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School district pension reform as a cut in state school aid
*Chuanyi Guo, **Darren Lubotsky, ***David Merriman and ****Jason Ward
November 1, 2017
*Department of Economics, Univ. of Illinois at Chicago & Inst. of Gov't and Public Affairs, Univ. of Illinois, Email [email protected]
**Department of Economics, Univ. of Illinois at Chicago & Inst. of Gov't and Public Affairs, Univ. of Illinois, & National Bureau of Economic Research, Email [email protected]
***(corresponding author) Dept. of Pub. Admin., Univ. of Illinois at Chicago & Inst. of Gov't and Public Affairs, Univ. of Illinois, Email [email protected]
****Department of Economics, Univ. of Illinois at Chicago, Email [email protected]
Abstract
The state of Illinois is responsible for all employer contributions to the public school teachers’ pension system. To the extent that teachers’ view pension benefits as part of their compensation, pension benefits can thus be thought of as state aid to local school districts. In April 2010, Illinois enacted a major reduction in the pension benefits offered to public school teachers hired after January 1, 2011. We simulate the reduction in pension benefits earned by essentially identical teachers hired right before and after the policy change and show that, depending on the choice of retirement dates, pension benefits under the new Tier II plan will be reduced by as much as one half. Because the legislation creating the new pension system delayed the effective date by about eight months, local school districts had a window in which to hire teachers under the old, more lucrative, pension system to capture additional state aid. We conduct empirical analyses and show that there was no surge in hiring during the relevant window. Furthermore, we show that there is no evidence that school districts in excellent financial condition, who should have had the financial capacity to speed up hiring, acted differently than school districts in poor financial condition with respect to hiring in this window. We show that districts with relatively low starting wages have systematically higher rates of hiring before, during, and after the policy change. However, we find no evidence that the hiring rates of high and low wage districts reacted to the policy change in any systematic manner. We conclude with directions for further research.
Preliminary and incomplete draft: Please do not quote or cite.
Table of Contents
I. Introduction ..................................................................................................................... 1
II. Illinois’ 2010 pension reform and the lifetime value of pension benefits .......................... 2
III. Preliminary empirical analysis: Was there a hiring surge? ................................................ 4
IV. Preliminary empirical analysis: Did fiscal constraints prevent school districts from
responding to the “free lunch” between passage of Tier II and its implementation? ........ 7
V. Directions for further analysis .......................................................................................... 9
VI. Reference ....................................................................................................................... 10
VII. Figures and Tables .......................................................................................................... 11
Figure 1: Nominal Pension Benefit for Ms. Early and Ms. Late .............................................................. 11
Figure 2: Total Number of State‐Level Newly Hired Teachers ................................................................ 12
Figure 3: Number of State‐Level Newly Hired Teachers (by Percentiles) ............................................... 13
Figure 4: Hiring Rate of State‐Level Newly Hired Teachers (by Percentiles) .......................................... 14
Figure 5: Median Number of State‐Level Newly Hired Teachers (by Organization Types) .................... 15
Figure 6: Median Hiring Rate of State‐Level Newly Hired Teachers (by Organization Types) ................ 16
Figure 7: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Financial Score
(Unconditional) ....................................................................................................................................... 17
Figure 8: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Average
Financial Score (Unconditional) .............................................................................................................. 18
Figure 9: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Financial Score
(Conditional on Total Number of Teachers Employed) .......................................................................... 19
Figure 10: Relationship between Hiring Rate and Starting Salary for State‐Level Newly Hired Teachers
(Unconditional) ....................................................................................................................................... 20
Figure 11: Relationship between Hiring Rate and Starting Salary for State‐Level Newly Hired Teachers
(Conditional on Highest College Degree Earned & Total Number of Teachers Employed) .................... 21
Table 1: Contributions to TRS Fund by Sources from FY 2007 to FY 2016 ($ thousands) ....................... 22
Table 2: Major Retirement Benefit Provisions for TRS Tier I and Tier II Members ................................. 23
1
I. Introduction
Public pensions are one of the biggest fiscal challenges facing Illinoisans.1 There are five
state affiliated public‐sector pension systems in Illinois: Teachers’ Retirement System (TRS) for
public school teachers outside of Chicago; State Employees’ Retirement System (SERS) for
employees of the state government; State Universities Retirement System (SURS) for
employees of public universities, community colleges and other affiliated state agencies;
Judges’ Retirement System (JRS) for judges; and General Assembly Retirement System (GARS)
for the General Assembly members. In 2016, according to an official estimate, the five
statewide pension systems have $129.8 billion in unfunded liabilities.2
On April 14, 2010, Illinois Governor Patrick Quinn signed Senate Bill 1946 (later Public Act
96‐0889) into law which established a two‐tiered pension system for Illinois public‐sector
pensions.3 The pension reform modifies the benefits and retirement rules by creating a Tier II
pension benefit for Illinois public employees who first contributed to one of the state employee
pension plans on or after January 1, 2011.4 Employees who contributed to any Illinois state
pension system prior to January 1, 2011 are not affected by the Tier II portion of the pension
law.
