According to the National Council on Teacher Quality or NCTQ, “State pension systems are severely underfunded. Most retirement eligibility rules are burdensome and unfair. Costs to teachers and school districts are on the rise. The squeeze is on teachers in numerous other ways.” These are the key findings in a recent report called No One Benefits: How Teacher Pension Systems Are Failing Both Teachers and Taxpayers on state teacher pension policy by NCTQ, an organization founded in 2000 to provide an alternative national voice to existing teacher organizations and to challenge the current structure and regulation of the teaching profession.
Ed News Colorado asked Greg Smith, executive director of the Colorado Public Employees’ Retirement Association (Colorado PERA), for his thoughts on the NCTQ report.
Greg Smith: From our perspective, Colorado PERA’s hybrid defined benefit plan accomplishes the priorities identified by the NCTQ report. The extraordinary investment return realized through Colorado PERA continues to work for Colorado taxpayers while providing fair, portable benefits to valued K-12 educators throughout the state. The comprehensive reform enacted in Colorado in 2010 was the first in the nation and restored Colorado PERA’s long-term sustainability. Unfortunately, the NCTQ report does not recognize many of the reforms enacted in Colorado, nor does NCTQ fully acknowledge the hybrid portability features existing in Colorado PERA law.
Defined contribution vs. defined benefit
In short, the report finds the structure of teacher pension systems in the United States “untenable.” In ultimately concluding that a defined contribution system is the better mechanism for public sector retirement, the report ignores from the outset the value that a pension plan provides in attracting and retaining quality educators. The report also fails to recognize the data that suggests that the defined benefit system is the most cost effective way to provide a secure retirement.
Through the outperformance of a professionally managed, globally diversified institutional investment program and the economies of scale over individual accounts, a defined benefit program delivers the same retirement income at a 46 percent lower cost than a defined contribution plan. According to the National Institute for Retirement Security’s research “A Better Bang for the Buck,” defined benefit plans 1) avoid the problem of “over-saving” by pooling the longevity risks of large numbers of individuals, 2) are ageless and therefore can maintain an optimally balanced investment portfolio rather than shifting over time to a lower risk/return asset allocation as is the case for individual investors, and 3) can achieve higher investment returns compared to individual investors because of professional asset management and lower fees.
In the case of Colorado PERA, members and taxpayers have been the beneficiaries of a 30-year annualized return of 10 percent on the Colorado PERA investments. During the 25 years ending Dec. 31, 2011, employers/taxpayers have paid $13.5 billion into the Colorado PERA system. During that same time, Colorado PERA distributed $37.8 billion to retirees and increased the investment portfolio from $5.9 billion to $38.2 billion. That’s $70 billion in value for a $13.5 billion taxpayer investment – a lot better than any 401(k)’s have performed, and a valuable benefit for Colorado educators and taxpayers.
Portability for Colorado teachers
Not only is the 401(k) approach inferior in its ability to generate retirement security, it offers no greater portability than the Colorado PERA hybrid defined benefit plan. Consistent with NCTQ’s principles, Colorado teachers always have access to their contributions into the system plus a competitive interest rate if they should leave public employment. They also have access to employer-paid money subject to a reasonable and equitable vesting schedule. Colorado PERA provides the right balance between portability and the employers’ interest in limiting costly turnover in teachers.
Turnover is extremely expensive and can be detrimental to the quality of education. When the objective is to have a consistent staff of quality educators, the overall compensation package should be designed to incentivize them to stay in the same educational environment. This is accomplished in Colorado through PERA’s hybrid portability features and the opportunity for a lifetime benefit for career teachers regardless of where they taught in Colorado.
With regard to state-to-state portability, PERA members are limited by both federal and state law to a maximum of 10 years of purchased service credit in the PERA system. Members are required by state law to pay the full actuarial cost associated with the purchase of service credit so PERA receives the amount of money necessary to fund the benefit being purchased. The NCTQ report actually points to a portion of Colorado PERA’s portability feature as an example other states should follow (on p. 36).
Pension reform in Colorado
With the passage of Senate Bill 10-1 many changes were made that both increased the funding to the system and lowered the cost of the benefits paid by the system. As a result of decisive and comprehensive action in 2010, Colorado PERA’s unfunded liabilities were reduced by over $9 billion overnight and the costs of future pensions were substantially reduced. These changes included contribution increases for both employers and employees that phase in over time, a decrease in the Cost of Living Adjustment (COLA) paid to all members including existing retirees, requirements that members work longer before reaching eligibility to retire with full benefits, and a reduction in the benefits for members who retire early in the future, among other cost-saving changes. Also, there was a change to when members receive a match of their contributions when they leave employment and decide to exercise that portability feature and take their account with them.
Prior to SB 10-1, regardless of the amount of service credit, any member who left employment and decided to take a refund received a 50 percent match on their contributions. SB 10-1 added a requirement that the member have at least five years of service in order to be eligible for a 50 percent match. Frankly, there was both a cost consideration and a retention incentive to go to a five-year vesting period.
Regrettably, the data used by NCTQ to come up with Colorado’s public retirement picture did not take into consideration the increased contributions from employers and employees and the benefit changes that are contained in the SB 10-1 reforms.
With the contribution increases, which will ratchet in over a period of years, and the benefit changes outlined above, PERA is projected to be fully funded within approximately 30 years. Contribution rates, when fully implemented, will meet or exceed the NCTQ recommended funding standards to ensure the long-term existence of a reliable pension for Colorado educators. In addition, consistent with objectives identified by NCTQ, Colorado has implemented safeguards to prevent politics from interfering with this reform. There are limited steps that can be taken to control what a future General Assembly does, but it is written into law that legislators cannot enact any benefit increases that have not been the subject of an actuarial study to ensure that there is adequate funding for the benefit increase.
Also, SB 10-1 included automatic triggers for when contributions can change and when the COLA can be adjusted. In some states, teacher unions negotiate increases in pension benefits. This currently doesn’t happen in Colorado.
Rate of return
Questions have also arisen about PERA’s annual projected rate of return on pension investments. In 2009, as part of the process for developing its comprehensive recommendation to the General Assembly to ensure the long-term sustainability of the fund, the PERA Board of Trustees reduced the assumed rate of return on its investments to 8 percent from 8.5 percent. Most recently, the board voted in November to keep the rate steady at 8 percent. The board follows a disciplined process in evaluating the investment return assumption which includes retaining renowned actuarial and investment experts. KPMG, PERA’s outside independent auditor selected by the State Auditor’s Office, called PERA’s process “the most rigorous it has seen.”
Some people have said that this figure is too high and therefore, not realistic. The PERA board recognizes the controversy over this expectation and the fact that reasonable people can disagree about what the future holds. In response, the board has led the public pension industry to a new level of transparency by reporting PERA’s funded status using a range of return expectations from 6.5 to 9.5 percent rate of return. (See the PERA Comprehensive Annual Financial Report, page 35.) The annualized rate of return since the 2008 financial crisis has been in excess of 10.9 percent. See also the Colorado PERA fact sheet “8 Reasons Why PERA Can Earn 8 Percent.”
The topic of retirement as a component of teacher compensation is an area that has garnered significant attention since the Great Recession. After the NCTQ report was released, the Center for State and Local Government Excellence issued “Compensation Matters: The Case of Teachers,” authored by Alicia H. Munnell and Rebecca Cannon Fraenkel of the Center for Retirement Research at Boston College.
This research concluded that total compensation (including a pension) matters when attracting the best talent to the teaching profession. Since 1931, Colorado PERA has been able to change with the times to remain sustainable. With a proven track record of providing value to the taxpayers and an equitable benefit to Colorado’s educators, we must have the discipline and patience to let the landmark, bipartisan reform legislation work.
Colorado PERA appreciates the opportunity to provide comment regarding the NCTQ report findings and we thank Ed News Colorado for its interest in providing a broader perspective on the important issue of retirement security as it relates to the education community.
Gregory W. Smith became executive director of $40 billion Colorado PERA in November 2012. Smith joined Colorado PERA in February 2002 as general counsel and in July 2009 he was promoted to the additional role of chief operating officer. Smith has testified before various committees, subcommittees, and roundtables of the U.S. House of Representatives, U.S. Treasury Department, and the U.S. Securities and Exchange Commission on public retirement plans.