Brown’s CalSTRS problem

Taxpayers, new teachers to bear the brunt
By

Gov. Jerry Brown last week made a down payment on pension reform in the form of seven specific recommendations to slow the growth in pensions for public employees, including teachers. It’s the obvious steps to curb abuse, like banning retroactive pension increases, the purchase of additional pension credits, and the spiking of income in the final year to boost pension payouts.

But the release of CalSTRS’ annual report and the Legislative Analyst Office’s readable summary of it** last week shows why Brown is taking his time on dealing with the bigger issue: CalSTRS’ large unfunded liability. The remedy for straightening out the retirement system will be painful for taxpayers and for future teachers and administrators.

The reason, the LAO said, is unequivocal: “CalSTRS’ current fiscal model is unsustainable. … There is no realistic way for CalSTRS to ‘grow its way’ out of this problem through favorable investment returns over the long term, as the system’s own officials have acknowledged clearly.”

Though CalSTRS rebounded nicely with a 12 percent return in the past year, the loss of a quarter of its portfolio value in 2008 created too big a hole to count on the growth of  investments to keep up with obligations to current teachers and administrators and those already retired. As a result, payments into the system must be raised.

The current yearly contribution to CalSTRS is $5.2 billion: $2.3 billion from educators who pay 8 percent of their pay into the retirement fund, plus a match of $2.3 billion from school districts and county offices, plus  $688 million from the state. (The state also contributes  about $700 million more into a cost-of-living account.) CalSTRS actuaries are saying it will take an additional $3.9 billion annually for a fully funded system over the next 30 years – an increase in the contribution level of 75 percent.

Given the state’s precarious financial condition, no one is predicting the state will raise contributions this year. They could be phased in gradually, starting in a few years. But the longer the delay and the slower the phase-in, the higher the contribution level ultimately will have to be. Pay now or pay more later.

Unlike other public pension systems in California, in which employees can negotiate contribution levels, only the Legislature can set contributions for CalSTRS. A long line of court decisions has held that lawmakers cannot raise the contribution level of current employees or cut their benefits.

Brown may still choose to challenge those rulings – and raise the retirement age or put a cap on the level of income on which retirement benefits are paid, as some are urging. But it’s a dicey strategy. So over the next decade, billions of dollars in retirement obligations may have first dibs on new revenue that could have gone toward restoring programs and teaching positions cut over the past three years.

The only other way to gradually cut into the state’s liability is to whack the pension benefits of new teachers. That’s unfortunate, since the state needs to make teaching a more attractive profession, but it’s also all but certain, in one form or another.

Beside raising new teachers’ contributions and lowering the state’s and districts’ share, one option is a hybrid plan that combines a smaller defined benefit with a 401(k)-type matching program – technically, 403(b) – in which the risk of investment decisions is shifted to teachers.

An alternative pushed by the bipartisan Little Hoover Commission is to require future teachers and principals to pay into Social Security (currently requiring workers and employers each to contribute 6.2 percent of pay). Teachers, along with some fire and safety workers, opted long ago not to enroll in Social Security – and, for the most part, for good reason: A teacher with 35 years of experience retiring at 65 will receive more than twice what a worker making the same pay will get from Social Security.

But most young teachers don’t think about pensions; they worry about pay. Especially if cutting retirement benefits of new teachers is coupled with a long-term commitment to raise the pay of new teachers, converting to Social Security does have some advantages:

  • Social Security is portable, while CalSTRS is not. Teachers who don’t work five years in the profession – a huge percentage – aren’t vested and lose the districts’ and state’s contribution to their retirement. With Social Security, they’d get full credit for their work.
  • An alternative to CalSTRS would reduce pressure on middle-aged teachers, especially the low performers, to stay in a profession they may have tired of. As Merrill Vargo, executive director of Pivot Learning Partners, noted in a recent column, “Most people aren’t gluttons for that much punishment … so what is the incentive that keeps teachers hanging on when an employee in the private sector would be polishing her resume and scouring Craigslist for the next opportunity? Once we ask the question, one part of the answer is pretty obvious: it’s the pension.”
  • Participating in Social Security would eliminate a penalty that discourages people who have paid into Social Security from making a mid-career switch into teaching. They currently lose about $4,300 per year in retirement benefits under something called the windfall elimination provision, which deducts part of what they’re entitled to under Social Security. Congress shows no inclination to fix the problem.

CalSTRS’ challenges are real, and the unfunded liability to taxpayers is large. Those who dismiss the call for pension reform as merely another attack on teachers and the middle class should read the LAO summary.