We study the effect of this reform on the value of pension benefits for public school
teachers in Illinois and whether the reform induced districts to hire additional teachers before
the pension cut went into effect. The Teachers’ Retirement System (TRS) is the largest
statewide pension system and accounts for approximately 57% of both the total assets and
liabilities of the five State systems combined.5 TRS was established by the Illinois General
Assembly in 1939 for the purpose of providing retirement, disability, and death benefits for
Illinois certified public elementary and secondary schools educators.6 TRS provides a defined
1 This was stated by COGFA pension manager, Dan Hankiewicz, in 2011. See http://illinoistimes.com/article‐9048‐pinchin%E2%80%99‐pensions.html. 2 Commission on Government Forecasting and Accountability. (November 2016). Special Pension Briefing. Available at http://cgfa.ilga.gov/Upload/1116%20SPECIAL%20PENSION%20BRIEFING.pdf. 3 The law also amended provisions in 13 state‐affiliated pension funds. These pension systems are: State Employees’ Retirement System (SERS), Illinois Municipal Retirement Fund (IMRF), Teachers’ Retirement System (TRS), State Universities Retirement System (SURS), General Assembly Retirement System (GARS), Judges’ Retirement System (JRS), Chicago Teachers’ Pension Fund, Metropolitan Water Reclamation District Retirement Fund (MWRDRF), Municipal Employees' Annuity and Benefit Fund of Chicago, Laborers’ and Retirement Board Employees’ Annuity and Benefit Fund of Chicago (LABF), Park Employees' Annuity and Benefit Fund of Chicago, County Employees’ and Officers’ Annuity and Benefit Fund of Cook County, Forest Preserve District Employees' Annuity and Benefit Fund of Cook County. See http://www.senatorcullerton.com/27‐issues/articles/66‐2010‐pension‐reform‐stabilizing‐illinois‐retirement‐systems and https://www.srs.illinois.gov/SERS/reciprocal_sers.htm. 4 Teachers' Retirement System of the State of Illinois. (June 2017). Tier II Member Guide. Available at https://www.trsil.org/sites/default/files/documents/TierIIMemberGuide.pdf. 5 Commission on Government Forecasting and Accountability. (November 2016). Special Pension Briefing. Available at http://cgfa.ilga.gov/Upload/1116%20SPECIAL%20PENSION%20BRIEFING.pdf. 6 Teachers' Retirement System of the State of Illinois. Comprehensive Annual Financial Report For The Fiscal Year Ended June 30, 2016. Available at https://www.trsil.org/sites/default/files/documents/CAFRfy16.pdf.
2
benefit (DB) pension plan to all eligible public school teachers, which provides a formula‐based
retirement annuity for all members. TRS members do not participate in the federal Social
Security program.7
TRS has three sources of funding: member contributions, investment income and
employer contributions and payments by employers.8 As of July 1, 2016, both Tier I and Tier II
members contribute 9.0 percent of creditable earnings to TRS. TRS invest these assets to create
diversified investment income. Table 1 shows how much each source of funding contributed to
TRS during each year from FY 2007 to FY 2016. In general, State of Illinois appropriations and
investment returns provide the largest share of contribution of funds.9
<Insert Table 1>
II. Illinois’ 2010 pension reform and the lifetime value of pension benefits
Table 2 highlights the major benefit changes for Tier II TRS members compared to Tier I.
As shown in the table, the biggest differences between the two tiers are in a member’s
retirement eligibility, final average salary used to calculate retirement benefits, and the annual
cost‐of‐living adjustment. For Tier II teachers, the normal retirement age is 67; however Tier I
employees may retire as early as age 55 with full retirement benefits if they have appropriate
service credits. A higher retirement age makes the pension plan less generous, both because
members will contribute to the fund for a longer time and because they will receive retirement
benefits for a shorter time. Changes in the way the final average salary is calculated reduce Tier
II members’ pension payments. The final average salary used to compute benefits for Tier II
members is the highest eight consecutive years of service out of the previous 10 years, while it
is the highest four consecutive years out of the previous 10 years for Tier I members. A dollar
cap is also imposed on Tier II creditable earnings used to compute the final average salary. In
addition, the pension reform reduced the cost‐of‐living adjustment, which accounts for the
impact of inflation on retirees’ retirement benefit, to the lesser of three percent or one‐half of
the annual increase in inflation rate, not compounded, for Tier II members. In contrast, Tier I
retirees receive a flat annual three percent cost of living increases that is compounded. This
greatly reduces the relative pension benefit growth for Tier II retirees.
