A Cost-Benefit Analysis of LAUSD’s Early Retirement Incentives
BRENT TERCERO | JESSICA PAPIA | ROBERT TROMBLEY
Master of Public Policy Candidates, 2012
University of Southern California
Price School of Public Policy
During the 2008-2009 school year, the Los Angeles Unified School District (LAUSD) experienced a budget shortfall of more than $800 million. To help reduce the deficit and prevent teacher layoffs, the district implemented an early retirement incentive program. This benefit-cost analysis demonstrates that incentivized retirements will save the district $103 million over the next five years. It is less clear how these retirements will affect the institutional knowledge of the district; however, the impact on student achievement should be minimal. As California continues to suffer budget shortfalls, efforts to prevent layoffs and programming will be crucial to LAUSD’s reform efforts.
During the 2008-2009 school year, the Los Angeles Unified School District (LAUSD) experienced a budget shortfall of more than $800 million. To help reduce the deficit, the district implemented an early retirement incentive program for the first time in 17 years. Ultimately, 1,472 employees, both teachers and non-teachers, enrolled in this program. While the district reduced costs by avoiding these salaries, a benefit-cost analysis was required to determine the net benefits for the policy. We conclude that this program, even with conservative assumptions, produces a positive net present value and ultimately will save the district millions of dollars over the next five years.
To determine the costs and benefits, this analysis examines the policy over a five-year time horizon, focusing on the costs of the program and the costs saved as benefits. The costs include a $51.2 million incentive that the district will pay out over five years and a $1.5 million one-time payment that serves as a “golden handshake” for eligible employees. The benefits include costs saved from the salaries, statutory benefits, and healthcare of employees incentivized to retire early. Using the 5% nominal discount rate used by the district, we found the program to have a net present value of more than $103 million, which LAUSD could use to reduce the number of teachers it laid off.
We made several assumptions in the analysis in order to determine what costs and benefits for the district stemmed from the early retirement incentives. One of our key assumptions centered on how we calculated the average number of employee retirements, which we needed in order to distinguish how many additional employees retired due to the incentives. As a result of the uncertainty, we conducted a sensitivity analysis varying the number of incentivized retirees. We then conducted a threshold analysis using the standard deviation of average retirements over the last ten years. Even with the lowest estimates of incentivized retirements, the Net Present Value remained positive.
While determining the costs of the program, the baseline scenario did not account for potential impacts on student achievement. Although data regarding student achievement individualized by teacher was not available, we performed a sensitivity analysis to determine how much student achievement would have to suffer to cancel out the economic gains of the incentives. With graduation rates as a proxy for student achievement, we calculated the corresponding economic impacts of this policy on student achievement, either by increasing classroom sizes or decreasing the number of effective teachers in the system. Our sensitivity analysis found the retirements to have a negligible impact on classroom sizes (Appendix E), and our threshold analysis found that the magnitude of graduation rate changes needed to negate the benefits of the early retirement policy was unrealistically high.
Areas of uncertainty remain, however, for future research. This analysis was not able to monetize the long-term impact of the retirement incentives that may result from lost institutional knowledge and the loss of veteran teachers. While we recommend this policy for LAUSD, especially in light of continuing budget deficits in the coming years, the district must ensure a plan is in place for the proper transfer of institutional knowledge.
Background and Problem Statement
Due to the economic downturn and decreased state and local tax revenue, the LAUSD faced an $869 million budget shortfall entering the 2009-2010 school year.1 Since that time, LAUSD has cut its budget by more than $1.04 billion including $408 million in the 2011-2012 school year.2 During this time-span, the district has been forced to make reductions of more than 10,500 classified and certificated positions, including 5,900 teaching positions.3 In order to minimize severe class size increases and the impact on students, LAUSD has utilized several different strategies to close its budget deficit.
