Invisible Windfall: The Distribution of Pension Wealth Enhancements During the 1990’s and Their Long-Run Consequences AEFP Annual Meetings Boston, MA March 15-17, 2012 Cory Koedel, University of Missouri Shawn Ni, University of Missouri Michael Podgursky, University of Missouri & GWBI Fellow 1

Invisible Windfall Like many other states, Missouri enacted large enhancements to teacher pension benefits during 1990’s Little analysis of the effects of these enhancements in any state Large windfall ($2.4b) and very unequally distributed. Experienced teachers had large windfall gains. Net benefits for young teachers much smaller and possibly negative. Benefits favored higher SES and low minority schools Peculiar structure of gains and elastic behavioral response of teachers likely to make ultimate costs much larger than anticipated (“peak value” to “peak plateau”) Teacher quality effects probably small and possibly negative 2

Invisible Windfall Like many other states, Missouri enacted large enhancements to teacher pension benefits during 1990’s Little analysis of the effects of these enhancements in any state Large windfall ($2.4b) and very unequally distributed. Experienced teachers had large windfall gains. Net benefits for young teachers much smaller and possibly negative. Benefits favored higher SES and low minority schools Peculiar structure of gains and elastic behavioral response of teachers likely to make ultimate costs much larger than anticipated (“peak value” to “peak plateau”) Teacher quality effects probably small and possibly negative 3

PSRS 1995 Formula factor 0.023, early retirement by rule, COLA cap 65 percent 1996Implement unrestricted “25 and out” 1997COLA cap increased from 65 to 75 percent Formula factor raised to for full retirement (with corresponding upward adjustments for early retirement) 2000Implement Rule of 80, FAS changed to highest three years of salary 2001COLA cap increased to 80 percent 2002Formula factor increased to if YOS ≥ 31 (new factor applies to all service years for eligible individuals) Table 1. Key Parameters of the Missouri Pension System, 1995 – 2002 (there were no changes after 2002). Initial Parameters as of 1995 are Reported in Row 1. 4 Key Enhancements

5 Educators in public schools in the United States are nearly universally enrolled in defined benefit pension plans. Most plans are administered at the state level and share a common structure. The following formula is used to determine the annual benefit: Final Average Salary DB pensions: F = formula factor, YOS = years of service, FAS = final average salary Note: Missouri teachers (PSRS) are not covered by Social Security

6 For each teacher the present discounted value (PDV) of pension wealth at time s, with collection starting at time j where j ≥ s, can be calculated as: Pension Wealth Real interest rate = 4%, Inflation Rate = 3% Salary growth modeled on MO data

Life Cycle Pension Wealth Accrual for Typical Teacher: 1995 Rules 7

1996 Rules 8

1999 Rules 9

2000 Rules 10

2002 Rules 11

12 How Big Were the Gains?

Total K-12 Enrollment † 781,000792,000801,000809,000813,000811,000814, , , ,000 Teachers 49,49151,12552,92354,50455,94357,40058,25658,92659,699 60,904 63,411 Avg. Age Avg. Experience Avg. Current PW ($) 91,387104,300107,012109,080120,071127,348124,628126,078127, ,643118,439 Counterfactual (1995) N/A94,37695,56697,52798,86897,78695,22496,09397,740 94,97193,876 Difference --9,92411,44611,53321,20328,20329,40429,98529,516 26,67224,563 Avg. Peak-Value PW ($) 280,867284,146289,200291,923319,167331,929332,155337,180339, ,965340,489 Counterfactual (1995) N/A284,146285,720288,407290,111286,873285,583289,512291, ,370292,410 Difference---03,4803,51629,05645,05646,57247,66847,916 46,59548,079 Avg. Expected PW ($) 207, ,086 Counterfactual (1995) N/A 206,329 Difference--- 37,757 Teacher Contribution (% of Earnings) Total Enhancement Value – Current PW ($ Millions) N/A ,1861,6971,7131,7671,762 1,624 1,558 Total Enhancement Value – Peak Value PW ($ Millions) N/A ,6252,5862,7132,8092,861 2,838 3,049 Total Enhancement Value – Expected PW ($ Millions) 2,394 Table 2. Summary of Pension-Enhancement Effects in Missouri. Counterfactual Pension Wealth Computed Using 1995 Pension Parameters Dollars.

Total K-12 Enrollment † 781,000792,000801,000809,000813,000811,000814, , , ,000 Teachers 49,49151,12552,92354,50455,94357,40058,25658,92659,699 60,904 63,411 Avg. Age Avg. Experience Avg. Current PW ($) 91,387104,300107,012109,080120,071127,348124,628126,078127, ,643118,439 Counterfactual (1995) N/A94,37695,56697,52798,86897,78695,22496,09397,740 94,97193,876 Difference --9,92411,44611,53321,20328,20329,40429,98529,516 26,67224,563 Avg. Peak-Value PW ($) 280,867284,146289,200291,923319,167331,929332,155337,180339, ,965340,489 Counterfactual (1995) N/A284,146285,720288,407290,111286,873285,583289,512291, ,370292,410 Difference---03,4803,51629,05645,05646,57247,66847,916 46,59548,079 Avg. Expected PW ($) 207, ,086 Counterfactual (1995) N/A 206,329 Difference--- 37,757 Teacher Contribution (% of Earnings) Total Enhancement Value – Current PW ($ Millions) N/A ,1861,6971,7131,7671,762 1,624 1,558 Total Enhancement Value – Peak Value PW ($ Millions) N/A ,6252,5862,7132,8092,861 2,838 3,049 Total Enhancement Value – Expected PW ($ Millions) 2,394 Table 2. Summary of Pension-Enhancement Effects in Missouri. Counterfactual Pension Wealth Computed Using 1995 Pension Parameters Dollars.