<Insert Table 2>
7 Teachers' Retirement System of the State of Illinois. (September 2016). Employer Guide. Available at https://www.trsil.org/employers/guide. 8 Teachers' Retirement System of the State of Illinois. Comprehensive Annual Financial Report For The Fiscal Year Ended June 30, 2016. Available at https://www.trsil.org/sites/default/files/documents/CAFRfy16.pdf. 9 Teachers' Retirement System of the State of Illinois. Comprehensive Annual Financial Report For The Fiscal Year Ended June 30, 2016. Available at https://www.trsil.org/sites/default/files/documents/CAFRfy16.pdf.
3
Since retirement benefits are a large share of educator compensation, an important
question is how the 2010 pension reform will affect the value of pension benefits for Tier II
teachers, compared to an otherwise identical teacher enrolled in the Tier I plan. To get a feel
for the magnitude of this pension change, consider two teachers Ms. Early who joined the Tier I
TRS plan at 11:59pm on December 31, 2010 and Ms. Late who joined the Tier II TRS plan at
12:01am on January 1, 2011. Imagine that both Ms. Early and Ms. Late start their careers at
exactly age 25 at the (average) salary of $40,000 per year and that both receive annual raises of
2% per year each year until they retire.10
Suppose both teachers retire at exactly age 62. Both of them earn a final annual salary of
$83,227 when they retire (two minutes apart) in 2048. Figure 1 shows the pension benefit each
(retired) teacher would receive (in thousands of nominal dollars) each year after retirement.
Ms. Early would receive a starting pension of $60,609 at age 63 while Ms. Late’s pension would
be only $40,811 at the same age. Thus, Ms. Late’s initial pension would be reduced about 50
percent because her employment started two minutes later than Ms. Early. As shown in the
figure, Ms. Late’s pension benefit is lower than Ms. Early’s for the rest of her life. This is a result
of two factors: First, her final average salary (the average of her salary in the last eight years of
employment in this instance) is lower than Ms. Early’s final average salary which is, in this
instance, the average salary during the last four years of her employment. Even more important
is the fact that Ms. Late’s pension is reduced by 30 percent for the rest of her life because she
retired before the standard retirement age of 67 for Tier II members. Ms. Early’s pension is not
reduced since she retired at the standard retirement age of 62 for Tier I members.
In addition, the absolute distance between the two women’s pensions gets larger over
time. This is because Ms. Early’s annual cost of living increase of three percent is compounded.
Our calculations assume that Ms. Late also gets a three percent annual increase in her pension
(an optimistic scenario that would only occur if the inflation rate were six percent or above),
but it is not compounded.11 At age 87, Ms. Early’s pension would be $123,205 while Ms. Late’s
pension would be $70,194 or just 57 percent of Ms. Early’s pension.
Figure 1 also shows the scenario in which Ms. Late retires at age 67. Ms. Late would
receive a starting pension (when she was 68) of $64,369 instead. But now she no longer suffers
from the life‐time 30% penalty because she retires at the standard retirement age for Tier II
members. However, in order to avoid this penalty Ms. Late must forego any pension at during
her first five years of retirement, a period in which Ms. Early would collect about $320,000 in
pension benefits. At age 87, Ms. Late’s pension would be $101,059, which is 82 percent of Ms.
Early’s pension.
10 In our sample, $39,290 is the median salary level for newly hired teachers across districts in Fiscal Year 2011. We round off to $40,000 for the simulation. 11 If the inflation rate were less than six percent, Ms. Late’s pension would be reduced while Ms. Early’s pension would be unaffected.
4
<Insert Figure 1>
Costrell and Podgursky (2011) show similar dramatic differences in the present value of
pension benefits net of the cumulative value of employee contributions, by comparing a 25‐
year‐old teacher in Tier I to this identical teacher if she were in Tier II. They find that the Tier II
teacher will experience negative net pension wealth during her first 26 years of service.12 The
peak of net pension wealth for the teacher under Tier I plan is $520,000 at age 60, while the
peak under Tier II plan is only $220,000 at age 65. The gap between net pension wealth in Tier I
plan and Tier II plan peaks at $400,000 at age 60. Johnson and Southgate (2014) explore the
expected value of lifetime pension benefits net of teacher contributions with years of service
for teachers hired at ages 25, 35, 45, and 55. Tier I teachers hired at age 25 will experience plan‐
related financial losses until 22 years of service, and then experience a surge in the net value of
future pension benefits until reaching the maximum at $740,000 at 35 years of service.