As part of its cost-cutting measures, LAUSD implemented a multi-faceted plan including salary and hiring freezes, decreased use of rental facilities, the cancellation of summer school, and a $369 million reduction in central and local administrative office costs.4 These measures included more than 5,500 layoff notices to younger, untenured, and elementary teachers.5 In addition to these cuts, LAUSD implemented furlough days for all employees and offered a onetime early retirement incentive to senior, higher salaried employees.
By offering early retirement incentives, LAUSD sought to immediately eliminate more expensive salaries from its payroll while preventing the layoffs of an even larger number of younger, less expensive employees. Employees who accepted the incentive received a bonus of 40 percent of their final salary. This bonus will be paid out by the Public Agency Retirement System (PARS), which will receive $51.2 million from LAUSD over five years to cover the cost of the incentive.6 Additionally, LAUSD offered a “golden handshake” agreement to some administrators, which provided them an additional two years of service for their pension calculations. LAUSD was required to make a $1.5 million payment to CalPers to cover this cost. In order to be eligible for early retirement, employees had to be at least 50 years old with at least 30 years of service or 55 years old with at least 5 years of service.7
These retiring teachers, according to LAUSD Deputy Chief Human Resources Officer Justo Avila, were not replaced.8 By allowing these positions to dissolve, the district asserted they would save hundreds, even thousands, of teaching positions. Ultimately 1,472 employees accepted the incentives, including 914 teachers.9 As a result of these combined programs, including the early retirement incentives, LAUSD hired back many employees after terminating their employment. After issuing more than 5,500 Reduction in Force (RIF) notices, LAUSD rescinded more than 3,500 of these notices.10 While 2,000 teachers entered unemployment, the District rehired more than 1,800 back as substitutes.11
LAUSD has lauded early retirement incentives as saving both resources and personnel. This assessment analyzes the effectiveness of early retirement incentives in terms of costs and benefits to LAUSD. We also determine the number of positions saved and the potential impact on student achievement. Ultimately, this analysis will seek to answer the following question: Are early retirement incentives for teachers cost effective?
Benefit-Cost Analysis Baseline
Our baseline scenario consists of several assumptions based on a literature review, interviews, and trends in LAUSD. Costs include payments to CalPERS and PARS while benefits are the costs saved of those retirees who were incentivized to retire. We also anticipated that this policy could potentially have a negative impact on student achievement due to increased student-teacher ratios, and the loss of more experienced teachers (the full results for our baseline benefit-cost analysis are in Appendix A).
We used a five-year time horizon to discount the costs for the incentives and the benefits of the salaries saved. LAUSD will make payments to PARS for five years, and PARS will pay out the incentives to the employees who opted to retire.12 Beyond five years there is a great deal of uncertainty concerning the future financial picture of the district.
We considered several important issues to determine the appropriate discount rate for our analysis. First, we determined that the project would not displace private investment and that it was not large enough to raise costs for private investors. We realized that due to the nature of this project, the benefits are costs saved. LAUSD is not making money off an investment, per se; rather, their benefit is the money they save by not having to pay for the employees who decide to retire early. In addition, the project affects private investment on the benefits and costs side in equal proportion.
Based on these considerations, we first determined that the Social Rate of Time Preference would be the appropriate discount rate to use. The interest rate for the five-year United States Treasury Bonds is 2.90%.13 Although this would be an accurate measure for federal investments, in our final calculations, we used a nominal 5% discount rate, as this is the standard discount rate that LAUSD uses for its own budgeting purposes.14 We checked to see if this different discount rate impacted our results, but we found that using the 5% discount rate instead of the 2.9% rate has only a small effect on the total Net Present Value for the project (Appendix B).
When determining which costs and benefits to include, we first considered which stakeholders mattered for the scope of our analysis. Changes in the educational system can affect the school district, school employees, students, parents, and the larger community. This incentive program has wide ranging implications for teachers, administrators, and other school employees who must make retirement and payment decisions based on their own financial and personal considerations. In addition, students, parents, and the larger community are affected by this policy if the quality of the education in LAUSD changes. However, we have chosen to limit our scope to LAUSD.
