Let's not forget about education's ugly little dilemma

Perhaps the only thing related to K-12 education that Ohio's governor and lawmakers aren't talking about "fixing" is the State Teachers Retirement System (STRS) (see here). That's odd, as few things are more out-dated, cost-laden and in need of reform than public pension systems.

None of STRS's problems have changed in the two years ago since we pointed them out in our report Golden Peaks and Perilous Cliffs: Rethinking Ohio's Teacher Pension System (see here). The STRS system is still opaque, costly, encourages early retirement, hinders mobility, and backloads teacher compensation from early in a career to the very end. And according to the system's latest annual report (which covers July 2007 through June 2008) the financial health of the system is worsening (see here). As the economy has melted down STRS's unfunded liability has topped $18 billion (up $3.7 billion from the previous year). As this liability has increased, so has its amortization period, up from 26.1 years in 2007 to 41.2 years in 2008 (despite state law requiring an amortization period of no more than 30 years).

STRS says its troubles are due to "investment returns being less than expected, retirees living longer and payroll growth being less than expected." The Wall Street collapse has only made matters worse. Also, retirees are not going to start dying younger and teachers are not going to willingly retire later when the incentives favor them retiring in their mid-50s.

Many individuals and families have seen the values of their 401(k)s plummet over the last year, and many of us have had to adjust our expectations accordingly. Teachers and other public sector employees do not have to do this in Ohio, or most other states, because their retirement benefits are guaranteed by the state. No matter how bad the public pension investments tank, the only ones who will take any of the hit will be taxpayers.

We wonder what taxpayers will think of a move to raise taxes and divert hundreds of millions or a couple of billion in "education" money to the STRS and other state retirement systems so folks can continue to retire in their mid-50s while the rest of us look at working until our 70s?

Public pensions are such a serious issue that economists got together last month at Vanderbilt University to discuss them (see here). Well before the financial meltdown, roughly 40 percent of the major teacher pension plans, nationally, were short of cash. Public pension funds are generally considered in OK shape when their assets are roughly 80 percent of liabilities. But Jay Greene, of the University of Arkansas, who attended the Vanderbilt meeting, points out that those supposedly solid pensions assume eight percent returns (see here).

No responsible financial manager ought to be banking on that. Greene agrees. He says it makes more sense to gauge growth, and presumably future pension payments, on the risk-free rate of long-term U.S. Treasury bonds. They are currently earning a little less than four percent. Assuming a four percent return, a teacher pension that would have been 70-percent funded at eight percent would drop to 44-percent funded.

To get a significantly higher return requires a lot more risk, but the gamble is, ultimately, with taxpayer money.

When the inevitable proposals surface for increasing pension contributions and making other changes to the system, the governor and legislature should seriously consider a redesign akin to what the federal government is starting to do for Social Security and Medicare.

Mike Lafferty is a Editor at the Thomas B. Fordham Institute