However, for age‐25 hires in Tier II plan, the expected value of net lifetime benefits peaks at 42
years of service for only $130,000.
Such dramatic changes in compensation might be expected to result in behavioral
reactions from both potential employees and potential employers. We study a detailed set of
data on Illinois school districts (employers) and their employees during the period prior to and
after this dramatic policy change.
III. Preliminary empirical analysis: Was there a hiring surge?
When the Illinois’s Governor signed legislation in April 2010 creating the Tier II pension
system with an effective date of January 1, 2011, he left a potentially very large “free lunch” on
the table. Any teacher hired prior to the effective date would be grandfathered into the Tier I
system for the remainder of her career. Employers (local school districts) that value the
incentives for career longevity built in the DB pension system and prospective employees had a
very strong monetary incentive to capture this free lunch by completing new hires before the
January 1 effective date since the employer costs would be paid entirely by the state
government and employees’ contributions are the same under Tier I and Tier II. On the other
hand, districts perhaps might not respond to the pension cut if they had limited financial
flexibility or limited use for additional teachers. It may also be the case that districts prefer a
12 Aldeman and Johnson (2015) estimate how long teachers hired at age 25 must remain teaching in the same state in order to get promised pension benefits from their state’s pension plan worth more than their contributions. For Illinois, the break‐even point is 28 years of service for Tier I and 35 years for Tier II. See Negative Returns: How State Pensions Shortchange Teachers. Available at https://www.urban.org/sites/default/files/publication/71521/2000431‐Negative‐Returns‐How‐State‐Pensions‐Shortchange‐Teachers.pdf.
5
less‐generous pension if it makes it more likely that less effective teachers leave the profession
earlier.
We test whether there was a surge in hiring between April 14 and December 31, 2010.
School districts interested in attracting high quality candidates could offer them significantly
more total compensation prior to January 1 and should have rushed to fill any available
openings and perhaps even to pre‐hire for openings they expected to occur in the near future.
Potential employees might have changed life plans—perhaps speeding accumulation of
educational credits or cancelling or postponing a “gap year” to rush into the labor market while
they could still secure lifetime rights to participate in a generous pension plan.
Of course, we would not expect every employer or every potential employee to be aware
of, or act on, these incentives. But we might find enough action on the margin to measurably
effect hiring during this period. We use detailed teacher level data to examine this question
empirically.13 We restrict our sample to all Illinois public elementary districts, high school
districts and unit districts outside the city of Chicago. We exclude Chicago since its teachers
participate in a separate retirement system and the local school district is responsible for the
employer share of pension contributions. Also, in order to abstract from issues of workforce
composition we restrict our data to full‐time teachers who do not have an administrative
assignment.
Unfortunately our data does not provide information about the exact month in which a
teacher was newly hired in the state.14 However the data does indicate the total in‐state
experience accumulated by each teacher in June each year. Any teacher hired after SB1946
could have had at most 1.3 years of experience in the June 2011 data. Notice that even a
teacher recorded as having 1.3 years of experience (or less) in the June 2011 may not have
been hired in the (April to December 2010) window to join the Tier I pension system after
legislation creating Tier II was signed. For example, a teacher could have 1.3 years of experience
in June 2011 because she worked for six months during the 2009‐10 academic year and then
left for maternity (or some other) leave and returned sometime mid‐year during the 2010‐11
academic year. If this teacher was recorded as having 1.3 years or less experience in the June
2011 data we would record her as “newly hired” even though she would not have started work
in the relevant window. Notice also that teachers hired after January 1, 2011 would appear in
the June 2011 data as having less than 1.3 years of experience but would not have been hired in
the relevant window (i.e. they would not be eligible for pension benefits under Tier I). Thus, the
13 The data come from Illinois State Board of Education (ISBE). ISBE provides a publically available administrative dataset for educator employment information, which is named as Teacher Service Record (TSR). In 2013, TSR was replaced with Employment Information System (EIS). TSR is available at http://206.166.105.35/research/htmls/educator‐employment.htm. 14 In general, almost all full‐time teachers are hired during the summer.
6
number of teachers recorded in the June 2011 data as having 1.3 years or less of state
experience represents an upper bound on the number of teachers actually hired during the
April through December 2010 window. It turns out that, in our data, the number of teachers
having 1.3 years or less of state experience in June of 2011 is very similar to the number with 1
year or less of state experience (3,194 vs 3,184).
In Figure 2 we compare this number to the total number of newly hired teachers in the
state with state experience less than or equal to 1 in June of other years. Figure 2 provides no
support for the hypothesis that school districts increased the pace of hiring to avoid the Tier II
pension system. The simplest reading of Figure 2 is that hiring in 2010‐11 (a little more than
3,000) teachers was consistent with the downward trend in hiring going back to at least 2008.
