Teacher Pension Paradox: Rising Costs and Stagnant or Declining Benefits

The Issue:

Teachers’ strikes across the United States reflect increasing frustration with stagnant compensation and a perceived lack of sufficient funding for education. An important component of the stagnant compensation of teachers is the rising costs of funding pensions. Accumulated debt, in the form of promised pension obligations, is squeezing education budgets and triggering benefit cutbacks for newer generations of teachers. To the extent that school revenues are diverted to pay down pension debts, fewer funds are available to raise the salaries of current teachers and to fund education.

Accumulated debt, in the form of promised pension obligations, is squeezing education budgets and triggering benefit cutbacks for new teachers.

The Facts:

• Most teachers in the United States are covered by a public defined-benefit pension plan. In defined-benefit plans the employer agrees to provide the employee with a guaranteed payment at retirement. The employer is obliged to put aside sufficient savings to meet the expected future pension payments. But actual pension obligations can exceed the assets accumulated by the system, for instance, if the actual rate of return on assets is less than the rate that was used when computing needed contributions. The unfunded liability of a defined benefit plan is its debt. Most public school teachers are covered by state retirement plans in which the level of assets falls well short of liabilities. The challenges affecting teachers' defined-benefit pension plans are an important component of a broader public sector issue impacting the finances of many states and localities (see this EconoFact memo.)
• Virtually every teacher defined-benefit pension plan in the United States has experienced an increase in unfunded liabilities since the turn of the century, and in many states the increase has been substantial. As of 2013, the average cost of servicing pension debt across states, according to actuaries, was almost 11 percent of teacher salaries; up from 5.6 percent of salaries in 2007. The substantial debt carried by teacher plans has a myriad of causes, but the two biggest are that actuaries have assumed a rate of return on assets in excess of what financial economists recommend (see here) and, moreover, their assumed rate has not been consistently met; in addition, in some states statutory contributions have been below the annual required contribution calculated by actuaries.
• Pension contribution costs are rising to cover unfunded liabilities. When plans incur debt, the response is to raise contribution rates paid by teachers, school districts, and state governments. Recent rate increases in many states have been substantial – for example, legislation in California will more than double district contributions to the pension plan on behalf of teachers over a 7-year period, from around 8 percent of teacher salaries in 2013 to over 19 percent of salaries by 2020.  Since 2004, total employer contributions for teacher retirement benefits, inclusive of Social Security (in states where teachers are covered by Social Security in addition to the state plan), have increased from 12 to almost 23 percent of salaries on average nationally. In contrast to the experience of teachers, retirement benefit costs for private sector professionals have remained flat over this timespan, at about 10 percent of salaries (see here).
• Recent rate increases to plans nationally are needed to pay down debt and do not pay for improved benefits for teachers. In fact, new hires in many states have experienced benefit reductions as states have attempted to pay down debts and reduce costs. Previous generations of teachers benefited because promised pensions were more valuable than the resources set aside to fund them. Benefits improved in many states in the late 1990s and early 2000s on the heels of an extended bull run in the stock market, and a belief that these high returns would continue (see here). But the current generation of teachers must pay down these unfunded liabilities. Many states are making pensions less generous by reducing the benefit formula or raising the age and experience requirements for regular retirement for new hires. The disconnect between rising pension costs and stagnant (or declining) pension benefits likely contributes to general discontent around teacher compensation in the U.S.
• Concerns over pensions have been factors in recent teacher strikes. Recognizing the problems associated with defined-benefit plans, some states have shifted newly hired teachers into plans that more closely resemble those of private sector professionals (defined contribution plans akin to a 401k). This was a factor in the recent teacher strike in Kentucky, where teachers and legislators wrangled over the details of pension reform.