Pension Reform Lacking Direction at the Moment

The problem is the solution is elusive at best.  Recently the word came down that neither Governor Arnold Schwarzenneger nor Republican candidate for Governor Meg Whitman will back an initiative that would have reduced pension payments and extend retirement ages for new state and local government hires.  Would have is the operative word because the initiative has been suspended in part because they were counting on major funding from Ms. Whitman.

“We need to align public employee retirement benefits to those available in the private sector. New state workers should receive a 401(k)-style defined-contribution plan. For most existing state workers, we need to increase the retirement age from 55 to 65, require longer vesting periods, and ask them to contribute more to their retirement benefits.”

She continued:

“For most existing state workers, we need to increase the retirement age from 55 to 65, require longer vesting periods, and ask them to contribute more to their retirement benefits.”

Employers, and in this case the government is the employer, prefer the defined contribution plan over the defined benefit plan that guarantees a retiree a monthly pension payment for life since it avoids the type of long-term debt and unpredictable future costs.

While this may sound good, they would have to get the employee groups to accept it.  I know conservatives think private is automatically the solution over public, but functionally, I’m not sure there is a difference.  Besides, just as CalPERS took a beating over investment losses, so too did those who held 401(K)’s.  The difference here is that if the CalPERS tanks, the public sector has to find the money to compensate, if 401(K)’s and stock market tank, there is no assurance for the employees – so why would they accept such changes.

In addition to the shifting of the risk from the public sector to the employee, the plan also sees savings coming from workers contributing more to their retirement benefits and that also has to be negotiated.  We saw this happen in Davis where the PASEA workers did a flat swap of increased salary in exchange for an equal share of their pensions that they pay into themselves.  In the end, it is a wash.

Raising the retirement age is also a good idea, but it also has to be negotiated.  And that means the employees are going to have to get something in return.

Part of the problem as a Redding Record Searchlight article makes clear this morning, the most “common-sense solution to California’s burgeoning pension problem is simply illegal.”

They write:

‘Government lawyers, CalPERS officials, union representatives, even conservative political rabble-rousers like the journalist Steve Greenhut, who spoke at a Greater Redding Chamber of Commerce-sponsored event Wednesday morning – all agree that there is no way in California to change the rate at which a public employee’s pension builds up.

Once a city council or board of supervisors approves a contract, the pension formula – such as the “3 percent at 50” plan for most police officers and firefighters – is inviolable, “a one-way ratchet,” as Greenhut put it.”

As Ed Mendel who writes for Calpensions which devotes itself to this very issue writes,

“Changing the pension benefits of current workers may be difficult, unless they consent. Most pension reforms focus on new hires because the courts have ruled that pensions promised current workers are vested rights, protected by contract law.”

The problem here is that during the last decade salaries increased very quickly, particularly at the local level, and also the pension-formulas were increased.  Suddenly cities were paying their employees a lot more and giving them larger pensions.  During times of economic growth, that may appear sustainable, but as we saw in Davis, that increase in revenue came from the housing bubble and once the bubble popped, the city had no back up plan.

Part of the solution here would be to slow the increase of salaries to allow inflation to bring them back to where they were at the start of the last decade.  That would greatly reduce the pressure on the pension funds.  But no one has really looked at it in those terms on the reform side.

Those who believe this can be done legislatively without negotiation are probably fooling themselves.  Moreover, the people who get hurt the most in such schemes are those at the bottom collecting a rather modest pension, where the problem lies really at the top with public safety and managers getting six figures.

A two-tiered process is what some are pushing where new employees receive significantly less than prior employees.  I do not believe that will prove anymore sustainable.  Moreover, any savings derived from that will be years down the road after the current crop of employees with their lucrative retirement plans retire.

State and to a greater extent local governments got into this problem through the rapid increase in salaries and benefits, now they can extricate their problems by holding the line on salaries, increase these salaries below the rate of inflation, and allow attrition to take effect.  The question is whether they have the discipline to do that.

—David M. Greenwald reporting