A pension deficit disorder

Policy Review, Winter 1995
by Glass, Stephen

This year the largest number of teachers ever will become eligible for retirement. They're the lucky ones. With the help of teachers' unions, many of these instructors have won high salaries, small class sizes and seemingly generous retirement plans. Unions have fought long and hard for teacher benefits, and have emerged as the most important political advocate for the interests of public educators. That's why the vast majority of teachers join unions and pay steep annual dues. Aggressive lobbyists like the National Education Association don't deliver on the cheap.

However, when it comes to one of the most significant teacher benefits--employee pensions--the unions' performance is a matrix of betrayal. Unions have crafted a pension system that stymies teachers' career advancement. By penalizing educators who change districts, instructors and their families are forced to give up job opportunities and stay put, or jeopardize their retirement security.

Just ask John Kahle.

Kahle landed his first job in Overland Park, Kansas where for three and one-half years he taught writing to high school and junior high students. Like many teachers, the young instructor decided he needed to complete more graduate work to excel. He enrolled in a master's program in Nebraska and resumed teaching in Lincoln.

But shortly after his move, Kahle discovered that his pension wasn't portable: he lost all the money put in by the state, and some of the money he put in himself. One year later, Kahle's wife was accepted into the graduate history program at the University of Minnesota. Kahle now teaches seventh-grade English at Eden Prairie Central Middle School and once again he lost some of his pension when his family moved north.

"The inability to take my pension with me has been one of the most frustrating parts of being a teacher," Kahle added. "Teachers can feel trapped in a specific location since they lose if they move."

Or ask Clementina Duron, a principal in one of Oakland's roughest Latino neighborhoods.

After nearly a decade working in the public school system, Duron had a dream of starting a new school that would provide more educational opportunity for Latino students. So when the California legislature paved the way last year for publicly funded independent schools, called charter schools, Duron was one of the first to sign up.

In the year that has followed, Duron has jumped through countless hoops to get the 120-student Jingletown Middle School off the ground. Without any startup capital she has leased a school building, hired maintenance staff, developed a curriculum, and even has a waiting list of more than 30 students.

But Duron can't hire teachers from public schools.

It's not that she doesn't pay them well enough: The payscale surpasses the Oakland public school system. Nor are the medical benefits inferior: Jingletown's teachers have the same health plan as their public school counterparts.

According to Duron, non-portable pensions have been the silent obstacle to educational reform.

"I interview teachers who want to come here and we want to have, but pensions stop them, "Duron said, adding that the teachers prefer Jingletown's smaller class size and focus on academic basics. "It's hard to have any incentive when they will lose their pension."

These stories illustrate how pension systems have indentured educators by trapping them in jobs they don't want. Teachers' unions use pension politics to increase their own institutional power at their members' expense. In particular, this year teachers' unions demanded more representation on pension boards and increased social investing--despite their proven downward effect on investment yields. Moreover, the unions have vowed to fight all efforts to reform pension policies that would both increase mobility and eliminate underfunding.

STAGNANT PROFESSIONALS

Like doctors and lawyers, teachers consider themselves professionals, educated men and women who possess a universally applicable skill. An algebra instructor in Oregon would have no difficulty teaching the quadratic formula in Alabama. But unlike their professional counterparts, teachers cannot take advantage of a fluctuating market if they want to keep their nest egg intact: They are unable to move from state to state and in some case from a city to the suburbs. Teachers' unions have successfully lobbied all 50 state legislatures to create complex pension systems that severely punish mobility.

The typical teacher accumulates a pension over a 25-to 35-year period, as the teacher and the district/state jointly contribute to the statewide retirement system. Nearly all teacher retirement plans are defined-benefit systems where teachers are guaranteed a specific annual pension calculated as a percentage of their final salary. The state invests the contributions in order to pay future benefits.