Since LAUSD is the stakeholder who has decided to incentivize early retirement to save money in their budget and prevent future teacher layoffs, we decided to use them as our client and consider the benefits and costs of this incentive program as it pertains to LAUSD. These include the direct costs and benefits, and—if there were changes to the quality of education provided—we would monetize that in terms of the increase or decrease in the percentage of the potential tax revenue that would go to LAUSD.
For this policy, the main financial costs stem from the early retirement incentives. These incentives stem from two avenues: 40% of the employee’s final salary in 2008-2009, paid out over five years, and the cost of two more years of creditable service towards the pension for some employees.15 To pay for this incentive program, LAUSD made payments of $10.6 million each year for five years, and these payments incorporate the cost of the incentive and administrative costs for PARS.16 Another cost for LAUSD was the lump sum payment that they made to CalPERS; this $1.5 million one-time payment was made in the 2009-2010 school year in order to pay for the additional creditable years of service for some employees.
Since LAUSD had to pay these incentives for all employees who retired, we did not distinguish between teachers who retired due to the incentives and the employees who would have retired anyways. In our analysis, we assumed that LAUSD made these payments at the beginning of each school year. We also did not inflate these payments because they were set, contracted amounts for the five years. Thus after discounting at 5%, the costs over five years for the incentives had a Net Present Value of $49,687,075.34 (Figure 1).
The benefits in this policy are costs saved for LAUSD. These costs saved stem from the cost of teachers who chose to retire at the end of the 2008-2009 school year because of the incentives. For each employee who retired, LAUSD no longer had to pay for that employee’s salary, health care, or statutory benefits. We assumed that LAUSD reaped the full benefit for each retired employee at the end of each school year. Teachers and other employees in LAUSD are allowed to choose whether they want to annualize their salaries across the full year or whether they want to only receive their paychecks during the school year17; since we did not have the data regarding each retiring employee’s choice regarding their pay schedule, we decided to wait until the end of the year to include the full benefits of the costs saved for that employee.
Incentivized Retiree Population
To accurately calculate the benefits to LAUSD that stemmed from this incentive program, we needed to determine how many additional employees above the average retired at the end of the 2008-2009. We used the LAUSD Teacher Turnover18 data on teacher retirement trends for the past 10 years and averaged the number of teacher retirees from 2000 to 2008. We found that in the school years before there were retirement incentives, 653 teachers – on average – retired from LAUSD each of those years. Using this average as a proxy, we saw that 914 teachers retired with the incentives and calculated that 261 additional teachers retired due to those incentives. Our calculations are based on the assumption that, besides the retirement incentives, there were no significant differences between the cohort of 2008-2009 retiring teachers and the teachers who had retired in years previous.
These incentives were offered to all employees in LAUSD, and we needed to determine how many additional non-teachers (including administrators, support staff, librarians, etc.) retired due to these incentives. For the 2008-2009 school year, 558 non-teachers retired.19 Lacking retirement trend data for these positions, we had to make several assumptions in order to determine a proxy value for our calculations. In the 2008-2009 cohort of retiring employees, there was a non-teacher to teacher ratio of 0.61. Using this ratio, we calculated that if 261 additional teachers retired because of the incentives, then 159 additional non-teachers retired (Appendix C).
We could not determine which specific employees retired only because of the incentives or which specific salary amounts LAUSD would no longer have to pay, so we used the average salaries for teachers and non-teachers. We determined that the average salary for teachers who retired in 2008-2009 was $72,128.71 and that the average salary for non-teachers who retired in 2008-2009 was $94,048. For our benefit-cost analysis, we aggregated only the salaries for the additional retirees.
We did not inflate the employees’ salaries because of the salary freeze implemented by the district.20 However, we did need to incorporate the effect that furlough days would have had on the employees’ salaries, if they had not retired. In 2009-2010, LAUSD employees had five furlough days, which amounted to a 1.875% pay decrease; in 2010-2011, this increased to seven furlough days, or the equivalent of a 2.625% pay decrease.21 For our baseline scenario, we assumed that the economy would remain the same and that the number of furlough days would remain a constant seven days for the following three years.
