As Pension Costs Rise, Public Colleges Pay the Price

As Pension Costs Rise, Public Colleges Pay the Price

Public colleges tend to offer less in salaries than their private counterparts do. But many of them have had a secret weapon to retain faculty and staff members that private colleges cannot match: generous pensions.

Pensions have narrowed the compensation gap between public and private colleges. They can function as “golden handcuffs,” rewarding workers who stay for decades and keeping them from fleeing to competitors during their most productive years.

But public pensions everywhere are in crisis, overwhelmed by a wave of retirements, decades of fiscal mismanagement, and investment losses during the recession. The erosion of traditional pensions is putting new pressure on many public colleges to remain competitive in the academic job market just as they deal with large cuts in state support.

The nation’s pension shortfall is gigantic: States are $1-trillion short of being able to afford the retirement benefits they have promised workers, according to a study this year by the Pew Center on the States. Some economists say retirement plans in 20 states are on track to run out of money by 2025, making future cuts in public pensions that support college workers inevitable.

At some colleges, the pension crisis has already hit home.

In a move seen as a harbinger for other troubled states, Illinois recently approved sharply reduced benefits for new employees, and it raised the age at which employees can retire with full benefits to 67, the highest of any state. College officials there fear the reduced benefits will damage their ability to retain faculty and staff members in the future.

Pension costs are spiraling out of control at the University of California, which, unlike most college systems, runs its own pension plan. Within two years, the 10-campus system expects to contribute $700-million per year just to keep its plan afloat—nearly as much as the cuts in state support last year that generated protests and threw the system into crisis. Employees are likely to have to pay at least 5 percent into their retirement plans after years of not paying anything.

“People have just not faced the coming train wreck,” says Daniel L. Simmons, vice chair of the system’s faculty senate.

Private colleges have suffered investment losses of their own, of course. But their retirement plans are less at risk, because they have largely abandoned defined-benefit plans, which guarantee employees a fixed level of benefits after they retire, in favor of defined-contribution plans, which put the investment risk on employees.

In recent years, many employees of public colleges have elected not to enroll in defined-benefit plans, which are typically more difficult to carry over to new jobs. But a majority of all workers at public colleges, and more than a third of full-time faculty members, are still enrolled in defined-benefit pension plans, surveys indicate. As lawmakers seek to escape pension shortfalls, new employees in those plans may receive lower retirement benefits, be forced to make higher contributions, or need to work longer until they can afford to retire.

Some experts say that in the rush to avoid financial ruin, states are ignoring larger questions of how to design sustainable retirement plans for college workers.

“You can’t simply cut the pension and still be competitive in the academic-labor market unless you compensate people in some other way,” says Jeffrey R. Brown, an economist at the University of Illinois and associate director of the Retirement Research Center at the National Bureau of Economic Research.

In the long run, Mr. Brown says, states’ saving money on pensions puts pressure on colleges to raise tuition and to spend more on salaries to make up for lost compensation. “We make changes for future employees, and we congratulate ourselves for doing that,” he says. “I’m afraid those decisions were made in a vacuum.”

Golden Promises

The choices that got the University of California’s $37-billion pension plan into trouble were shortsighted and ultimately destructive. They are also exceedingly common.

In 1990, the system’s retirement plan appeared enormously wealthy: It was estimated to have nearly double the money needed to cover future retirement benefits. In response, the system’s Board of Regents started a “contribution holiday,” stopping any new contributions to the plan from both colleges and employees.

The strategy worked for a while. Workers received the equivalent of a salary increase, and campuses could spend money they had been devoting to the retirement plan on other projects. Despite the lack of new money, the plan remained fully financed without receiving any new money for 19 years.

But the recession reduced the university’s investment by $16-billion, or a third of the plan’s value. Now, in order to keep the fund solvent, the system and its employees must contribute billions of dollars in the coming years just as the system struggles to survive deep cuts in state support. Workers will most likely be paid less over all, and campuses will need to divert money from other priorities, creating new pressure to raise tuition.

In retrospect, much of the recent growth of the University of California was misleading, says Robert M. Anderson, a Berkeley economics professor and member of a panel that is proposing major changes in the system’s pension plan.

“Over the last 19 years, the university took the money that it wasn’t putting into the pension to open a new campus, grow existing campuses, grow the medical school and law schools, and so forth,” Mr. Anderson says. “It’s not that the money was wasted, but on the other hand, it covered up the fact that we weren’t getting enough money from the state to cover the mission the state was expecting us to cover.”

Unless it makes changes, the system is on track to spend more on retiree pensions and health care than it does on instruction by 2014, says Peter J. Taylor, the system’s chief financial officer. “There’s no way on God’s green earth we can look our public in the eye, whether it be parents writing a tuition check or a legislator in Sacramento, in four years and say give us more money,” he says.

To cut costs, the system is expected to propose a revamp this year, including raising the retirement age from 60 to 65, sharply increasing employer and employee contributions, and reducing the total amount of benefits. Like most pension changes, the majority will apply only to new workers, a restriction driven in many states by laws that prevent officials from touching the benefits of existing employees.

Faculty and staff members fear that the changes will weaken the system’s generous benefits package, one of the main reasons they decided to work at the university. The moves will also require the system to contribute 10 percent of its payroll to the pension plan by 2012—the rough equivalent of a $700-million budget cut.

“It’s not going to be easy,” says Paul A. Staton, chief financial officer at the University of California at Los Angeles Medical Center. “It’s going to be a big issue to deal with, and I don’t think people fully understand the impact this is going to have.”

Mr. Staton says the increased contributions would cost the medical center $100-million annually by 2012, or 7 percent of its operating budget. Making up that difference will involve sharply cutting expenses like purchases of new medical equipment, and burning up reserves, he says.