One plausible explanation for this trend was that the severe recession that began in 2008‐09
reduced the non‐defined benefit assets of many families and deterred retirements. The lag in
retirements may have been reflected in diminished hiring. The upturn in hiring in 2012 (to
about 4,500) probably represents lagged demand after several years of diminished hiring. There
is certainly no indication in this data that the switch from Tier I to Tier II caused hiring to speed
up in the relevant window or to slow down once Tier II took effect.
<Insert Figure 2>
Perhaps there was no shift in overall hiring but there was a change in the cross‐district
distribution of hiring. We investigate this hypothesis by calculating the number and the hiring
rate of state‐level newly hired teachers separately at the 50th (median), 80th, 90th, and 95th
percentile level in each fiscal year in Figure 3 and Figure 4. In Figure 3, the pattern of changes in
the number of newly hired teachers across fiscal years is consistent across the four different
percentile levels. The number had been declining since Fiscal Year 2008, and Fiscal Year 2011
hiring was the lowest across years at all four points in the frequency distribution. Figure 4
provides more evidence of this pattern. Hiring rates (number of new hires divided by total
number of teachers employed) are also uniformly lower in 2011.
<Insert Figure 3 and 4>
These basic results carry through when we separate districts by organizational type—
elementary, high school or unit as shown in Figure 5 and Figure 6.
<Insert Figure 5 and 6>
7
IV. Preliminary empirical analysis: Did fiscal constraints prevent school districts
from responding to the “free lunch” between passage of Tier II and its
implementation?
School districts that did not speed up hiring during the period between April 10 and
December 31, 2010 gave up significant potential benefits for their future employees. According
to simulations done by Johnson and Southgate (2014), the expected present value of a Tier II
pension may be as much as $600,000 less than the expected present value for an otherwise
identical Tier I employee. Since employee contributions are the same under the two pension
programs and since local school districts pay none of the employer cost under either program,
the expected present value of state transfers from hiring a Tier I employee compared to a Tier II
employee may be as much as $600,000. A typical (median) district that hires four new teachers
each year may have foregone as much as $2.4 million ($600,000*4) by hiring under Tier II rather
than Tier I. This is large—about 52 percent of the $4.6 million in annual general state aid to the
average unit district. If school districts had simply increased their 2011 hiring to the level it was
in 2006 (about 8,000), they would have effectively gathered significant transfers from the state.
One possible explanation for their failure to do this was that districts did not have the
fiscal ability to commit to significant increases in hiring at that point in the business cycle. In
order to investigate this hypothesis we merged data on school district hiring with data on
school district financial scores. School district financial scores are a weighted average of five
components including such measures as fund balance to revenue ratio, expenditure to revenue
ratio and cash on hand15. Financial scores are used by the Illinois State Board of Education to
assess the fiscal condition of school districts and decide whether intervention may be
appropriate (see Crosby (2016) for more details). Each district gets a score between 1 and 4
designating their fiscal condition as appropriate for: recognition (≥3.54), financial review (3.08
to 3.53), warning (2.62 to 3.07), watch (≤2.61). The state may intervene in the fiscal affairs of
school districts with scores of 3.07 and below16.
We hypothesized that school districts with relatively low financial scores might not have
had the fiscal latitude to respond to the change in incentives resulting from the introduction of
Tier II but that districts with a strong financial profile might have responded more aggressively.
Figure 7 shows annual scatterplots of school district hiring rates against financial scores. Each
graph has a footnote showing the slope and standard error from a bivariate regression of the
hiring rate on financial score. In each year the line is essentially flat—hiring rates are apparently
independent of financial score. We also ran a pooled regression with data from all years and
15 The other two components are percent of short‐term borrowing ability remaining, and percent of long‐term debt margin remaining. 16 The authors thank Andrew Crosby for making data on district financial scores available to us.
8
added a variable that interacted financial score with a dummy variable for 2011 to test the
hypothesis that those with a higher financial score accelerated their hiring in 2011 to take
advantage of the last opportunity to get new employees into Tier I. The point estimate of the
coefficient on the interaction variable is actually negative but not significantly different from
zero. This result provides no support for the hypothesis that districts with a strong financial
profile attempted to accelerate hiring.
<Insert Figure 7>
Figure 7 used each district’s financial score at a particular point in time but district
financial scores fluctuate over time and it is possible that hiring depends upon the long term
financial condition of a district rather than year‐to‐year fluctuations. To examine this
hypothesis, in Figure 8 we plotted hiring rate in each year against each district’s average
financial score over the whole period. Again, we find no systematic relationship and no
indication that districts with a strong financial profile reacted in a special way in 2011.
