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Who Benefits from Pension Enhancements? Who Benefits from Pension Enhancements?

Who Benefits from Pension Enhancements? - PowerPoint Presentation

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Who Benefits from Pension Enhancements? - PPT Presentation

Cory Koedel Shawn Ni Michael Podgursky The Policy Event Between 1995 and 1999 the average annual nominal return to the DJA was 25 percent 200 percent cumulative growth over a 5year period These abnormally high returns improved funding ratios for state pension systems many systems were re ID: 613932

enhancements pension benefits teachers pension enhancements teachers benefits enhancement system percent capture average progression benefit earnings teacher retirement rent

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Slide1

Who Benefits from Pension Enhancements?

Cory KoedelShawn NiMichael PodgurskySlide2

The Policy Event

Between 1995 and 1999, the average annual nominal return to the DJA was 25 percent.200 percent cumulative growth over a 5-year period.

These abnormally high returns improved funding ratios for state pension systems; many systems were reporting actuarial surpluses by the late 1990s.A common response in many states was to enhance pension benefit formulas.This response transformed a transitory increase in asset values into a permanent increase in liabilities.Slide3

The Policy Event

This study provides a detailed accounting of the pension enhancements for Missouri educators.Teacher pension systems were among the most actively enhanced during the pension-enhancement boom.

The National Conference of State Legislators (1999, 2000, 2001) reports that benefits for educators were enhanced in more than half the states (and they do not provide a full accounting).The Missouri enhancements look very similar in substance to enhancements that occurred for teachers in other states.Slide4

Key Results

Three Generalizable Lessons

1) Senior teachers are the major beneficiaries of retroactive pension enhancements.Their benefits are enhanced despite their lifetime contributions being structured to fund a less generous flow of benefits.

2

) Pension enhancements

harm

new teachers in expectation.3) Pension enhancements offer little value even for “new career teachers” (who will work until retirement with probability one).

Summary Assessment

Pension enhancements are not a recruiting tool.

They represent a form of rent capture (by senior teachers).

Another example of rent capture from pension funds during times of high stock market returns is the skipping out on required contributions by governments and employers (e.g., like for the UC employee fund).

Like all forms of rent capture from the system, pension enhancements burden future members and employers moving forward.

In Missouri, the combined employee/employer contribution rate to fund the pension system increased from 21 to 29 percent of teacher earnings between 2005 and 2012.

We estimate that half of this increase is due to liabilities accrued as a result of the pension enhancements. The rise in contribution rates appears to have been “artificially” halted for now…Both new teachers and the system as a whole are worse off today as a result of the pension enhancement legislation.Slide5

Background

Defined benefit determined by the following formula:Y

= Annual BenefitF = Formula Factor (currently 0.025 in MO)YOS = Years of Service FAS

= Final Average Salary (average of highest three years of earnings)

Early Retirement: 25-and-out ; Rule-of-80Slide6

Calculating Pension-Wealth

We calculate the present discounted value of pension wealth for each teacher at time s as:

j is the initial collection date, j ≥

s

After each year of work we find optimal collection date

P

t|s is the probability of being alive in period t

given that the teacher is alive in period

s

.

d is the discount factor (we discount at a 4 percent real rate)Slide7

Missouri Benefit EnhancementsSlide8

Enhancement Progression

1995Slide9

Enhancement Progression

1996Slide10

Enhancement Progression

1999Slide11

Enhancement Progression

2000Slide12

Enhancement Progression

2002Slide13

Distribution of Pension Wealth GainsSlide14

Incorporating Contributions

Notes about contributionsContributions did not rise as benefits increasedBut they did rise well before 2008 financial crisis

Rate was 21 percent from 1995-2004.Starting in 2005 it rose by 1 percentage point per year (max) through 2012 (to 29 percent today)

To remain flat in 2013 (Updated experience study with some questionable assumptions greatly relieved the pressure to fund the system)Slide15

Incorporating Contribution Rate Increases Attributable to Enhancement LegislationSlide16

Who Benefits from Pension Enhancements?

Three Generalizable Lessons

1) Senior teachers are the major beneficiaries of retroactive pension enhancements.2) Pension enhancements harm new teachers in expectation.

3) Pension enhancements offer little value even for “new career teachers” (who will work until retirement with probability one

).

It

is also important to recognize that labor mobility is generally on the rise, and more-skilled individuals are

more

likely to

move (e.g., see

Groes

et al., 2010).

Summary Assessment

Pension enhancements are not a recruiting tool. They represent a form of rent capture (by senior teachers).A key concern is that benefit enhancements reduce the desirability of the compensation package in education, in expectation, for new workers.For those of us who care about improving teacher quality, and understand that the education sector is competing with other sectors in the labor market for skilled workers, this is bad news.Slide17

How did this Happen (Everywhere)?

Who should have protested?Perhaps it is the job of the stewards of the system to look out for the long-term well being of the system itself.

Superintendents, principals and/or other education administrators (???)There was no visible protest to these reforms.The problem: we have put educational administrators in a highly conflicted position in this regard.Slide18

Final-Average-Salary DB Pension Plans

An important difference between the typical subnational public pension plan and social security is that the stream of benefits during retirement does not depend on lifetime earnings

“Final average salary” calculations are used instead, which usually depend on the highest 1-5 years of earnings. In contrast, Social Security benefits depend on (up to) a 35-year earnings history.

This feature of these plans leads to disproportionate gains from the system accruing to promoted individuals who earn late-career salary increases.

Their lifetime contributions are based in part on their pre-promotion earnings, but their benefits fully capture the salary increases that come with

promotion.

These individuals stand to benefit the most from pension-enhancement legislation.

Although educational administrators are small in number (so the increases to their pensions are not important in aggregate), the FAS aspect of these plans creates a bargaining situation that does not seem to be in the best interests of children in K-12 schools, or taxpayers.

Labor and management are negotiating from the same side of the table…

Slide19
Slide20

Gains in Expected Pension Wealth from Total System Enhancements between 1995 and 2002 for Novice Teachers and Same-Vintage Teachers, Principals and Superintendents (age-50,

exp-21)

.