In at least some states and school districts, the share of pension costs now amounts to nearly a third of payroll, concludes a new analysis from Moody’s Investors Service, a credit-rating firm.
The gradually increasing burden of retirement costs on districts isn’t a new phenomenon. But the latest analysis is a good reminder of how pensions act as the third rail of district and state school finance—even if the average educator, parent, and principal doesn’t know a ton about their complexities.
Retirements don’t directly have much to do with the instructional quality students receive, but indirectly, they have a lot of impact. Cash going into these systems generally means it’s not going toward building improvements, teacher pay, learning materials, or programs.
That doesn’t mean teachers don’t deserve a generous retirement. Over the years, though, analysts have questioned whether the way the systems are structured serves the current teacher population well. And increasingly they’ve pointed out theproblem of unfunded liabilities and their costs.
Here are three things for district leaders to take away from the new analysis.
In a few states, the district share of pensions is about 30 percent of payroll
First, a quickie explainer. For most districts, teachers participate in a state retirement system, which requires annual contributions from employers (as well as from teachers). Depending on the system, sometimes the state pays all or most of the employer share; in others, districts share the cost with the state.
When the pension is underfunded—that is, it has more future obligations than actual money in the bank—then that unfunded liability becomes a debt, which incurs interest spread out in additional payments just like interest on a home mortgage. Debt servicing is also part of the annual contributions.
Moody’s plotted all of this on a graph—both contributions to the plan and debt servicing—and represented it as a proportion of overall payroll. In Utah and Louisiana—as well as New York City and Chicago, two cities with their own pension plans—districts are spending about 30 cents on every dollar of payroll on pensions. In another 19 states, districts have to foot at least 15 cents on every dollar.
“The problem is when district [share] is going up and up and up, and they can’t keep pace. This ultimately means budget cuts, and that usually first means programs and then personnel. Who’s suffering at the root of all of that? Kids,” said Max Marchitello, a consultant on school finance and teacher pension plans.
The data also show an interesting phenomenon at work, noted Thomas Aaron, a vice president and senior credit officer at Moody’s, who co-wrote the analysis. Once costs approach the 30 percent threshold states tend to step in and assume more of the share. Illinois stepped in to help out Chicago in 2017, and Colorado increased its payments to help alleviate districts’ burdens in 2018.
Be aware, though, that just because a pension is costly for states or districts doesn’t mean it’s actually particularly generous in terms of benefits. (The Moody’s report doesn’t show the relative strengths or drawbacks of the actual pension plan—or how well it works for teachers who leave the profession early vs. later; see this Bellwether Education Partners analysis for one attempt to break down those tradeoffs.)
Instead, the costs have a lot to do with the decisions managers and actuaries have made—like whether they’ve assumed the pensions will have a high rate of return, and how much debt the pensions are carrying.
It’s also tempting to think that it’s better for school districts when states are footing most of the bill, as in those states with the big light blue lines in the chart above. But the reality is that no matter how the arrangement works, districts often bear the brunt when pension costs rise; states just send proportionally less general education aid through to districts.
“In most cases as I understand it, that money is not some separate slush fund the state pays out of,” said Marchitello. “They’re paying some number of billions for K-12, and some increasing percent of that amount is going toward the pensions.”
Some states have taken steps to prop up their pensions
Fiscal year 2021 was a really good investment year, for the most part. States didn’t see the economic slowdown many had predicted from the pandemic. A few states took steps to bolster their teacher-pension systems using some of the windfall, the Moody’s analysis showed.
“With pensions, paying more and sooner is really the way out of unfunded pension liabilities, and conversely pushing out the costs is a way to increase risk and ensure much higher long-term costs,” said Aaron of Moody’s.
California reduced its K-12 pension contributions in 2020 and suspended an increase in the percent it’s supposed to contribute. But after the economy bounced back, it added $174 million into the system meant to restore those amounts, and topped it off with an additional $410 million extra into the systems, the analysis notes.
Colorado, similarly, suspended a $225 million supplemental pension payment in 2020, meant to drive down overall costs. But by 2022, it had not only restored the missing payment and made one for this year but had also pre-paid part of 2023 and 2024.
So far, 2022 has been a different story, with declines in overall investment returns.
In all, it’s a good reminder that market forces affect this element of school funding—just as they shape tax revenue and other sources of school funding.
Most public pension systems are still underfunded to some degree, according to Equable Institute, an organization that seeks to help make public sector plans more sustainable. It recently released a report finding that public pensions across the nation are about 85 percent funded—largely thanks to last year’s bull market—but that figure will almost certainly decline this year due to the slowdown.
All of this has implications for the fiscal decisions districts and states make now
States and pension boards make most of the decisions about pension plans, constraining what districts can do to respond to rising costs. But this cuts the other way, too. When districts do things like raise teacher salaries, they are ultimately also increasing the state plan’s pension obligations. (This is the source of major state-district tension, as Education Week has reported.)
“The mathematical reality is that the level of wages today affects the accumulation of liabilities in the future,” said Aaron of Moody’s. “The higher they go, the more those costs are going to be.”
And that’s hard for districts that, right now, are trying to find and hire good talent and use perks to keep teachers in their jobs.
“It’s tough because they don’t have a lot of leverage,” said Marchitello. “Telling them not to raise teacher pay has consequences for them in terms of competitiveness, or teachers leaving, or malcontent. It’s not politically palatable.”