Chad Aldeman and Andrew J. Rotherham
Education Sector
July 2010

Alderman and Rotherham mince no words: Teacher pensions are a huge
problem. First, they drain state and district budgets: The total public
pension liability—much of which is owed to teachers—facing the states
approaches $500 billion under the most conservative assumptions. In
other words, the average American owes nearly $1,500 to his state’s
public sector retirees, and each Alaskan owes a whopping $5,133. Second,
the “defined benefit” structure of most pension plans was designed for a
orce that stayed in one job for a career; today, however, employees
often switch careers, which means old-style pensions may actually deter
high-quality teachers from entering and staying in education. By
comparison, the private sector mostly uses “defined contribution” plans.
The names say it all: In the former, the benefit—i.e., the payout in
the unknown future—is defined, based on a formula that factors in things
like years on the job; in the latter, the contribution—i.e., how much
the employer pays into the fund now—is what’s set, with no guarantees
for future value. This short-term/long-term disconnect undergirds
pension politics, too: Politicians have a natural incentive to reward
teachers with improved benefits when times are flush, while state laws,
even constitutions, often prevent them from ever decreasing
benefits when times are scarce. So what to do? The most interesting
suggestion here is the little known “cash balance” plan, in which
employees have portable accounts that grow based on annual contributions
(à la defined contribution), but annual returns are guaranteed so that
investment risk is borne by the employer (à la defined benefit). This
paper is short and simple, maybe too simple, but an excellent entrée
into a complex and critical issue. Read it here.

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