Hegar cautions Texas on financial challenges impacting credit rating
Managing money in our day-to-day lives is quite a balancing act. The key is not to spend more than you have, make stable investments and accrue funds for a nest egg that will serve you well in case of an emergency or during your retirement years. This would be the best-case scenario for everyone, but life happens and that can wreak havoc on anyone’s good fortune. Then the inevitable happens…You have to borrow money. Now you are obligated to pay it back with interest and if you let those payments slide or default on that loan, your credit score will suffer. The same concept can be applied to cities and states.
In December, Texas Comptroller Glenn Hegar sent a letter to Gov. Greg Abbott and legislative leadership outlining long-term challenges to the state’s financial health. “As a former legislator, I know only too well the difficulties that can come with the budget process, as lawmakers attempt to reconcile thousands of competing needs,” wrote Hegar in his letter. “The hot-button demands of the next two years always seem more important than issues that can be allowed to slide for ‘just one more session.’ Unfortunately, delaying action on some of our long-term obligations will only cost us more over time, much like compounding interest on a loan.”
On Tuesday, Hegar sent out a press release highlighting a report that examines four long-term financial obligations that if left unaddressed, could negatively impact the state’s credit rating and limit the amount of revenue available for general spending. Three of those obligations include the state employee pension funding, the Teacher Retirement System-Care (TRS) program and the Texas Guaranteed Tuition Plan. The fourth obligation is the deferred maintenance projects for state buildings. President and CEO of Strategic Partnerships, Inc., Mary Scott Nabers shared the repercussions of deferred maintenance in a recent article, “Deferred maintenance…the same as debt? Really?”
Credit ratings apply to businesses and government that seeks to
borrow money. Credit assessment and evaluation for companies and governments is generally done by a credit rating agency such as Standard & Poor’s, Moody’s or Fitch. These agencies are paid by the entity that is seeking a credit rating for itself or for one of its debt issues. Credit rating agencies typically assign letter grades to indicate ratings such as AAA for excellent and lower at AA+ all the way to C and D. A debt instrument with a rating below BBB- is considered to be speculative grade or a junk bond, which means it is more likely to default on loans.
Texas has a stable rating of AAA, but Hegar cautions that the state, sooner rather than later, needs to address these obligations that vary in scope, timing and severity. Texas’ state and local government pension funds have more than 2 million members in 93 different plans. The Employees Retirement System (ERS) manages three funds for different groups of public employees: ERS for most state employees, the Law Enforcement and Custodial Officers Supplemental Retirement Fund and the Judicial Retirement System Plan Two.
Texas Government Code 815.403 requires the state to make annual contributions to the ERS pension fund equal to 7.4 percent of the total compensation received by all ERS members in that year. Texas failed to meet this requirement in all but two years from 1988 through 2013. The U.S. life expectancy has risen from 69.7 in 1960 to 78.7 in 2010. This increase puts fiscal pressure on pension systems. Other factors include fewer contributing members and early retirements for law enforcement and custodial officers- representing 30 percent of the ERS population.
Proposed policy options to improve ERS include the following:
- Raising member and/or state contributions;
- Making a one-time payment to the pension fund from general revenue or the Economic Stabilization Fund;
- Selling pension obligation bonds;
- Reducing benefits offered to current and/or future hires;
- Changing the plan to a defined contribution or hybrid plan.
The Teacher Retirement System of Texas (TRS) administers two health benefit programs: one for current public school employees and their dependents, the Texas School Employees Uniform Group Health Coverage Program and one for retirees and their dependents, the Texas Public School Retired Employees Group Benefits Program (TRS-Care). Hager addresses TRS-Care only. As of Aug. 31, 2016, the TRS-Care program covered about 261,500 retirees, dependents and surviving spouses. TRS-Care was created in 1985 and was expected to remain stable for ten years. Its funding formula hasn’t changed since 2005 and hasn’t kept pace with plan costs, requiring supplemental appropriations. In 2003, the Legislature appropriated $516 million from the Texas Economic Stabilization Fund to cover a TRS-Care shortfall.
Other driving factors that contribute to TRS-Care shortfalls are increased pharmacy costs, rising emergency room visits, growing population and high claims, more than $150,000, for members with chronic conditions. The 2015 Legislature created the Joint Committee to Study TRS Health Benefit Plans to examine sustainability and affordability. The committee presented their proposal in November 2016:
- Health reimbursement accounts for retirees ineligible for Medicare;
- High deductible plan for non-Medicare-eligible retirees with a $4,000 in-network deductible and monthly cost of $430;
- Medicare advantage plan for Medicare-eligible retirees who would enroll in Medicare Advantage, have a $500 deductible and pay a monthly cost of $146.
The Texas Guaranteed Tuition Plan is a prepaid tuition plan that was created in May 1995 and opened for enrollment in 1996. Fund participants select contracts for public or private colleges or universities and purchase them in a lump sum or through installments to lock in current tuition rates for the beneficiary’s later use. The plan stopped accepting new contracts when the Texas Legislature deregulated tuition in 2003, in anticipation of higher tuition rates. There are about 60,000 active accounts.
The plan’s contract payments and earnings have failed to keep pace with tuition and inflation. The plan had a projected unfunded liability of $617.2 million as of Aug. 31, 2016, a 15.3 percent increase from the previous year. Any shortfall automatically triggers a draw on general revenue. The plan was analyzed in October 2016 and the following options were provided:
- Legislature appropriates $100 million to the fund in September 2017 to fund the plan through September 2020;
- Legislature appropriates half of the total liability, $317.7 million, in September 2017, keeping the plan funded through March 2022;
- Legislature appropriates $400 million and the plan remains funded until March 2023;
- Legislature appropriates $635.5 million and keeps the plan funded through 2038.