September 2013

A Grand Bargain on Teacher Benefits

September 12, 2013

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.

Alternative Models

Funding

Retirement Insecurity

The Failures of the 401(k)

September 12, 2013

Chad Aldeman

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.

Alternative Models

Baltimore To Buy Cheaper Teachers

September 12, 2013

Chad Aldeman

Baltimore announced plans over the weekend to offer buyout incentives to teachers with more than 10 years of experience. Buyout plans–where states or districts offer up-front money to encourage experienced employees to retire–are tempting budgetary solutions, but they’re not viable long-term human capital strategies.

Using the Baltimore proposal as an example, they plan to give 350-750 experienced teachers 75 percent of their annual salary, spread out over five years, if they announce plans to leave the district by April 15. Because it’s open to anyone with more than 10 years experience, some of these teachers will be eligible for retirement benefits immediately, but some won’t. Many will be eligible for health care benefits as well.

Running the numbers from the proposal, Baltimore calculates they’re going to be saving about $14,000 per teacher ($5 million in savings if 350 teachers participate or $10 million if 750 sign up), but these numbers do not include some hidden costs. To begin with, the move will shift costs from the district’s salary rolls to the state’s retirement system, which will eventually trickle back down to Baltimore. With employees retiring earlier than they planned to, this means the state will be paying out an additional year of benefits to those who are eligible.

The savings also include budgeting for new hires to fill the vacated positions. So Baltimore will be replacing one experienced teacher’s salary and benefits with a new teacher’s salary and benefits plus the cost of the retired teacher’s pension and health care. It also costs money to hire, train, and retain new employees.

None of this gets to the fact that experienced teachers are, on average, more effective teachers than the unexperienced ones Baltimore plans to replace them with. Nor does this measure target individual teachers who are more or less effective in the classroom: The only basis will be years of experience, with only a slight nod to the area they teach (teachers from the same subject area will be ranked by seniority). Essentially, with this plan Baltimore will be buying a less expensive teacher workforce. The losses to students are incidental.

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

What Not To Do On Teacher Pensions

September 12, 2013

Chad Aldeman

New York City Mayor Michael Bloomberg has proposed new pension rules that would require workers to work at least 10 years, double the current requirement, to qualify for a pension. This is a really short-sighted idea for someone who professes to care about the quality of government workers, including the city’s 75,000 teachers. Raising the vestment age would save the city money in the short-term, but it would mean government workers would essentially not have a retirement plan until they reached 10 years of service. That would hurt recruitment and retention efforts, and it would also create strong push and pull incentives to stay on the job, regardless of burnout or a desire to pursue a new career, until they reach that 10-year milestone. For better ideas on revamping pensions, see here.

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

Mobility and Portability

New Jersey Starved the Pension Beast

September 12, 2013

Chad Aldeman

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.

Funding

Pension Politics

Retirement Insecurity

Pension Hysteria

September 12, 2013

Chad Aldeman

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:

Alternative Models

Funding

States Try to Change the Rules After the Game Is Over

September 12, 2013

Chad Aldeman

The Wall Street Journal highlights a lawsuit going before a Minnesota court today that could significantly impact the way teacher pensions are looked at from a legal standpoint. Essentially, the state said it was broke, its teacher pension plan was too generous, and it was going to reduce future benefits, even to current retirees. The Minnesota case is the first of three key tests in the states to determine whether these actions are legal. The graphic below shows what changes other states are making to their pension plans.

First, if you care about teacher pensions, go read a copy of the Minnesota lawsuit (.pdf). One defendant worked for the City of Duluth for 34 years as a Draftsman before he retired in 2000. The other taught at a Minnesota public school for 14 years before retiring in 2008. These two retirees are part of a potential class-action lawsuit that could include up to 130,000 persons already receiving pensions from the state of Minnesota. The state has chosen not to enroll its public-sector employees in Social Security, meaning they have no other government-provided retirement benefit. To ensure that worker pension benefits do not wear away over time, the state has used a dual-component formula to allocate regular cost-of-living adjustments (COLAs) indexed to the rate of inflation.

In 2009 and 2010, Minnesota decided the COLAs were too generous, and so they reduced them and made them contingent on the plan’s overall funding level. We’re talking about small percentage changes here, but, over time, it adds up to real money.

The state claims its pension fund is broke and it needed to make these changes to ensure the plan’s long-term survival. That claim falls short on several accounts. For one, the state pension plan has never been fully funded and, after one of the worst decades in stock market history, it looks worse than it probably should. Two, Minnesota, like other states, enacted retirement benefit enhancements during the stock market boom of the late 1990s.

Legal Issues

Keeping Up, And Down, With the Joneses

September 12, 2013

Chad Aldeman

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.

Funding

Mobility and Portability

Pensions and Human Capital

The Sensible Social Security Solution

September 12, 2013

Chad Aldeman

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.

Funding

Teachers and Social Security

Fuzzy Math on Teacher Retirements

September 12, 2013

Chad Aldeman

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.

Funding

Pension Politics

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September 2013