In addition to paying for an employee’s salary, LAUSD also pays an additional 10.86% of an employee’s salary towards their statutory benefits.22 These benefits include the employee’s pension and Social Security (8.25%), Medicare (1.45%), Worker’s Compensation (0.86%), and unemployment insurance (0.3%). Thus, we also calculated the costs saved from statutory benefits for the teachers and non-teachers who retired early. We did not inflate the statutory benefits for the employees because the amount for these benefits is a percentage of the employees’ salaries, which we discussed above.
LAUSD pays $12,228 in annual health care costs for each of its employees.23 We multiplied this cost by the total number of projected incentivized retirees (420 employees) to determine the costs saved in health care for LAUSD each year of our analysis. In addition, we inflated the health care costs at 10%, which is the projected increase provided by LAUSD.24
Thus after discounting at 5%, the benefits over five years for the incentives had a Net Present Value of $152,819,142.13 (Figure 1).
Areas of Uncertainty
Due to assumptions that we made in our baseline scenario and specific data that we were not able to access, we have several areas of uncertainty in our analysis. We are most interested in getting more specific data about how many employees would not have retired if there were no incentives. Although we used teacher retirement averages and trends, this is still inexact. We did not have any past trend data to rely on for non-teachers. Also, we do not know what the economy will be like in the future, and how employee salary or furlough days may change. Thus, our baseline scenario assumptions necessitated several sensitivity analyses in order to determine possible cost and benefit Net Present Values and a threshold analysis to determine under what conditions the decision to incentivize early retirement would no longer be cost effective.
Calculating the Incentivized Retiree Population
We calculated the benefits – or costs saved – using only those additional employees who retired because of the incentives. Without access to the years of service of the workforce or survey data of employees prior to retirement, it was difficult to determine how many additional employees retired because of the program.25 Although we used the data for average teacher retirement over the last ten years in order to approximate the additional retirees (Appendix D), uncertainty still exists regarding the precise number of employees who would have retired at the end of the 2008-2009 school year without the incentives. It is likely that this number falls within one standard deviation of the mean. Therefore, we performed a threshold analysis to determine the Net Present Value for a low, baseline, and high range estimate of employees who would have retired without the incentive policy.
Potential Teaching Positions Saved
As one of its main policy goals, LAUSD asserted that these incentives would save thousands of teacher’s jobs in 2009-10.26 Our baseline scenario, however, shows that these incentives prevented 259 teacher positions from being eliminated (Appendix E). Since our baseline scenario is based on the average teacher salary, we decided to conduct a sensitivity analysis to calculate the potential range of teaching positions that could have been preserved by this policy. Using the high and low ends of incentivized retirees, we calculated the minimum and maximum number of teaching positions that LAUSD could save in the 2009-2010 school year with the money from this policy. Figure 3 shows the impact on the number of teachers hired in the 2009-10 school year using the money saved from the teachers incentivized to retire.
Furthermore, our baseline scenario is based on the average teacher salary. We decided to conduct a sensitivity analysis to calculate the potential range of teaching positions that could have been preserved by this policy. Using the low (Figure 4) and high (Figure 5) ends of teacher salaries, we calculated the maximum and minimum number of teaching positions that LAUSD could save in the 2009-2010 school year with the money saved from this policy.
Graduation Rate Threshold Analysis
Studies show that teacher effectiveness has a significant impact on student achievement. Current state and federal education reform efforts have focused on increasing the number of effective teachers in the classroom through the use of performance evaluation tools. This push has been influenced by studies that found “when scores are standardized, they suggest that one standard deviation increase in mathematics performance at the end of high schools translates into 12% higher annual earnings.”27
We were concerned that early teacher retirement incentives could have a negative impact on student achievement. If the incentive prematurely eliminated valuable teachers from the workforce, students would have access to fewer quality teachers. However, retiring teachers could also be ineffective, and their retirement could allow for a higher-qualified and more cost-effective teacher to take his or her place.28 While LAUSD has been collecting value-added data during the last three years, we were unable to obtain this information for the retiring teachers. Since we cannot determine the effectiveness of the teachers that retired, we calculated what type of negative impact on student achievement these incentives would have to have in order to cancel out the financial benefits of the incentives for LAUSD.
