Teacher Pension Workshop: Connecting Evidence-Based Research to Pension Reform

Costs and Cross-Subsidies: Reconciling Two Strands of Teacher Pension Analysis

by Andrew G. Biggs

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Retirement plans for public school teachers are the subjects of two strands of recent economic analysis. Market valuation analysis attempts to more accurately value the liabilities of such plans by utilizing a discount rate matched to the nearly-guaranteed nature of teacher pension liabilities, rather than discounting liabilities at the assumed return on a risky portfolio of investments as public plans currently do. The market valuation analysis finds that teacher pensions are more costly to governments and more valuable to teachers than was previously understood. The second strand analyzes cross-subsidies between short-career and long-career teachers, finding that most shorter-career teachers fail to receive benefits equal to their contributions and thus fail to "break even." However, the cross-subsidization analysis fails to incorporate the methodological improvements of the market valuation of pension liabilities. When teacher pension benefits are discounted using a low interest rate to match the low risk of those benefits, teachers of nearly all career lengths at least break even and most teachers fare substantially better than they would under a defined contribution plan. However, this better treatment merely reflects the higher cost and greater generosity of teacher pensions relative to alternate retirement plans.

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