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In theory, public sector workers like teachers accept lower current salaries in exchange for better benefits like health care and pensions. But a new paper suggests that common perception about how we pay public sector workers is fundamentally flawed.
A new National Bureau of Economic Research paper from Maria Fitzpatrick examines a real-life choice offered to Illinois teachers in the 1990s. The state offered late-career teachers a chance to upgrade their benefit at a very discounted rate. Based on their responses and take-up rates, they actually valued the pension at only about 20 cents on the dollar. In other words, they'd prefer to have $2 in current wages over $10 in pension wealth (adjusted for today's dollars). Taxpayers and employers have to pay the full cost of the benefit, but, because the true costs are hidden, teachers don't value them fully.
This is a bit like a Christmas gift from your Great-Aunt Mildred. She may have spent $50 on a dandy argyle sweater, but you might only think it’s worth $10. (This isn’t just a silly abstract example; economists have documented that this "deadweight loss" actually happens.)
In this metaphor, teacher pensions are like the sweater: Protective and well-intentioned, but ultimately under-valued and under-appreciated. Teachers would rather just have cash, or at least a nice gift card.
Illinois’ state constitution now guarantees current workers and retirees pension benefits. But nothing in its constitution guarantees that the state fund them.
Illinois has a history of promising much while paying little. According to a recent report, Illinois struggled to fund its pensions for decades, extending back to 1917. Illinois’ first pensions were a fixed, flat annual benefit, but neither benefits nor contributions were tied to salary. Instead, teachers paid an arbitrary flat contribution based on milestone service years. State contributions were based on certain taxable properties. Pensions initially were treated as gratuities or gifts that the state could adjust or take away, and funds were not held in a trust and could be used for other purposes.
Even when pensions were later restructured and included employer and employee contributions tied to salaries, the plans continued to struggle. In 1969, the Illinois Teachers’ Retirement System was 40 percent funded and the Chicago Teachers Pension Fund was only 32.7 percent funded. Overall, the state’s five pension systems were just 41.8 percent funded. This means for every dollar the state needed to fund future payments, it saved only 41.8 cents. Not much has changed since 35 years ago: today the Illinois Teachers’ Retirement System is still just 40.6 percent funded and the Chicago Teachers’ Pension Fund 49.5 percent funded, according to the plans’ own actuaries.
In 1970, the state constitution was amended to include the following (known as the Pension Protection Clause):
Membership in any pension or retirement system of the State, any unit of local government or school district, or any agency or instrumentality thereof, shall be an enforceable contractual relationship, the benefits of which shall not be diminished or impaired.
The above language protects pension benefits, but the Constitution is silent on funding those benefits. There is no recourse for forcing a state to pay its annual required contribution or address shortfalls, and Illinois has consistently skipped or shorted its pension payments for decades. On top of this, both politicians and worker unions have an incentive to advocate for pension increases without paying for them.
After the recession, the political landscape turned. Illinois politicians passed legislation that scales down benefits for new workers, enacts a funding plan requiring 100 percent funding by 2043, and provides a funding guarantee (if the state comptroller fails to make state pension contributions, affected pension systems can sue to order payment). The legislation, however, was challenged and will be argued in the upcoming month and may eventually proceed to the state Supreme Court. The decision will have big implications for how Illinois deals with its growing pension shortfalls and worker benefits in the future.
Illinois has carried significant pension debt for close to a century. What makes this different is now the costs are starting to catch up. Consistently short funding pensions has led to higher contributions and rising debt costs that eat into salaries and other social spending. It’s time for Illinois to change the course of its history.
New Jersey has a gaping $3 billion hole in pension funding. But there’s more at stake than just finances. Undergirding New Jersey’s deepening pension hole is a system that disadvantages the majority of its teachers.
Last week the newly formed bipartisan New Jersey pension commission issued a report, detailing grim numbers on escalating benefits costs. Missing from the report, however, was how the current system impacts the workforce.
For teachers (who make up over 60 percent of workers covered by New Jersey’s state pension plans) the current pension system disproportionately allocates benefits. Close to half of New Jersey teachers won’t qualify for a minimum pension. That means, for the 153,500 teachers currently in the system, nearly 70,000 won’t receive any retirement benefits despite paying into the pension system. Of the remainder who do qualify, many won’t break even according to an Urban Institute report and will end up contributing more towards the system than what they will get back in benefits, losing money.
In crafting their proposal, the Commission needs to consider the impact that policy changes will have on individual teachers and the teaching workforce as a whole. Teachers need a flexible yet secure retirement plan. A well-designed 401k plan can address these problems, but a poorly designed one could just as easily fail teachers. Also, there are other alternatives. A smooth-accrual defined benefit or cash-balance plan is another viable design that can be fiscally sound while making sure teachers have sufficient benefits and rewarding them for their service.
By focusing only on finances, the Commission is missing a key opportunity to create a more fair system and opens the door for a misaligned solution. The answer can’t just be cut benefits—New Jersey needs to restructure and rethink the overall design of its retirement system to make it better for all workers.
