In Albany this week, UFT President Michael Mulgrew floated a plan to save the city money by letting teachers retire earlier. But a new report on the health of the city’s teachers pension fund suggests that Mulgrew’s proposal would only compound the fund’s potentially crippling budget crunch.

The fund’s annual report, released last week, shows that it lost 29 percent of its value, more than $9 billion, last school year, even as the portion the city is required to pay reached unprecedented heights.

The mix of rising costs and declining value raises serious questions about how the city will be able to afford to pay the pensions it has promised in the future without major concessions by the teachers union.

The fund, called the Teachers Retirement System (TRS), is a collection of investments paid for with a combination of taxpayer dollars and teacher salaries. Every year a chunk of it is used to pay retired teachers and principals the pensions state law says they are owed.

picture-63Last year’s financial crisis sunk the fund to its lowest level in more than 15 years, effectively erasing all of the gains made in the past decade’s bull market, according to a database of TRS’s financial reports. Over that time span, the fund’s value, adjusted for inflation, has shrunk by more than $11 billion.

This leaves a $15 billion gap between what the fund expects to pay out in the next 30 or so years and what it will have saved by that time, according to the TRS’s preferred accounting method. Another way of calculating these “unfunded liabilities” used in the private sector puts the number even higher, at $27 billion.

“It’s not a crisis. It’s a long-run big problem: The pension system is far more costly than it ought to be,” said Charles Brecher of the Citizens Budget Commission, an independent group that advocates for changes in city and state finances.

Sources of the “big problem”

At the center of the mismatch between what is promised and what was saved is the basic structure of what is called a “defined benefit” pension. A typical defined benefit plan promises a certain annual payout to retirees, usually in the form of a percentage of the retiree’s final annual salary. In New York, these payouts are defined by law and are not adjusted to reflect how much a member contributes over time.

Nobody expects the amount a member contributes to fully fund his promised pension. The idea is that the difference will be made up through a combination of taxpayer dollars and market returns.

The problem is that since 2000 a slew of factors have made this gap between how much teachers put in and how much they take out larger than ever before. One reason is that salaries have gone up 43 percent in the past decade, hoisting up the final amount retirees can expect each year. Current teachers’ pay-ins, based on higher salaries, help a bit. But the effect is dampened by the fact that even as teacher salaries have gone up, the proportion of member contributions used to pay for the plan in each year has gone down. In 1999, teachers’ contributions made up 18 percent of the total. In 2009, they were only 6 percent.

Another gap-widening factor is the fact that, for the past decade, a state law has allowed the highest-paid teachers in the city to opt out of contributing to the pension altogether. The rule has changed with the start of a new pension system for employees entering work today.picture-65

In addition to raising salaries, the city has also granted a series of pension sweeteners in exchange for union concessions. In 2007, teachers with 25 years of service won the right to retire at age 55 with no penalty, a union victory that came in exchange for a touted performance-based pay deal.

The sweeteners reduced the retirement contributions for teachers and principals, putting more of the burden to pay for pensions onto the city. They also allowed per diem salary — money teachers make for taking on extra tasks like running after-school clubs and sports — to be counted in the overall final salary number. And, in 2008, a provision allowed teachers to retire early without being dinged in their pension earnings.

Together, the rising salaries and pension sweeteners have created a perfect storm: increasing costs just as the plan’s performance has plummeted in the down market. Although the TRS has not performed significantly worse than the market according to the new report, the annual rate of return it assumes — 8 percent — is high by most private standards. (To be fair, most public pension plans also use a number around 8 percent. Similar private sector plans assume a rate of around 4 percent.)

Assuming a steady and high rate of return leaves little room for error. Imagine that the fund fails to make 8 percent returns one year and instead breaks even. To recover the lost ground the next year, TRS will have to make last year’s 8 percent and this year’s, a total of 16 percent returns. The recession of the past two years has followed this pattern of compounding losses. As a result, the fund was so far behind last year that even the high market returns from earlier in the decade couldn’t make up for the losses.

picture-64All of this has left taxpayers to make up the burden. In the late 1990s, the amount the city put into the pension fund every year was around $500 million in today’s dollars. By 2009, the sum the city had to contribute ballooned to $2.2 billion. 

This amount is incredibly high, especially compared to the New York State Teachers Retirement System, which serves all teachers outside of New York City. Last year, the state contributed half as much to its teacher retirement system as New York City contributed to the TRS, even though there are twice as many retirees in the rest of the state as there are in the city.

Even the new Tier V pension plan, which increased all new teachers’ required contribution to the plan and doubled the amount of time before they can qualify to draw a pension, has not alleviated all costs. That’s because the Tier V law included a special provision for New York City’s teachers that no other plan received, allowing them to retire with a full pension at age 55 if they’ve taught for 27 years. Teachers in the rest of the state must wait until age 57 to retire with a full pension.

Though the city is not benefiting as much from Tier V as the rest of the state, Tier V reforms are still expected to save the city $19.1 million next year, according to Division of Budget estimates.

But E.J. McMahon, of the conservative-leaning Manhattan Institute, warns that Tier V will do little to close the TRS’s budget gap. Instead of making retirement benefits fundamentally sustainable, Tier V actually turns back the clock to before the recent decade of pension sweeteners, he argues. Tier V “does not deserve the label reform,” McMahon said.

Brecher doesn’t even think Tier V merits its name. “They call it that, but it’s not really a tier in the sense that it’s a big change in the benefit structure,” he said.

Grim prospects

Going forward, the city cannot alter any current TRS member’s benefits due to a state law that prohibits the public pensions from being “diminished [or] impaired.” Only a handful of states have this provision, which guarantees that pension reforms affect only future teachers.

One possible alternative for the future is a cash balance plan, which California and Nebraska have adopted for their employees. Cash balance plans blend features of the TRS model (the defined benefit plan) with features of private sector pensions, known as defined contribution plans, to spread out risk more evenly among employees and employers. Although cash balance plans were surrounded by controversy when they were first introduced, in recent years they have been gaining popularity in academic and public policy circles.

Another option is a straightforward defined contribution plan, like the 401k plans that are offered to private sector workers and even some CUNY and SUNY faculty. Such plans are subject to market fluctuations and are dependent on the quality of investment advisors, but some consider them less likely to see costs spiral out of control.

“Anything that has a defined benefit at the end of it … is complicated, more costly and subject to manipulation by the union through a legislature that doesn’t understand it,” McMahon said.

Any of these alternative pension plans could make their way into city teachers’ contract one day, but for now the UFT is publicly committed to at most tweaking the current system, as Mulgrew indicated before legislators yesterday.

“We believe in a defined-benefit plan,” said Dick Riley, a UFT spokesman, adding that he would not discuss contract negotiations with the media.

Whatever happens, making TRS sustainable is likely to require city teachers to give up some of the perks of their profession.

“It’s up to the union to decide whether they’re going to make some concessions on these benefits or take layoffs and both deprive kids of educational services or members of their jobs,” said Brecher of the Citizen’s Budget Commission. “That’s the trade-off.”

Kim Gittleson is a research assistant employed by Ken Hirsh, a GothamSchools funder and contributor.