September 2013

The big news out of the latest Public Education Finances Report is official confirmation that school districts spent less money per student in 2010-11 than they had the year before, the first one-year decline in nearly four decades. It’s worth taking some time to reflect on that fact, but the full report is also a valuable source of data on state and district revenues and expenditures and the entirety of the $600 billion public K-12 education industry. One key takeaway is that employee benefits continue to take on a rising share of district expenditures.

Just How Rosy Are Pension Plan Assumptions?

September 12, 2013

Conventional wisdom says that public sector pensions are far too optimistic in assuming an 8-percent investment return. Indeed, the stock market has far underperformed that goal lately, leaving pension plans in precarious financial shape.

But, if we expand our time frame to a longer horizon of, say, 25 years, it turns out that conventional wisdom is false. Using actual investment return results from state pension plans as of the end of 2012, the National Association of State Retirement Administrators found that median investment returns actually exceeded state targets over longer time periods:

5 years: 2.9 percent

10 years: 7.5 percent

20 years: 7.9 percent

25 years: 8.9 percent

This 25-year period included the bull market of the 1990s, one of the longest economic expansions in modern history, but it also included the subsequent crash, the disappointing 2000s, and the Great Recession of 2007-09. It wasn’t a “typical” 25-year period, but no 25-year period is typical. In fact, if you look at the performance of a balanced investment portfolio over long time horizons, it almost always beats state investment assumptions. As is often repeated, past performance is no guarantee of future results, but we shouldn’t ignore it, either. It’s tempting to focus on how bad the last five years have been, but it would be odd to argue that we should pay attention to only very recent history while disregarding the longer perspective.

So why are state pension plans in such poor financial shape today? There are two main reasons. One is that at the end of the 1990s, when state pension plans looked like they were in great shape, many states adopted benefit enhancements. State legislators looked at well-funded retirement plans, buoyed by an amazing stock market run, and decided they could support higher benefit payments. They couldn’t. Inevitably, short-term thinking put them in trouble today.

Second, the plans suffer from tremendous volatility. Investment returns now contribute about two-thirds of a pension plan’s earnings in a given year. When they turn negative during an economic crash, plan funding falls precipitously. But looking at a state pension plan after a recession and declaring it financially insolvent is no different than spendthrift state legislators expanding benefits at the end of the 1990s. They’re both driven by short-term thinking.

Pension Plans That Attract (Some) Florida Teachers

September 12, 2013

The research field of teacher pensions has been a relative backwater, but lately it just keeps getting more interesting. Yesterday, the Fordham Institute released a new paper from Marty West and Matt Chingos analyzing a 2002 policy change in Florida which allowed teachers to choose between a traditional defined benefit pension plan and a 401k-style defined contribution plan. The authors were able to track who chose which plan, what subject they taught, how effective they were in the classroom, how long they remained teaching, and whether the pension plan’s structure had any effect on retention.

Perhaps not surprisingly, they found that math and science teachers, teachers with advanced degrees, and charter school teachers were all more likely to opt for the portable defined contribution plan. These teachers may enter the profession not planning to stay for long or, in the case of charters, may anticipate switching to another school that’s not enrolled in the Florida defined benefit system (Florida charters have a choice on whether to participate or not).

Important, they did not find any differences in effectiveness between those who chose the defined benefit plan and those who chose the defined contribution plan, but they did find differences in attrition rates. Teachers who opted into the defined contribution plan were one percentage point more likely to leave before their second year and nine percentage points more likely to leave after their fifth year. This will give fodder to the crowd that claims that defined benefit plans do a better job of retaining employees than 401k-style defined contribution plans and support those seeking to preserve the status quo in most other states.

But wait, there’s more to this story. If you care at all about the thousands of teachers who will one day become ex-teachers, this paper puts numbers on just how many there are and how much money they’re losing. In the seven years of the study, Florida districts hired 92,000 first-time teachers. The authors found that roughly 40 percent of these beginning teachers stay less than six years, the amount of time Florida required a teacher to be employed before becoming eligible for pension benefits. By not meeting the vesting requirement, the authors estimate each of those ex-teachers will lose out on retirement savings of up to $27,784 in today’s dollars.

It was outside the scope of the study, but Florida recently lengthened the vesting period from six to eight years, meaning even more teachers are likely to become ex-teachers before qualifying for pension benefits, leaving even more money on the table. (See how Florida’s vesting requirements compare to other states here.)

Alternative Models

Retirement Insecurity

Pensions Have Have an Impact on Achievement– But It’s Not What You Think

September 12, 2013

According to important new research, teacher pensions—both how generous they are and how they are structured—have important effects on the quality of the teaching workforce. This research provides some insight into how the looming retirement of the Baby Boom generation may affect students.

Last week the Center for Retirement Research released a research brief looking at whether teacher salaries and teacher pensions affect the quality of new teacher hires, measured by SAT scores. Even after controlling for things like the poverty level of the school, minority enrollment, gender, and location of the teacher’s preparation program, it found that teachers from more highly selective institutions sought out teaching jobs with higher compensation. Teachers preferred both higher salaries and higher retirement spending, which is somewhat surprising given that retirement costs are often assumed to be opaque to employees, especially younger ones who won’t be thinking of retirement for many years.

In the mid-1990s, Illinois offered an early retirement incentive which allowed employees to purchase extra years of creditable service for calculating their retirement benefit. Over a two-year period, Illinois lost 10 percent of its teachers, most of whom were experienced teachers, as the early retirement incentive led to a threefold increase in the retirement of experienced teachers in the 1994 and 1995 school years. Across the state, average teacher experience declined and the number of new teachers increased substantially.

In Education Week, Sarah Sparks covered a new study looking at the Illinois early retirement program. In a nutshell, even though the “5+5”program led to huge numbers of older, more experienced teachers retiring, it did no harm academically. In fact, student achievement may have gone up.

All else equal, and since we know that teacher effectiveness rises with experience, we would have expected student achievement to go down. Yet, despite the influx of novice teachers, student math and English test scores either stayed the same or went up. Importantly, those results held true for low-income, minority, and low-achieving students as well.

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

Mobility and Portability

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

September 12, 2013

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

State Pension Plans

Mayor Bloomberg Made a Bad Trade

September 12, 2013

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

You're Probably Not Saving Enough for Retirement

September 12, 2013

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

Retirement Insecurity

Just How Rosy Are Teacher Pension Plan Investment Assumptions?

September 12, 2013

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.