There's a strange paradox going on in public pension funding.
On one hand, pension plan assets are higher than ever. Rising stock markets--the S&P 500 has tripled since reaching a low in March 2009 and over the last 10 years, the largest public pension plans have earned an average return of 7.45 percent, broadly in line with the median long-term goal of 8 percent--have boosted pension plan coffers to the highest level of assets they've ever had. Nationwide, state and local pension plans have collectively accumulated $3.7 trillion, an astonishing sum of money.
On the other hand, pension funding ratios remain virtually unchanged. According to the latest figures, pension plans have not made much of a dent in their long-term unfunded debt. How could this be? A recent article from The Arizona Republic summarizing a Moody's Investors Services report helps illustrate why:
1. Insufficient Contributions: State and local governments have a tendency to under-fund pensions even during good times. But economic crashes hit pensions at the same time they hit state and local governments. When faced with the choice of contributing to under-funded pension plans or paying for current services like schools, roads, and prisons, politicians tend to opt for the latter.
2. Compound Interest: When governments delay contributions into the future, they're inevitably raising the long-term cost of the debt. Like a creditor paying off only their minimum balance, states have pushed many of their costs out to some future day of reckoning.
3. Less Aggressive Assumptions: Many states responded to recent recessions by adjusting their investment assumptions down from 8.25 to 8 percent or from 8 to 7.5 percent. It's important and a good policy for states to recognize a more modest investment return, but it forces them to admit much higher liabilities than they previously assumed.
4. Actuarial Miscalculations and Demographic Changes: Pension plan valuations depend on assumptions about a host of factors like how much employees will earn, how long they'll stay, how long they'll live in retirement, etc. Things like higher-than-expected pay raises, higher retention rates, and longer life spans all add liabilites to a pension plan. States have tended to err on the side of under-estimating their actual future costs.
The end result is that pension plans are in almost exactly the same shape they were during the worst of the recent recession. Pension plans were counting on rising stock market values to overwhelm these factors, but so far that bet hasn't panned out. The horrifying truth is that the current bull market--which has already been one of the best periods in modern history in terms of both duration and strength--has been unable to significantly restore pension valuations. That's a scary reality for taxpayers, retirees, and current workers, who must hope markets continue to rise. If not, and until we see more systematic reforms, we may see another round of contribution increases and benefit cuts.
Update: Bloomberg reports on a miniscule uptick in funding ratios. Using the latest available data, it found that, "the median state system last year had 69.3 percent of the assets needed to meet promised benefits, up from 68.7 percent in 2012." State pension plans need continued strong performance in the stock market for funding levels to improve more rapidly.
While Teach for America (TFA) teachers are working to close the achievement gap, most are also losing out on core retirement benefits like a pension and/or Social Security, creating a gap in retirement security.
Teach for America has produced close to 40,000 teachers over the past decade and continues to grow rapidly. Corps members serve a two-year commitment in low-income urban or rural schools (disclosure: I was a TFA corps member and taught in Baltimore for three years). They work as full-time teachers and receive salary from their district employers and presumably retirement benefits from their state or local system.
Although TFA teachers are just a drop in the bucket compared to the entire teaching pool, the program gets frequent national attention, especially about its retention and effectiveness numbers. A recent study from the University of North Carolina examined retention and effectiveness amongst early-career teachers in the North Carolina public schools, dividing teachers by their preparation program. The study found that TFA teachers, while only comprising a small fraction (0.5 percent) of all North Carolina teachers, outpaced all other teacher preparation programs in teacher evaluation ratings and their added impact on student achievement. TFA teachers, however, had the lowest retention rates. Less than a third of North Carolina TFA teachers stayed for 3 years and only 10 percent stayed for 5 years.
While most TFA teachers may not realize it, almost all are losing out on retirement benefits for their time in the classroom. Consistent with national trends, TFA teachers are not staying in the classroom long enough to meet state service requirements or vesting requirements for a pension (to be clear, TFA is simply too small to be the cause of these national trends). Most states require a 5 to 10 year vesting periods. Nationally, almost two-thirds (60.5 percent) of TFA teachers continue working as public school teachers beyond their two-year commitment, but nearly three-quarters (72 percent) of all TFA teachers will leave the classroom before five years. In North Carolina, 90 percent left without retirement benefits despite the state’s decision to keep lower service requirements at 5 years rather than 10 years. In several states, TFA teachers are not covered by Social Security because of state prohibitions against public school teachers and/or public sector workers; teachers in these locations lose out on pension and Social Security benefits.
Recently, Teach for America announced it would pilot a new program aimed at increasing preparation and retention amongst their teachers. The decision marks one of the biggest policy changes in its program history. In making this historic shift, the program should also consider that a significant portion of its members have lost out on core benefits, and teachers, as working professionals, need adequate pay and retirement security. Salary and benefits are obviously not the reason teachers teach, but they are important levers that stakeholders need to consider for strengthening recruitment and retention.