The Politics of Teacher Retirement Plans
An Interview with Frederick M. Hess and Juliet P. Squire

by Michael F. Shaughnessy
EducationNews.org
August 6, 2009

http://www.frederickhess.org/6069/the-politics-of-teacher-retirement-plans

1) You guys have just released a report about teacher pensions. First of all, why write about this aspect of teaching?

This has been a tough year for those who think that each generation should address its own challenges and not palm them off to the next generation. Elected officials have used trillions of borrowed dollars to hand out sweeteners and stopgap measures—calling these measures "investments." In reality, though, we're burdening our children with staggering liabilities in an attempt to avoid the consequences of our own lack of discipline.

This tension is especially pronounced when looking at teacher benefits and pensions in K-12 schools. Public officials have made expensive promises to influential adult constituencies and left our kids to foot the bill for generous pensions. State pension systems were more than $730 billion in the red—even before the market meltdown last fall. Furthermore, these plans have little promise to improve education. Teacher pensions are inflexible; they emphasize time served and lack portability. This makes them ill-designed for attracting and retaining talented teachers in today's labor market. The result is a system that increasingly funnels K-12 dollars toward generous benefits while simultaneously hindering efforts to boost teacher quality. The fiscal crisis has brought this issue to the forefront of the debate. It is important for reformers to take a second look at this huge financial outlay and reconsider how political incentives can be reshaped to encourage meaningful reform.

2) How do the trends in public pension plans compare to trends in private companies?

Public and private pension plans have diverged substantially over the past thirty years. The private sector has increasingly adopted more flexible models. These include defined-contribution plans, in which employees bear the responsibility for investing their funds, and cash-balance plans, which have a guaranteed level of benefits but accrue steadily rather than at the end of an employee's career and can be rolled over into an IRA or another employer's retirement plan, should the employee change jobs. In 1979, 62 percent of private-sector workers were enrolled in defined-benefit plans, compared to 16 percent in defined contribution plans. By 2005, those numbers had reversed, with 63 percent of private-sector workers participating in defined-contribution plans and just 10 percent participating in defined benefit plans. Cash-balance plans have also become increasingly popular, today including 23 percent of private sector employees. In other words, most employers are responding to a more mobile workforce by making it easier for workers to enter or exit jobs without putting retirement benefits at risk.

Most public pension funds continue to operate under a defined-benefit model. Just eleven states and the District of Columbia have adopted any kind of defined-contribution alternatives. Just four of these have defined-contribution plans as their primary plans. And a recent analysis by Janet Hansen found only two "hybrid" cash-balance public pension plans across the country.

3) Given the large number of teachers and the vast amount of money dedicated to their pension plans, one may wonder what affects how state policymakers design pension benefits. What did you find out?

Discussion of teacher pensions has typically focused on economic and technical questions like whether pensions are adequately funded, how they impact state and district budgets, and how benefit formulas affect efforts to attract and retain talented teachers. But it is self-defeating to view public pension reform primarily as a technical exercise. The key decision-makers are motivated by political incentives, not economic ones.

There are four incentives acting on public officials that may work against the fiscal stability of a pension fund. The first incentive is that pensions are fundamentally designed for delayed gratification. This means that public officials can win votes by making promises today while leaving the costs for others to deal with later—an inducement to short-sighted behavior. Second, from a politician's perspective, the larger public is not equipped to understand the costs and benefits of pension systems. The complex benefit formulas and actuarial adjustments mask the cost of generous promises to anyone who isn't a CPA, making pensions a less transparent and more appealing way to increase teacher compensation. Third, many stakeholders—including legislators, board members, employee unions, fund management firms, and actuaries—may have investment preferences that are not necessarily aligned to the long-term interest of the fund. Officials may want to hire management firms or make investments based on political, rather than fiduciary, considerations. Finally, political officials and pension boards may also have incentives to take undue risks in their investment strategies, since they stand to reap the benefits of successful but risky investments in the short term (e.g. by providing larger payouts or collecting smaller contributions) and can push the consequences of shortfalls off until later.

4) What safeguards are in place to ensure that pension plans are well-funded? Are they adequate?

There are few meaningful safeguards to prevent policymakers from running down pension plans. Federal law sets standards and requirements for private pension plans through the 1974 Employee Retirement Income Security Act, but these do not apply to public pensions. While ERISA is beset by its own shortcomings, there is little similar oversight for public plans. Public plans are governed by accounting standards set up by the Governmental Accounting Standards Board, which provide the framework for the annual audits that most governments contract to independent accounting firms—but GASB has little or no enforcement power and limited incentive to confront the states and localities that contribute to its budget. As a result, pension analysts are concerned that many states adopt methods determined more by politics than sound fiscal standards.

