Pension Sustainability: Arizona

2011 Retaining Effective Teachers Policy

Goal

The state should ensure that excessive resources are not committed to funding teachers' pension systems.

Meets a small part
Suggested Citation:
National Council on Teacher Quality. (2011). Pension Sustainability: Arizona results. State Teacher Policy Database. [Data set].
Retrieved from: https://www.nctq.org/yearbook/state/AZ-Pension-Sustainability-9

Analysis of Arizona's policies

As of June 30, 2009, the most recent date for which an actuarial valuation is available, Arizona's pension system for teachers is 79 percent funded and has a 30-year amortization period. This means that if the plan earns its assumed rate of return and maintains current contribution rates, it would take the state 30 years to pay off its unfunded liabilities. While its amortization period meets regulatory benchmarks, Arizona's funding level is just below the conventionally recommended minimum funding level of 80 percent. The state's system is just short of being financially sustainable according to actuarial benchmarks.

In addition, Arizona commits excessive resources toward its teachers' retirement system. The current employer contribution rate of 10.10 percent and employee contribution rate of 11.39 percent are each too high, in light of the fact that local districts and teachers must also contribute 6.2 percent to Social Security. The rate is determined according to statutory requirements, which mandate that the employer contribution rate must equal the cost to fund this year's expenses (the normal cost) plus any amount needed to amortize any unfunded liabilities over a 30-year period. While these rates allow the state to pay off liabilities within 30 years, it does so at great cost, precluding Arizona from spending those funds on other, more immediate means to retain talented teachers.

Citation

Recommendations for Arizona

Ensure that the pension system is financially sustainable.
The state would be better off if its system was over 95 percent funded to allow more protection during financial downturns. However, Arizona should consider ways to improve its funding level without raising the contributions of school districts and teachers. In fact, the state should work to decrease contributions. Committing excessive resources to pension benefits can negatively affect teacher recruitment and retention. Improving funding levels necessitates, in part, systemic changes in the state's pension system. Goals 4-G and 4-I provide suggestions for pension system structures that are both sustainable and fair.

State response to our analysis

Arizona maintained that the Arizona Constitution (Article XXIX, Section 1.A.) requires retirement benefits to be funded with contributions and investment earnings using actuarial methods and assumptions that are consistent with generally accepted actuarial standards. Accordingly, the funded status of the Arizona State Retirement System (ASRS) will gradually improve due to the actuarial assumptions in place and therefore continue to keep the ASRS financially sustainable.

The state asserted that systemic changes have been proposed by the ASRS to the legislature since 2003. Collectively, these changes are expected to reduce the total contribution rate by over 3 percent and reduce long term liabilities by $5 to $7 billion. A legislative study committee has also been created to analyze the public pension plans in Arizona and to consider more suggestions.

Further, Arizona stated that the ASRS has exceeded its annual rate of return expectation (8 percent) in 20 of the past 30 years. During that time, members and employers benefited from contribution rates as low as 2 percent. The ASRS was well over 100 percent funded when the downturn began in 2001. Of the 10 years where the expectation was not met, five have occurred in the last decade. 

In Arizona, public employers have always made their actuarially required contributions as required by the constitution, which has kept the ASRS in relatively good financial condition. The ASRS, along with many other pension plans, mitigates contribution rate volatility by "smoothing" its investment returns over a 10-year period. 

Last word

NCTQ maintains that Arizona's funding ratio is slightly below suggested benchmarks and commends the state for maintaining a 30-year amortization period. However, this analysis shows that the contributions necessary to fund a system of this format place a considerable burden on teachers and school districts.

How we graded

Many states' pension systems are based on promises they cannot afford to keep.

Teacher salaries are just one part of the compensation package that teachers receive. Virtually all teachers are also entitled to a pension, which, upon vesting, provides compensation for the rest of their lives after retirement. In an era when retirement benefits have been shrinking across industries and professions, teachers' generous pensions remain fixed. In fact, nearly all states continue to provide teachers with a defined-benefit pension system, an expensive and inflexible model that neither reflects the realities of the modern workforce nor provides equitable benefits to all teachers.

Under defined benefit systems, states have made an obligation to fund fixed benefits for teachers at retirement. However, the financial health and sustainability of many states' systems are questionable at best. Some systems carry high levels of unfunded liabilities, with no strategy to pay these liabilities down in a reasonable period, as defined by standard accounting practices. Without reform, these systems are a house of cards, vulnerable to collapse as funding cannot keep up with promised benefits. And it is taxpayers who will have to pay if it all tumbles down.

Pension plans disadvantage teachers early in their careers by overcommitting employer resources to retirement benefits.

The contribution of employers to their workers' retirement benefits is a valuable benefit, important to ensuring that individuals have sufficient retirement savings. Compensation resources, however, are not unlimited, and they must fund both current salaries and future retirement benefits. Mandated employer contributions to many states' teacher pension systems are extremely high, leaving districts with little flexibility to be more innovative with their compensation strategies. This is further exacerbated for states in which teachers also participate in Social Security, requiring the district to pay even more toward teacher retirement. While retirement savings in addition to Social Security are necessary, states are mandating contributions to two inflexible plans rather than permitting options for teachers or their employing districts.

This approach to compensation disadvantages teachers early in their careers, as the commitment of resources to retirement benefits almost certainly depresses salaries and prevents incentives. Lower mandatory employer contribution rates (in states where they are too high; in some states they are shamefully low) would free up compensation resources to implement the kinds of strategies suggested elsewhere in the Yearbook. In addition, some states require high employee contributions; the impact this has on teachers' paychecks may affect retention, especially early in teachers' careers.

Research rationale

NCTQ's analysis of the financial sustainability of state pension system is based on actuarial benchmarks promulgated by government and private accounting standards boards. For more information see U.S. Government Accountability Office, 2007, 30 and Government Accounting Standards Board Statement No. 25.

For an overview of the current state of teacher pensions, the various incentives they create, and suggested solutions, see Robert Costrell and Michael Podgursky. "Reforming K-12 Educator Pensions: A Labor Market Perspective." TIAA-CREF Institute (2011).

For evidence that retirement incentives do have a statistically significant effect on retirement decisions, see Joshua Furgeson, Robert P. Strauss, and William B. Vogt. "The Effects of Defined Benefit Pension Incentives and Working Conditions on Teacher Retirement Decisions", Education Finance and Policy (Summer, 2006).

For examples of how teacher pension systems inhibit teacher mobility, see Robert Costrell and Michael Podgursky, "Golden Handcuffs," Education Next, (Winter, 2010).

For additional information on state pension systems, see Susanna Loeb, and Luke Miller. "State Teacher Policies: What Are They, What Are Their Effects, and What Are Their Implications for School Finance?" Stanford University: Institute for Research on Education Policy and Practice (2006); and Janet Hansen, "Teacher Pensions: A Background Paper", published through the Committee for Economic Development (May, 2008).

For further evidence supporting NCTQ's teacher pension standards, see "Public Employees' Retirement System of the State of Nevada: Analysis and Comparison of Defined Benefit and Defined Contribution Retirement Plans." The Segal Group (2010).