Blog: Funding

New Jersey Governor Chris Christie has been in the news a lot lately for his handling of the Garden State’s budget crisis around government-worker benefits. The New York Times did a piece earlier this week on a confrontation between Christie and teacher Marie Corfield around cuts to education funding, and 60 Minutes featured Christie in a wide-ranging piece on the state of state budgets. Neither of these stories has fully gotten to the heart of why the state now has a $20 billion liability for teacher pensions, and neither of them mentions the fact that only eight years ago the state had a teacher pension fund surplus.

So what happened? A stock market crash certainly hurt, but the state has made its own problems along the way. Through a combination of low contribution rates and benefit enhancements, New Jersey starved the pension beast.

Traditionally, Starve the Beast has been employed by fiscal conservatives to force budget deficits, which in turn lead to demands for reductions in the size of government. The argument goes that if the government spends more than it takes in, it should stop spending. As the chart below shows, this tactic has certainly been employed in New Jersey’s Teachers’ Pension and Annuity Fund. The blue line represents what the state’s actuaries have told the legislature it needs to invest in order to cover its future teacher pension obligations. The red line represents what it actually put in. In only one year of the last 13 did the state meet its actuarial obligation, and it only met it that year, 1997, because the state issued pension obligation bonds to help retire previous underfunding debts. In two years, 2001 and 2002, the state actuary decided the fund required no contributions, and the state gladly complied. In the other ten years, the state has failed to invest enough to cover its teacher pension obligations. Collectively, the difference between what New Jersey should have invested and what it actually put in–the difference between the blue and the red lines–is $5.2 billion.

Ezra Klein has a good post laying out some of the issues around public-sector workers and their retirement benefits, but I want to amplify two of his points. The first is around some of the overblown rhetoric going around right now (epitomized by this David Brooks column that was Klein’s inspiration in the first place) suggesting that public-sector defined benefit pension plans are causing massive holes in state budgets. In our report on teacher pensions, we write:

A historical context is also useful. While the current funding ratios are less than ideal, they are not catastrophic. The most recent figures from the Public Fund Survey, a compilation of 101 state and municipal retirement plans, show that the aggregate funding ratio for these plans reached a high of 102 in 2001 at the end of the Internet-led bull market.Through a combination of poor investment returns and benefit enhancements, the ratio had fallen to 85 by July 2008, about where it was in 1994.

In other words, after the longest bull market in history followed by one of the worst decades for investment returns on record, we’re in roughly the same position we started in.  That doesn’t mean the financial problems with teacher pension plans are insignificant–and the political incentives to raise benefits during boom times skews things here–but it is useful to view them in an historical context (I might argue some of the non-financial problems are actually more important).

The second point worthy of amplification is when Klein writes:

And while states are facing serious pension problems because they still offer defined-benefit pensions, we’re also going to see the retirement of millions of private-sector workers who don’t have defined-benefit pensions, and either haven’t contributed enough to their 401(k)s or saw their wealth wiped out in the recent turmoil. We’re facing a pension crisis in the public sector, but we’re also looking at a retirement crisis in the private sector.

This is spot-on. As we get closer to the mass retirements of workers who’ve never had a defined benefit pension plan, something that will be upon us in the coming decades, we really have no idea what to expect. Preliminary research suggests it’ll be downright ugly:

Public- and private-sector workers’ retirements used to be structured similarly. Not that long ago, both groups were likely to have access to defined benefit pension plans that guaranteed monthly payments until death. Both sets of workers retired at about the same ages.

These things have changed over the last 25 years as private-sector employers have abandoned DB plans, private-sector workers have been retiring at older ages, and public-sector workers, including teachers, have been retiring younger. By 2009, only one in five private-sector workers had access to a DB plan, compared to 89 percent of teachers and 84 percent of all state and local government employees who are still enrolled in one.

People make retirement decisions for all sorts of reasons. Maybe they have grandchildren they want to spend time with, or a hobby they want to develop. People also base their retirement decisions on both the amount and the structure of their retirement benefits. Even after controlling for total wealth, the security offered by DB plans–those guaranteed monthly payments until death–lead people to retire 1-2 years earlier than they would with 401k plans. Because of the generosity and the structure of their retirement plans, teachers now retire more than four years younger than private-sector workers.

This divergence didn’t always exist, but it’s becoming a real problem. The workers at companies that used to offer DB plans but now only have access to less-secure 401ks are not likely to tolerate this imbalance forever. The Wall Street Journal is reporting that many employers who cut their matching contributions during the Great Recession have been slow to reinstate them, which will only make the problem more pronounced. Teachers and other public workers have long traded lower base salaries for better benefits and more security, but that dichotomy has become more obvious and more important. Taxpayers may not continue to look kindly on generous teacher and government-worker retirement plans as their own are being cut. 

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

One of the big problems with teacher pension plans is that they’re not portable. A teacher who works 30 years in the same state can expect to earn retirement benefits that are 30-70 percent higher than a peer who divides that same career into two 15-year stints in different states. The teachers, the salaries, the job, everything can be the same, but the mere fact of moving, even one time, can significantly impact a teacher’s retirement wealth.

This problem is exacerbated in the 13 states where teachers and other government employees do not participate in Social Security. These states, representing about one-third of America’s teaching work force, have made the calculation that they will be able to provide better retirement benefits to workers by investing contributions in the stock market rather than paying taxes into Social Security. That calculation may be correct for the state itself over the long run (but it doesn’t look too smart right now…), and it may mean higher benefit payouts for workers who stay in the system, but it’s certainly a losing proposition for teachers who move across state lines.

The New York Times has an interesting story about Maine’s ongoing attempt to move teachers into Social Security. It reports that only about one in five teachers in Maine stick around long enough to earn maximum retirement benefits, and the rest leave, taking neither a full pension nor Social Security benefits with them. Mobility figures are similar in other states.

The proposed changes will not affect current workers, and thus will not improve the condition of the state’s pension fund. Still, it’s a sensible solution to both improve the state’s long-term fiscal outlook while simultaneously helping out mobile teachers. 

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

Michael Mulgrew, head of the United Federation of Teachers in New York City, suggests the city can ease its budget crisis by offering early retirement incentives for experienced teachers to retire. In today’s New York Post he writes:

Retirement incentives are particularly effective in the Department of Education, since senior teachers make more than twice the salary of entry-level teachers. There are about 25,000 experienced teachers to whom such an incentive could be offered right now. Given current salary levels, the retirement of 1,000 of them would save the city $55 million per year. If 4,000 senior teachers were to retire, the system would save more than $220 million – even if every retiree is replaced by a new teacher.

This is a common argument you hear during budget crises, but the math does not add up. Given New York City’s hiring spree over the last decade, not to mention local pressure to keep class sizes low, it’s safe to assume the retiring teacher would indeed be replaced. To get to Mulgrew’s $55,000 savings per teacher, we have to assume the district will replace a teacher that’s maxed out on the salary schedule ($100,000 in NYC) with one without a Master’s degree or any years of experience ($45,000).  Mulgrew’s figure is the maximum amount and any variation (say, if the new hire had a few years of experience or additional credits beyond a bachelor’s degree) would reduce the savings. More importantly, this calculation does not include the minimum $44,000 annual pension that a retiring teacher with that level of experience would be eligible to receive. Including health insurance costs–New York covers 90 percent of retiree health expenses–would wipe out any remaining “savings” completely. This does not count any one-time payments or new early retirement incentives that might be used to encourage senior teachers to retire.

These payments do come out of slightly different pots of money, and it might be tempting during a budget crisis to play around with numbers and come up with magic savings, but ultimately that’s just dishonest. 

The Foundation for Educational Choice has a new report today attempting to change the way we treat public pension plans. It essentially boils down to this: States themselves claim their pension funds covering teachers, principals, and other educators, are 78 percent funded, but the authors use different calculations based on what’s expected of private companies, derive another number and poof! the funding ratio drops to 60 percent. They then throw out the eye-boggling stat that states are actually $933 billion in the red due to unaccounted pension obligations.

Don’t believe it.

See, private pension funds are different than public ones, and they should be treated differently too. Private companies are required to contribute, on behalf of their defined benefit (DB) pension plans, to something called the Pension Benefit Guaranty Corporation (PBGC). The PBGC asks all employers with a DB plan to fully fund it so their future obligations are covered in case they ever go out of business or run out of money. When private employers fail to meet these obligations, they pay into the PBGC fund at higher levels. The PBGC can then compensate workers if their employer goes belly up. So when Enron, TransWorld Airlines (TWA), and Bethlehem Steel went bankrupt, their workers still earned some retirement benefits that had been promised them.

States, unlike private companies, do not fold under. Indiana, which according to the authors has a DB pension plan for teachers that is only 42% funded, is not likely to go out of business and take its workers down with it. The state of Indiana can assume a riskier investment return for its pension fund than an employer like those mentioned above or any other modern private firm (and, just for good measure, it’s worth pointing out that Indiana assumes only a 3 percent real rate of return).

All this is lost on the report’s authors, who would prefer states lower their assumptions on stock market returns from about 8 percent down to 6, the standard rate used by corporations in their calculations. This would mean telling a state like Pennsylvania, which has accumulated a 9.23 percent return in the stock market over the last 25 years (as ofFebruary 2010), that its 8 percent investment assumption is too high.

There are good reasons to consider changes in state pension plans, but this isn’t one of them. Expect more on this topic from Education Sector in the coming months.

Question: What do you get when you add a bad stock market + equally bad state budgets + generous pension benefits + an enhancement of those benefits + rising health costs + an aging workforce?

Answer: A large unfunded liability.

Example A is Pennsylvania, which recently announced they will be increasing the employer contribution rate for retired teacher pension and health benefits in 2010-11 by 72 percent over current levels. The projections into the future are even worse, as the Public School Employees’ Retirement System of Pennsylvania (PSERS) is currently predicting the rate to nearly triple in 2012-13.

The graph below shows a 60 year look, 30 years back and 30 years forward, at employee and employer contributions into PSERS. The blue line is the percentage of salary that the average employee contributes, and it has been pretty steady over time, although it has risen slightly. The red line is the combined contribution of school districts and the state (determined by formula, but the state contributes a little more than half), and it has fluctuated wildly. It was in double digits from 1973 to 1997, hit a low of 1.09 (1.09!!) in 2002, and is expected to reside above 30 percent from 2014 to 2020.

The projections already include an eight percent annual investment gain for the next 30 years, but even after that assumption added to the large employer contributions, the state will still have an unfunded liability of over $7 billion in 2039, in present dollars. To put that in perspective, the state and all its school districts contributed only $617 million last year.

The options to fix this situation are not very appealing, nor are they unique to Pennsylvania. State and local governments could, and probably will, raise taxes. That’s pretty much inevitable, but it’s also politically unpalatable. Because pension benefits are considered a legally binding contract, the state cannot reduce benefits to current employees. So, instead, they’re likely to address the political problem by taking what amounts to mild budgetary solutions and reducing benefits or changing the retirement structures for future employees and requiring higher employee contributions. PSERS could also seek to increase its investment performance (they’ve averaged a 9.25 percent return over the last 25 years), but to do so would require it to take on more risk.