Health Care and Education & Workforce Development and Real Estate & Retail

Daniels' team shakes up pension fund for teachers: Retirement plan may risk more on private equity

January 9, 2006

Under Gov. Mitch Daniels, Indiana is renewing its commitment to making sure teachers receive their pensions. But in the process, the state may also put their pension principal at greater risk.

State Budget Director Chuck Schalliol said the $7.5 billion Indiana State Teachers' Retirement Fund is considering expanding its holdings in private equity. The enormous pension fund already allocates 5 percent of its assets, or $240 million, toward such investments, which include venture capital, real estate and leveraged buyouts.

Highly speculative, private equity investments bear enormous risk. But they also can provide colossal returns.

"Some universities now invest over 50 percent [of their assets]," Schalliol said. "I'm not advocating 50 percent. But we will look at whether 5 percent is getting the fund the best returns it could get."

Increasing TRF's commitment even 1 percent would mean tens of millions in new cash available for private equity investments.

And if Daniels, a Republican, is willing to take on even more risk, TRF could devote hundreds of millions more to the class. Daniels already is following a similar strategy at the Indiana Public Employees' Retirement Fund. With both pension funds, the administration hopes much of the money will flow to Indiana deals.

If the private equity investments pay off, they could dramatically reduce taxpayers' share of teacher pension obligations. If they don't pan out, taxpayers' burden would increase.

Unfortunately, TRF's $7.5 billion in assets aren't nearly enough to satisfy the pension obligations. In all, Indiana has another $8.4 billion in unfunded teacher pension liability.

The debt built up over generations as legislators neglected to set aside the pensions' necessary cash. The problem was compounded by Indiana's investment laws, which until 1996 prevented the state from speculating on anything riskier than bonds.

These days, TRF is allowed to invest in every instrument on the market. Any higher-than-expected returns help make up some of the unfunded liability.

To pay the rest, the state must spend tax money, diverting spending from other agencies and projects. In 2006, Indiana will kick in $552.8 million toward teacher pensions through a combination of tax and lottery dollars. Because of baby boomer retirements, annual payments are projected to increase every year before peaking at $1.6 billion in 2029. In comparison, the state's entire budget this year is $21 billion.

During the recession, legislators used $372.2 million in TRF money to shore up the state's budget for 2004 and 2005. The Daniels administration is attempting to balance the state's books, Schalliol said, and won't rely on such measures again.

"We've stopped raiding the pension fund," he said. "We've passed the first honestly balanced budget in over a decade. In putting that budget together, we said we're going to bite the bullet and not take any more money from the pension stabilization fund."

Meanwhile, TRF is attempting to boost its returns. Last summer, Daniels replaced its entire board of directors. In October, he named Christy Wheeler, a former Guidant Corp. attorney, as TRF's executive director. Under its new management, TRF is reviewing the pension fund's investments and their managers.

Since it began diversifying its investments a decade ago, TRF has relied most heavily on the advice of San Franciscobased Callan Associates. Callan helps TRF select and monitor nearly two dozen professional money management firms, each handling a different asset class. Nine investment consultants are being considered for Callan's job, Wheeler said. Callan is among the finalists. TRF plans to make its decision by February.

"Diversification has been a journey," Wheeler said. "This is a perfect time to consider investment policy. The new board will have new ideas."

Wheeler is taking steps to improve TRF's customer service to pensioners. But the largest policy change on the table is the potential expansion of TRF's private equity investments. The pension already has made 53 commitments in that area worth $240 million.

Chief Investment Officer Robert Newland said that on paper TRF is showing a 23-percent return on those investments. But that's just an estimate. The actual return could end up lower or higher. It won't be realized until TRF sells its private equity holdings.

Teachers may be comfortable with allowing TRF to take a bit more investment risk. Indiana State Teachers Association Deputy Director Dan Clark said as long as Daniels' administration follows best practices in the pension industry, his union won't object to additional private equity investments.

"Those pension payments are going to ramp up very quickly. It's an appropriate goal for them to pursue," Clark said. "The obligation is to the members of the fund. They've got to maximize their return."

Clark also applauded the state's commitment to paying its share of teachers' pensions. But not if it means Indiana must reduce its spending elsewhere, particularly in education or health care. Rather than make cuts, Clark said, ISTA would prefer to see the state raise more money through a graduated income tax.

Bottom line, Schalliol said, the state must maintain its renewed pension dedication. Every time legislators raid pension money to finance current spending, he said, they make the problem of pension obligations worse for future generations.

"The best analogy is our current U.S. Social Security system. They talk about the Social Security trust fund, but in reality, it's running out of money," Schalliol said. "We're not in a desperate situation, so long as the Legislature is wiling to appropriate a growing amount to cover this."


Christy Wheeler, the new executive director of the Indiana State Teachers' Retirement Fund, is helping the state face its $8.4 billion debt for teacher pensions.
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