Recently, Chicago Public Schools (CPS) has been in the news as it grapples with rising pension costs. The tradeoffs CPS is facing to make its required pension payments, in terms of tangible educational services, have brought increasing visibility to pension issues in Chicago. The precarious fiscal situations of other teacher pension plans—and make no mistake, most plans across the U.S. are facing serious fiscal challenges—have not yet become so dire as to make front-page headlines, but are already impacting education financing in important ways.
Like other public workers, the vast majority of public educators are enrolled in defined-benefit (DB) pension plans. Retirement benefits in these plans are characterized by a formula that depends on salary and years of covered employment. The pension funds rely on actuaries to determine how much must be contributed during teachers’ careers in order to pay for the promised benefits that they will receive in retirement.
In principle, this is a reasonably structured system, but in practice it is now apparent that pension funds systematically collect too little in contributions from working teachers (and on their behalf from employers). When teachers retire, they are owed more than they have contributed over the course of their careers. The effect on pension-fund balance sheets has been the steady accumulation of unfunded liabilities; effectively debt.
In a recent paper with a team of colleagues, we document a stunning number: on average across state pension plans that cover public educators, over 10 percent of salaries for new workers are being collected and used to pay down previously accrued pension liabilities. To say this another way, it is as if teachers’ retirement contributions are subject to a 10 percent management fee that they personally do not benefit from. This is a deep deficit that makes accumulating net wealth over the long term very difficult.
In the new paper we show that pension plans have been redirecting resources from younger to older teachers for quite some time. Even before the 2008 financial crisis, on the back end of an extended period of strong economic growth, unfunded pension liabilities were large (on average across states, five percent of teacher salaries were required to pay off these liabilities as of 2007). The fact that teacher pension plans have been carrying substantial debt for an extended period of time, and the debt remained even after an unusually long period of sustained economic growth (through 2007), suggests that this is a structural problem, not a momentary aberration.
Factors contributing to unfunded liabilities in educator pension plans
A variety of factors have contributed to the accumulation of unfunded liabilities in educator pension plans. One factor is skipped pension payments by government agencies on behalf of teachers, but despite being a high-profile factor, skipped payments are not a primary driver of the problem nationally. Another factor is that during good economic times in the past, like the late 1990s, pension funds retroactively improved benefit formulas, which increased pension liabilities. From a budgeting perspective his type of policy change would be palatable if symmetric benefit cuts were made during economic slowdowns, but pension benefits are protected, at least for existing workers, so this is not possible (nor would such cuts be desirable). A third factor, and the factor that research shows to be the most significant contributor to rising pension debt, is that actuaries have consistently assumed a rate of return on investments that is too high. When the actual return does not match the assumed rate, pension shortfalls occur.
The pension plans that cover teachers across the United States have accumulated substantial pension debt, and the key factor driving debt upward (perpetually unmet actuarial assumptions on investment returns) remains largely unaddressed in most plans. Today’s working teachers are being saddled with significant pension debt costs, with over 10 percent of their salaries currently being diverted to pay down the debt without contributing to their own retirement benefits at all.
Given this state of affairs, it is perplexing that pensions rarely come up in education policy discourse, and teachers themselves have not expressed dissatisfaction with these systems. I have always attributed this to a lack of information—the high pension debt costs are buried in the financial reports of the pension funds and not readily accessible. But admittedly this is speculative, and I wish I had a more definitive answer as to why there is so little policy discussion of pension issues in public education. If it is an information problem as I suspect, it would support calls for greater transparency in pension reporting. In the meantime, debt costs in educator pension plans across the United States are quietly absorbing valuable educational resources.