Too Little
to Not Fail
Why the ORP (and probably
the TRSL) Doesn’t Work
Robert Turner, Ph.D.
LSU Health Sciences Center
rturne@lsuhsc.edu
Louisiana Retirement Plans
The Teacher Retirement System of Louisiana (TRSL) is a defined
benefits retirement program. As shown in the next figure, the benefit
is based on a Benefit Factor (BF), length of service, and salary. It is
not impacted by market performance. Faculty hired more than 10
years ago vest at 10 years and have a BF of 2.0% up to 20 years
where it goes to 2.5% (age 65). Faculty hired less than 10 years ago
vest at 5 years and have a BF of 2.5%.
The Optional Retirement Plan (ORP) was created about 20 years
ago and is a defined contribution plan. The employee and institution
contribute to an investment account controlled by the individual.
Vesting is immediate and the funds are portable. The retirement
benefit is determined by the amount of money in the account.
There is nothing fundamentally wrong with either type of plan if they
are properly designed.
Robert Turner
Retirement Benefits
PLAN VESTING
BENEFIT
(YoS/age)
TRSL YoS: years
% Factor x YoS x Salary Factor
defined
of service
benefit
% Factor:
Salary Factor:
new 5 yrs/60 21/2%
Average of 3
old 10 yrs/60 2% < 20 YoS
highest years
(7/1999)
21/2% at 20 YoS of salary
ORP
defined
contribution
1 day/NA What ever you have
Robert Turner
The Problem
Many faculty on the ORP have realized that the potential
retirement benefit provided by their ORP is a fraction of the
benefit they would have received if they were on TRSL. Many
have expressed the need to significantly delay retirement
because of the sad state of their ORP accounts. What is the
cause of this situation? There are several possibilities:
•The individual faculty member has made poor investment decisions
•The market has performed poorly
•There is a fundamental problem with the ORP program
This presentation will examine these possibilities and determine
the primary factor
Robert Turner
Is the Problem Poor Investments?
The next figure addresses the first possibility: Is the fundamental problem
poor investments by the employee? This can be tested by asking how would
ORP benefits compare to TRSL benefits if an ORP member’s investment
return had been equal to TRSL or the S&P500 in the past?
The TRSL website provides the average annual return in % (AAR) for TRSL
investments for the past 17 years and the contribution (%) each year to ORP.
The contribution is the percent of salary (employee + institution) that goes
into the ORP account. A reasonable salary profile is assumed. The benefit is
the income provided when the accumulated funds are used to purchase an
annuity (6.8%) at age 60.
The green bars indicate the annual dollar benefit provided by TRSL for the
2% and 2.5% benefit. When ORP performance equals TRSL (red bar), the
benefit is about half compared to 2% and even less when compared to 2.5%.
When ORP performance equals S&P500, benefit is even less. The benefit
provided by ORP is far from comparable to TRSL.
Poor investment performance is not the fundamental problem.
Robert Turner
Urban Myth:
You Made Bad Investments
compare
Robert Turner
Is the Poor Market the Problem?
The following figure addresses this question: How would ORP benefits
compare to TRSL benefits if market performance was “average and normal”
and the ORP member’s return was consistent with the market. We can
examine this question by assuming an average annual investment return
equal to 8.25%/year. This is the percentage assumed by the TRSL actuaries
for investment returns when calculating future revenue and liabilities. It is
also about the AAR of the S&P 500 the past 20 years through 2009. The
other assumptions are the same as the previous figure.
With normal market performance, the ORP benefit (red bar) is better, but still
significantly less that TRSL and only a little more than half of that provided by
the 2.5% TRSL benefit (dark green).
Obviously, poor market performance reduces ORP benefit, but it is not the
fundamental problem.
Robert Turner
Don’t Blame a Poor Market
Robert Turner
What Does ORP Need?
The next figure addresses this question: Since 8.25% isn’t enough, what investment
average annual return (AAR) is needed so that ORP performance is comparable
TRSL?
The TRSL benefit (black line) was based on the 5yrs, 2.5% vesting requirement and
the same salary profile used in previous figures. The ORP contribution (13.6%) for next
fiscal year is used. ORP benefit was again calculated for investment AARs of 9%, 12%,
15%, and 20%, as indicated by the colored lines.
To equal TRSL, you need an investment AAR greater than 20% at 10 yrs. Going back
40 years for the S&P 500, no ten year period has had an AAR greater than 20%. At 15
yrs, you need an AAR greater than 15%. Only eight times (20%) in the past 40 years
has the 15 year AAR exceeded 15%. At 20 yrs, you need an AAR greater than 12%.