For instance, the health of public pension funds is measured by actuaries, who examine pension obligations, the current available funding, and predict the return rate on current investments. However, these estimates are often malleable and by manipulating actuarial assumptions, such as an expected rate of return, a fund can appear better funded than it would if it used more conservative assumptions. Scholars Tim Eaton and John Nofsinger have suggested that pension funds are systematically more likely to use assumptions requiring smaller government contributions during fiscal downturns in order to mask shortfalls. Many economists fear that actuaries routinely underestimate the cost of public pensions by as much as a third. The GASB standards and use of independent actuaries are not enough to protect against these political incentives.

5) What opportunities does the current fiscal crisis lend to growing pension obligations?

Fiscal crises have the potential to alter the political calculus around pension plans. Typically, teachers unions are the most influential and organized constituency in state legislatures. They actively oppose pension reductions and lobby for increased benefits. This is not illogical: pension benefits are obviously concentrated upon today's career educators and long-time public employees have a great deal invested in existing pension systems. At the same time, the costs are spread widely among a state's citizens. The result is predictable. Those who stand to lose their benefits are typically far more energized, organized, and vocal than any of those who would be marginally better off, making it unpopular and politically perilous for public officials to address funding shortfalls or change retirement rules. These political dynamics can flip when fiscal crises highlight how the public's interests are being compromised in order to cater to public employees. In several instances, vocal taxpayer watchdog groups have brought substantial attention to the costs of increased benefits and prevented state legislatures from adopting them.

Meaningful pension reform requires that advocates mobilize and agitate the public by explaining the costs of current arrangements and framing debates over policy and practice in terms of the actual costs imposed. This is extraordinarily difficult to do, and the reality is that it typically only happens when fiscal crisis throws existing policy choices into stark relief. When those opportunities do emerge, reform-minded legislators and advocates have a chance to harness public opinion and frame benefit increases as irresponsible, craven, and kowtowing to "special interests." In these circumstances, reformers must promote measures to modernize benefits and deliver responsible fiscal stewardship, and not simply settle for makeshift patches that soon allow states and localities to carry on business as usual.

6) You discuss how the workforce has changed in recent decades. What does the generation gap between new and veteran teachers look like, and what does it suggest for pension plans moving forward?

A national 2008 Education Sector survey of teachers showed that new and veteran teachers diverge on a number of prevalent issues. More than a quarter of recent hires think that the unions "lean more toward taking care of the needs of veteran teachers" and just 4 percent think that they favor newer teachers. New teachers are more likely to favor reforming traditional pay systems than are veteran teachers: they are 10 to 20 percentage points more likely than veteran teachers to favor giving financial incentives to teachers, whose classes routinely outperform on standardized tests, who hold certification from the National Board for Professional Teaching Standards, or who receive outstanding evaluations from their principals.

The pool of potential teachers has shifted drastically in recent decades and pensions must be redesigned to better suit these new entrants. The system of teacher training, hiring, staffing, and compensation that worked passably well in the 1950s is no longer well-suited to the needs or labor market realities of 2009. Pension plans frequently assume that the new generation of teachers will teach in the same state or district for the length of their career. This might have made sense when the typical college graduate would hold only a small number of jobs in their career and most teachers were college-educated women with few career options. Today, however, the average college graduate holds eleven jobs in a lifetime—the majority of those before the age of thirty—making it hard to be confident that new hires can be retained for an extended period, much less for decades. Successful pension reform begins by acknowledging that the new generation of teachers is cut from a different cloth.

7) How does the design of pension plans affect the sector's ability to attract talented teachers?

Defined-benefit pension plans can discourage potential teachers—including talented midcareer applicants—who might not be inclined to commit to a decades-long career in a single job or locale. They reflect an expectation that personnel will teach in the same state or district for the length of their career. In 2007, an employee had to work approximately six years to become fully vested in the typical public pension fund, with seven of the nation's largest teacher pension funds requiring ten years of service or more. Pension systems reflect a strict careerist tilt, in which educators are penalized for departing before serving twenty-five or thirty years and in which they are penalized for remaining longer. Economists Robert Costrell and Michael Podgursky have observed how pension rules reduce worker flexibility and penalize teachers for moving across state lines or into and out of schooling.

