defined defined-contribution component, TRS members would make their own investment decisions, and the resulting difference between individual returns would likely be very wide. TRS modeling has shown that under a defined contribution plan, 92% of retirees will ultimately receive less than the current defined benefit. Two-thirds would receive no more than 60% of the current benefit. Only a handful (about 8%) would receive more than the current benefit.    

The study report says the estimated underperformance is attributable to lower investment returns from a shorter investment period, access to fewer asset classes, less disciplined investment approaches, and potentially higher fees.

TRS conceded that alternative plan structures can shift risk away from the State since members become responsible for managing their own investments. However, according to the report, changing structures from a defined benefit plan to an alternative plan can present other risk factors, including how to manage the unfunded liability of the legacy defined benefit plan and the risk that diminished retirement income could increase retiree use of social services post-retirement due to a lack of retirement self-sufficiency.  

In addition, TRS noted that changing benefits under the existing plan for new hires only does not have an impact on the current unfunded liability. The system can currently pay projected benefits until 2075, but has an unfunded liability of $24.1 billion.  

Other public systems have also conducted studies that show a switch to a hybrid or defined contribution plan would be costly (see“Study Warns Against DC Plan for Wis. State Employees”).  

The TRS report can be accessed from its web site at http://www.trs.state.tx.us.