The School Administrator Payoff from Teacher Pensions

The costs of retiree benefits for educators, including legacy costs from unfunded benefits for previous retirees, consume a large and growing share of public spending on K-12 education. Between 2004 and 2012, data on fringe benefits from the Bureau of Labor Statistics show that pension costs for public educators rose from 11.9 to 16.7 percent of salaries. In contrast, pension costs for professionals in private firms. The stewards of the system benefit the most were relatively flat, at about 10 percent of salaries, over the same period. These gaps are likely to continue to widen as states and school districts attempt to pay down large unfunded liabilities in educators' defined benefit (DB) pension plans. Using estimates from the pension funds themselves, the Pew Center on the States estimates that the unfunded liabilities of state and local governments for retirement benefits total roughly $1 trillion. (About half of that is school-related, since K-12 workers represent about half of state and local employment.) That trillion-dollar number, as vast as it seems, understates the seriousness of the situation. Most economists agree that the official calculations greatly underestimate the true liabilities. Estimates of the unfunded liabilities more than double if similar calculations are performed using standard methods in financial economics. Defined benefit plans provide retirees with a guaranteed lifetime benefit, the annual value of which is typically based on number of years of service and average salary during the years of their careers. Between 1973 and 2005, the share of private-sector workers covered by DB pensions declined substantially, from 88 to 33 percent, while the share of workers in a defined contribution (DC) plan only, e.g., a 401k or IRA, jumped from 16 to 63 percent. DB plans remain the norm in the public education sector, however, despite the fiscal problems and the weak economic rationale for mobile professionals like teachers, many of whom move out of state or out of the profession and lose much of their accumulated benefits. Furthermore, as a result of pension enhancements enacted during the stock market boom in the 1990s, the role of DB pensions in the total compensation package for public educators has become larger over time. This is a clear area where the public and private sectors are on opposite trajectories. There are a variety of reasons DB pension plans have persisted in public education. The most obvious factor is strong teacher support. Unquestionably, teachers unions have vigorously advocated for generous DB retirement benefit plans. A largely overlooked factor is that education administrators, the stewards of the system, are enrolled in the same plans as teachers. This is typically not the case in large private-sector firms, where senior managers have their own retirement benefit plans. As we document below, the rule structure in educator pension plans, combined with the career-cycle timing of teachers' promotions into administrative positions, results in senior management in K-12 education enjoying the largest net benefits from these plans. With such high personal stakes, there is no reason to expect K-12 administrators or the organizations that represent their interests to support pension reform efforts. Yet it is these administrators who are expected to be the professional voice for the school districts that are bearing the heavy cost of employee pension benefits. Final-Average-Salary DB Plans The DB pension plans in which virtually all public school teachers and administrators in the United States are enrolled share the same general features. In these plans, the annual retirement payment, or annuity, is based on the product of three variables: years of service, a formula factor, and the final average salary. In the state of Missouri, the formula factor is 2.5 percent and the final-average-salary calculation averages the highest three years of earnings. …