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.
How many make it this far? In the graph below, I’ve included three different estimates of the cumulative attrition rate of teachers. The green line comes from the Teachers’ Retirement System of the State of Illinois. Their annual financial report estimates how many teachers will leave each year based on their experience and whether or not they have tenure. The green line shows those estimates over a 10-year period. The blue line comes from a 2003report by Richard Ingersoll which used the Schools and Staffing Survey to calculate the national attrition rate for the first five years of a teacher’s career. The data are a bit old at this point, but it’s one of the only places that has looked at attrition in this way. For our purposes, I’ve extended the line out to 10 years, using the dotted line to signify where my estimates take over. Last, the red line is a relatively rough cut from the National Center for Education Statistics, which reports that 16 percent of teachers change jobs every year (this estimate is probably too high, but it’s another data point to consider).
The left circle shows how many teachers would have met Illinois’ old pension vesting requirement of five years, and the right circle shows how many teachers are likely to make it to ten years, the new requirement. By Illinois’ own estimates, 59 percent of teachers will fail to meet the vesting requirements. Compared to three years ago, an additional 24 percent of teachers won’t meet the new vesting requirement. If we use the Ingersoll numbers, nearly half wouldn’t have met the old five-year vesting requirement, and only 29 percent will meet the 10-year requirement.
On this and other pension issues, states are moving in the wrong direction. They’re shoring up the finances of their underfunded pension plans by creating less generous plans for new workers, asking them to contribute more, and increasing penalties for mobility. Illinois has roughly 130,000 teachers. If we do some back-of-the-envelope math and average the state’s and the Ingersoll estimates together, it means that 85,000 current Illinois teachers will leave the profession in the next ten years with little retirement savings to show for their experience. To paraphrase NCTQ, few will benefit.
This blog entry first appeared on The Quick and the Ed.
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.
Taxonomy: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.
The consequences of this are unknown. It’s almost a guarantee that Social Security will become even more important in retirement plans. But will soon-to-be-retirees, a large and important voting bloc, push for even stronger government support? Are politicians ready to tell the truth that years of subsidizing retirement plans through the tax code, through various tax-subsidized accounts, just aren’t doing enough? Will private employers start offering more generous retirement plans, or will workers start demanding them? Most fundamentally, are Americans prepared to start saving significantly more money for retirement?
For all of their problems, defined benefit pensions plans have historically been good at getting employees and employers to set aside money for workers’ retirements. Without those guarantees and left to their own savings and investment decisions, workers have proven fallible. This will start becoming even clearer in the years to come.
This blog entry first appeared on The Quick and the Ed.
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.
The chart below graphs these 30-year periods against state assumptions. The blue bar represents the real rate of return assumed by 49 out of 50 states (New Jersey does not publish an inflation rate). The most common assumption, used by 19 states, was a real return between 4.5 and 4.99 percent. States could get there in any number of ways. They could assume an 8 percent investment return and a 3.5 percent inflation rate, or they could assume a 4.75 investment return with a 0 percent inflation rate. Most states tended towards the former than the latter, but all that matters is the difference between these two figures.
The red bars indicate the frequency that real rates of return were observed over 30-year periods. The most common occurrence put investments minus inflation between 5 and 5.49 percent.
The most important thing to understand from this chart is that states are generally conservative in their investment assumptions***. Every state is below the 83-year average. There were five 30-year periods where many states would have assumed a rate in excess of what they actually returned, but, for the most part, state assumptions are more conservative than historical averages.
*This being an education blog, I chose to focus only on plans that include teachers, but teachers are the largest group of workers covered in state retirement plans, and the plans including teachers are very similar to plans covering other government employees.
**The data come from the Shwartz Center for Economic Policy Analysis, an older version of which appeared in this paper.
***Remember that the returns used in this chart are significantly more conservative than the average state investment portfolio. That means two things. One, the riskier investments actually born by states would produce higher highs and lower lows, and, two, the real rate of return on riskier investments like equities, despite greater volatility, would actually be higher over time.
Update: Chris Tessone takes issue with my assumptions, but he misses several key points. One, it’s true that past performance is no guarantee of future results, but that doesn’t mean it should be casually disregarded, either. It’s not like we’re talking about a small sample size: My data use 83 years of stock and bond performance, which includes many dramatic boom and bust eras. Two, his statement that pension funds are “heavily weighted in the direction of private capital investments” is just not true. Most pension funds have a small portion, say 10 percent, invested in private capital investments like real estate or commodities. The funds mainly invest in equities and bonds.
Most importantly, my post was solely about the financial elements behind public sector pensions. I have been quite strong in my criticism of the structure and the incentives for workers in the plans. But the structure and the financial assumptions are separate issues. For more, read our Better Benefits report.
This blog entry first appeared on The Quick and the Ed.
Taxonomy: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.
The Wall Street Journal featured a very good article this weekend on how poorly the 401k is functioning as the primary retirement savings account for millions of Americans. Launched in the 1980s to allow management-level employees to put away more money for their retirements, companies embraced 401ks as alternatives to costly defined benefit pension plans. The first group of workers relying solely on 401ks for their retirement are just now approaching retirement age, and the numbers do not look good:
Consider households headed by people aged 60 to 62, nearing retirement, with a 401(k)-type account at their jobs.
Such households had a median income of $87,700 in 2009, according to data from the Center for Retirement Research at Boston College, which derived this and other numbers by updating Fed survey data, at The Journal’s request. The 85% needed for retirement would be $74,545 a year.
Experts estimate Social Security will provide as much as 40% of pre-retirement income, or $35,080 a year for that median family. That leaves $39,465 needed from other sources. Most 401(k) accounts don’t come close to making up that gap.
The median 401(k) plan held $149,400, including plans from previous jobs, according to the Center for Retirement Research. To figure the annual income from that, analysts typically look at what the family would get from a fixed annuity.
That $149,400 would generate just $9,073 a year for a couple, according to New York Life Insurance Co., the leading provider of such annuities— less than one-quarter of the $39,465 needed.
Just 8% of households approaching retirement have the $636,673 or more in their 401(k)s that would be needed to generate $39,465 a year.
In other words, the vast majority of workers are going to be working more years, trying to find part-time jobs, and relying more heavily on their Social Security benefits. This is important context for the debate over public-worker retirement benefits, and it should be a cautionary tale to anyone who thinks 401k-style investment plans are the solution to our country’s impending retirement crisis.
This blog entry first appeared on The Quick and the Ed.
Taxonomy: