The BIG teacher pension bite

Nearly a billion dollars of debt threatens taxpayers, teachers and students

The Minneapolis Teachers Retirement Fund Association (MTRFA) is drowning in nearly a billion dollars of red ink. The fund could go bankrupt in a decade if nothing is done, pension experts say.

A fix has enormous significance for Minneapolis schools. Attracting and keeping good teachers will be harder if they have higher pension deductions and fear benefit cuts.

And if taxpayers pony up more than the $21.2 million a year they already do, there might be less for school, state or city programs.

The problem has lingered for nearly a century, but now something must be done.

"We could run out of money in eight or 10 years," said MTRFA Executive Director Karen Kilberg.

Larry Martin, executive director of the Legislative Commission on Pensions and Retirement, said MTRFA default "is a very real possibility" if investment performance didn't improve.

In a January 2004 memo, Martin pegged the default at between nine and 13 years - calling the Minneapolis teachers fund "the worst-funded large Minnesota public pension plan and has beenfor decades."

Fund investments returned 15 percent last year, but they still dipped into assets. The fund is either $852 million or $967 million short, depending on the accounting method used.

There are two ways to understand the large number.

The fund has barely half the money to pay future pension benefits to approximately 10,000 active and retired teacher members, according to a December outside actuarial review.

Looked at another way, the 95-year-old fund is not saving for any currently active teacher's retirement; it needs their contributions to pay current retirees.

The city, School Board and state collectively pay $21.2 million a year to offset the shortfall - which already cuts into money that could otherwise support teacher salaries, school programs, city services such as police, or lower taxes.

Delayed solutions make the fix costlier - giving the city's legislative critics one more club with which to thump Minneapolis and its leaders.

State law governing the fund says benefits can be cut if the assets aren't there.

Two legislators advocate very different fixes.

St. Cloud Republican Rep. Jim Knoblach's plan would limit pension increases to 2 percent for all teachers hired before July 1, 1978. (Teachers hired after July 1, 1978, have a different package.)

The cap would stay on no matter how high inflation or how well fund investments do - until MTRFA has 100 percent of what it needs to pay retirees. Knoblach's plan does not fix the problem, but it buys more time. However, the cap may face legal challenges (see "Cutting pensions," facing page).

Minneapolis DFL Sen. Larry Pogemiller, with MTRFA's support, had proposed merging the city teacher's fund with the healthier state teacher's fund, a costly plan that one year later, seems out of reach.

Understanding what should be done now means understanding an old problem.

History lesson

The Minneapolis teachers fund was in the red practically from the start. It was last fully funded in 1913 - four years after it opened as a voluntary organization. By 1924, it had less than 30 cents on the dollar to pay future benefits (known as full funding; see Chart #2 at left).

The city was the original employer of record. In 1949, the fund peaked at 90 percent of full funding.

The financial condition declined after 1953, when the pension formula changed. Instead of a savings plan, pensions were based on a teacher's years of service and the highest five salaried years.

The state took over the fund in 1976 as part of property tax relief legislation, state documents said. The fund was then $76 million short, or 57 percent fully funded, MTRFA data said.

The state takeover included a new law prohibiting the city from levying taxes for teacher pensions.

Kilberg said the change hurt the fund in two ways. The state kept the city from plugging the pre-'76 shortfall, then the state failed to fulfill its own funding obligations.

By 1986, when the state passed responsibility to the School Board, the shortfall more than tripled to $278 million in a decade, or 51 percent of full funding.

A rising stock market boosted MTRFA's funding level to 67 percent by 1999. The subsequent market drop knocked it back to 52.4 percent in 2004.

How has the fund survived three generations of shortfalls?

For one, legislators have let the day of reckoning slide. In 1957, MTRFA had a 1997 full-funding target date. By 1979, the fund was no better off than in 1957 and the Legislature extended the deadline to 2009. The 1989 Legislature extended it again to 2020.

Last fiscal year, the fund fell $38 million further behind that 2020 full funding goal. The gap widened even though working teachers and the School District paid

$11.7 million more than needed to cover their retirement payments (see "Overpaying for the past," facing page). In essence, their overpayments help fill the hole left by previous generations of teachers and state and city politicians.

