Teachers Unions – Part 9

How guaranteed but unfunded pensions help union members and hurt taxpayers.

Continuing this essay series on the influence of teachers unions on America’s public schools, this essay focuses on the benefits of unfunded but guaranteed liabilities (in the form of pensions) public school teachers enjoy as part of their union-negotiated benefits packages.

As Terry Moe writes in his book Special Interest: Teachers Unions and America’s Public Schools:

[F]or the most part, pensions are governed by state statute, with less local flexibility than for other benefits, and the politicians who make the concessions are often state legislators and governors rather than school board members. They are all doing the same thing, though, by responding to the incentives of their jobs, which prompt them to see many employee benefits as virtually free goods to be paid for later by someone else … [N]ew accounting changes by the Government Accounting Standards Board (GASB), the independent nonprofit that sets accounting standards for state and local governments, are for the first time forcing school districts to calculate and publicize all of their future financial obligations and indicate how they intend to pay for them. The impact of GASB 45, as the new accounting rule is called, is destined to be revolutionary. The financial obligations of state and local governments, including school districts, have long been obscured by political trickery, creative accounting, and flat-out secrecy. But as governments slowly come into compliance with GASB 45, the public is finding out just how devastating the financial picture really is. Early audits revealed, for example, that for retiree health benefits alone the Los Angeles Unified School District has incurred future obligations of $5 billion, equal to 80 percent of its annual operating budget, and that the Fresno Unified School District has incurred obligations of $1.1 billion, equal to almost twice its annual budget. For New York City as a whole, audits have revealed the unfunded obligations to be a whopping $59 billion … When pensions are taken into account, the situation goes from bad to horrible. The 2010 Pew study estimates that, even without factoring in the full effects of the recession (their financial data are from 2008), state-run pension programs — which typically include teachers—are underfunded to the tune of $452 billion. A 2010 study by Barro and Buck argues that the situation is still worse. It points out, quite correctly, that even under the new GASB rules staterun pension funds are allowed to make much rosier assumptions—for example, about their expected rate of return on investments—than privately run pension plans are legally allowed to make; and it shows that, when more appropriate assumptions are employed, these state pension funds turn out to have unfunded liabilities of $933 billion. The secret is out. And with such jaw-dropping information publicly available in the years to come, school districts (and other governments) will have to get serious about actually funding these obligations — and thus about eating into their operating budgets or augmenting them with painful new taxes to make the necessary payments … These troubles and constraints are mainly relevant for the future.  Because of them, the mix of teacher compensation will change as time goes on.  But the point to be appreciated is precisely that teacher compensation is a mix. It is partly a matter of the salaries that teachers make, but it also contains a range of other payments, rights, and privileges that are quite valuable in themselves and are traded off against salaries precisely because teachers do value them. What matters, in the end, is the totality of all these forms of compensation, not salary alone.

In a previous essay we explored public sector union-negotiated unfunded pension liabilities generally, and here we’ll focus on teachers union-negotiated unfunded liabilities in particular.  As Moe writes:

