Dropout Nation

From the continuing woes of Atlanta Public Schools (including the legacy of the test cheating scandal that led to the forced retirement of its once-lauded superintendent, Beverly Hall), to the ongoing opposition of traditionalists to the passage of a constitutional amendment allowing the state to authorize charter schools, to the the debate over a proposed Parent Trigger Law, Georgia has garnered plenty of attention on the education reform front. But the Peach State will have to give real attention to the growing deficit of its teachers’ pension. Between 2006 and 2011, the Teachers Retirement System of Georgia’s pension deficit increased by a six-fold — just as pension annuity payments have increased by a two-fold in that same period — thanks in part to the global financial meltdown as well as imprudent moves by the state One of those self-inflicted wounds: Granting pensioners a three percent increase in annuity payments in order to offset state taxes (even after the state moved a few years ago to allow pensioners to exempt the first $65,000 they generated in income). Although TRSG moved in January to end the benefit, the consequences of the benefit, along with the overall problems that come with defined benefit pensions, will be borne by taxpayers for decades to come.

So how much is TRSG’s pension deficit. It officially reported a $10.6 billion underfunding for 2011 in its 2012 consolidated annual financial report. But as Dropout Nation has noted over the past few months, official reports don’t tell the whole story. For one, like so many teachers’ pensions, TRSG assumes a 7.5 percent rate of return on investments, an inflated number considering the market hasn’t generated around 5 percent over the past couple of years. TRSG’s own portfolio has only had a 10-year average actual rate of return of 5.7 percent and a five-year rate of return of 2.95 percent; its investments only grew by 2.16 percent in the last year (and its portfolio of stocks actually declined by a fifth of a percent, even as the Standard & Poor’s 500 experienced a 5.15 percent gain).

So Dropout Nation used the formula developed by Moody’s Investors Service for determining what is likely the actual pension deficit, using a more-realistic 5.5 percent assumed rate of return. Based on the Moody’s formula, Georgia’s teacher pension deficit is $13.4 billion, 27 percent more than what what TRSG officially reported. Based on a 17 year amortization schedule, Peach State districts and taxpayers will have to shell out an extra $786 million a year just to pay down the deficit. That’s 73 percent more than the $1.08 billion districts paid out in 2012. This pension pain is only going to get worse, especially as Baby Boomers within the teaching ranks leave the profession. The average number of Peach State teachers becoming pensioners increased by 25 percent between 2006 and 2011; on average, some 7,136 teachers will retire each year. Those numbers have likely increased even more thanks to the rush by teachers this year to retire in order to take advantage of the now-phased out three percent annuity boost. And with teachers contributing just 36 cents out of every dollar poured into the system, it may be time for the Peach State to ask instructors to help ease the burden.

But Georgia isn’t the only southern state where pension deficits are greater than actually reported — or where teachers are allowed to contribute less to their retirements that private-sector counterparts. Three other states analyzed by Dropout Nation had pension deficits that were between 27 percent and 36 percent greater than officially reported. This is no surprise. Since January, this publication has found that states such as California, Texas, Indiana, and Pennsylvania (as well as cities such as Chicago and New York City) are not being upfront about the true levels of insolvency for their pensions. Which means the $1.1 trillion tab for underfunded teachers’ defined-benefit pensions and unfunded retired teacher healthcare costs are even greater than officially reported.

One of the least-considered aspects of the defined-benefit pension deficits that have made traditional teacher compensation far too expensive to keep around is the fact that the full costs of the retirement plans to taxpayers and children are dealt with in an honest and transparent manner. Because public pension systems often use inflated rates of returns on their investments (often around eight percent, even as actual rates of return of stocks on the Standard & Poor’s 500 index was only around four percent during the last decade), and use techniques that would not be acceptable in the private sector such as failing to fully realize investment losses as well as  “smoothing” (or adjustment) techniques used to keep the volatility pensions experience with investments from wrecking havoc on budgets, pension deficits are often reported as being lower than they actually are. Thanks to the efforts of Moody’s and others, states, including those in the American South, will be forced to be more-transparent about these deficits. States will also have to ditch traditional teacher compensation systems to ultimately address the underfundings as well. This includes requiring teachers to pay more into the pensions than they already do.