Total K-12 Enrollment † 781,000792,000801,000809,000813,000811,000814, , , ,000 Teachers 49,49151,12552,92354,50455,94357,40058,25658,92659,699 60,904 63,411 Avg. Age Avg. Experience Avg. Current PW ($) 91,387104,300107,012109,080120,071127,348124,628126,078127, ,643118,439 Counterfactual (1995) N/A94,37695,56697,52798,86897,78695,22496,09397,740 94,97193,876 Difference --9,92411,44611,53321,20328,20329,40429,98529,516 26,67224,563 Avg. Peak-Value PW ($) 280,867284,146289,200291,923319,167331,929332,155337,180339, ,965340,489 Counterfactual (1995) N/A284,146285,720288,407290,111286,873285,583289,512291, ,370292,410 Difference---03,4803,51629,05645,05646,57247,66847,916 46,59548,079 Avg. Expected PW ($) 207, ,086 Counterfactual (1995) N/A 206,329 Difference--- 37,757 Teacher Contribution (% of Earnings) Total Enhancement Value – Current PW ($ Millions) N/A ,1861,6971,7131,7671,762 1,624 1,558 Total Enhancement Value – Peak Value PW ($ Millions) N/A ,6252,5862,7132,8092,861 2,838 3,049 Total Enhancement Value – Expected PW ($ Millions) 2,394 Table 2. Summary of Pension-Enhancement Effects in Missouri. Counterfactual Pension Wealth Computed Using 1995 Pension Parameters Dollars.

Total K-12 Enrollment † 781,000792,000801,000809,000813,000811,000814, , , ,000 Teachers 49,49151,12552,92354,50455,94357,40058,25658,92659,699 60,904 63,411 Avg. Age Avg. Experience Avg. Current PW ($) 91,387104,300107,012109,080120,071127,348124,628126,078127, ,643118,439 Counterfactual (1995) N/A94,37695,56697,52798,86897,78695,22496,09397,740 94,97193,876 Difference --9,92411,44611,53321,20328,20329,40429,98529,516 26,67224,563 Avg. Peak-Value PW ($) 280,867284,146289,200291,923319,167331,929332,155337,180339, ,965340,489 Counterfactual (1995) N/A284,146285,720288,407290,111286,873285,583289,512291, ,370292,410 Difference---03,4803,51629,05645,05646,57247,66847,916 46,59548,079 Avg. Expected PW ($) 207, ,086 Counterfactual (1995) N/A 206,329 Difference--- 37,757 Teacher Contribution (% of Earnings) Total Enhancement Value – Current PW ($ Millions) N/A ,1861,6971,7131,7671,762 1,624 1,558 Total Enhancement Value – Peak Value PW ($ Millions) N/A ,6252,5862,7132,8092,861 2,838 3,049 Total Enhancement Value – Expected PW ($ Millions) 2,394 Table 2. Summary of Pension-Enhancement Effects in Missouri. Counterfactual Pension Wealth Computed Using 1995 Pension Parameters Dollars.

17 How Were They Distributed?

18 Avg. Pension-Wealth GainsAvg. AgeAvg. Experience Gains Decile (lowest to highest) One 4, Two12, Three16, Four19, Five25, Six31, Seven40, Eight52, Nine69, Ten104, Table 3. Distribution of Enhancement-Driven Gains in Expected Pension Wealth Across the 2009 Teaching Workforce. Gains are Relative to Baseline Expected Pension Wealth Using the System Parameters and Exit Rates from the Pre-Enhancement Period Dollars.

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21 Model AModel B Student Share on Free/Reduced Lunch (11.6)* (10.7)* Urban Middle/High (1086.1) Suburb Elementary 3,958.2 (956.1)* Suburb Middle/High 1,593.8 (962.0) Rural Elementary -5,396.8 (756.1)* Rural Middle/High -6,263.9 (789.7)* Year 2009 R-Squared N 59,249 Table 6. Relation between Enhancement-Driven Gains in Expected Pension-Wealth and Teachers’ Schooling Environments in 2009.

22 Expected OutcomesPeak-Value Outcomes Contribu tions Pension Wealth Net Pension Wealth ContributionsPension Wealth Net Pension Wealth Teacher ProfilePension Regime Age Experience Pension Rules Expected Contributions , Post , Difference: Teacher Internalizes District Cost Post Difference: Table 5. Projected Total Pension Wealth for a New Teacher in 2012 under Different Pension Regimes and Contribution Scenarios. Entering teachers probably worse off

23 Did they change teacher behavior?

24 Teacher Turnover and

25 Conditional Distribution of Experience for Teachers Exiting With Years Experience

Mean Experience Median Experience Mean Age Median Age N Experience and Age of Teacher Retirees: 1993, 2002, and 2007 (Missouri )

Conclusion 27