Teacher retirement programs, unlike salaries and other benefits, are largely set up and controlled at the state level, although certain details can often be negotiated locally through collective bargaining. The plans are typically designed around formulas — which are periodically changed, often in response to political pressure from the unions—that determine the size of teacher pensions as a function of three main factors: age, years of service, and final salary (or some enhanced version of it). In Ohio, for instance, a teacher qualifies for a full pension if she is sixty-five years old or if she has taught for thirty years. The latter requirement is what really counts, because many start teaching at twenty-five or before, and they have thirty years of service by their mid-fifties. If a qualifying teacher with thirty years of service has a final salary of $70,000, say, the state formula would yield a retirement annuity of $46,200. If such a teacher had thirty-five years of service, however, the retirement annuity would jump by a whopping 45.4 percent, to $61,950. And if she had thirty-nine years of service, it would increase another 13 percent to a full $70,000. Someone who started teaching at twenty-five, then, could retire at the age of sixty-four and receive 100 percent of her salary for the rest of her life, with protections for inflation. The vast majority of America's workers can only dream of such a thing. In almost all these teacher retirement programs, including Ohio's, the formulas produce uneven jumps in benefits as a function of years served — in Ohio, the big jump comes at year thirty-five — and as a result, there are strong, built-in incentives for teachers to retire early (usually right after they qualify for the big jump). Teachers often retire in their middle to late fifties. In Ohio the average retirement age is fifty-eight. This in itself is a major form of compensation: teachers can retire at a relatively young age, look forward to many years of active retirement, and have a healthy annuity to support them. Forever. In addition — and this cannot be emphasized enough — they do not have to shoulder any of the financial risk. This too is a hugely valuable form of compensation. The elimination of risk is a key feature of defined-benefit programs and a key reason unions insist on them rather than accepting defined-contribution programs as alternatives. With defined-contribution plans — which most workers have, if they have any retirement plan at all beyond Social Security — the value of their retirement fund fluctuates with the stock market and the larger economy and can decline considerably during economic downturns. During the economic meltdown that began (roughly) in 2008, these retirement funds plummeted in value, threatening the security of millions of American workers. But that didn't happen to teachers. They have defined-benefit programs. With defined-benefit programs, the amount of the retirement annuity (usually with inflation safeguards) is “defined”: it is guaranteed. It does not fluctuate with the stock market or the economy and can be counted upon as future income. All the financial risk is borne by state and local governments. If the money these governments place in pension funds is inadequate or if the investments they make are unwise or victims of downturns in the stock market, they are responsible for making good on the annuities anyway. As we've seen, the money provided for these pension funds is inadequate. Politicians have awarded handsome pension benefits and then failed to ensure that the programs are fully paid for, creating a true financial crisis for governments and taxpayers. This is a disaster on many dimensions. But it also means, regarding the issue at hand, that the full costs of teacher pensions are not reflected in the contributions that teachers and their employers are making into the pension funds. They are paying less than they should for what they are receiving. This too is part of the compensation package. And it is an aspect of compensation that researchers mistakenly ignore … With pensions, therefore, teachers benefit in three crucial ways. The retirement payments are substantial compared to what most Americans receive. The payments are guaranteed to them, forever, entirely without risk. And no one is paying the true costs.

Still, as mentioned in a previous essay, research also shows that teachers are generally disserved by the pension programs their unions negotiate for them.  Researchers have found that:

Teacher pension systems are not only expensive; their structures are inequitable and misguided. Roughly 75% of teachers will be net losers from their pension plan because they will quit or change school districts before they have reached the minimum years of service to be eligible to receive a pension; or they will retire or leave the system before their contributions and the interest earned on them are more than the pension for which they then qualify. Even the winners in this pension lottery—the roughly 25% of teachers who remain on the job in the same system long enough to earn substantial retirement benefits—will have traded years of lower salaries in exchange for disproportionately large retirement benefits.

And regarding health insurance for public school teachers:

If we look at teachers generally, not just those from districts with collective bargaining, we find that 95 percent of them are provided with medical coverage, compared to 71 percent of all private workers and 85 percent of private sector professionals. Some 43 percent of teachers pay no monthly premium at all for these benefits, a bonus that is much less common among private sector workers (24 percent) and professionals (21 percent). The health services that teachers are receiving, moreover, are considerably more costly to provide — and thus are likely to be more extensive and valuable — than those in the private sector. For example, the average single-coverage monthly premium for teacher health care (which the district pays, in whole or in large part) is $458, which is 40 percent more expensive than the health care package for private sector workers ($328) and 29 percent more expensive than the health care package for private professionals ($355). These figures on teacher benefits, moreover, are for all teachers, and some 35 percent of them (mainly in southern and border states) do not have collective bargaining … In [the] seventy-five largest districts, health care benefits are universal, and virtually every single district — whether there is formal collective bargaining or not — offers teachers dental care and vision care. When it comes to how much teachers have to pay in premiums, however, there are clear differences: in 50 percent of the districts with collective bargaining, versus 32 percent of the districts without, teachers pay nothing for individual health care benefits, and in 82 percent of the collective bargaining districts, versus 64 percent of the districts without, teachers pay less than $50 a month … Pensions and health benefits provide valuable types of security for teachers after they retire. But the ultimate security is that, during the years when they are actively teaching, they essentially cannot be fired.

