1. How will the COVID-19 pandemic influence teacher pension plans?
There are two big ways this pandemic will create fiscal problems. First, the current economic recession is shrinking tax revenues. Much of this revenue goes towards funding for education, which is usually the largest expenditure for a state government. Lower revenue results in states having fewer dollars to provide to school districts. This may result in state legislatures deciding to reduce their payments into state pension funds for one to two years, which will make current levels of pension debt billions deeper. Second, the financial market downturn is creating losses for pension funds. Even if financial markets improve in the coming months, it is unlikely that any pension fund will achieve its targeted investment return for the year.
It is very unlikely that the pandemic will result in current retirees losing their pension checks. As of publication, every teacher pension fund in the country had at least a few billion in assets — if not a few hundred billion. While the financial losses will be hard, they won’t result in bankrupt pension funds this year.
2. How will the losses from the financial market affect teacher pension funds specifically?
Pension funds measure two key financial metrics—the value of the assets in their fund and the value of all pensions that have been promised into the future, counted up and then adjusted into the value of today’s money. At any given time, these should be about the same amount. The issue arises when there is less money in the fund than promised benefits, creating a funding shortfall called unfunded liabilities.
The financial market losses will create additional unfunded liabilities. The ratio of assets to promised benefits — called funded status — will also decline. The average funded status of a teacher pension fund is 73%, meaning there are 73 cents in assets for every dollar of promised benefits. That level is going to dip even lower.
The net result is that contributions into pension funds will have to increase to cover the additional shortfall created by the financial market losses. And those could come from school districts and/or teachers.
3. Were teacher pension funds prepared for this pandemic related financial crisis?
Most teacher pension funds entered 2020 in a fragile state, exposed to high risks created by overly optimistic investment return assumptions. This meant that states did not save as much as they should have over the past decade when the economy was strong, because they thought they were going to have unrealistic investment returns. Plus, many teacher pension funds reduced the amount of relatively safe bond investments they held in their portfolios to try and get bigger returns from alternative investments.
On the positive side, pension funds in general have increased the diversification of their assets between 2008 and 2020. Most major pension funds have developed a more sophisticated investment strategy during the past decade too. Theoretically this will have made pension fund investments better prepared for this financial crisis than the last one. But it remains to be seen. The diversification of teacher pension fund investments meant putting more money into hedge funds, private equity, and other “alternative” investments that can be risky. It is not yet clear whether all of the diversification will have helped or hurt teacher pension plans.
4. How badly will financial losses be for teacher pension funds?
We don’t know yet what the total losses will be. But we do know that the goal for pension funds is not just to earn a positive return. Every pension fund has an annual investment target, which on average is 7.2% for this year. As of publication, major pension funds around the country were facing annual returns between -5% and -10%. And even if markets improve before the end of the fiscal year, they have a long way to climb back — the target isn’t just getting into the positive investment return range like 1% or 2%, but all the way to the average assumed target of 7.2%.
For the purposes of measuring investment returns, every pension plan operates on a specific fiscal year. Most teacher pension funds measure their investment returns between July 1 and June 30 of the following year (though there are a few exceptions). That means for most pension funds they have just three months between the market losses they started to suffer in March 2020, and the end of their fiscal years on June 30, 2020, to build any recovery. After June of this year, we will know just how bad the financial losses from the pandemic were.
5. Will the pandemic make hidden funding cuts worse?
Yes. America’s hidden education funding cuts have been caused by the combination of slow growing education budgets and rapidly increasing teacher pension costs. Both of these factors are going to be exacerbated by the COVID-19 pandemic.
First, the economic recession is causing businesses to close, which will cause reductions in state education spending, unless there is a complete federal bailout providing those funds. Even with federal financial support, education budgets are likely to be curtailed — similar to what happened after the 2008-09 recession, even with the assistance of federal bailout funds for states.
Second, financial market meltdown is going to cause pension costs to increase in coming years.
It is possible that some states will take so-called “pension holidays” and reduce their payments into teacher pension funds for the near-term. This may or may not be prudent, given how tight state budgets get during this recession. But even if states manage to reduce hidden funding cuts in the near-term by shortchanging teacher pension funds, the costs of this will only be larger in the long-run, creating an on-going future of perhaps not-so-hidden education funding cuts.
6. Okay, so how are states going to fix this given the current recession? How do we pay for this?
This isn’t going to be easy. States and cities will need to juggle competing demands for funds. Immediate health needs such as housing, medical supplies, and food are certain to be the priority as the pandemic unfolds. There will also be long-term challenges caused by reduced taxpayer resources, but this is not a new challenge for policymakers.
Even in the best of times resources are still limited. Elected officials always have to manage trade-offs between using resources for services today, and ensuring they are appropriately saving to make good on promises for the future. And over the next few years they will have to continue weighing up whether or not to increase taxes, how much to provide to various programs, and whether or not to pay all of their pension bills.
The main thing that state leaders can do to ensure their pension funds are put on a path toward long-term solvency, while also prioritizing public health today is to (a) admit that the policies guiding public pensions today make them too fragile; (b) adopt realistic assumptions about the future; and (c) adopt a plan that will phase in necessary cost increases over time until pension plans are 100% funded.
Equable is here to assist any policymaker or state leader who would like guidance on the best practices for building these payment plans. See our Solutions article for more. Visit “America’s Hidden Education Funding Cuts” for more on how teacher pension costs have been eroding education budgets over the past two decades.