K12 Pension Issues

Like many other states, Colorado faces a growing public sector pension funding crisis. Anybody who doubts the existence and severity of this crisis need only review the many news stories and reports collected below.

We believe that the ultimate resolution of this crisis, at least for the schools pension plan, will depend in considerable measure on the extent to which K12 is willing and able to substantially improve student achievement results before the full force of the onrushing crisis hits our state budget. Our contention, based on experience in Alberta, is that substantial improvements in student achievement results will make it much easier to convince voters to spend more on K12 pensions and avoid either increases in employee contributions or cuts in future benefits.

The logic behind this conclusion is quite straightforward. Absent dramatic improvements in investment returns or falls in retirees’ expected lifetimes (both of which seem highly unlikely today), there are only four ways to resolve the defined benefit pension funding shortfalls facing Colorado.

(1) Raise taxes, and increase employer (school district) contributions to the pension plan;

(2) Do not raise taxes, but cut other K12 program spending (e.g., materials, sports, music, arts, technology, counselors, etc.) to pay for higher employer contributions to the pension plan;

(3) Do not raise taxes or employer contributions, but instead raise employee contributions to the pension plan to more than the current 8% rate. This would reduce employees’ take-home pay.

(4) Do not raise taxes or employer or employee contributions, but instead reduce future pension benefits.

That’s it.

Of course, at this point somebody will always suggest that issuing a huge pension bond is the magic bullet solution to our problem. It isn’t, at least under the conditions that pension beneficiaries would like to see.

To simplify, in a pension bond transaction, some entity issues billions in bonds, and the proceeds are given to the pension fund (e.g., PERA) in exchange for the fund’s contractual agreement to make principal and interest payments on the bonds. One underlying assumption in a pension bond deal is that the pension fund will earn a higher rate of return on the invested proceeds than the interest rate it has to pay on the bonds. But what if this isn’t the case (and it usually isn’t, as pension returns fluctuate while the bond interest rate remains constant)?

Pension beneficiaries will argue that if the pension bond deal doesn’t pay off, then taxpayers will have to cough up more funds to avoid any cuts in pension benefits. In essence, the pension bond deal they want is “heads I win, tails you lose.” Most taxpayers will rightly argue that this shouldn’t be the case, since beneficiaries willingly took on more risk by leveraging up their retirement fund (i.e., by turning it into a leveraged hedge fund).

The only way a pension bond deal makes sense is if pension beneficiaries agree to cut their benefits if it doesn’t work out. And that seems unlikely to happen. So a pension bond proposal will likely turn into political kryptonite.

So if members of PERA’s schools fund really want to help themselves, they will pull out the stops to substantially improve achievement results within their current budgets. If they don’t — if they continue to resist painful changes — then Colorado could soon find itself in the same ugly end game that is already playing out in other states. (For more on this issue, read “Five Forces are Driving Three End Games in K12.”)

News Stories from 2016 and 2017 on the Public Sector Pension Crisis (Newest First)

Analytical Reports on the Public Sector Pension Crisis (Newest First)