One southern state facing a larger pension deficit than officially reported is the Teachers Retirement System of Alabama, whose pension underfunding has doubled over the past six years (as of 2011). TRSA officially reported a $9.3 billion pension deficit for 2011, the latest year available. But that is based on an inflated 8 percent rate of return on investments that is greater than what the pension has actually experienced in the past few years. In fact, the portfolio for Alabama’s teachers’ pension declined by $1.6 billion between 2010 and 2011. More importantly, the deficit also doesn’t reflect the $2.8 billion in unrealized losses accrued between 2007 and 2011. If those losses were added in, the officially-reported pension deficit would increase to $12.2 billion.

So what is the true underfunding? Based on the Moody’s formula (with a  more-realistic 5.5 percent rate of return) and not adding in the unrealized losses, Alabama’s pension deficit is $12.7 billion, or 36 percent more than officially reported. Based on a 17-year amortization schedule, districts and taxpayers would have to pay an extra $745 million a year over the next two decades just to pay down the underfunding; that is double the $756 million districts and taxpayers paid out to the pension in 2011. What if the unrealized losses were added in? The pension deficit is $16.5 billion, with districts and taxpayers having to pay an extra $971 million a year over the next 17 years just to pay down the underfunding.

The Yellowhammer State has begun addressing some of its pension issues. This includes increasing teacher contribution rates for those participating in its Tier I from five percent to 7.5 percent of salary; currently, teachers only contribute 30 cents of every dollar paid to the pension. This is good. But the lack of transparency on the actual level of underfunding means that it still isn’t doing enough to address the insolvency.

Then there is the Arkansas Teachers Retirement System, which has seen its underfunding increase by a two-fold between 2006 and 2011. The pension reports a $4.4 billion pension deficit as of 2011, the latest year available.  But as with Alabama, the Arkansas pension assumes an eight percent rate of return that 2.5 percentage points higher than the 5.5 percent rate of return it has actually experienced over the most-recent five-year period. Using the Moody’s formula, which calls for a more-realistic 5.5 percent rate of return, Arkansas’s pension deficit is $5.9 billion, or 35.6 percent greater than officially reported. Districts and taxpayers will have to pay an extra $349 million a year– nearly double the $400 million paid out in 2011 — just to pay down the deficit. Considering that contributions from teachers account for only 26 percent of the annual payout into the fund, expect districts and the state to demand that teachers pay more into the fund. Which won’t make the National Education Association affiliate there very happy. The good news is that the ATRS is exploring ways to deal with its deficit. But it could help that effort out so more if it stopped inflating its rate of return and show the true size of the underfunding that must be overcome.

Meanwhile in Tennessee, state officials are actively tackling the virtual insolvency of its two pensions, including the State Employees, Teachers, Higher Education Employees pension, which covers the Volunteer State’s K-12 instructors. The state treasurer has already proposed to create a hybrid retirement plan for newly-hired teachers and other civil servants, combining elements of defined-contribution and defined benefit plans. While the passage of such a plan may help ease future burdens for Tennessee’s districts and taxpayers, it won’t do much to tackle the pension deficit for the long haul — especially with the officially reported numbers being lower than what is likely reality.

Tennessee officially reported a $2.6 billion pension deficit in 2011 for its SETHEEPP pension for teachers and other civil servants, a two-fold increase over underfunding levels four years ago. But that is based on an assumed rate of return of 7.5 percent, an inflated number that doesn’t square with rates of return in the investment marketplace; in fact, the rate of return for Tennessee’s pensions combined was just 5.6 percent, or 1.9 percentage points below the rate of return. Using the Moody’s formula (and assuming a more-realistic 5.5. percent rate of return), the pension deficit for SETHEEPP is $3.3 billion, or 27 percent higher than officially reported. Over the next 17 years, districts, the state government, and, ultimately, taxpayers, will have to shell out $328 million more a year to pay down the deficit; this is 45 percent more than the $731 million paid out in 2012. Considering that teachers and other civil servants contribute a mere 21 cents out of every dollar paid into the pension, it is more than likely that Tennessee will ask them to pay more toward their retirement.

States and taxpayers must deal with this aspect of the education crisis in a sensible way. But it cannot be done if the true data on pension deficits isn’t put on the table.