<Insert Figure 8>
Figure 8 does not control for any factors other than year and financial condition that
might affect hiring. We thought that large districts might have both high rates of attrition (and
thus high hiring rates) and relatively poor financial condition. The high natural hiring rates in
large districts might be offset by lower hiring rates due to poor financial condition and lead us
to falsely conclude that financial condition did not affect hiring rates. Figure 9 shows
scatterplots of hiring rates against financial score conditional on district size (measured by
number of teachers employed in the district). Again, we find no systematic relationship
between the variables and no indication that anything special was happening with respect to
hiring in 2011.
<Insert Figure 9>
Teachers’ pension benefits depend primarily on two parameters—wages at the end of
their careers and longevity. Thus, pensions may be a more important (and salient) component
of compensation in districts that offer high wages and in which teachers have longer tenures. In
Figure 10 we examine the relationship between the starting salary of new teachers—which we
expect to be highly correlated with teacher wages throughout the tenure distribution—and the
hiring rate. Here we find a clear inverse relationship—the higher wages are the lower the hiring
rate. While the relationship varies somewhat from year‐to‐year, in general a $10,000 increase
in starting wages is associated with a hiring rate that is lower by 0.3 to 2.1 percent. This is
probably because districts that offer lower wages face more attrition as teachers leave either to
go to higher wage districts or to leave the profession. Higher rates of attrition necessitate
higher hiring rates. The general patterns hold in 2011 but there is no indication that higher
9
wage districts made special efforts to hire in that year—the estimated coefficient on an
independent variable interacting a 2011 dummy with average starting salary in a regression
pooled across years is not significantly different from zero.
<Insert Figure 10>
As shown in Figure 11, this basic story does not change when we condition on the size of
the district (measured by number of teachers) and teacher education.
<Insert Figure 11>
V. Directions for further analysis
In our view, the analyses in the previous two sections provide strong evidence that
school districts did not increase hiring in response to the “free lunch” created by the lag
between the adoption of Tier II pension legislation and its implementation. This leaves a
number of important questions for future research.
1. What other margins might have been affected by the introduction of the Tier II pension
system? It is possible that teachers with greater financial literacy and/or better outside career
options may have shifted away from entering teaching since lifetime compensation declined
significantly. Such a shift might be detected by exploring compositional changes in the mix of
colleges and universities providing new teachers to Illinois. If higher average levels of academic
rigor / selectivity are positively correlated with these traits, then such changes may suggest that
the pension system induced a quality change in new teachers. If this is the case, the ultimate
empirical question of interest will be what effect such a change will have on student academic
outcomes.
2. What longer term impacts will the introduction of the Tier II pension system have on
teacher labor markets in Illinois? One possible explanation for school districts’ lack of response
when Tier II was introduced is that the districts believed young newly hired teachers are either
ignorant of the portion of compensation associated with their pension or have a very high
discount rate and so care very little about the magnitude of the pension. Even if this were the
case we might expect that pension benefits would affect retention in later years. As workers
gain experience and get to know their senior colleagues they are likely to get a better
understanding of the importance of pension benefits. Will workers in Illinois’ Tier II pension
system recognize how much their pension benefits will be diminished relative to their senior
colleagues? Will this affect their labor market behavior through channels such as increased
rates of attrition from the profession? We cannot fully answer these questions since experience
with Tier II was introduced only six years and a half years ago. However, we plan to compare
early career labor market behavior (including attrition) of Tier I and Tier II teachers.
10
3. If attrition rates increase, particularly for late career teachers, as a result of the
introduction of Tier II pensions, an important policy question is whether this benefits the state,
individual districts and students. Teacher salaries are school districts’ single largest cost. By the
last decade of a 30‐year career, many districts are paying a salary to late career teachers that is
approximately equivalent to two early career teachers. Extensive empirical evidence suggests
that the returns to teacher experience are greatest in the first few years of the career and then
level off or even are associated with a decline in student achievement (see Rice (2010) for a
summary of this literature). Irrespective of pension benefits, if districts pay continuously
increasing salaries for teachers of fixed quality after a relatively short period of initial skill
acquisition, then a policy that increases attrition of mid to late career teachers may improve
districts’ fiscal condition without a negative impact on student achievement.
4. What are the cross‐district equity implications of the introduction of Tier II? We argued
that Illinois’ teacher pensions can be looked at as large implicit intergovernmental transfers. It
is likely that pension benefits disproportionately benefit relatively high wealth school districts
where wages and job tenure are relatively high. Tier II represents a large cut in such transfers.
Does the introduction of Tier II also make the school funding system more progressive by
increasing the share of state aid going to low wealth districts? The impact of the pension
changes on different school districts will depend in part upon labor market reactions of
teachers. Are teachers from all types of districts more likely to leave the profession after a short
tenure? Are teachers in relatively low wage districts more or less likely to seek to move to high
wage districts? Are highly qualified teachers relatively less likely to enter the profession?
