State teacher pension plan: What, me worry?
November 27, 2007
Teacher retirement systems across the country are receiving much attention as of late. Lawmakers and leaders of Ohio's state teachers' pension plan need to read a feature in the new issue of Education Next (see here) by economists Robert Costrell and Michael Podgurksy. In the article they explore the peculiar incentives of teacher retirement systems around the country and the impact they have on the composition of our teaching workforce and on public finance. This will not come as a surprise to Gadfly readers as Costrell and Podgurksy examined Ohio's system in a report in June that identified a $19 billion unfunded liability for pensions and questioned the impact of the system's generous, optional retiree health-insurance program on the fiscal health of school districts and teachers (see here).
One solution, according to Costrell and Podgursky, is to switch from defined benefit (DB) plans to defined contribution or cash balance plans that tie benefits to contributions made by teachers and their districts. Most of the private sector in America has switched to defined contribution (DC) plans over the last 20 years. A few teacher pension plans (Ohio's is one) have also started to offer DC plans but with strings attached that make them less appealing than the traditional DB plans.
In Education Next, Costrell and Podgursky provide a detailed primer on how teacher pensions work and their pitfalls. Teachers typically earn relatively little in the way of pension benefits until they reach their early 50s. The system encourages teachers to "put in their time" until then, whether or not they are well-suited to the job or want to make a career out of teaching. Then, after 25 or 30 years, the pension system begins to punish teachers for staying on the job too long, pushing them out the door at a relatively young age even if they are still good teachers and want to keep teaching.
Teacher pension systems also have important implications for recruitment. Many young teachers might prefer more of their compensation paid up front rather than diverted into a system from which they may well never benefit, according to the economists.
Retirement benefits have major impact on school finances because teachers are living longer. According to Costrell and Podgursky, a teacher retiring at age 55 in Ohio with a $50,000 inflation-indexed annual pension has received an annuity valued at over $1 million.
Finally, retiree health insurance can add much more to the taxpayer-supported bill. To fund these benefits requires large contributions from employees and employers. In Ohio, for example, contributions currently stand at 24 percent of salary (10 percent from the teacher and 14 percent from the district). But even this falls well short of what is needed.
The Columbus Dispatch reports on STRS's efforts to shore up its retiree health-care benefits by putting the squeeze on already hard-pressed local school districts and working teachers (see here). Through H.B. 315, STRS would create a dedicated health-care benefit fund and add at least $9.8 billion in health-care costs to its obligations. Over five years, school district contributions to the system would increase to 16.5 percent of an employee's salary and working teacher contributions would reach 12.5 percent. All this, and still no guarantee that these larger contributions would cover future health-care costs any more than current contributions will cover future pension checks.
The financial journal Barron's also has weighed in on the state of public pension systems with an editorial calling for a defined-contribution system that is simpler and fairer than the increasingly archaic defined-benefit system. Barron's calls for a public pension system that "does not lock people into jobs they do not like or pushes people out of jobs they want to do" (see here).
Citing an example, provided by Costrell and Podgursky, "an Ohio teacher can work for 24 years accumulating benefits that would be paid starting at age 60, if he quit or retired at any time in those 24 years. But on working a 25th year, the teacher suddenly becomes eligible for retirement at 55, gaining five years of benefits in an instant. Missouri uses a ‘rule of 80,' permitting retirement when age and years of service add up to 80, as long as the teacher is over age 45."
"Such features have been seen in private plans," according to Barron's, "but they are more powerful when there is an inflation adjustment in benefits. That's a feature almost never seen in private pensions, which of course are sponsored by entities lacking the power to levy taxes on their customers."