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鈥檚 Investors Service, a credit-rating firm.
The gradually increasing burden of retirement costs on districts isn鈥檛 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鈥攅ven if the average educator, parent, and principal doesn鈥檛 know a ton about their complexities.
Retirements don鈥檛 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鈥檚 not going toward building improvements, teacher pay, learning materials, or programs.
That doesn鈥檛 mean teachers don鈥檛 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鈥檝e 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鈥攖hat is, it has more future obligations than actual money in the bank鈥攖hen 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鈥檚 plotted all of this on a graph鈥攂oth contributions to the plan and debt servicing鈥攁nd represented it as a proportion of overall payroll. In Utah and Louisiana鈥攁s well as New York City and Chicago, two cities with their own pension plans鈥攄istricts 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.
鈥淭he problem is when district [share] is going up and up and up, and they can鈥檛 keep pace. This ultimately means budget cuts, and that usually first means programs and then personnel. Who鈥檚 suffering at the root of all of that? Kids,鈥� 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鈥檚, 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鈥� burdens in 2018.
Be aware, though, that just because a pension is costly for states or districts doesn鈥檛 mean it鈥檚 actually particularly generous in terms of benefits. (The Moody鈥檚 report doesn鈥檛 show the relative strengths or drawbacks of the actual pension plan鈥攐r how well it works for teachers who leave the profession early vs. later; see .)
Instead, the costs have a lot to do with the decisions managers and actuaries have made鈥攍ike whether they鈥檝e assumed the pensions will have a high rate of return, and how much debt the pensions are carrying.
It鈥檚 also tempting to think that it鈥檚 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.
鈥淚n most cases as I understand it, that money is not some separate slush fund the state pays out of,鈥� said Marchitello. 鈥淭hey鈥檙e paying some number of billions for K-12, and some increasing percent of that amount is going toward the pensions.鈥�
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鈥檛 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鈥檚 analysis showed.
鈥淲ith 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,鈥� said Aaron of Moody鈥檚.
California reduced its K-12 pension contributions in 2020 and suspended an increase in the percent it鈥檚 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鈥檚 a good reminder that market forces affect this element of school funding鈥攋ust 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 鈥攍argely thanks to last year鈥檚 bull market鈥攂ut 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鈥檚 pension obligations. (This is the source of major state-district tension, as Education Week has reported.)
鈥淭he mathematical reality is that the level of wages today affects the accumulation of liabilities in the future,鈥� said Aaron of Moody鈥檚. 鈥淭he higher they go, the more those costs are going to be.鈥�
And that鈥檚 hard for districts that, right now, are trying to find and hire good talent and use perks to keep teachers in their jobs.
鈥淚t鈥檚 tough because they don鈥檛 have a lot of leverage,鈥� said Marchitello. 鈥淭elling them not to raise teacher pay has consequences for them in terms of competitiveness, or teachers leaving, or malcontent. It鈥檚 not politically palatable.鈥�
