Pension fix will cause painful unintended consequences
Governor Kasich is set to sign legislation that will extend the life of the state’s five public pension systems, including the State Teachers Retirement System (STRS). The legislative fix includes what the Cleveland Plain Dealer refers to as a “combination of raised retirement eligibility ages, raised employee contribution rates, new guidelines for cost-of-living adjustments or a new formula to calculate benefits.”
In short, lawmakers have bought the current defined benefit pension systems some more life. But the STRS system, and this is true to varying degrees of the other retirement systems, is still burdened by fundamental flaws that will force quality educators to retire sooner than they want, and make teaching and educational leadership less competitive in attracting top talent over the long-haul.
The state’s action has undeniably extended the life of STRS. Consider that the legislation moves the unfunded liability facing STRS from “infinity” to 36 years. By law, state pensions must be able to cover their liabilities within a 30-year period, and 36 is certainly a lot closer to what the law demands than is infinity. So far so good, and considering that states like Illinois can’t even agree on how to make their current pension systems solvent this is something of a success. At least in Ohio taxpayers aren’t likely to face new taxes any time soon to pay for retirement promises made to public sector employees, and current educators can count on their pensions.
But, the changes to STRS and the state’s other retirement systems have some unintended consequences that are sure to have a negative impact on public education in the years and decades ahead. First, the pension changes will encourage early retirement of relatively young and able educators. Here’s why.
As explained by the economists Michael Podgursky and Robert Costrell, teachers, principals and superintendents in the STRS defined benefits system become eligible to draw a pension at a specific age that depends on the number of years of service. In Ohio, under current rules there are three ways an educator can qualify for regular retirement benefits:
- Five years of service and an age of sixty or more;
- Twenty-five years of service and an age of fifty-five or more; or
- Thirty years of service, regardless of age.
Benefits in the system are then determined by a formula of the following sort:
Annual Benefit = (years of service) x (final average salary) x r
The final average salary, under current rules, is an average of the last three years of salary, and r is a percentage that is known as the “replacement factor.” For example, if r were two percent, an educator retiring after thirty-five years of service would receive an annuity of 70 percent of his or her final average salary. Under current Ohio law, for years of service up to thirty, r = 2.5 percent. (To see the details of this formula and how it works in Ohio see Podgursky and Costrell’s report here).
Under the new pension rules, beginning on August 1, 2015 the formula for new retirees will change and become less generous. Specifically, the law changes the “years of service” factor from three to five. This means the last five years of salary will determine the retirement allowance rather than the last three, thus lowering the final number. Further, the replacement factor will decrease from 2.5 percent to 2.2 percent. Taken together this will result in a smaller pension. Teachers, principals and superintendents who are eligible to retire have every incentive to get out before August 2015, and surely most have already done the math.
Because of the changes to the pension system, for example, it is expected that up to half of the current 16 superintendents in Franklin County (Columbus area) are likely to retire in the next two years. Most of the retirees will be in their mid to late 50s, and absolutely capable of giving more to kids and schools. But their experience and leadership will be lost to the system. The same will surely be true when it comes to principals and teachers as well.
Longer term, most of the savings that come from the new changes to the pension system won’t be realized for decades, and as such they will come on the backs of the next generation of teachers and educators. As reported by the Wall-Street Journal last weekend “Changes made to the retirement plans of newly hired workers are expected to reduce pension costs by 25 percent over the next 35 years, according to Boston College estimates.”
In practice, prospective and new educators will have to pay higher rates over a far longer period of time for fewer benefits upon retirement. This will also trigger lower starting salaries as required employee contributions rise from 10 to 14 percent over several years, which will be a further disincentive for enticing the best-and-brightest young Ohioans into teaching and education leadership. Many new and prospective educators, who are facing student loan debts, thinking about starting families, or hoping to own a home might very well look at the new compensation system and decide they are much better off pursuing another profession.
Ohio’s pension reforms undeniably bought more time for the current STRS and those in it. But the unintended consequences of the reforms will be to drive out good talent early, and make it harder for schools and districts to recruit new talent into education in the future.