Only 13 times (33%) in the past 40 years has the 20 year AAR exceeded 12%. At 25
and 30 years, you would need a smaller AAR; however, as one approaches retirement
there is a need to be more conservative so earlier years would need to be a little
greater.
ORP needs an unrealistically high return to provide comparable benefits.
Robert Turner
Not Good Odds
12+%
13/40
20%/yr
15+%
8/40
15%/yr
12%/yr
20+%
0/40
Robert Turner
9%/yr
Designed to Fail
The previous figures have shown that the ORP is
designed to “FAIL” because it does not provide
benefits comparable to TRSL when
1. market performance is reasonable
and
typical.
2. Investment performance is
reasonable
relative to market performance.
What is the problem?
Is there a solution?
Robert Turner
How the Contribution is Calculated
The next figure explains how the contributions to TRSL and ORP
are determined. The top boxes show a 20 year average; the bottom
boxes the amounts for next fiscal year.
The employee contributes 8% of salary. The institutional
contribution is divided into a smaller part called “Normal” and a
larger part called “Unfunded Liability”. TRSL gets all three pieces
for a 20 year average total of 23.6% of the employee’s salary. Only
the employee contribution and the Normal part (6.7%) goes to the
ORP account. This has averaged 14.6%. The Unfunded Liability
(8.9%) piece paid by the institution for the ORP employee goes to
TRSL. The ORP participant pays TRSL a 0.1% management fee.
In FY 2010-2011, the percentage for TRSL is increased to 28.2%,
the highest in history. For ORP, the percentage is decreased to
13.6%, the smallest in history.
Robert Turner
Contributions for Employees on
TRSL vs ORP
Plan
20 yr
Average
LSUHSC
Normal
LSUHSC
Unfunded
Total
TRSL
Total
ORP
TRSL 8.0% 6.7% 8.9% 23.6% 0.0%
ORP
2010 2011 FY
You
8.0% 6.7% 8.9%
9.0%
+0.1%
14.6%
TRSL 8.0% 5.7% 14.5% 28.2% 0.0%
ORP
8.0% 5.7% 14.5+0.1%
% 14.6% 13.6%
Robert Turner
History of TRSL and ORP
The next figure shows the history of contributions to TRSL and ORP.
In the 39 years prior to 1989, the contribution to TRSL averaged more
than 16% of salary. From 1973 to 1988, the actuary recommended an
increased contribution of about 21% but the contribution stayed under
18%. By the end of the 1980’s, TRSL had an unfunded liability of
about $4 Billion. Some unfunded liability was due to TRSL taking over
two other retirement programs, but much resulted from mandated
increases in benefits provided by TRSL. In 1989, the TRLS
contribution significantly increased and has averaged 23.6%. The
ORP began in 1990 and has had an average contribution of 14.6%.
It seems strange that a contribution of 14%-15% was specified for the
ORP when decades of 16%-17% for the TRSL didn’t seem to be
enough.
Robert Turner
ORP Was Born
Why This
much?
Robert Turner
A Little Conspiracy Theory
When the ORP was created, the institutional contribution was divided
into two parts: Normal and Unfunded Liability. TRSL has always
received the Unfunded Liability contribution for all employees. Given
the terminology and actions, what follows is a best-guess at the (not
necessarily correct) rationale for the programs. This is illustrated in
the next figure.
The increased contribution (>20%) was more than enough to cover
benefits provided by TRSL. In fact, the historic 16%-17% was more
than was needed. Only 14%-15% was required by ORP and TRSL to
cover benefits. The difference, the Unfunded Liability (9%) would be
used to pay down the TRSL unfunded liability. Since there was no
unfunded liability on ORP, that 9% could go to TRSL.
Or, maybe, ORP was created to bail out TRSL. Entice TRSL
members to transfer to ORP which eliminates future liability, and take
most of the institutional contribution for ORP members.
Robert Turner
Born to Lose?
Robert Turner
Is 14+% Enough for TRSL?
Is 14+% sufficient to provided adequate benefits? This is tested in
the next figure. There are two measures of TRSL unfunded
liability: UAL and UAAL. They give almost identical values.
If 14+% was adequate to pay for benefits, then during periods of
normal market performance, the 9% Unfunded Liability component
could be used to pay down the UAL/UAAL. During the first half of
the 1990’s, the S&P 500 returned 9%/year, a reasonable
performance. During this time, the total contribution to TRSL was
24+%. One would expect a significant drop in UAL/UAAL. In fact,
it remained constant indicating that 14+% was grossly inadequate
and that the whole 24+% contribution was needed just to cover
benefits and expenses.
