Chad Aldeman's blog

  • In Teacher Pensions, Even the Fixes Are Moving in the Wrong Direction

    September 12, 2013
    Chad Aldeman

    NCTQ’s new report on the state of state teacher pension plans is well worth your time. If you’re new to the pension issue, it does a great job of breaking down the issues in simple and clear language. If you know your way around defined benefit plans, there’s still lots of good resources on, for example, the number of states that made changes to their pension formulas over the last four years. And, if you only care about a particular state, it has lots of tables where you can find exactly how your home state is doing.

    So go read it all and save it as a resource. For this blog, I want to pull out one of its main findings and show why it matters. Since 2009, 13 states have changed their vesting requirements, and 11 of those 13 made this period longer. The vesting period is amount of time a teacher must be employed before becoming eligible for pension benefits. If they meet the minimum vesting requirement, they’re eligible for a pension. If they don’t, they typically can get their own contributions back and some interest on those contributions, but they forfeit the contributions their employer made on their behalf.

    The graph below shows the distribution of state vesting requirements. In 2012, 25 states required teachers to stay in the state pension plan for at least five years before vesting, and 15 required them to stay 10 years.

    With today’s increasingly mobile workforce, five or 10 years is a relatively long time to stay in one job. Many teachers will never meet their vesting requirements and will be forced to forfeit their employer’s contributions and, in many states, they will also lose out on any interest that their investments would have accrued.

    Let’s use Illinois as an example of how many teachers will meet the state vesting requirements. In 2010, faced with the one of the largest pension deficits in the country, Illinois created a new, less generous pension plan for new teachers that lengthened the vesting requirement from five years to ten. Education Next ran a report from Bob Costrell, Mike Podgursky, and Christian Weller that showed how the changes will affect teachers who stay their entire career teaching in Illinois (see Figure 2 here). However, we know that a large percentage of teachers won’t ever make it to five years in the profession, let alone 10.

    Mobility and Portability
    Pensions and Human Capital
    State Pension Plans
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  • Mayor Bloomberg Made a Bad Trade

    September 12, 2013
    Chad Aldeman

    With news that a $75 million teacher performance pay experiment in New York City yielded no positive results, it’s worth remembering the deal that Mayor Michael Bloomberg struck just to put the plan in place. All the way back in 2007:

    If union members agree, the number of years of service required for a teacher to earn a full pension would be reduced to 25 from 30. In exchange, current teachers would have to agree to a 1.85 percent increase in their pension contributions. A 1.85 percent increase in contributions will also be required from future teachers, who will have to work at least 27 years — instead of 30 — before being able to retire with a full pension.

    In announcing the pension changes, Mayor Bloomberg assured the public that the deal would save taxpayers “tens of millions” of dollars in the long run, but the math just doesn’t work in his favor. To achieve those savings, Bloomberg is assuming the pension plan will pick up the entire tab of retirees’ pension and health care costs, so the city exchanges one older worker, with higher compensation, for one younger worker, with lower compensation. That’s not a safe assumption, because, sooner or later, the pension costs trickle back to the city.

    More importantly, while the merit pay plan died a quiet death last year, the new pension benefits, on the other hand, are permanent. The state of New York, and indirectly New York City, will be paying for expanded teacher benefits forever. New York State’s Constitution prohibits any reduction in benefits for current employees, even those benefits that are merely potential. Reducing the benefit calculation would be impermissible if it resulted in a single participant receiving one single dollar less than they would have received under the old formula, even if the benefits have yet to be earned. These restrictions can be removed only through changes to the state’s constitution.

    The merit pay study was written by Harvard professor Roland Fryer, and it’s being published by the National Bureau of Economic Research, so I trust it’s of high quality. Look for more analysis on that later, but for now, just remember that Michael Bloomberg traded a young, largely untested prospect (merit pay) for thousands of grizzled veterans (all those retiring teachers). 

    This blog entry first appeared on The Quick and the Ed.

    Pension Politics
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  • You're Probably Not Saving Enough for Retirement

    September 12, 2013
    Chad Aldeman

    Articles on retirement security, like this one from the NY Times, are good to read and know about. The short version is that few of us are saving enough for retirement, so we’re going to see more “retired” people working part-time, retiring later, or, worst case scenario, looking for a government fix. The situation is even worse for younger Americans.

    One thing that’s particularly relevant for this blog is that defined benefit pension plans are more or less a thing of the past for most workers, and in the next five or ten years we’re going to have a whole class of workers becoming eligible for retirement age who’ve never had a DB plan in their entire working career.