The state/district contribution forms the bulk of teacher pensions; on average, the teacher contribution is about 6.5 percent of his annual salary, while the state typically contributes 12 to 13 percent, with some contributing more than 19 percent every year. Teachers are always entitled to their own contribution, but they can only receive the much larger state portion once they have become "vested," which requires working in the system for a specific number of years. Therefore, in order to safeguard themselves from losing the lion's share of their pension, teachers must remain in the same region until they are vested. In the private sector employees never have to wait more than five years to be fully vested, but state legislators have set longer waiting periods for teachers. Twenty states require teachers to work for 10 years before vesting and West Virginia requires teachers to work for 20 years before being vested in the system. In fact, only five states require less than the five year ceiling found in the private sector.

In addition to elevated vesting ages, almost all state programs have been constructed as " cliff vesting" systems, in which employees cannot receive any of the state contribution until they have worked the stipulated number of years. In the private sector, on the other hand, many pension programs are graduated, allowing non-vested employees to receive a portion of the employer contribution.

WORSE THAN THE PRIVATE SECTOR

Also unlike the private sector, vesting- requirements don't protect teachers. Teachers who move are penalized by the states if they don't work in the system for a specific number of years.

Consider a typical case: A teacher takes an out-of-state teaching job after working for 16 years in New York state--six years after being vested. This teacher is four years short of the 20-years-of-service level required for retirement. While the state must pay this instructor a pension at age 60, along with other vested teachers, it penalizes the teacher five percent per year for each year short of 20 years. Hence, the teacher's pension is reduced by 20 percent.

"Simply stated, teachers who change systems experience a significant drop in their pension," says Bruce Cooper, a Fordham University professor of education.

A study published by Carnegie Forum on Education and the Economy, found that teachers who spend 20 years with one employer and then 15 years with another earn only 70 percent of the pension benefits that they would have earned had they remained with a single employer.

Teachers' unions--the supposed protector of the nation's educators--are the chief culprit in enslaving their own constituency. While the unions were extremely effective in starting pension programs decades ago, in recent years they have focused on advancing their own interests at the expense of the instructors.

SIMPLE REFORM

There is a simple pension reform that would permit teachers to move between districts, whether for family reasons or in search of greater opportunity. It is called a defined-contribution system.

Under this system, increasingly common in the private sector, teachers would each have their own, completely portable, pension accounts. When they retired, their pensions would consist of the states' and their own contributions plus the rate of return on their investments.

Michigan's Governor John Engler converted state employees, including teachers, from a defined-benefit to a defined-contribution system last year. Maine has also begun a defined-contribution system for new teachers.

In addition to their portability, defined-contribution plans offer enormous advantages for teachers. Teacher pension plans in 35 states and the District of Columbia are seriously underfunded--with promised benefits exceeding expected assets by a total of $63.4 billion. Only 38 percent of Maine's pension promises are funded, only 33 percent of Indiana's, only 9 percent of West Virginia's. The Oklahoma Teacher Retirement System is projected to run out of money in the 2015, leaving $800 million a year in unfunded obligations. The Oklahoma state legislature will then be confronted with two options: Raise taxes about $1,000 a year per family, or welch on their promise to retired teachers. The latter seems more likely.

A defined-contribution plan gives the teacher greater certainty, because pension security does not depend on future tax increases. Moreover, because each teacher owns his retirement assets, a defined-contribution system can prevent pension funds from being raided by state legislatures for non-investment purposes.

Teachers' unions, however, j are staunchly opposed to defined-contribution plans. The Michigan Education Association fought Governor Engler tooth and nail over his pension reform. "The unions wanted control and the new system also allows teachers to more readily move," Engler's press secretary John Truscott said. "The MEA tried everything to stop us." At its latest conference, the American Federation of Teachers endorsed a resolution calling for "stringent measures" to battle defined-contribution plans.

MORE UNION POWER, BUT LOSING MONEY

Why this resistance? One reason may be that control of retirement funds gives teachers' unions phenomenal financial power. Teacher pension assets now total $342 billion, an enormous pool of capital, and the unions go to great pains to ensure that their allies make investment decisions, even if it means jeopardizing the retirement income of their own members..