Only during the late 1990’s with the expanding tech bubble could
the TRSL pay down UAL/UAAL. With the two subsequent
“crashes”, the UAL/UAAL have spiraled up to about $10 Billion.
Robert Turner
No, 14+% Is Not Enough
It took the full 24+%
contribution just to cover
benefits when market
performance was “average”.
9%/yr
29%/yr
No significant paydown in liability
Robert Turner
More Is Better
Clearly, 14+% is not enough to support the benefits guaranteed
by TRSL or to provide adequate benefits on ORP. What would
have happened if ORP participants had received the full
contribution provided to TRSL instead of the reduced 14+%.
The next figure is the same as the first figure except that the
contribution to ORP equals exactly that of TRSL (avg. 23.6%) the
past 17 years. Market performance for ORP equals that for TRSL
and the S&P 500.
The ORP benefit is significantly better than with the actual 14+%
ORP contribution, but still less than TRSL for the 2% and 2.5%
benefit. Of course, actual market performance during these years
was not good.
Robert Turner
With a Contribution Equal to TRSL
(23.6%)
compare
Robert Turner
To Small to Not Fail
In the next figure, ORP benefit was calculated using the actual
TRSL contribution (23.6% avg.) instead of the actual ORP
contribution, and “normal” market performance of 8.25%/year.
Under the conditions of normal market performance/reasonable
investment return and increased contribution, ORP benefit was
almost equal to the TRSL benefit. With a contribution of about
25%, the ORP benefit would be comparable to the TRSL benefit.
The fundamental problem with the ORP is that the actual
contribution is too small and virtually guarantees that the ORP
will FAIL.
Robert Turner
With an Adequate Contribution, the
ORP Does Not “FAIL”
(23.6%)
Robert Turner
Other ORP Programs
Many state universities have ORP-type retirement
programs. The employee/institution contributions are
shown in the next figure. Note that the LSU employee
contribution is higher than most others and the
institutional contribution is smaller. Still, the total
contribution is about the same (14%-15%) for most
states, with the exception of Ohio State which is
significantly higher.
If 14+% is too small of a contribution, then why is that
the level for most universities?
Robert Turner
How Does Our ORP Compare to
Other ORPs?
Robert Turner
One Minor Difference
There is one important difference, as illustrated in the next figure.
At all universities except LSU and Ohio State, the ORP program is
designed to provided retirement income that supplements Social
Security. They are not intended to be the only, complete, standalone retirement program. LSU and Ohio State do not participate
in Social Security. Thus, these programs are complete, standalone programs. This explains why the Ohio Contribution to the
ORP program is 20+%.
Robert Turner
Only a Piece of Retirement
standalone
supplemental
Robert Turner
The Magic Number is ~25%
The next figure shows the total contribution to retirement
programs. When Social Security is included, the total contribution
is about 25%.
A notable exception is LSU where the total contribution is slightly
more than half the other universities and the State contribution is
a fraction of the other states.
These data support the conclusion that a contribution of about
25% is needed to turn the ORP into a viable stand-alone
retirement program.
Robert Turner
Total Contribution Including
Social Security
Robert Turner
Summary
• The fundamental problem with the ORP is not poor investment
decisions or a poor market; although both add to the problem.
• The fundamental problem is a percent contribution that is much
too small for the ORP to function as a “stand-alone” retirement
plan.
• Our ORP is designed to fail as a “stand-alone” retirement
program in that the benefits will never be comparable to TRSL
without unrealistically high investment returns.
• Essentially, our ORP is a “supplemental” retirement plan that is
presented as an alternative to TRSL which is a “stand-alone”
plan.
• A faculty member contributes the same amount (8%) to ORP as
TRSL but receives much less in university contributions and
retirement benefit.
Robert Turner
Summary
• Both TRSL and ORP are “failing” because of underfunding. That
is, the contribution percentage is too small.
• In FY 2010-2011, the percentage for TRSL is increased to 28%,
the highest in history. For ORP, the percentage is decreased to
13.6%, the smallest in history. The logic must be
- the market has been poor, TRSL needs more money
- the market has been poor, ORP needs less money
• When TRSL fails, the burden is spread across all citizens of
Louisiana.
• When ORP fails, the burden falls on the individual faculty
member.
Robert Turner
What Needs to be Done
• If the ORP is going to be a “stand-alone” plan and a viable
alternative to TRSL, it needs to be fixed by increasing the
contribution to about 25% of salary.
• The other option is to let it continue as a “supplemental” plan
with the addition of another plan, e.g., Social Security.
• For many current ORP participants, any fix to the ORP is toolittle, to-late. There should be a one-time opportunity to switch to
TRSL.
Robert Turner
The End
Robert Turner