** The LAO report was written by Jason Sisney, the LAO director of state finance.

10 Comments

  1. This is an excellent column.  As a PERS retiree, I’ve been actively seeking to help various groups formulate pension reforms.  My advice has consistently been that no pension reform is worth its salt if it doesn’t address the problem with CalSTRS as well as the even larger looming problem of state retiree health care.
    I’ve found that the hardest point to get across is the one you imply in your last sentence.  Pension reform is NOT, or at least should not be about punishing public workers and retirees.  On the contrary, a well-managed defined benefit pension is an efficient way to provide public employees with a benefit to help keep their total compensation competitive.  The problems arise when the pension system is not well managed.  Specifically, when you have employee groups dominating both the pension boards and the legislature you run a huge risk of creating an over-committed, underfunded, unsustainable system.
    Not just CalSTRS, but CalPERS and most local pension systems have got themselves into that condition to a greater or lesser extent.  Wanting to restore sustainability to those systems is not anti-union or anti-public employee, although some of the current momentum for pension reform is certainly powered by that animus.  To the contrary, it is pro-public employee and pro-good government.
    Unfortunately, the situation is now so bad that the only road to sustainability goes through some very rough territory.  But, it will be worth the trip and the only real choice is to postpone the journey, which will make it infinitely more difficult.

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  2. This is indeed a good piece with reasonable suggestions.  As a retired teacher receiving a CalSTRS pension, I would be amenable to raising the retirement age (I retired at 63 but easily could have worked longer), increase the employee contribution, or reconfigure teacher pensions into social security for the intriguing reasons noted above.  What I would ask in return (and the unions are blind for not doing so) is a corresponding belt-tightening from the rest of the educational establishment.  At this time the most visible lack of such belt-tightening is the Obama administration’s Race to the Top (RTTT) education grant, with its attendant requirement that qualifying states replace their standards with the federal Common Core Standards (CCS).  CA will not receive an RTTT grant, yet it has still agreed to drop our current standards, regarded by nearly everyone as among the best in the nation, at a cost estimated by EdSource in excess of $1 billion- about a fourth of the shortfall in CalSTRS.   Protestations about the deficiencies of the current standards are thrown out casually as if some great significance is obvious, but look around at the carnage in our public schools, in terms both of economic and educational collapse.  No one would expect this unfolding disaster to be reversed by new standards except those whose livelihoods will be enhanced.  No fair just to squeeze teachers!  Everyone needs to give!

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  3. “Specifically, when you have employee groups dominating both the pension boards and the legislature you run a huge risk of creating an over-committed, underfunded, unsustainable system.”

    This is a political moral hazard that is implicit in defined-benefit systems. Politicians will always give preference to a powerful political special interest groups over the legitimate interests of the future and/or those who are likely unaware of how their interests are being undermined. Defined-contribution systems are paid for in the present with dollars taken from present taxpayers creating the necessary competition of interests required for a functioning democracy.

    Bringing teachers into the Social Security system will have costs. Being out of it is, on the whole a benefit for teachers, even if certain teachers are hurt because the offset formulas are lacking precision. That’s because Social Security has a significant social welfare component which would be a net negative for most teachers who earn decent money. That is also true concerning the SS disability fund which is out of money quite soon as well as the cost relating the pyramid scheme financing of Social Security, an example of the moral hazard I cite above.

    However there’s no moral reason to allow some people to escape the burden of Social Security, especially those so connected to the political party that “defends” it so vociferously. A fix by Congress of the system should include that, as has been suggested by honest reformers.

    Finally, why is it “attacking or punishing” government employees to expect that their retirements reflect those of the taxpayers that must fund them? Shouldn’t government be promoting equal treatment between all citizens and not creating a privileged economic class of its own employees?

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  4. A CALSTRS member does pay 8% of their gross salary, but a school employer pays 8.25% of the gross, so as usual a journalist gets it wrong. The employer does not match the employee’s contribution but currently pays a quarter percent more than the employee.