Consider Resolution 29, recently endorsed by the AFT's Retirement Issues Committee, which called for action against state legislatures which demand that pension fund trustees have some financial knowledge. Currently, many of the systems' board members are retired and active teachers which are often selected by the union. But, the Retirement Issues Committee resolved that efforts to set minimum qualifications for trustees, in order to ensure pension fund investments are decided according to established principles, are "unacceptable pre-conditions." The unions prefer to increase the number of teachers on pension fund boards and control which teachers will fill these positions.

Greater union involvement on pension fund boards is harmful to teachers. Olivia Mitchell, a professor of risk management at the University of Pennsylania's Wharton School, determined that low funding levels were correlated to increased employee representation on public pension system boards.

In a study of 168 public employee retirement systems, Mitchell found that raising the number of employees on pension fund boards by 10 percent lowers investment yield by 2 percentage points. Currently the average teacher pension board consists of ten members, six of whom are teachers. Therefore increasing the board by only one member will result in investment returns dropping from an average of between seven and eight percent to between five and six percent.

For instance, in 1993, Mississippi unions lobbied the state legislature to add another teacher to the Public Employees' Retirement System, bringing the total number of members to ten. Mississippi PERS, with assets of about $5.8 billion averages about an eight percent return on its investments annually. Thanks to the new teacher on the PERS board, according to Prof. Mitchell's calculations, the Mississippi pension fund is likely to make $116 million less per year on its investments.

PENSION RISKED TO STOP REFORM

Teachers' unions are now using their control of pension funds to try to deny capital to companies competing with public education. At its 1994 convention, the National Education Association adopted a resolution calling on state chapters to lobby retirement systems to divest from corporations that support the commercialization or privatization of public schools.

Simply stated, the NEA has risked its members retirement benefits in a political battle against educational reform.

In some cases, the union-dominated pension funds lose money because they make investments for political reasons. During the late 1980s, the Kansas Public Employees' Retirement System, which includes the state's teachers, invested heavily in a number of Kansas-based companies in the hopes that it would keep jobs in the state. Among those investments was a savings and loan association which later failed and left the fund with a loss of $65 million and a coal company which filed for bankruptcy. In total, KPERS has written off $200 million in investments targeted for political reasons.

Union officials insist that pension plans are in excellent fiscal shape. Even so, at the NEA's 1993 Retirement and Benefits Forum in South Carolina, a budget specialist was asked to explain how tax structures could be reformed to "assure adequate funding" of pension plans. Steven Gold of the Center for the Study of the States outlined several strategies including increasing income tax, increasing property tax, and increasing sales tax.

"It's really a matter of putting together a package of tax increases and designing it carefully," Gold told the union members, noting they should prepare now: "It is possible that in 1995, or some time before long, states will be able to raise taxes." Teachers looking at the strength of the tax-limitation movement in federal, state, and local elections in 1994 would be well-advised to consider whether they can rely on future tax increases to guarantee their defined-benefit plans.

Defined-benefit systems not only expose educators to unfunded liability risk, they also hamper educational reform. For instance, under a defined-contribution plan, Clementina Duron would have no trouble attracting teachers: Public school instructors could readily move in and out of the system.

Teachers' unions have always fought educational reform--from voucher and privitization efforts to charter schools. Lobbying to maintain outdated defined-benefit plans over defined-contribution plans has become one of the unions' tools in this ongoing educational war. Without teacher mobility, educational reform is impossible since each new system relies to some degree on schools competing for the best teachers.

A defined-contribution system will ensure educators' retirement security and will remove a stumbling block to educational reform. However, if teachers continue to follow their unions, past performance demonstrates that investment yields will certainly fall and teachers will find their silver years tarnished.

Stephen Glass is assistant editor of Policy Review.