Cross-Subsidization of Teacher Pension Normal Cost: The Case of CalSTRS

Abstract

Under traditional defined benefit pension plans, annual contributions are set at a uniform percentage of pay to fund accruing benefits. That normal cost rate masks wide variation in the cost of individual benefits, generating an extensive and non-transparent pattern of cross-subsidization. We provide a comprehensive analysis of cross-subsidies in employer contributions across all entry and exit ages. The gains and losses of winners and losers must add up to zero, and we explain why they do not in some previous work, which claims that nearly all teachers are winners in the California Teachers Retirement System. To the contrary, we find about two-thirds of all entrants are losers. The losers earn benefits with an average annual employer cost of 0.8 percent of pay, vs. 5.7 percent for the winners. In effect, this is a system of widely varying, but non-transparent employer matches to the employee contribution, unlike a retirement account plan with a uniform match.