University of Arkansas Office for Education Policy

Thoughts on Arkansas’ Teacher Retirement System

In The View from the OEP on February 6, 2019 at 11:38 am

This week, we are pleased to announce that Dr. Josh McGee has joined the team at OEP! McGee’s policy and research expertise will enhance OEP’s capacity to help policy makers and education leaders make evidence-informed decisions to improve Arkansas’ public education system.  Today, Dr. McGee shares his thoughts on Arkansas’ Teacher Retirement System.


Over the past two decades teacher retirement benefits have been a significant topic of conversation in statehouses across the country. For a number of reasons, including longer lifespans and lower than expected investment returns, teachers’ retirement benefits in Arkansas and nationally are turning out to be more expensive than policy makers had expected. School districts and state governments have not been putting aside enough each year to fully cover the cost of the benefits their teachers have earned, and as a result, unfunded liabilities, or pension debt, has grown dramatically, as has the cost of paying down this debt.

EDRE’s own Robert Costrell has an excellent graph illustrating the rising cost of teachers’ pensions. On average in the U.S., the cost of retirement benefits per pupil has grown by nearly two and a half times since 2004 from $530 to $1,312 today. Teacher retirement costs now make up more than 10% of all education expenditures, and because retirement costs have increased faster than education budgets, in many places they are crowding out schools’ ability to increase pay, purchase supplies, adequately maintain buildings, etc. (see reports here and here). In response to rising retirement costs, nearly every state has reduced teachers’ benefits and/or increase their contributions. The majority of state’s and district’s annual contributions, around 70 cents out of every dollar contributed, now goes to pay down pension debt rather than to pay for new benefits earned by today’s teachers.

The good news is that while Arkansas’ teacher retirement system (ATRS) has faced similar challenges as other public pension plans, it is in better financial shape than the average public plan, and as a result, its costs have not grown nearly as steeply. Below are graphs depicting ATRS’s funding and cost per pupil. As presented in Figure 1, at the end of FY2017, the latest year for which data is available, ATRS was 79% funded with a $4.2 billion pension debt, which is better than the national average of 72% funded for public pension plans.  Although the annual employer cost of Arkansas’ teachers’ retirement benefits has risen by $242 per pupil since 2001, Figure 2 illustrates it is still below the national per pupil average in both dollar terms ($822 vs $1,312 per pupil) and as a percentage of education expenditures (7.9% vs 10.7%).

Figure 1: Arkansas Teacher Retirement System Liabilities, Assets, and Debt, 2001-2017.

Screen Shot 2019-02-06 at 1.37.40 PM

Figure 2: Employer Contributions per Pupil, US and Arkansas, 2001-2017 (Projected through 2023). Graph reposted from Robert Costrell’s testimony before the Arkansas Legislature’s Joint Committee on Retirement on September 11, 2018.

Pension 2 

The fact that ATRS has remained in relatively good shape over the past two decades is a testament to the proactive, responsible steps that policymakers working together with ATRS have taken to keep costs in check while also ensuring a meaningful and secure benefit for the state’s teachers. Having that said, there are still significant risks on the horizon which the state would do well to understand and work to mitigate. Below is a brief discussion of three of the biggest challenges facing ATRS.

First, despite a nearly decade-long bull market since the Great Recession, Arkansas has made limited progress in paying down its pension debt. This is at least partially due to the backloaded repayment schedule (a.k.a. amortization), which is based on the expectation that the payments into the plan will grow by 2.75% annually. Because of this backloading, current contributions are not large enough to cover the interest on the pension debt, so under current funding policy, the debt is expected to grow for the next 10 years before finally declining until it is fully paid off in 29 years. This is akin to paying the minimum on a credit card – yes, you will eventually pay it off, but you’ll end up paying a whole lot more than the original amount and will have less financial resilience over a longer period of time. ATRS has acknowledged the value of accelerating the pension debt repayment schedule to avoid negative amortization, and we strongly recommend that the state consider doing so.