To get back on the path to full funding in 2020, teachers or the district would have to kick in another $38 million this year - 15.2 percent of payroll - according to a 2004 actuarial review. Again, even though the district and current teachers are overpaying, the chasm left over 90 years demands more.

State law does not require any unit of government to fully fund the pension. However, state and local sources are already giving $21.2 million to the fund, combined.

In 2004, the state gave MTRFA

$16.8 million to fix the shortfall, according to fund data. (The state has made similar contributions each year since 1998, roughly $125 million over seven years.)

As a local match, the School District and city each pay about $2.2 million annually - enough to hire 30 experienced teachers and nearly 30 full-time cops, if pensions weren't a problem.

Benefit boom

The fund has also given investment-related pension increases it could not afford, as prescribed by law.

Pensioners are guaranteed a 2 percent annual increase no matter how the fund's investments do. And since 1988, benefits also go up by every percentage point of investment return over 8.5 percent, using a five-year rolling average.

For instance, if the five-year return is 12.5 percent, pensioners see a 6 percent bump: the guaranteed 2 percent plus 4 percent (12.5 percent minus the 8.5 percent benchmark.)

Good investment years translate into permanent pension increases paid out year after year - even when future investment returns fall. Despite the fund's widening shortfall, benefit increases have outpaced the Consumer Price Index by 37 percent since 1988 (see Chart #3, facing page).

Ed Burek, deputy director of the Legislative Commission on Pensions and Retirement, calls the benefit increases the top factor that has gotten MTRFA into trouble in recent years.

A statewide teachers fund also has an investment-related pension escalator, but with a key difference: it does not pay investment-related increases if it doesn't have the money, Burek said.

Still, the better-funded state teachers plan increased benefits by 24 percent more than the Minneapolis teachers received from 1987 to 2004, according to fund data. Both increased significantly faster than the Consumer Price Index (see Chart #4, facing page).

Pogemiller said the Legislature-approved benefit structure for

Minneapolis teachers could be part of the problem, but there was "blame all around."

That included "blame for employees or unions agitating for benefit increases, that - if they had a crystal ball - they may have been more cautious. [Also, the] lack of wisdom by outstate and suburban legislators to more appropriately fund this thing 20 years ago," he said.

Kilberg, MTRFA's executive director, said there is no question the pension escalator is flawed. It needed to be fixed as part of a comprehensive solution, not as the only change in the plan.

Investment problems

Critics say MTRFA's own investment decisions have also hurt the fund - a point disputed by its leaders.

The seven-member MTRFA board has six teachers and a School Board representative; they oversee the fund's investment policy. Pension analyst Burek wrote that MTRFA's funding woes are largely "self-inflicted and could have been avoided or at least minimized by more reasonable investment performance."

He cites two periods that cost the fund $228 million - and any appreciation in subsequent years.

From 1982 to 1992, MTRFA mistimed portfolio changes, and its managers' choices resulted in lower earnings than unmanaged stock funds, Burek's memo stated. The "opportunity loss" was $168 million during the decade.

From 1994 to 1997, the fund underperformed the State Board of Investment by 2 percent a year - a relative loss of nearly $60 million, he wrote.

MTRFA's 2003 annual report noted that it terminated its contract with Advanced Investment Management (AIM), one of its stock managers. AIM violated its contract and had "excess losses" of $11.3 million; MTRFA sued and recovered only $490,000. The nearly $11 million loss equals five years of city or School District contributions, or two-thirds of the state's annual subsidy.

The lost $228 million, compounded by the Consumer Price Index, translates into $292.4 million, according to Southwest Journal calculations - about a third of the fund's current shortfall.

Kilberg criticized the Burek analysis, likening it to how people could see better choices they could have made with their personal investments.

"You can manipulate numbers any way you want to," she said. "Hindsight is 20-20."

She said Howard Bicker sits on her fund's panel of voluntary advisors. Bicker is the executive director of the State Board of Investment (SBI), whose returns feed the state teacher's fund.

However, unlike the SBI, the city teacher's fund does not use a paid consultant for such things as choosing fund managers or setting its asset allocation. Kilberg said her fund could get information from SBI and do its own database searches. "Most people complain about their consultants," she said.