VI. Reference
Costrell, Robert, and Michael Podgursky. "Reforming K‐12 Educator Pensions: A Labor Market Perspective." TIAA‐CREF Institute, Policy Brief, February (2011).
Crosby, Andrew W. "Intergovernmental Financial Monitoring and Intervention: Does it make the Grade?." PhD diss., University of Illinois at Chicago, 2016.
Johnson, Richard W., and Benjamin G. Southgate. "Evaluating Retirement Income Security for Illinois Public School Teachers. Public Pension Project Report." Urban Institute (2014).
Rice, Jennifer King. "The Impact of Teacher Experience: Examining the Evidence and Policy Implications. Brief No. 11." National center for analysis of longitudinal data in education research (2010).
11
VII. Figures and Tables
Figure 1: Nominal Pension Benefit for Ms. Early and Ms. Late
4060
8010
012
0N
om
inal
Pe
nsio
n B
ene
fit (
$ in
000
s)
60 63 66 69 72 75 78 81 84 87 90Age
Ms. Early if retiring at age 62Ms. Late if retiring at age 62Ms. Late if retiring at age 67
12
Figure 2: Total Number of State‐Level Newly Hired Teachers
Note: Throughout this paper, newly hired teachers are defined as those with one year or less of in‐state experience in June of the relevant year except in Fiscal Year 2011 when we treat any teacher with 1.3 years or less of in‐state experience as newly hired. The 2011 number is an upper bound on those who might have been hired in the window (from April 2010 to December 2010) after the Tier II pension system was signed but before it took effect.
13
Figure 3: Number of State‐Level Newly Hired Teachers (by Percentiles)
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Figure 4: Hiring Rate of State‐Level Newly Hired Teachers (by Percentiles)
Note: The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year.
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Figure 5: Median Number of State‐Level Newly Hired Teachers (by Organization Types)
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Figure 6: Median Hiring Rate of State‐Level Newly Hired Teachers (by Organization Types)
Note: The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year.
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Figure 7: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Financial Score (Unconditional)
Note: (1) The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level
newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year. Each dot represents the average hiring rate across districts with each financial score. The slope of the fitted line for each fiscal year is shown under each figure together with the standard error in parentheses. The dashed lines rest at scores equal to 2.61, 3.07, and 3.54 respectively, separating the four fiscal condition designations.
(2) In order to figure out whether the slope in FY 2011 is statistically significantly different from other years, we regress the hiring rate (unit: %) on financial score, interaction between financial score and FY 2011 dummy, and dummies for each fiscal year. The coefficient on the interaction term is ‐0.5648, with the standard error 0.5084.
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Figure 8: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Average Financial Score (Unconditional)
Note: (1) The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level
newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year. The relationship between these two variables is plotted with 50 equal‐sized bins, with each dot representing within‐bin average. The slope of the fitted line for each fiscal year is shown under each figure together with the standard error in parentheses. The dashed lines rest at scores equal to 2.61, 3.07, and 3.54 respectively, separating the four fiscal condition designations.
(2) In order to figure out whether the slope in FY 2011 is statistically significantly different from other years, we regress the hiring rate (unit: %) on average financial score, interaction between average financial score and FY 2011 dummy, and dummies for each fiscal year. The coefficient on the interaction term is 0.1280, with the standard error 0.5648.
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Figure 9: Relationship between Hiring Rate for State‐Level Newly Hired Teachers and Financial Score (Conditional on Total Number of Teachers Employed)
Note: (1) The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level
newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year. We residualize financial score by total number of teachers employed in the district. The relationship between hiring rate and conditional financial score is plotted with 50 equal‐sized bins, with each dot representing within‐bin average. The slope of the fitted line for each fiscal year is shown under each figure together with the standard error in parentheses.
(2) In order to figure out whether the slope in FY 2011 is statistically significantly different from other years, we regress the hiring rate (unit: %) on financial score, interaction between financial score and FY 2011 dummy, total number of teachers employed, and dummies for each fiscal year. The coefficient on the interaction term is ‐0.5632, with the standard error 0.5084.
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Figure 10: Relationship between Hiring Rate and Starting Salary for State‐Level Newly Hired Teachers (Unconditional)
Note: (1) The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level
newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year. The relationship between these two variables is plotted with 50 equal‐sized bins, with each dot representing within‐bin average. The slope of the fitted line for each fiscal year is shown under each figure together with the standard error in parentheses.