    To see why this matters, check out the chart below from a recent McKinsey report.  It’s divided by age and income, and it shows how much, or how little, workers have saved for retirement and what form that savings takes. At the bottom right-hand side are workers aged 60-65 who earn $20-50,000 a year. Sixty percent of their retirement income will come from Social Security, 22 percent will come from a defined benefit pension plan, only 1 percent will come from personal savings, and they’re facing a 17 percent shortfall between what they have saved and what they’re likely to need. Looking at the next youngest age bracket, workers aged 40-59 earning the same amount, they can expect 48 percent from Social Security, only 4 percent from a DB plan, an 6 percent from personal savings (including 401k plans and IRAs). They face a 42 percent shortfall.

    These figures would be improved, although not erased, through a stock market boom. The awful truth is that Americans just aren’t saving enough for retirement.

    Alternative Models
    Funding
    Retirement Insecurity
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  • Just How Rosy Are Teacher Pension Plan Investment Assumptions?

    September 12, 2013
    Chad Aldeman

    It’s common nowadays to read critiques of public-sector pension plan investment assumptions. State and local pension plans assume an average investment return of 8 percent, which, in this economy, just feels too rosy. The mainstream media has picked up on it, running articles pointing out that the 8 percent mark has not been met over the last decade, and there’s an entire cottage industry in the accounting world arguing the unfunded liabilities should be evaluated on much lower investment assumptions.

    Are they right?

    To find out, I compared long-term real investment returns with the real rate of return assumed by state teacher pension funds*. The word “real” in this context means investment returns minus the effects of inflation. The investment return data calculates the real return of a conservative portfolio invested 25 percent in the S&P 500, 25 percent in small US stock, 25 percent in long-term US corporate bonds, and 25 percent in an equal split of 30 day treasury bills, intermediate-term treasury bonds, and long-term treasury bonds**. I calculated the assumed real rates of return of state teacher pension plans by subtracting their inflation assumption from their investment return assumption.

    The average one-year real return for the balanced portfolio has been 6.72 percent since 1926, a common starting place for the modern stock market. For comparison’s sake, the average state teacher pension plan assumes a real rate of return of 4.59 percent. In other words, they’re relatively conservative in relation to historical averages.

    Averages, of course, can mask highs and lows. What’s more important is to see how various extended periods of time performed compared to the state assumptions. To do that, I used 30-year rolling averages of real returns. So, for example, 1926 to 1956 was one period and 1927 to 1957 was another. The series ended with the 30-year period from 1989 to 2009. Thirty-year periods also matter in the real world, because that is the time horizon states are given to calculate how much they would have to invest today in order to be fully funded in the future.

    Funding
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  • A Grand Bargain on Teacher Benefits

    September 12, 2013
    Chad Aldeman

    In the midst of an excellent piece arguing unions aren’t winning negotiations on salaries–they’re winning negotiations on everything else–David Leonhardt makes a really important point:

    Unfortunately, though, politicians do not have the same incentives to be tough negotiators on issues besides money. Why not? Because most government agencies are monopolies. They face no competition. Whether they perform beautifully or miserably, they cannot be run out of business. They also can’t be run out of business by pushing off costs until a future day. So they delay too many costs and don’t perform their jobs well enough.

    The delaying of costs is obvious. Both politicians and union leaders have decided that generous future benefits offer the easiest way to hold down spending and still satisfy workers. The result is government pay that’s skewed too heavily toward pensions and health insurance.

    Study after study has found that public-sector workers have traded lower salaries for better benefits, but there’s no particular reason that trend must continue. A smart governor would approach the public-sector unions in her state and ask to trade some of the expensive, unpredictable health care costs and back-loaded pension benefits for higher salaries**. This could even be a revenue-neutral trade that manages to make both sides better off.  The governor would be getting greater predictability in her budget, while union leaders would put more cash in the pockets of their members. A smart union leader would take the deal, because people tend to value cash more than they do in-kind contributions, so union members may even feel like they’re better off. Perhaps most importantly, it would help put public-sector worker compensation more in line with that of private employees.

    **In many states, it’ll illegal to reduce the accrued retirement benefits of workers, but the courts have found such reductions acceptable if they’re accompanied by increases in compensation. 

    This blog entry first appeared on The Quick and the Ed.

    Alternative Models
    Funding
    Retirement Insecurity
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