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  5. John, thanks for this great post. In the tech sector (where I started my career), companies often include restricted stock grants that employees may sell only if they stay with the company.  These restrictions, known as “golden handcuffs,” typically are a few years in duration.  If the company is thriving and the stock price rises, then employees have a financial incentive to stick around a few years to “vest” away the restrictions.
    The teaching profession has golden handcuffs, too.  In the early years, most teachers think little about pensions.  (Why should they?  Unless they stay five years, which many do not, they won’t qualify for one anyway. Unlike Social Security wages, STRS contributions collected from those who bail out are eventually swept back into the pot for the benefit of those who stick it out past year four.)  After a few years, teachers might start to think about switching districts for personal or professional reasons. But that carries risks:  teachers that switch districts change employers, losing their seniority.  Frequently, a teacher that has climbed a few years up the salary schedule can only switch districts if she or he is prepared to take a pay cut to do so.  A change of districts also resets the teacher’s seniority LIFO clock: Budget hiccup = pink slip.
    After about ten years or so, it makes zero financial sense for a teacher to change districts, and by then the teacher may have gotten some idea about out how major a part of teacher compensation is “deferred” compensation in the form of a pension. In the private sector, some executives are able to defer a portion of their compensation until retirement, an arrangement that provides tax advantages as well as retirement security (assuming the employer doesn’t go bust) because they trade current compensation for a future stream of payments. Teachers in California ALL receive the benefit of deferred compensation through STRS.  Actually, it’s something like a deferred compensation arrangement paired with a life insurance policy.
    A teacher’s contributions to STRS are small relative to the payout, especially if they live a long life.  On Ed100.org, the post about Pensions (post number 3.11, scheduled for April 5) includes a graph that shows the bizarre pattern of each year’s total compensation including both actual compensation and each year’s increase in lifetime pension expectations under STRS. File this one under the truth-is-weirder-than-fiction file. Total compensation spikes in year 30, dips in year 31, and jumps back up in years 32-37, when about half of compensation (on the order of $125,000 per year) is deferred. In year 39, the incentive reverses, and teachers actually LOSE total compensation if they continue to work in year 40.
    To be clear about what the graph says, teachers in year 32 are not receiving cash compensation of $125,000 per year. Their paycheck is about half that amount. The other half – the less visible half – is the pension equivalent of a big deposit to an IRA savings account.
    None of this is to argue that teachers shouldn’t have great compensation, or great retirement security. But the system as it exists today is not sustainable, it is blighted with odd incentives, and it is set up in a way that understates the financial attractiveness of a teaching career relative to other options.

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  6. One of Governor Brown’s pension reform proposals is to eliminate “air time,” the purchase of government employee service credit.

    On the surface, that sounds like a good idea, but without providing supporting data, it’s nothing more than a sound bite.

    If I buy five years of service credit, it would increase my pension $800 a month but it would cost me a whopping $134,000!

    It would take 14 years to break even on money that would otherwise be earning me interest.

    It amounts to an interest free loan for the state unless I beat the odds of the life insurance actuary tables.

    Did Brown run the numbers? If so, let’s see them.
    Selling “air time” might prove to be a money maker for CalStrs.

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  7. The earlier in one’s career air time is purchased, the better of a deal it is.  Further, with 2008-20011′s current volatile market, it is a good investment so long as you plan on staying til 60 or more years and also plan on living a long time.
    On your side, CalSTRS recent pamphlet is encourageing members to purchase airtime in light of gov. Brown’s plan to curtail it.  But CalSTRS is urging it because they feel financially airtime purchase is good for CaSTRS!

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  8. Just read this article. I am trying to figure out what to do because I have 4.5 years of service credit and now teach out of state, so I will not eligible for benefits. There is a chunk of money sitting in my CALSTRS account. Trying to decide if I should leave it on the chance I will one day live back in CA and teach at least one more semester, or roll my retirement into an annuity. Not sure if having only 5 years of srvice cedit is even worth it. This stuff is confusing! Thanks for the article.

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  9. I know this is an old article, but there are some interesting points here. 

    It feels to me like everyone is kind of missing the whole point of retirement benefits. The point is of course that people who no longer work can still support themselves. The term ‘themselves’ of course being the requisite one. In addition to the fact that they do not need to rely on the state (which they otherwise would) the fact that they continue to earn and spend money maintains them as part of the tax base and as one of the drivers of our consumer economy. These points are probably even more important as our population gets older (and because we dont lose our right to vote in old age..  :-) ). 

    There are a couple points in the article that people should not miss. The first is the implication (not explicitly enough stated imho) that the current ‘problem’ was largely (entirely?) created by outside forces. As an example, before the current economic crisis, CalPERS was actually over-funded, but detractors never bother to mention that. The other is the quite enlightening quote from the LAO, “There is no realistic way for CalSTRS to ‘grow its way’ out of this problem through favorable investment returns over the long term…”  Thats a very interesting statement for me given that they are a professional investment entity, and have guaranteed (and substantial) contributions. Given that the alternative (generally termed 401k) is run by non-professional ‘investors’ (who, it has been shown, do much worse than professional investors, and even have a rate of return that is correlated with their level of income–read, the poor make the least return, often even losing money), and that the contribution is optional (the fact that it is optional means there is no economic force that will factor needed contributions into wages, in fact just the opposite), and thus invariably much lower than in defined pension plans, what that statement says to me is that moving everyone to 401ks is actually LESS sustainable.

    In the end, the goal here is a sustainable retirement, not to figure out some investment model that best matches some group’s political ideology. The state has as much interest in that as anyone, perhaps even more so because they are on the hook for those of us who will retire into poverty–over 90% of 401ks investors according to some estimates–and they will lose a significant tax base if we fail to achieve this. And of course, the state is all us.

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