The city teacher's fund investments earned 15 percent in 2004. The fund has received clean audits, she said. And over the past 20 years, it has had an average annual return of 9.1 percent, exceeding annual investment targets that have ranged between 6 percent and

8.5 percent during that time (to compare returns, see Chart #3, facing page).

Paradoxically, Kilberg says any annual investment return above 8.5 percent since the late '80s would only hurt the fund - because they would trigger bigger permanent pension increases and deepen the shortfall.

She said the best case is to earn exactly 8.5 percent on a five-year average - which would produce no investment bonus, translating into a flat 2 percent per year pension increase.

"That is what the Catch-22 is for us," she said. "Why would we want to swing out there and get the best investments we can possibly get, if we know that, in the long term, it will hurt us by creating bigger unfunded liabilities?"


Ironically, Kilberg's "2 percent scenario" is precisely the amount to which Rep. Knoblach would limit most currently retired Minneapolis teachers.

Knoblach said he would reintroduce a bill similar to one in 2004. It would:

– Give MTRFA incentive to turn control over to the State Board of Investment by requiring the city teacher's fund to "impose a charge on active members, retired members and other benefit recipients," if its investments underperform the State Board.

– Cap pension hikes at 2 percent for fund members hired before July 1978. These teachers do not get Social Security; under the bill, they would not get investment-related hikes until MTRFA is fully funded. Pensioners hired after mid-1978 would get investment-related hikes similar to the state teachers fund. (These teachers get Social Security benefits and pay the same withholding percentage as other employees.)

In 2004, teachers in the older MTRFA plan got $34,397 a year on average, according to the independent audit. For comparison, retired Minneapolis Police officers in the Minneapolis Police Relief Association (who also don't get Social Security) received an average of $38,687 a year in 2003, according to a recent city report.

Retired Minneapolis teachers in the newer plan received $10,906 a year on average, plus Social Security.

The Legislative Commission on Pensions and Retirement staff said the Knoblach plan would extend the fund's life "for a significant number of years."

Knoblach's plan would make teachers in the basic plan bear the full cost of fixing their fund, which would reinvest a higher share of investment income.

Pogemiller called Knoblach's pension-cap plan a "nonstarter" because it would unilaterally cut benefits and undermine faith in all public pensions. Pogemiller said potential employees would say, "Here is an employer that doesn't keep its word."

Said Pogemiller, "Whether someone in a previous generation made a bad decision on a benefit doesn't mean you can go in and say, 'Well, that is too expensive. We are going to take that away from you.' You can't do that. The precedent that sets is just chilling," he said.

In 2004, Pogemiller proposed an alternative that would have consolidated MTRFA with the state teachers fund. That plan had a huge hurdle to clear: the state fund doesn't want to get stuck with the Minneapolis teachers' pensions tab.

Gary Austin, the state fund's executive director, said his group did not seek consolidation but does not oppose it - as long as the Minneapolis fix isn't "on the shoulders of our membership."

Pogemiller also planned to funnel the current $21.2 million in state and local MTRFA aid to buy pension bonds to try to fund a merger with the state teachers. The plan had a large unfunded gap, which has only gotten worse in the past year.

MTRFA backed the merger component but said it is too costly to try this session, Kilberg said.

She added that one option would be to close MTRFA to new members and shift active teachers into the state fund.

That plan would leave current retirees in MTRFA but not resolve their funding problem.

Despite the $125 million in recent state contributions, Pogemiller said the state has not met its responsibility left over from the mid-'70s, and the state would ultimately need to fix the problem.

"The quicker that recognition comes to more legislators, the quicker they will say, 'OK, the buck stops here. Let's get it done now because it's cheaper if we do it now rather than later,'" he said.

Minneapolis legislators such as Pogemiller do not have the political clout they once did. And the 2005 Legislature faces a budget deficit and a desire to increase state funding for K-12 education.

Minneapolis does have one big factor working in its favor. Pogemiller said retired Minneapolis teachers live all over the state and talk to their legislators about the issue.

"This is not just a Minneapolis problem," he said.