Second, public workers are living longer than public pension plans currently expect, and this is especially true of teachers. That’s what the Society of Actuaries (SOA) found as it works to updated mortality tables for public employees (see news article here and SOA report here). While it’s really awesome that teachers are enjoying longer lives, the cost of retirement benefits is going to go up significantly if/when ATRS updates its mortality assumptions in the next few years. The state and ATRS should formally study changes in public employee mortality based on the SOA’s findings and plan experience, and they should aggressively update the plans mortality assumptions to ensure the state has the most accurate picture of future benefits costs.

Third, the state and ATRS are betting on a 7.5% investment return to finance a huge share of teachers’ retirement benefits. While ATRS recently lowered its return assumption, it is still higher than the national average of 7.4% and much higher than their most sophisticated peers like the teachers’ retirement systems in New York City and California both of which have lowered their assumed return to 7%. The assumed return is important because it is the key ingredient used to estimate how much money the state and districts need to set aside today to fully cover the cost of the benefits owed to teachers when they retire. Using a higher expected return means budgetary costs will be lower today; however, it also means making a bigger bet on the market to cover a larger share of benefits costs over time, and as a result, it significantly increases the risk that contributions will need to rise in the future to make up for investment returns that didn’t materialize. Investment returns falling short of expectations was the single largest factor that contributed to the current pension debt, and returns will continue to be a big driver of teachers’ benefits cost. To provide a sense of scale, ATRS estimates that if the assumed return was lowered by 1 percentage point to 6.5%, which is roughly in line with the recommendations of the Society of Actuaries Blue Ribbon Panel on Public Pension Funding (SOA BRP), then the pension debt would increase by more than $2.5 billion or 60 percent. Given we are likely headed into a period of lower investment returns and the next recession is lurking somewhere in the not too distant future, sticking with a high assumed return places future state and school budgets at significant risk, not to mention teachers’ retirements. The state and ATRS should work together to remove some funding risk by developing a plan to lower the assumed return and increase contributions over time, bringing the assumed return in line with the SOA BRP recomendations.

These three risks are not insurmountable, and Arkansas is certainly not anywhere close to a crisis that requires drastic action. It is very important, however, that the state be vigilant, and seek to address potential issues well before they become larger problems. Like any system that relies on the power of compounding (i.e., exponential growth), problems with ATRS’s funding can get out of hand quickly if allowed to fester. This is why stress testing, as proposed in HB1173, and having formal cost-sharing plan developed in advance are so important. Not performing routine stress testing is like driving without headlights – you may survive, but the potential for unexpected disaster is huge. We recommend that the state adopt stress testing requirements for all of its pension plans, including ATRS, so that policymakers better understand the risks they face down the road and can make plans to navigate effectively through them.

In addition, the importance of planning ahead cannot be overstated. Once a pension plan gets into funding trouble, without an established plan address the problem, de facto cost-sharing will ultimately occur through ad-hoc changes that are almost guaranteed to disproportionately affect certain groups of employees (i.e., new teachers or retirees) and/or taxpayers (i.e., future vs. current). In contrast, a formal cost-sharing plan can distribute unexpected cost increases between taxpayers and employees in a predetermined, fair, and transparent manner. We recommend the state work with its pension plans to more clearly define its funding goals (here is an example from Texas) and the steps that would be taken should the plan experience unexpected cost increases. Additionally, we recommend that any future changes to benefits, like COLAs, or contribution rates should only be made in the context of having a clearly defined funding policy and cost-sharing plan. 

About Josh :

Josh

McGee most recently served as the Executive Vice President of Results-Driven Government at the Laura and John Arnold Foundation where he worked on a diverse set of issues ranging from retirement policy to how we address the national opioid epidemic. McGee is a Senior Fellow at the Manhattan Institute and is Chairman of the Texas Pension Review Board. McGee also serves on the boards of several nonprofits including MDRC, EdBuild, and the Equable Institute.

Leave a Comment

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: