Sunday, May 15, 2016

Solving the Pension Problem

Teacher pensions are a mess. Actually, teacher pensions are twenty-some different kinds of messes, depending on how your particular state has decided to skin that particular cat.

Chad Aldeman at Bellwether Partners has been on this particular case for several years. Bellwether is a right-tilted thinky tank co-founded by Kim Smith, who also helped start up Teach for America and NewSchools Venture Fund. Other co-founders include Andrew Rotherham (contributing editor at US News, former special assistant in Clinton White House), Monisha Lozier (former ed reform headhunter), and Mary K. Wells (former manager at Bain). Bellwether has several key partners, including NewsSchools Venture Fund, Stand for Children and, of course, the Bill and Melinda Gates Foundation. Yes, the reforminess is strong with this group.

Aldeman himself works in the Policy and Thought Leadership department, and previously worked at the US Department of Education where he worked on ESEA waivers, teacher preparation, and the Teacher Incentive Fund.

One on Aldeman's projects at Bellwether has been and all the issues it connects to (here he is writing about it almost exactly two years ago). But he's back with a new report called "What Do Pac-Man and Pensions Have in Common?" It's a handy title, telegraphing as it does exactly where he's headed.

Warning. Pensions are complicated and confusing and heavy on the mathiness and economics. My stock in trade is reducing complicated ideas to simple strokes, but I'm telling you up front that I may cut some critical corner in the paragraphs ahead, including part of Aldeman's argument. But I'm going to give it my best shot because this is serious stuff in serious need of some solutions, and we need to talk about both what should be done and what can be done. So, take a deep breath, and here we go.

Traditionally, pensions fall into two types-- defined contributions and defined benefits. For defined contributions, I put a bunch of money into a fund for years (maybe my employer agrees to put some in, too) and it sits there gathering money, or not, and when I retire, whatever has the pile of money has grown (or shrunken) into is what I get.

For defined benefits, my employer and I agree that if I retire when I'm X years old (as someone born in 1957, I've come to expect that once I pass 60, the formula for X will always be X= My Age + 4 years), a certain sum of money will be waiting for me, generally based on my best annual earnings in the last years before I retire.

Defined benefits requires some smart economics guys to figure out what will have to be paid in over my thirty-plus years of service in order to yield, through wise investment, the agreed-upon final amount. That's the deal many teachers in many states have always had, only things aren't going so well.

Some of the problems are ethical in nature, because a pension fund is a huge pile of money just kind of lying there, and politicians are eternally tempted to "borrow" from that pile with every intention of paying it back, someday. But even if politicians keep their itchy hands in check, well, if you check that last paragraph, you'll see the phrase "through wise investment." Over the last decade that has been a huge problem. Take for instance, my state of Pennsylvania, which back in the early 2000s said, "Let's go ahead and let school boards slack on their local contribution to the pension fund because we have got some genius investments going in this can't-miss housing market and we'll make such a killing in the market that the state won't have to put in as much money to keep the pensions solvent. It's a win-win for everyone! What could possibly go wrong??"

The state, like lots of other folks, figured out in 2008 exactly what could go wrong, and districts now have run out of road down which to kick the can. Pension payments are mushroom like a nightmare balloon payment, with districts facing payments of one third of their payroll costs going to plug the gaping hole in the pension fund.

Different versions of this scenario are playing out around the country, creating a big political mess. On the one hand, pensions are a promise that states made to their teachers. On the other hand, promises and moral imperatives do not make money grow on trees. Teachers did not make this mess, but this is probably one of those situations where assigning culpability doesn't get us any closer to an actual solution.

Aldeman's argument is that increased pension costs are eating everything else, that if districts didn't have to pump so much money into pensions, they could spend that money elsewhere, like salaries or health care or ice cream every Tuesday in the teachers' lounge (okay, that last one was mine, but I'm feeling a little hungry).

But what's really crimping into school budgets are the debt costs. States and districts are now contributing an average of 12 percent of teacher salaries every year just to pay down large unfunded liabilities, a result of politicians over-promising and under-saving. For the average American teacher, that's equivalent to $6,800 a year in money that could be going in their pockets but instead must be put into preserving inequitable pension systems. 