(2) In order to figure out whether the slope in FY 2011 is statistically significantly different from other years, we regress the hiring rate (unit: %) on average salary, interaction between average salary and FY 2011 dummy, and dummies for each fiscal year. The coefficient on the interaction term is ‐0.000025, with the standard error 0.000027.
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Figure 11: Relationship between Hiring Rate and Starting Salary for State‐Level Newly Hired Teachers (Conditional on Highest College Degree Earned & Total Number of Teachers Employed)
Note: (1) The hiring rate is calculated at fiscal year‐district level. It is equal to the number of state‐level
newly hired teachers divided by the total number of teachers employed in a district in a particular fiscal year. We residualize starting salary by individual’s highest college degree earned and total number of teachers employed in the district. The relationship between hiring rate and average conditional starting salary is plotted with 50 equal‐sized bins, with each dot representing within‐bin average. The slope of the fitted line for each fiscal year is shown under each figure together with the standard error in parentheses.
(2) In order to figure out whether the slope in FY 2011 is statistically significantly different from other years, we regress the hiring rate (unit: %) on average salary, interaction between average salary and FY 2011 dummy, and dummies for each fiscal year. The coefficient on the interaction term is ‐0.000024, with standard error 0.000028.
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Table 1: Contributions to TRS Fund by Sources from FY 2007 to FY 2016 ($ thousands)
Source 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Member contributions
$826,249 $865,400 $876,182 $899,401 $909,577 $917,661 $921,423 $928,746 $935,451 $951,809
State of Illinois 737,671 1,041,115 1,451,592 2,080,729 2,170,918 2,406,364 2,703,312 3,438,383 3,377,665 3,742,469
Employer contributions
115,915 130,673 152,329 171,421 155,111 154,895 157,179 158,335 145,591 148,041
Investment income (loss), net of expenses
6,831,324 (2,014,902) (8,688,286) 3,679,643 7,234,539 224,107 4,561,768 6,782,031 1,770,550 (44,103)
Total 8,511,159 22,286 (6,208,183) 6,831,194 10,470,145 3,703,027 8,343,682 11,307,495 6,229,257 4,798,216
Source: Teachers' Retirement System of the State of Illinois. Comprehensive Annual Financial Report For The Fiscal Year Ended June 30, 2016.
Available at https://www.trsil.org/sites/default/files/documents/CAFRfy16.pdf.
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Table 2: Major Retirement Benefit Provisions for TRS Tier I and Tier II Members
Tier I Members
(Hired before January 1, 2011) Tier II Members
(Hired on or after January 1, 2011)
Retirement Eligibility and Age Requirements
Age 55 with 35 years of service (full benefits with no reduction)
Age 60 with 10 years of service (full benefits with no reduction)
Age 62 with 5 years of service (full benefits with no reduction)
Age 55 with 20 years of service (reduced 6% for every year that the member’s age at retirement is under age 60)
Age 67 with 10 years of service (full benefits with no reduction)
Age 62 with 10 years of service (reduced 6% for every year the member’s age at retirement is under age 67)
Retirement Formula
Most members are based on a formula: “2.2% × years of creditable service × final average salary”.
Some members employed before July 1, 1998 have their benefits determined by an older, graduated formula.
The final average salary: the member’s highest average salary earned during four consecutive years out of the last 10 years of service.
Annuities are capped in one way: The maximum retirement benefit a member can receive is 75% of final average salary.
Members are based on a formula: “2.2% × years of creditable service × final average salary”.
The final average salary: the member’s highest average salary earned during eight consecutive years out of the last 10 years of service.
Annuities are capped in two way: (1) The maximum retirement benefit a member can
receive is 75% of final average salary. (2) In determining a final average salary, no member’s
salary will exceed a limit that is tied to the Consumer Price Index. The limit in FY 2016 was $111,571.63
Annual Cost‐of‐Living Adjustment (Post‐
Retirement Increase)
The increase is 3%, compounded annually.
The increase is based on current retiree benefit.
The increase is calculated using the lesser of 3% or 1/2 of the change in Consumer Price Index, not compounded.
The increase is based on original retiree benefit.
Early Retirement Option Members who are at least age 55 but under age 60
may qualify for the Early Retirement Option. Not Applicable.
Survivor Benefits Annuities are set at 50% of the retired member’s
earned retirement annuity. Annuities are set at 66 2/3% of the retired member’s
earned retirement annuity.
Source: Teachers' Retirement System of the State of Illinois. EZ Guide to Tier I and Tier II Retirement Under Public Act 96‐0889. Available at
https://www.trsil.org/sites/default/files/documents/EZguide.pdf; Teachers' Retirement System of the State of Illinois. Comprehensive Annual
Financial Report For The Fiscal Year Ended June 30, 2016. Available at https://www.trsil.org/sites/default/files/documents/CAFRfy16.pdf.