Public employee pensions are no different from health care costs…well sort of

15 Feb

If you listen to teachers, police and other public employees, they will tell you that the only thing wrong with their pensions is that the states have not funded them.  In many cases, they are right; they are not adequately funded.  Why are public pension underfunded?  Well, governments do not have the money, they diverted money from pension funding to other perhaps more visible, attractive spending, and they used actuarial assumptions, which make it appear a plan has lower unfunded liabilities than it does.  By “they”, I refer to politicians.

That is only part of the story. Think of it this way, during the health care debate the cause of high health care was presented as insurance company premiums when in fact it is the cost of health care. When it comes to pensions, it is not the funding that is the real culprit; it is the generous provisions of the pension plan. 

That is not to say that all government workers receive $100,000 pensions although some do. Their pension is based on their earnings, their service and the pension formula. A lower earning maintenance worker is going to have a low pension in terms of dollars, but not necessarily in income replacement.

In trying to solve the problem, some states see the solution as requiring workers to contribute more toward their pensions.  That is like thinking you are controlling health care costs by requiring workers to pay more in premiums. 

The fact is it should be possible over time to lower worker contributions thus freeing up money to save for retirement such as in a 403(b) plan and maintain a defined benefit pension as well.

How can that be?

The benefits currently provided are not in tune with the real world.  For example, according to an article in the Wall Street Journal a police officer in Pittsburgh can retire at age 50 with 20 years of service and receive a pension equal to 50% of pay.  To do that the formula would have to provide a benefit based on 2.5% of pay for each year of service (or some equivalent of that).  The typical private pension plan is in the range of 1.5% of pay for each year of service and rarely exceeds 2% and then only on some years of service or a portion of earnings.  Government plans typically have automatic cost of living adjustments, virtually unheard of in the private sector.  Many public plans have disability provisions that are amazingly liberal in definition and application…and expensive.  Early retirement provisions are liberal.  The definition of earnings generally includes overtime, may be based on the last year’s pay and often easily manipulated by workers (and poor management) to boost earnings in the last or final few years of service. In some cases workers retire in their 40’s with a pension exceeding their base pay at the time of retirement, we should all be so fortunate.  In the real world, pensions typically do not include overtime and earnings are defined as a five-year average or even a career average.  Oh, and in some cases such as in New York, the pensions are free of state and local taxes.

Ah, twenty and out

Not all public pensions are the same of course, but most have plan provisions that put the private sector to shame…and burden the taxpayer in the process.

While the gripe is valid that politicians (in some cases) have not adequately funded pension promises and used overly optimistic investment return assumptions,  just imagine what your state and local taxes would be if they had done things the right way.

Because of this looming crisis, some critics see the solution as eliminating the defined benefit plan in favor of a defined contribution plan.  That is wrong and unnecessary.  Unions and the people they represent are better served helping to design pension plans that provide a reasonable benefit for a reasonable cost.  

Pensions are not the only problem, the tremendous liabilities accumulated for retiree health benefits is also a looming crisis.  While the private sector slashed and burned these benefits when the liabilities hit the earnings of companies because of an accounting change several years ago, the states went on their merry way making few if any changes and in many cases not even knowing the scope of their growing liability.  Some states had modest funding for these liabilities but diverted the money to other spending.  Consider this recent article in the New York Times.

Politicians, instead of currying favor with labor unions, must make decisions that are best over the long-term for all the citizens they purport to represent, including the people footing the bill.

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