It's worth noting that some authorities take exception to Aldeman's use of the "debt" here, and prefer "unfunded liability." From an article about the report in the Atlantic:

How to characterize state’s outstanding pension obligations is a matter of debate. Aldeman calls it debt. Others don’t like the term. “​​The unfunded liability is not debt,” said Teresa Ghilarducci, a professor on retirement security at The New School, in an email. Rather, the investments made for the pension fund have not yielded the amount needed to pay the retirement money to everyone, she said, pinning the blame on pension managers and state lawmakers for investing poorly or not putting enough money into the fund to keep it afloat.

Aldeman also asserts that the current structure of teacher pensions is bad because few teachers actually benefit from it. His figures suggest that only one in five teachers actually remain until the official retirement age (you can find the data in Figure 2 in this report, along with the explanation of methodology in the appendix). On top of that, teachers can lose pension benefits when changing states or by taking career breaks that put them under the necessary number of years. In short, Aldeman calls it a "system that creates a small number of winners at the expense of a large number of losers."

Some of the usual objections to teacher pension systems are not that compelling. Some folks don't like the number of years required to vest, but vestment periods for a decent pension are not that unusual-- after all, it takes time to make money with your money. Underlying the debate about how long it should take to build a pension is the debate about how long we want teaching careers to be. If your dream is a teacher pool that is churned and turned over regularly, then you don't need or even want to incentivize sticking around for the long haul. But if you think stability and quality are enhanced by having a school staffed primarily by career teachers-- lifers-- then it makes sense to encourage and reward that kind of career. If the pension debate is really about making the profession more attractive and rewarding for people who only want to spend a couple of years teaching, then that's the conversation we should be having (because turning teaching into a couple-years profession is a terrible, terrible idea).

It's certainly possible that the solution to the various pensions crises is actually quite simple-- fully fund the pensions and stop whining.

That is not the popular option. In Pennsylvania, our legislators repeatedly propose a two-tier system in which the currently-employed get our defined benefits pension and new employees get a nifty 401(k) so they can do their own investing (or end up paying someone to do it for them, because when you're struggling to get all your papers graded and your lesson plans written, you really want to devote a bunch of time to becoming an investment whiz). There are numerous problems with this idea, ranging from the eventual crisis when the new generation of teachers find they have no money to retire with to the more immediate crisis when the lack of any new funds going into the old pension system hastens its complete collapse. More aggressive politicians have tried to find ways to just chuck the whole system, but in the Atlantic piece, Aldeman takes a less destructive position:

"We don't recommend that states go after the pensions of existing retirees or people in the workforce now,” Aldeman said. "That doesn't mean we can’t design a better system going forward for new workers. It's not about dismantling; it's preserving promises you’ve already made while moving to something better."

Aldeman has some ideas about what something better might be, and in the Pac-Man report throws attention at something called a cash balance pension, which is, um, this thing where, you, um, with the money, and, uh... Yeah, this is where I had to turn back to my research assistant, Dr. Google.

Wikipedia says that a cash balance plan "works much like a defined contribution plan, [but] it is actually a defined benefit plan for legal purposes." You've got an individually-maintained account, hypothetically.

Investopedia also underlines the fact that the benefits are defined, meaning that the growth or tanking of the market won't affect the pay-out at retirement. And they wrap that up with this interesting line: "the company solely bears all ownership of profits and losses in the portfolio." Does that mean that if the state can beat the return they promised me on my retirement fund, they (or the company running the fund for them) get to keep the extra?

Aldeman's other ideas are not really new ones. Some kind of personal investment set-up, which means the district gives you more money and you go play with it on your own. This has been around forever and it has never been clear to me why this is a good deal unless I am a genius investment manager, want to take on managing my retirement fund as a part-time job, or want to help make some investment manager a little more wealthy, all the while still risking my entire retirement on the whims and fancies of Wall Street and, seriously, when have they ever steered any of us wrong before?

And some of the problems that Aldeman wants to solve are not actually problems. Is it "inequitable" that I'll get a better pension return when I retire after forty-some years than some TFAer will get for leaving teaching before she even hits four years of service? I don't think so.

