University of Arkansas Professor: Pension Plans Create Spikes in Wealth, Worsen Teacher Shortage

STANFORD, Calif. — The structure of many teacher pension plans is driving experienced teachers to retire early even though they are in high demand because of teacher shortages and requirements of the No Child Left Behind Act, according to a news release from the Hoover Institution at Stanford University. Robert M. Costrell of the University of Arkansas and Michael Podgursky of the University of Missouri-Columbia published the findings of their new study about teacher pension plans in the winter 2008 issue of Education Next.

At the same time, the pension structure has the perverse effect of locking younger teachers, who may want to leave or are better suited for another job, into “putting in time” so as to receive a large spike in pension wealth.

Not surprisingly, many teacher pension systems allow educators to continue to teach and collect their pensions at the same time, a practice called “double-dipping.” Those provisions — such as part-time employment, employment in areas with shortages and returning to full-time duty after a specified break in service — seem to be expanding, note Costrell and Podgursky.

Teacher pensions do not have a smooth, uniform trajectory of wealth accumulation. Rather, they’re typified by sharp peaks and valleys caused by changes in the annual annuity payment (determined by a benefit formula) and the number of years a teacher can expect to collect it. That arrangement induces teachers to stay on the job until they reap the benefits of sharp pension spikes, then pushes them to retire early — often in their early to mid-50s. Costrell and Podgursky point out that, for those who want to leave the profession, working just a few more years can mean a difference of several hundred thousand dollars.

In Arkansas, one of the five states in their study, Costrell and Podgursky noticed that, for a teacher who entered the profession at age 25, a particularly sharp spike occurs at age 50, when that teacher’s pension wealth increases by almost five times his or her salary. Pension wealth accrual drops off precipitously the following year and by age 54 has turned negative. Similarly, teachers in Missouri, California and Massachusetts experience pension spikes in their early to mid-50s, followed by much slower growth and ultimately shrinking pension wealth.

State legislatures often enhance the benefit formula when the stock market is up and the value of pension funds is high and then, when the market falls, find themselves saddled with large, unfunded liabilities. Costrell and Podgursky point to benefit enhancements enacted by the legislatures in California and Massachusetts that have created spikes where none previously existed. In Arkansas, benefit enhancements over the years have shifted the spike to the left, to earlier retirement. Likewise, Ohio’s multispiked system reflects its history of legislative benefit enhancements: the state once had a single pension spike for teachers at age 60; it now has three spikes, beginning at age 50.

 Retiree costs for teachers are thus spiraling out of control. The traditional defined benefit pension system that covers most public school teachers requires that both teachers and employers make large contributions each year to a pension trust fund.  In Ohio, for example, pension contributions currently stand at 24 percent of salary (10 percent from the teacher and 14 percent from the district). But this falls well short of what is needed, and pension officials are recommending an increase to 29 percent to shore up funding for pensions and retiree health benefits.

Because individual benefits are not tied to individual contributions in a defined benefit pension system, it’s expected that the pension fund as a whole will accumulate enough money to pay for total accrued liabilities. Costrell and Podgursky found that rarely to be the case. Many teacher pension systems have large unfunded liabilities. In 2006, California’s teacher pension system had an unfunded liability of $19.6 billion; in New Jersey, $10 billion; in Missouri, $5.2 billion; in Ohio $19.4 billion. Arkansas’ unfunded liability in 2006 was $2.3 billion.

Retiree health insurance also drives up costs dramatically. Because regular Medicare eligibility does not begin until age 65, teachers who retire in their 50s have a substantial gap in coverage. In response, many school districts and states have extended their health insurance coverage. Unlike the teacher pension system, however, payments for retiree health insurance are typically pay-as-you-go. Costrell and Podgursky point out that, under new accounting rules, benefit plans and employers will need to begin providing annual estimates of these liabilities. The early figures are shocking. Los Angeles Unified, for example, which provides complete health insurance coverage for retirees, has an unfunded liability initially estimated at $5 billion and rising.

“Peaks, Cliffs, and Valleys: The Peculiar Incentives of Teacher Pensions” can be read in the new issue of Education Next, now online at www.EducationNext.org. Education Next is a scholarly journal published by the Hoover Institution that is committed to looking at hard facts about school reform. Other sponsoring institutions are the Harvard Program on Education Policy and Governance and the Thomas B. Fordham Foundation.