The rise in pension costs over the next five years is “so rapid it’s hard to change your business that quickly,” Mr. Staton says. “We’re well positioned, but once it gets to $100-million, it’s tough to make that up.”

The Public Bargain

When he was deciding whether to take a position at the University of Illinois at Chicago in the early 1990s, John A. Shuler says, he knew he might be able to make more money at another college. But he took the job in part because the system’s retirement benefits helped make up for the lower salary.

The same pattern holds across much of higher education. Faculty members at public institutions report being more satisfied with their retirement benefits, on average, while faculty members at private institutions report being more satisfied with their salaries, according to a nationally representative survey in 2008 conducted by UCLA’s Higher Education Research Institute.

“That’s how I understood the bargain when I came aboard here,” says Mr. Shuler, an associate professor and librarian. “Obviously, it’s no longer working like that.”

Illinois makes the University of California look like a model of fiscal responsibility. The state has underfinanced its retirement plan every year since 1970, earning it the distinction of having the worst-financed public pension plan of any state.

In response to the shortfall, lawmakers enacted a bill this spring reducing benefits for new employees hired in 2011 or later. The bill raised the retirement age, cut the rate at which benefits are determined, and capped the salary that can be used to calculate pensions, at $106,000.

Economists say the changes will make only a small difference in Illinois’s long-term pension woes. But college officials say the reduced benefits are already proving a barrier to attracting new employees.

“We’re seeing this in our recruitment: prospects are concerned about the stability of pensions and health insurance in the state,” says Steven D. Cunningham, associate vice president for administration at Northern Illinois University.

In their bid to reduce pension costs, lawmakers removed features unique to the university pension program, which is run separately from other state pension plans. For instance, the annual cost-of-living adjustment on pension benefits for new college employees will no longer be compounded, a seemingly minor change that Mr. Cunningham says could cost workers 30 percent of their benefits over a decade.

“This will certainly have an effect on the university’s recruitment and retention, especially for employees who have options outside of the state,” he says. “And it will probably lead to some pressure for us eventually to somehow augment compensation to compete in the marketplace.”

That pressure is already being felt at the three-campus University of Illinois system, which will start discussions in the fall over how to keep its retirement benefits competitive. The system will consider starting its own defined-contribution plan to make up for the reduction in benefits, officials say.

Richard D. Ringeisen, chancellor of the Springfield campus, says that with efforts like the new supplemental plan, “we’re going to be fine” recruiting faculty and staff members.

“We think the state’s financial problems will preclude it from putting together attractive benefit packages,” Mr. Ringeisen says. “We’re looking at ways we can help ourselves.”

But he also acknowledged that in a state with the budget problems of Illinois—the state’s $13-billion budget deficit next year is estimated to be half of the total budget—preserving the level of worker compensation while meeting every other budget problem is getting harder. When asked if his campus would be able to handle higher retirement costs, he laughed.

“The money has to come from somewhere, doesn’t it?” he says. “We have to have great faculty. There is no university without great faculty.”

The Next Generation

As the academic work force has changed over the past few decades, some experts say colleges have missed an opportunity to rethink how retirement can better serve the needs of the next generation of workers. Faculty and staff members are far less likely to stay with a single institution throughout their careers. Workers tend to live far longer after they retire, collecting more money from retirement systems that promise them benefits until death. And younger workers are more likely to want control over their own retirement savings.

“One certainly could raise the question for whether the plans that have worked well for the last 25 years are the ones that could work well for the next 50 years,” says Robert L. Clark, an economist at North Carolina State University who studies retirement.

Some states are switching to a hybrid model that requires employees to participate in both a defined-benefit plan and a defined-contribution plan. The strategy can spread the risk between employer and employee, retaining a guaranteed level of retirement benefits while reducing the future risk of large shortfalls.

Georgia switched to a hybrid plan for all new public employees in 2009, following in the footsteps of Washington, Oregon, and Indiana. Utah, seeking to escape a looming pension deficit, will encourage new employees to enroll in a hybrid plan starting next year.

Officials of TIAA-CREF, which offers defined-contribution plans at most colleges, say moving to a well-structured hybrid plan can provide more retirement security—and political cover—than abandoning pensions completely. They point to Orange County, in California, which worked with TIAA-CREF to layer a defined-contribution plan over its existing pension system.

“The Orange County model is getting a lot of traction. I don’t think this is the first and last that we’ll see,” says Richard A. Hiller, the company’s vice president for government markets.

The University of Missouri is considering adopting a hybrid plan or abandoning its defined-benefit plan altogether, officials say. Unlike the college systems in Illinois and California, Missouri’s four-campus system has made consistent contributions to its self-run pension plan. But the recession has still left it with sharply rising pension costs.

Robert O. Weagley might seem like a natural proponent of keeping the plan the way it is. After all, Mr. Weagley, an associate professor of personal finance at Missouri’s Columbia campus, anticipates a comfortable retirement. Another university looking to hire him would need to make quite an offer to attract him, he says: He would need nearly $500,000 in the bank when he retires in order to match the pension plan that he is guaranteed in Missouri.

But his son, a Ph.D. candidate in the finance department at the University of Michigan at Ann Arbor, helped to change his mind about hybrid plans.

“He goes, ‘Dad, I don’t want to have anything to do with a defined-benefit plan. I want a defined-contribution plan,’ ” Mr. Weagley says.

His son, Daniel R. Weagley, says he would prefer to take extra money in salary up front rather than depend on a pension plan determined by the government. Mobility is important, he says—he doesn’t want to work in the same place his whole life.

“Besides, part of what worries me is that pensions can become underfunded and things like that,” the younger Mr. Weagley says. “I’d much rather have a 401(k).”

By Josh Keller

The Chronicle of Higher Education
August 29, 2010