In order to determine the economic impact of early retirement incentives in terms of student achievement, we used graduation rates as a proxy. Studies have shown that increased graduation rates lead to increased economic output.29 A study by the Alliance for Education found that increasing the graduation rates by more than 40,000 in the Los Angeles metropolitan area would provide hundreds of millions of dollars in economic activity and an additional $71 million for state and local governments in tax revenue over a 40-year period. Using this dollar figure, we were able to determine the reduced number of high school graduates necessary to eliminate the benefits of this incentive.
Our analysis found that early teacher retirement incentives are cost effective. As LAUSD continues to face budget difficulties, these incentives can prevent the district from having to make even more difficult cuts in staff and services with minimal impact on student achievement. By providing higher salaried employees incentives to retire, the district can retain younger employees with lower salaries. In order to mitigate any potential unintended consequences, however, we have several recommendations.
Study Impact of Reduced School and Central Office Staff
This study did not examine unintended consequences on central office and school site services provided to students. Without interviewing principals, central office employees, parents, students, and other stakeholders, it is difficult to determine the intangible impacts of these additional retirements. Special education, security, school counseling, school psychologists, and nursing staffs were reduced, and the impacts of these retirements are not yet well known. Areas of future study might examine the impact on central office and school site personnel reductions on services provided to students.
Mitigate Loss of Experienced Teachers
Senior teachers often provide mentoring for younger, more inexperienced teachers and this study did not quantify the potential cost of lost institutional knowledge. Unless schools proactively work to transition new leaders into these positions, valuable experience and skills could be lost to the district. In 2007, LAUSD examined the potential impact of baby boomer retirements on the district. The school board called for plans to be made to ensure the successful transition to a younger workforce. LAUSD should ensure that these plans are in place prior to offering any additional early retirement packages.
Ensure Equitable Distribution of Retiring Teachers Across Schools
Finally, concern has been raised regarding the whether or not certain schools are losing more than the average number of teachers from LAUSD’s retirement incentives and layoff policies. In particular, schools where students are already underperforming or may have more complex educational needs may suffer more from the loss of an experienced older teacher or an effective young teacher. Thus, LAUSD needs to study retirement and layoff trends by school population and performance and ensure that the changes in teacher population and experience do not disproportionately impact specific areas of the district.
Figure 7: Full Benefit-Cost Analysis, Baseline Scenario
Using LAUSD’s discount rate of 5% decreases the Net Present Value for the early retirement incentives by approximately $6 million.
Figure 8: Treasury Bond Interest Rate
Figure 10: Teacher Retirement Trends
In order to determine if there were an impact on classroom size that was significant enough to potentially impact student achievement, we calculated the number of teachers who retired because of the incentives and the number of potential teaching positions that could be retained with the money that LAUSD saved through incentivizing early retirement. One of LAUSD’s purported reasons for offering these early retirement incentives was to prevent further layoffs. (LAUSD to gauge the level of interest, 2008) Thus, using the 2010-2011 salary data for regularly credentialed teachers, we calculated the average salary a teacher could receive and determined the potential cost of an average teacher (Current salary tables, 2010).