A more flexible and portable model would ease exit from and reentry into the profession, and enable the teaching profession to more effectively compete for college-educated talent. Most employers are responding to a more mobile workforce by making it easier for workers to enter or exit jobs without putting retirement benefits at risk and education needs to follow suit.

8) What are some considerations that we need to keep in mind when thinking about reforming pension plans?

There are at least three considerations that pension reformers should consider. The first is the strategy to "starve-the-beast". Since there are temptations for legislators to spend and unions to demand any available dollars, there is a perverse discipline implicit in funding shortfalls that dampens the urge to ratchet up benefits. Two caveats are important to note: it is not clear how sustainable this strategy is over the long haul and even when public officials finally bite the bullet on the mismatch between promises and resources, there is little evidence that they have the stomach to address anachronistic pension designs.

Second, there is a persistent need to "grandfather" current teachers and retirees when promoting change. This is due not only to legal limitations but because unions will fight bitterly to protect the benefits of current members while, whatever they say, less passionately protecting those of future members. Viable reforms typically must placate current teachers as the price for change, limiting the fiscal benefits of new rules and delaying the process of transforming the workforce.

Third, the rewards for public officials who step up and take on pension reform are almost nonexistent. Given that the rewards for pension reform are so out of step with political incentives, it is essential to devise institutions and arrangements that don't depend on self-abnegating public officials to produce sensible reforms or responsible public stewardship. A useful example of this is how H. Ross Perot's 1992 bid for the U.S. presidency led to extraordinary attention to the federal budget deficit, which influenced policy choices by the Clinton administration and, most significantly, helped lead to the adoption of new budget rules in Congress that produced budget surpluses in the closing years of that decade.

9) How can we alter the political calculus?

There are ways to better enable public officials to make the kinds of difficult choices that are needed. One approach, particularly relevant to efforts to promote sound fiscal stewardship, is to craft rules that mitigate short-term political incentives by increasing the autonomy and independence of auditors to provide greater insulation from pension boards and legislators. Another tack might be the creation of a federal or multi-state body with the authority to police public pensions and to establish guidelines for fund balances and anticipated rates of return. Adopting such measures would be enormously difficult, since they run contrary to the normal incentives for elected officials, but they only need to be adopted once. Measures like this can solve the current problem but also alter the political calculus going forward.

A similar strategy is to insulate pension reformers from the wrath of veteran public employees while appealing to the sensibilities of civic leaders, journalists, and the broader public. In Georgia, for example, the 1983 Retirement Systems Standards Law requires that in order to even be considered by the legislature, any legislation with a fiscal impact on the state pension plan must undergo additional independent and legislative scrutiny. If the Legislative Counsel finds that the law has a fiscal impact on the retirement system, it can be passed but cannot be enacted unless it is concurrently funded. If a bill is passed but is deemed by the state auditor to be unfunded, the law becomes null and void. Of course, because Georgia's state auditor is appointed by the Governor, the safeguard is far from ironclad. Nonetheless, this kind of insulation and analysis creates a "cooling off" period and can provide an opportunity to ensure that the costs and implications are fully aired.

A third model is that of the U.S. Congress's Defense Base Realignment and Closure Commission. The historic problem in closing military bases was that legislators who embrace the theoretical notion of new efficiencies and cost savings also face enormous pressures to protect hometown jobs—even when they might entail wasteful or duplicative spending. The BRAC process established criteria for base closures on the front end and then required legislators to vote the entire proposed package up or down. Officials could no longer lobby to protect particular bases. This provided substantial insulation against irate constituents and framed a vote to reject closures as a vote for inefficiency and waste. A similar process for pensions, in which legislators are voting for a package of provisions to fundamentally modernize and rationalize teacher hiring (perhaps accompanied by heightened pay), could allow reformers to make a "no" vote look like a capitulation to narrow interests while offering a simple up or down vote that legislators could readily explain to the broader electorate as a vote in the public interest. None of this should be taken to suggest that such a path is easy or likely, only that approaches like this offer a more fruitful course than those tried thus far.

10) Is there a web site where people can learn more or get a copy of your report?

The report is available on the NCPI website at http://www.performanceincentives.org/conference/papers2009.asp and on the AEI website at www.aei.org/futureofeducation.

Frederick M. Hess is director of education policy studies at the American Enterprise Institute. Juliet P. Squire is a research associate at the American Enterprise Institute.

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