We've invited a range of panelists—from union leaders to economists to teacher voice organizations—to participate in an online forum on teacher pensions. We’ve collected their responses and will be posting the authors’ contributions here, in their own words, on a rolling basis this week.
Today's guest post comes from Josh B. McGee, the Vice President of Public Accountability at the Laura and John Arnold Foundation.* As an economist and public policy expert, Josh focuses primarily on educating the public and policymakers about the nature and size of the public pension crisis problem as well as potential structural reforms that are comprehensive, sustainable, and fair.
1. Is there a teacher pension crisis? If so, what exactly is the problem?
Elected officials have been shortchanging public employee retirement plans for more than a decade. Public pensions are now more than $1 trillion underfunded. While the current situation does not represent a crisis in most jurisdictions, action is still needed to remedy problems that could undermine teachers’ jobs, salaries, and retirement security for decades to come.
The seeds of the current predicament were sown well before the 2008 financial crisis. Governments (and corporations, for that matter) have a long history of promising benefits without paying the full cost. The 1990s are littered with examples of plan sponsors enacting retroactive benefit increases and taking pension holidays without regard for the future consequences of their actions. Likewise, after the dual recessions of 2001 and 2008, plan sponsors engaged in, and continue to engage in, any number of practices that push the cost of past service onto future generations of workers and taxpayers.
The result has been predictable – rising legacy costs have begun to crowd out current classroom spending. Teachers, especially new, young teachers just entering the workforce, face stagnant salaries and steep cuts to retirement benefits. If nothing is done to improve the sustainability of the system, teachers will be destined to face additional benefit cuts the next time the markets hit a snag or politicians decide not to pay for the benefits that have been promised. In the end, it is the very teachers the system is meant to protect who lose when they are forced into a post hoc negotiation over a pension debt.
The problem is threefold. (1) The current system’s cost structure is opaque and unnecessarily complex. Estimating cost accurately requires predicting a whole host of variables, many of which are not core to the promise being made to workers over a very long-time horizon. (2) The opaque nature of the cost and the great length of time between when benefits are funded and when they are eventually paid out provide both the opportunity and a strong incentive for politicians to underfund benefit promises. (3) Current reporting standards and funding practices do not hold plans’ sponsors accountable for imprudent or reckless decisions.
Importantly, it is entirely possible, both in theory and in practice, to design a system that solves all three problems while still maintaining investment and longevity protection for workers.
2. How do we ensure that teachers have secure, sustainable, and affordable retirements?
There is very little mystery as to how to provide workers with retirement benefits that are affordable, sustainable, and secure. First and foremost, plan sponsors must pay for their promises. This means adopting a responsible plan to pay down the accumulated pension debt over a reasonable time frame. Plan sponsors should target at least 100 percent funding within a closed, 30-year period. Plan sponsors should avoid schedules with negative amortization and should strive to pay down the pension debt over as short a time period as is possible. And any future pension debt that accrues should be paid down in a similar fashion. It is time to put an end to pension holidays and partial payments.
Additionally, plan sponsors must address the current system’s benefit-design flaws. Teachers in many jurisdictions earn very meager benefits through much of their careers placing them on a retirement-insecure savings path. The majority of those who enter the classroom leave before ever earning a secure retirement. Teachers also face very strong incentives to work for a certain number of years and then retire regardless of their desire to teach or skill in the classroom.
Many pension plans have adopted partial fixes that were meant to address these design issues. For example, deferred retirement option programs (DROP) reduce the financial hit teachers take for working past the plan’s normal retirement age, and some plans, like those in Wisconsin and Oregon, essentially offer teachers the better of a cash balance plan or a traditional final average salary pension to mitigate retirement insecurity in the early and middle portions of a teacher’s career. However, these partial fixes only complicate the system further, making it difficult to understand for both teachers and the plan sponsor who are supposed to fund the benefits.
When discussing plan design, I am reminded of Occam’s razor, which holds that the simplest solution is the best. Retirement savings plans should be simplified such that benefit accruals and cost are more closely connected, investment and longevity protection is explicit and easy to understand, and there is a clear plan to deal with cost uncertainty.
The key elements that all primary retirement plans should include are:
- Automatic or mandatory enrollment.
- Sufficient contribution and benefit accumulation rates at all stages of an employee’s career.
- Short vesting periods not to exceed five years.
- Access only to pooled, professionally-managed investments with low fees and appropriate asset allocations.
- Automatic or mandatory annuitization upon retirement.
- Appropriate defaults for investment, withdraw, and benefit payouts.
Placing all workers on a path to a secure retirement regardless of tenure or when they were hired should be the principle aim of any retirement system. Unfortunately the current system falls short of this aim in most jurisdictions today.
*Disclosure: The Arnold Foundation provides support for teacherpensions.org.