The current defined benefit system is also essentially a deferred benefit system, with states and districts saying basically, "We're going to take part of the money we could pay you now and set it aside for when you're done." But bad economies and bad decisions mean that states have also deferred setting aside the pension money. So now they're saying, "Well, not only do we need to hold back money for now, but we need to hold back money from the last ten years, so we'd like to use a time machine, but we can't, so we're going to time machine our way into your paycheck instead."

When Aldeman says that the unfunded mandates are eating current benefits and in effect reducing districts' financial flexibility, he's not wrong. In fact, he's not even showing the whole picture which, in my part of the world, includes school closings and staff furloughs as districts stagger under several financial issues of which pension costs are one huge example (cyber school costs are another; incompetent state legislatures that can't pass a budget are another).

But how do we move forward when we're behind. If I said to the state right now, "Hand me the contributions I'm supposed to have in my pension account so I can just go invest in pork belly futures or oranges or beanie babies," they couldn't do it. So where does that leave us. How do we even change horses in mid-stream when our horse is still on the bank.

His point is that teachers should really welcome some messing with how pensions are done, and yet that tends to make us nervous, and Aldeman and the company he keeps are not exactly the people who inspire trust in those of us who have been following the path of ed reform. I would frankly feel more comfortable if he just flat out said what is in this for reformsters. I can see pieces of standard reform agenda peeking through (short teaching "careers" are great, let's find ways to cut costs and spend less on public ed) but I don't imagine that this is all about just making life better for teachers. I don't think Bellwether has an Altruistic Bleeding Heart division. (Update: and as an alert reader noted, the report was funded by the Laura and John Arnold Foundation-- that would be the Enron millionaire John Arnold, who has spent a lot of time and money, according to some, "on a nationwide effort to gut retirement security.")

Have I run in enough circles yet? I'm almost done, I promise. Like many folks, I'm a bit stymied by the pension mess. I don't trust people who want to just take my money and perform magic tricks. But the system we've got is a tottering mess held together with duct tape and warm thoughts, and I don't know that any policy leaders have the wit and will to hold things together. And I don't know anybody who sells pork bellies. Let's hope someone can sort this out soon.


  1. Defined contribution plans are not pensions. Only defined benefit plans are.

  2. Why does it seem our pensions and health insurance are now in trouble? They have always been in trouble. But it wasn't so clear until 2004 until GASB (Governmental Accounting Standards Board) issued GASB 45 in 2004, which forced all public entities to begin reporting unfunded liabilities rather than ignoring them. Is your retirement 20 years in the really in trouble? Maybe. That maybe assumes future investments, costs, and savings. And we know how well predicting the future really works. Part of the problem stems from increases in retirement percentages given by state legislatures and state executives to teacher union members as payback for political favors (read money). How do we fix this? Well, we could give back a bit on retirement calculations. And, we could ask current retirees to do the same, over time and in small increments. This is a tough situation and really is one of the problems of being part of government-funded public service. We are held hostage by our political overseers.

  3. Defined contribution plans have much to recommend them. From the teacher's point of view, you are fully paid when the work is done, you do not have to worry that you might be dismissed right before vesting, you do not have to worry about having your wages stolen from you if you leave before vesting, and you do not have to worry about some politician in the distant future keeping the promise that a long dead politician made to you.

    From the employers side, I think that you lose something by making teachers more mobile, but you gain something from having to pay all the costs of hiring a teacher in the year that you hire the teacher. Negotiations will go better if the local government does not make promises that the future government will have to fulfill.

    1. Someone seems to have forgotten the crash of 2008. And the crash of 2000. And the crash of 1987. And....

  4. Another issue is the public does not understand how our pensions work either. I read comments all the time from people complaining about the huge pensions teachers have-here in Texas we are required to pay 8% of our salary into TRS because we cannot qualify for Social Security. We get only what we pay into it if as you stated, we last 30 years in service as a teacher. I don't really see that as a great benefit.

  5. If you want to read about analyses of public pensions, go to google, type in "glen brown blog," and click on the tab "pensions." There are 541 posts on "teacherpoetmusician."

  6. I feel very lucky to live in Ohio, because for some reason our system still seems to work well. We don't seem to be at the mercy of politicians, and the people in charge seem very savvy. A lot of money was lost in the Recession, but they re-tooled the investments, raised retirement age slightly, decreased COLA a little, and re-worked the formula a bit, and it still seems pretty solvent. I get about 2/3 of the average of my five highest years of salary, which is not huge, but decent, and much better than I would do with social security. I sure wouldn't want a 401K instead, because the state people are much better at investing than I am. They also still provide very affordable healthcare, at least for me; spouses are a lot more.

