Blog: Pension Politics

Cities and states faced with rising pension costs have begun to search for the most effective way to balance retirement promises made to workers with the need for fiscal sustainability and employer flexibility. One such battle is currently playing out in California.
Illinois recently passed pension reform legislation with a number of complex provisions. To better understand the legislation and the issues around it, I spoke with Illinois State Senator Daniel Biss, a co-chair of a bipartisan working group exploring solutions to the state's pension crisis and a co-sponsor of the recent legislation.
In April there was a dust-up in the finance and education worlds when the American Federation of Teachers called out Dan Loeb, founder and CEO of a hedge fund, for simultaneously investing teacher pension fund assets while serving on the board of StudentsFirst’s chapter in New York, which advocates for pension reform, and advocating reform of teacher pensions himself. The whole episode was part of an enemies list exercise (pdf) by the AFT to put money mangers on notice if they deviated from the union’s line on pension reform. And it was, of course, easy fodder for one dimensional takes. But as is often the case the reality was more complicated.

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.

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.

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. 

Question: What do you get when you add a bad stock market + equally bad state budgets + generous pension benefits + an enhancement of those benefits + rising health costs + an aging workforce?

Answer: A large unfunded liability.

Example A is Pennsylvania, which recently announced they will be increasing the employer contribution rate for retired teacher pension and health benefits in 2010-11 by 72 percent over current levels. The projections into the future are even worse, as the Public School Employees’ Retirement System of Pennsylvania (PSERS) is currently predicting the rate to nearly triple in 2012-13.

The graph below shows a 60 year look, 30 years back and 30 years forward, at employee and employer contributions into PSERS. The blue line is the percentage of salary that the average employee contributes, and it has been pretty steady over time, although it has risen slightly. The red line is the combined contribution of school districts and the state (determined by formula, but the state contributes a little more than half), and it has fluctuated wildly. It was in double digits from 1973 to 1997, hit a low of 1.09 (1.09!!) in 2002, and is expected to reside above 30 percent from 2014 to 2020.

  • *indicates future projection

*indicates future projection

The projections already include an eight percent annual investment gain for the next 30 years, but even after that assumption added to the large employer contributions, the state will still have an unfunded liability of over $7 billion in 2039, in present dollars. To put that in perspective, the state and all its school districts contributed only $617 million last year.

The options to fix this situation are not very appealing, nor are they unique to Pennsylvania. State and local governments could, and probably will, raise taxes. That’s pretty much inevitable, but it’s also politically unpalatable. Because pension benefits are considered a legally binding contract, the state cannot reduce benefits to current employees. So, instead, they’re likely to address the political problem by taking what amounts to mild budgetary solutions and reducing benefits or changing the retirement structures for future employees and requiring higher employee contributions. PSERS could also seek to increase its investment performance (they’ve averaged a 9.25 percent return over the last 25 years), but to do so would require it to take on more risk.