Figure 10: Teacher Retirement Trends
1 Op. Cit. 1
2 LAUSD Budget Realities. Retrieved April 28, 2011: http://budgetrealities.lausd.net/faq
3 LAUSD: The Reality of a Budget in Crisis. (2011). Los Angeles Unified School District Board Presentation. Retrieved April 27, 2011: http://budgetrealities.lausd.net/sites/default/files/04_12_2011%20Board%20Deasy%20Presentation%20FINAL.pdf
4 Op. Cit. 2
5 Status Update of Certificated Reduction-In-Force and Reassignments. (2009). Los Angeles Unified School District Human Resources District. Retrieved on 27 April, 2011: http://notebook.lausd.net/pls/ptl/docs/PAGE/CA_LAUSD/FLDR_LAUSD_NEWS/FLDR_ANNOUNCEMENTS/S TATUS%20UPDATE%20OF%20CERT%20RIF%20NOTICES%208-18-09%20(3).PDF
6 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
7 Op. Cit. 10
8 J. Aviles (Personal Communication, 29 March, 2011)
9 J. Aviles (Personal Communication, 29 March, 2011)
10 Op. Cit. 6
11 Op. Cit. 6
12 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
13 Bureau of the Public Debt, Values and Yields for $100 Series I Bonds, Pp.2. Retrieved from treasurydirect.gov/tools/sbermay10.pdf, April 29, 2011
14 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
15 Los Angeles Unified School District. (2008). LAUSD to gauge the level of interest for early retirement among veteran teachers, principals, and administrators. Los Angeles, CA: Office of Communications. #08/09-179
16 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
17 Los Angeles Unified School District. (2003). Annualization FAQs. Los Angeles, CA: Payroll Services Branch. http://notebook.lausd.net/pls/ptl/docs/PAGE/CA_LAUSD/LAUSDNET/OFFICES/CFO_HOME/ADD_HOME/ADD_BRANCHES/PAYROLL_SERVICES/ANNUALIZATION_INFORMATION/FAQ%20FINAL%209.2.08.PDF
18 Los Angeles Unified School District. (2009). LAUSD teacher turnover: Ten-year report. Los Angeles, CA: Personnel Research & Assessment. C:Data Analysis/Turnover/10 Year Turnover 2009-10.xls
19 Los Angeles Unified School District. (2009). Retirement Incentive Data Los Angeles, CA: Personnel Research & Assessment. C:Data Retirementincentivedata.xls
20 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
21 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
22 Los Angeles Unified School District. (2008). Supplementary Retirement Plan (SRP): UTK-K-12 Teachers Assumptions. Los Angeles, CA: Public Agency Retirement Services (PARS).
23 Los Angeles Unified School District. (2008). Analysis report: September 15, 2008. Los Angeles, CA: Author.
24 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2009. Los Angeles Unified School District. Pp.27. Retrieved on 28 April, 2011 from: www.lausd.net
25 In a study done on the timing of teacher retirements in LAUSD from 1997 to 2001, Brown and Laschever found that age, years of service, economic incentives, and peer retirement are significant factors in teacher retirement decisions. In addition to economic incentives, the loss of a friend or coworker of many years appears to increase the likelihood of retirement as well.
Brown, Kristine and Laschever, Ron, (2010), When They’re Sixty-Four: Peer Effects and the Timing of Retirement, University of Illinois at Urbana-Champaign
26 LAUSD Offers Early Retirement To Workers. (n.d.). Retrieved April 27, 2011, from http://www.myfoxla.com/dpp/news/education/LAUSD_Offers_Early_Retirement_Workers_20090511
27 Hanushek, Eric A., The Economic Benefits of Improved Teacher Quality, Soguel, N. C., & Jaccard, P. (Eds.). (2007). Governance and Performance of Education Systems. Dordrecht: Springer Netherlands. Retrieved from http://www.springerlink.com/index/10.1007/978-1-4020-6446-3
28 Xu, Zeyu; Jane Hannaway, and Colin Taylor (2009). “Making a Difference? The Effects of Teach for America in High School.” CALDER Working Paper No. 17. Washington, D.C.: National Center for Analysis of Longitudinal Data in Education Research.
29 Alliance for Education: Education and the Economy: Boosting the Economy in the Los Angeles–Long Beach–Santa Ana, CA Metropolitan Statistical Area by Improving High School Graduation Rates, Retrieved April 27, 2011 from http://www.all4ed.org/files/LosAngelesCA_leb.pdf