  7. Nevada's pension is also quite strong, but the libertarian jackals want to get at it so they can profit in management fees and be free to screw over the work force. Our pension is limited in the risk it is allowed to take and has done quite well.....401K's have been pilfered left and right by the big banks, a state fund has a bit more clout to fight back with.

    1. The simple solution is to invest your 401K in some equities through an index fund like Vanguard 500 Index Fund Investor Shares. You will pay a very low management fee, and would have done significantly better over the last 10 years than if you had put your money in a mix of high performing hedge funds.

  8. I'll take 75 percent of my working pay anyway TE. As for 401K, why should I pay any management fee and trust some people I don't know? Nevada Pers is operated by people in the system, public servants, who have a vested interest in my interest...a decent retirement.

    1. Old Teacher,

      I just looked up the total compensation for the president of BlackRock, one of the investment managers for Nevada PERS. In 2015 his total compensation was over 20 millions dollars. Where do you think that came from?

      Compensation for Blackrock president Robert Kapito:

  9. Old Teacher,

    Lets take a look at Nevada PERS. Here is a list of the investment managers. Do you recognize any of the names? Do you know any of them?

    BNY Mellon
    Invesco Realty Advisors
    Mellon Capital
    Pathway Capital
    Payden & Rygel
    UBS Global

    Your investment advisors are

    Callan Associates
    Peavine Capital Managment

    Do you think these firms and the staff at NVPERS manage your retirement account for free? I can assure you that is not the case.

    Source for Nevada investment managers:

  10. Thought this would be helpful in calculating the value of the pension given to teachers. Sure, I understand that many do not qualify for SS (more on that in a minute). On one hand, the value teachers receive for the pension from their employee is roughly the same as the average private employer contribution - 5.1% of wages (teacher) vs 5.4% of wages (private).

    However, according to the Public Plans Database at Boston College, teachers also get benefits equal to (1.8%)x(yrs of service) x (salary at retirement). So for a teacher earning $40,000 with 30 yrs of service, that means a DB benefit of $20,330.

    By contrast, a private sector worker with a 401K, that 5.1% employer contribution for a worker earning the same $40,000 and a 4% interest rate (CBO assumption) yields a nest egg of $96,131. That would purchase an inflation adjusted annuity of $4,450/yr.

    In summary, in addition to the employer contribution (which is about equal), the public sector worker gets an implied investment rate in their DB plan which is much higher than any private sector person could get. Typical DB assumed rates of return are 8%. Now that may not sound like a big difference (8% vs 4%), but over 30 yrs, that equates to the annuity that the teacher receives ($20,330) being 4.5 times what the private sector person receives ($4,450).

    To be clear, I have nothing against paying teachers well - particularly in subjects where there is a shortage (e.g. Math) and particularly in areas where it is hard to find teachers (e.g. poor, urban areas). But as a tax-payer, I simply ask two things:

    1. Transparency - Whatever is paid to teachers should be transparent and reserved on a current basis. If they are paid $40,000 in salary and deferred benefits which have a present value of another $20,000, that's fine. But that means you account for that full expenses - just like ERISA requires of private sector pension funds.

    2. Market - Second, any teacher compensation should be a function of the market. Obviously, union monopolies make this more difficult. But if a teacher working in a non-union setting is willing to work for less (or requires more), then this should be reflected in public sector compensation. Even more importantly, the compensation of the teacher must be tied to what the teacher does. Even if you do not support merit pay, any job requires a minimum level of performance to keep the job. The same should be true for teachers.

    1. I think the lack of transparency is a feature, not a bug. Local school districts can negotiate relatively lower salaries now that must be paid by the people in the school district now in exchange for higher retirement benefits that must be paid by somebody else. Compensation paid by somebody else always beats compensation paid by the citizens of the district, so that is what is done.

      A defined contribution plan forces the people benefiting from the teacher's efforts to pay the full cost of the teacher's efforts. A defined contribution plan prevents the wage theft inherent in the vesting process of a defined contribution plan.