The Oklahoma Teachers' Retirement System is one of the five worst-funded state-run pension plans in the country.
Some have suggested starting a defined contribution plan as a way out of the problem. Unfortunately, the system's $4.8 billion unfunded liability is a major stumbling block in the way of replacing the TRS with a defined contribution plan. Even if Oklahoma wants to have a defined contribution plan, it still must meet that $4.8 billion obligation, and probably sooner rather than later.
Switching to a cash balance plan might be the only way out of the funding hole.
Something has to change in the way Oklahoma provides its public school teachers with pensions because it's unlikely the political will exists to ever fully fund the TRS.
As of June 30, 1998, the TRS had assets of $4.1 billion and liabilities of $8.9 billion. In short, the TRS is only about 46% funded.
How did the TRS get $4.8 billion in the hole? Legislators have found it relatively easy to promise pension benefits to such likable people as public school teachers. But those same legislators have balked at sending enough money to the TRS to meet those promises. Indeed, the state of Oklahoma has contributed the actuarially required amount only five times in the past 30 years.
No private pension plan could get away with this. The Employee Retirement Income Security Act of 1974 requires private employers to fully fund their pension plans, but ERISA does not apply to state-run pension plans. Consequently, the Legislature is free to spend current revenue on roads, tourism, prisons, even schools. They can cut taxes if they like. After all, these actions might help in the next election.
But just because some budget analyst says the TRS will run out of money in 20 or 30 years, that's no reason for this Legislature to worry. There is no immediate danger of default by the TRS. Current retirees are receiving their benefits. Future legislators can worry about how to pay for future benefits.
The bottom line is that the TRS is underfunded because the state of Oklahoma does not contribute enough to cover its pension obligations.
Indeed, the system began in 1943 with unfunded liabilities: all active teachers were given credit for years they already had worked when the state created this pension plan. And new or improved benefits have been enacted routinely, with little regard to their cost.
The TRS is a traditional defined benefit plan that provides retired teachers with a monthly pension benefit based on years of service and final average pay. In 1999, the average monthly benefit payment is about $1,200.
So what can be done to save the TRS from bankruptcy? That was the subject of a policy briefing in Oklahoma City on "A Pension Disorder: Ideas for Saving Oklahoma Teachers' Retirement." The briefing, which was sponsored jointly by the Oklahoma Council of Public Affairs and the American Legislative Exchange Council, brought together state officials and public pension experts from around the country.
The focus of the briefing was whether it would make sense to replace the TRS with a defined contribution plan, like a 401(k) plan. Under a typical defined contribution plan, the employer simply contributes a specified percentage of the worker's pay to an individual investment account for the worker. The benefit at retirement would be based on the sum of all of those annual contributions, plus investment earnings.
At the outset, Jim Harris, a budget analyst with the Oklahoma Office of State Finance, noted that under current law it will take more than 35 years to amortize the current $4.8 billion unfunded liability. Unfortunately, the unfunded liability first will grow to more than $6.5 billion in 2015 before finally being paid down in 2034.
Mr. Harris sees the TRS as a "crater that keeps on smoking." He emphasized that because the Legislature frequently sweetens TRS benefits without contributing additional amounts to cover costs, paying off the unfunded liability, even over 35 years, seems unlikely.
University of Virginia Professor Lawrence Kochard cited a number of advantages of defined contribution plans. They are portable; they must be fully funded each year. They are attractive to younger employees and so might help in recruiting young teachers. But he also discussed difficulties in replacing traditional pensions with a defined contribution plan. Oklahoma, he said, still would have to come up with the money to cover the $4.8 billion unfunded liability. That would be politically difficult.
Would it make sense to replace the TRS with a defined contribution plan?
There are some advantages. The TRS has a variety of perverse work and retirement incentives that can discourage young people from entering teaching and can push older teachers into premature retirement. That's because the TRS is back loaded: it rewards teachers who stay a long time, but it penalizes those who stay too long (that is, beyond retirement age).
Indeed, traditional defined benefit pension plans like the TRS count on backloading to keep costs down, They expect to pay full retirement benefits to just 30% or 40% of workers. But this backloading also discourages young workers from coming into public school teaching. At a time when Oklahoma wants to attract the best K-12 teachers it can, we have a pension system that is backloaded in favor of older teachers. Perhaps worse, there probably are many older teachers who want to leave teaching but are tied to the TRS until retirement age.
Defined contribution plans, on the other hand, are neutral as to work and retirement decisions. Because they are portable, younger workers can take their benefits with them if they change jobs, and burned-out teachers won't need to wait around until retirement age. And a defined contribution plan won't push older teachers out of the classroom; if they keep working, they will continue to have significant benefits added to their accounts.
But moving to a defined contribution plan would do nothing to erase that $4.8 billion unfunded obligation.
As an alternative, we might think about a cash balance pension plan, a defined benefit plan that looks like a defined contribution plan. A cash balance plan accumulates, with interest, a hypothetical account balance for each worker. The individual account balances are determined by the plan's benefit formula and consist of two components: an annual cash balance credit and an interest credit.
A simple cash balance plan might allocate 10% of salary to each worker's account each year and credit the account with 7% interest on the balance in the account. A worker who earned $30,000 in a year would get an annual cash balance credit of $3,000, plus 7% interest, on the starting balance in his or her hypothetical account.
Like a defined contribution plan, a cash balance plan spreads benefit accruals more evenly over a worker's career. That makes cash balance plans more attractive to young workers, and that will make it easier for Oklahoma to recruit new teachers. Older workers no longer would find themselves chained to their jobs until retirement age, like they do under today's backloaded plan.
Replacing the current TRS pension plan with a cash balance plan might dash the benefit expectations of some older workers, but generous transition rules could fix that problem. Workers who came into teaching under the traditional TRS pension plan could be given large starting balances to reflect their accrued benefits, and extra credit balances to ensure they would not be hurt by the transition.
We should have funded TRS in the years that our teachers earned their pension entitlements. Instead, we pushed those liabilities onto future generations. Now, even if we want to shift to a system of individual accounts, we still must meet that $4.8 billion obligation. But with a cash balance plan, we can have individual accounts now and still come up with that $4.8 billion later.
