States and Cities Eyeing Pension As Fiscal Source

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Faced with a $2-billion budget deficit this year, New York officials turned to a fiscal outlet that is looking increasingly tempting to other states as well—the massive state pension fund for teachers.

As the economy weakens across the country, lawmakers in a number of states and major cities have been eying these sometimes robust, sometimes anemic sources of funding as a cure for their budget crises.

The New York plan, which indirectly freed up state funds by permitting local school districts to defer hundreds of millions of dollars in retirement contributions, was accompanied by technical changes that, actuaries say, will protect the financial health of the $30-billion teachers' pension fund.

Nevertheless, teachers and their representatives are voicing widespread apprehension that their retirement funds will be "raided" into insolvency. Such forays are particularly troubling, they say, because they come at a time when the systems are preparing for the retirement of the "baby boom" generation of teachers in the next 10 to 15 years. And the next generation of teachers and taxpayers, they warn, may be reluctant to pay for that large group of retirees.

"The biggest challenges facing teaching-retirement systems [is] keeping politicians out of the trust funds. This is at the state level; this is at the federal level," Bruce Hineman, secretary-treasurer of the National Council of Teacher Retirement, told a gathering of National Education Association members in Florida last month. "We have money, and they don't."

Most retirement systems have little to fear at this stage from the recession now predicted by many economists. Typically, the trusts have been invested conservatively and hold widely diversified portfolios, said Dallas Salisbury, president of the Employee Benefit Research Institute. Furthermore, short-term economic fluctuations mean little to funds that commonly have a 30-year life cycle.

But the deterioration of the economy has put pressure on policymakers to seek out alternative sources of funding for more immediate needs.

A survey prepared for the NEA indicates that states have already begun to make their moves on educators' retirement funds. To this point, however, states have not so much raided pensions as they have neglected them.

Since 1985, seven states have deferred, delayed, or canceled contributions to teachers' pensions, according to the survey.

In 15 states, the study also found, employer-contribution formulas have been reduced during the past five years as a result of so-called over-funding, government budget problems, and changes in funding approach, benefits, or interest rates.

But Sophie M. Korczyk, author of a three-volume study on educators' benefits prepared for the NEA, cautioned that "the survey results only tell us what state and local governments are doing with their plans, not the impact these actions are having on the plans."

Indeed, in some cases teachers'-union officials have concluded that concerns about the pension funds can safely take a back seat to more pressing needs. New York City and Chicago officials recently adopted plans to reduce their contributions to the funds with union blessings, in order to free up money for salaries.

Few would argue that these pension funds are tempting. Public-employee pension funds have assets totaling some $750 billion.

More than other public employees, teachers shoulder some of the burden of providing for their retirement. Almost 80 percent of teachers contribute to their pension funds.

Moreover, many educators rely solely on their pensions to see them through retirement. More than a third are not covered by Social Security, according to Ms. Korczyk, president of Analytical Services, a financial-consulting firm specializing in employee-benefits policy.

Teachers, almost universally, participate in what are called defined-benefit plans, under which an employer guarantees a specified pension benefit upon retirement. Generally, their benefits amount to 60 percent to 70 percent of the average of their salary over their last three to five years of employment.

Under a defined-contribution plan, by contrast, the employer promises only to provide a specified amount for each employee, with the level of benefits determined by a variety of factors. Such plans may produce a higher yield and be less costly to employers, but also ask plan participants to bear more risk.

During the economic boom of the 1980s, high returns on investments boosted teacher-retirement funds that otherwise might have been malnourished.

New York State's system earned a double-digit rate of return on its investment during that period. As a result, the state reduced the share of payroll school districts had to pay into retirement funds from 23.49 percent 10 years ago to 6.84 percent this year.

Consequently, when the districts repay this year's deferment, estimated at between $312 million and $472 million, they "will be paying considerably less," said Hiram Korpeck, a teacher member of the New York State Teachers Retirement System Board.

New York City, which has a separate teacher-retirement fund, is also seeking to take advantage of relatively high investment earnings. The city has asked the state for approval to raise its interest-rate assumption from 8.25 percent to 9 percent. If the assumption is valid, the city can contribute less money to the pension fund without decreasing its assets because the higher rate of return will offset the decreased contribution.

Manipulation of the system in such a manner is not harmful if the trust has sufficient money to fund its long-term liabilities, say actuaries.

All of New York City's liabilities were being funded, said Mel Aaronson, a trustee of the New York City Teachers Retirement System. "It's one of the soundest pension funds in the public arena in the country,'' he asserted.

Even so, New York City's business community and some politicians have been critical of the proposal. They argue that any money saved by changing the interest-rate assumption should be used for other purposes, such as reducing the city's deficit, rather than for teacher raises.

The troubled condition of the Illinois and West Virginia teachers' pension funds illustrate the dangers of neglecting adequate funding for too long.

Illinois's pension system reaped high investment returns during the 1980s, partially offsetting inadequate state contributions. But, said Fred Husmann, executive director of the Teachers Retirement System of Illinois, "we can't rely on that to happen in the future."

In 1989, the Illinois legislature approved a law that would have addressed the system's long-term funding problems. But lawmakers did not provide any funding in the 1990 state budget for the effort, and ordered a 3 percent cost-of-living increase for pensioners.

The system, which has a $5.5-billion unfunded liability, currently stands at only about 40 percent of the amount that will have to be paid out, according to Mr. Husmann. "As the teaching population gets older, the zero hour keeps coming closer," he said.

West Virginia's system, burdened by years of neglect, would have gone broke by next year if the legislature in August had not approved a switch to a defined-contribution plan for teachers hired after July 1, 1991.

From its inception in the 1940s, the system was underfunded. During the state's lean years, explained David A. Haney, assistant executive director of the West Virginia Education Association, the legislature would forgo making appropriations while simultaneously granting cost-of-living increases.

Two years ago, the legislature acted to shore up the system by raising its contribution to 15 percent of payroll. Even so, by this year the system had accrued a $2.8-billion debt.

Under the system in effect for teachers hired before next July, employees contribute 6 percent of their salaries and the state contributes 15 percent. Workers in the new system will pay 4.5 percent and the legislature will split its 15 percent payment between the old and the new plans.

The new plan "stops the hemorrhaging in the current plan to a degree," said Mr. Haney. Nonetheless, the plan still needs a cash flow of $60 million to $80 million before 1993.

Another potential danger for the pension funds, analysts say, is that states will see them as a means of promoting general economic development—a goal that could undermine, or at least dilute, plan managers' fiduciary duty to make safe, lucrative investments.

This year, for example, the state investment board in North Dakota approved a scheme under which the teachers' and state employees' funds each purchased $12.5 million in certificates of deposit, at 8 percent interest, from the state-owned Bank of North Dakota. The money will be used to entice businesses to operate in the state.

In recent years, however, the funds had realized a higher rate of return from other investments, according to Gerard T. Friesz, executive director of the North Dakota Public Employees Association, F.S.E./A.F.T.

At about the same time, a venture-capital group tried to persuade the state investment board to invest pension monies in a start-up business enterprise. "Fortunately we've been able to fend off those efforts, but it's not a dead issue," said Mr. Friesz.

The teachers' and public employees' pensions funds were also able to kill a legislative proposal to require them to invest 2 percent of their assets within the state.

But even when they can avoid under-funding or pressure to make investments for reasons other than maximum returns, teachers' funds can still run into other threats. One such pitfall has faced the Missouri fund, union officials say.

In terms of its ratio of assets to benefits, Missouri has the healthiest system in the country, according to the NEA survey.

Independent of legislative funding, the teachers' system in Missouri derives all its money from the districts and the teachers, each of which contributes 10 percent of payroll or salary.

The teacher-retirement board has "always taken a very conservative approach to it, maybe too conservative an approach," said E.C. Walker, director of government relations for Missouri NEA.

But because the fund is so strong, Mr. Walker said, the legislature has tried in the past to consolidate it with other pension systems that were "not in very good shape."

The federal government also has designs on pensions, which, because they are untaxed, cost the budget some $60 billion annually.

Among the concepts that have been floated are proposals to tax a pension fund every time it buys into a secondary market, tax retirees' benefits, and require pensions to invest in infrastructure projects nationwide.

John Abraham, assistant director of research for the American Federation of Teachers and the union's benefits expert, advocates a federal law to safeguard public pensions. Private pensions are already regulated by the landmark Employee Retirement and Income Security Act of 1974.

"The issue here is one of control," Mr. Abraham argued. "As long as state or local funds are not treated as an individual entity, that means that the government can treat the money as a separate pool to be used for whatever purpose [lawmakers] deem important because they aren't going to be around 20, 30 years from now when teachers retire."

Vol. 10, Issue 10

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