As Andrew Biggs of the American Enterprise Institute writes, as teachers union pension liabilities increase, those pensions come to rely on even riskier investments to make up for losses – investments that are riskier in large part because the policies supported by public sector unions tend to hurt economic growth generally:

In an article published in the journal Education Researcher, I examined the funding of 27 teacher retirement systems from 2001 through 2019, using data drawn from the Public Plans Database,  and looked to what the financial travails of many teacher pensions could mean for the future. In 2001, the median teacher retirement system was 96% funded, buoyed by the tech bubble in the stock market. But in 2001 the tech bubble melted down, and then in 2008 the housing market melted down and triggered the Great Recession. By 2019, the median teacher pension was only 70% funded. One flaw that most economists see in teacher and other public employee pensions is the funding rules these plans follow. State and local government pensions, including teacher plans, effectively credit themselves with the higher returns paid by risky investments like stocks before those risks have paid off. That is to say, the amounts governments contribute each year assume that those contributions will earn 7% to 8% interest in following years. Private sector pensions, by contrast, are required under federal law to assume lower discount rates based on corporate bond yields. This doesn’t mean that private pensions can’t invest in stocks. They can and do. But they cannot credit themselves with the higher expected returns paid by stock and other risky investments before those risks pay off. Consequently, the federal rules for private pensions require higher contributions upfront to maintain solvency and have resulted in a much stronger funding base over time. The typical private pension plan has put aside roughly twice as much in assets to pay each dollar of promised benefits than have teacher pension plans. While public and private pension funding rules in the U.S. evolved differently, mostly for historical reasons, most economists see no reason pensions in the two sectors should be governed differently, and in many other countries there is no distinction between public and private sector plans. The reason teacher pension funding has suffered so much over the past two decades is that teacher pension plans overestimated the rate of return they would receive on their investment. In 2001, the median teacher plan assumed a future nominal investment return of 8.0%, ranging from a low of 7.3% to a high of 8.8%. But the median teacher plan received an average annual investment return from 2001 through 2019 that was 1.4 percentage points below the return it had assumed in 2001. The smallest gap between assumed and actual returns was a -0.2% shortfall for the Oklahoma Teachers program while the largest gap was for the New Jersey Teachers plan, which assumed 8.8% future returns in 2001 but received only 5.8% from 2001 through 2018. Not a single teacher plan actually underestimated their investment returns from 2001 to 2019. Pension liabilities tend to increase by about one fifth for each percentage point change in the discount rate applied to those liabilities. For many teacher pensions, over-optimism regarding future investment returns played the major role in the unfunded liabilities those plans face today. And yet many teacher pensions have responded to today’s underfunding by taking additional risk with their investments, hoping that higher returns in the future will make up for past shortfalls. The median teacher pension plan in 2001 held 65% of its investments in risky assets, which include stocks, private equity, hedge funds, other alternative investments, commodities, and real estate. By 2019, the median teacher plan held 76% of its investments in risky assets. But this increased risk-taking is happening against a backdrop in which teacher pensions are less able to weather a stock market downturn. Teacher pensions are growing more “mature,” meaning that these plans have relatively larger numbers of retirees and fewer active workers. By my calculations, in 2001 the median teacher retirement system had 2.3 active employees for each retiree. By 2019, there were only 1.3 employees per retiree. A pension plan with more retirees must pay out larger amounts each month, leaving less room for error in riding out the inevitable investment downturns. But with annual pension contributions by schools and teachers already having risen by 70% since 2001, pension administrators may wonder how much more they can demand. Schools must pay for buildings, books, and yes, teacher salaries—not merely fund pension benefits for already-retired teachers. Teachers and education policymakers may wish to consider more far-reaching changes. The reality is that, even as many teachers complain of low salaries, their compensation package may be overweighted toward retirement benefits—not just pensions, which are typically far more generous than private sector workers receive, but also retiree health benefits.

In the next essay in this series, we’ll examine how teachers unions promoted prolonged school closures related to the COVID pandemic.