Earlier this month we reported on the near-record underfunding of state and local government pensions. A number of factors were implicated, mainly: too generous benefits, too optimistic estimates of investment returns, and insufficient contributions.
Walter Russell Mead reflects on a possible trend:
Some of the nation’s most overburdened state and local governments are considering an unprecedented strategy for defusing their public sector pension time bombs: Offering workers lump-sum payments worth somewhat less than their pension guarantees in the hopes that enough will accept to meaningfully reduce long-term costs.
He draws on this article in Governing magazine which reports,
In Philadelphia, where the municipal pension plan is less than half-funded, Controller Alan Butkovitz is pushing a buyout of sorts aimed at the city’s most expensive workers. In exchange for taking an upfront cash payment based on their estimated lifetime benefits, the employee or retiree would accept a reduced level of pension benefits going forward. The benefits would be equivalent to what newer Philadelphia public employees are receiving now.
Mead identifies three problems with public pension programs.
But the problems with the current pension system go deeper than the simple fact that they can only be honored, if at all, with tremendous difficulty and sacrifice in many places.
First, there is the moral hazard problem: The easiest way out of collective bargaining issues for both politicians and union leaders is to promise increases in pension benefits down the line, but not to set aside enough money to pay them right away. This creates a “victory” for union leaders, who look strong to their members, and for politicians, who get union support but don’t have to annoy the public by by raising taxes or cutting other spending…
But there’s more. The defined-benefit pension system is designed to lock employees in place. Workers sometimes need to remain in the civil service for decades to become eligible for benefits. That’s one reason that unions fight so hard to make it very difficult to fire public employees, whether they are teachers or cops. Reforming this system, and making the public sector workforce more flexible and merit-based, would likely improve the quality of government service.
Finally, the pension problem is also exacerbated by economic and demographic population shifts within the United States. Financially-struggling Detroit and New Orleans, for example, used to be much larger cities than they are now.
He suggests a shift to the defined-contribution programs that are now standard in the private sector. That’s been proposed in Washington but has never gained traction, in part because of perceived transition problems.
An in-depth article in the Los Angeles Times offers a textbook example of the moral hazard problem Mead identifies.
With the stroke of a pen, California Gov. Gray Davis signed legislation that gave prison guards, park rangers, Cal State professors and other state employees the kind of retirement security normally reserved for the wealthy.
More than 200,000 civil servants became eligible to retire at 55 — and in many cases collect more than half their highest salary for life. California Highway Patrol officers could retire at 50 and receive as much as 90% of their peak pay for as long as they lived.
Proponents sold the measure in 1999 with the promise that it would impose no new costs on California taxpayers. The state employees’ pension fund, they said, would grow fast enough to pay the bill in full.
They were off — by billions of dollars — and taxpayers will bear the consequences for decades to come.
We won’t attempt to go into all of the details. Those of you who care about pensions, fiscal responsibility and budget sustainability will want to read it for yourselves. The decision was made in 1999, in the midst of a bull market. State workers, who have considerable influence on the CalPERS board, demanded a more generous pension benefit. While one CalPERS board member mentioned bull markets don’t last forever and asked that the board not act without more information from the state actuary, he was met with this response:
Board chairman William Crist, an economics professor at Cal State Stanislaus and former president of the faculty union, interrupted with sarcasm.
“I guess the best case for the retirement system is everybody dies tonight,” Crist said, meaning the fund wouldn’t have to pay any benefits. “We could go through a modeling exercise where we make all sorts of different assumptions and make predictions, but that’s really more than I think we can expect our staff to do.”
An unusual rejection of modeling from an economist, certainly, but some modeling was done. The actuary, Ronald Seeling presented best- and worst-case projections.
Then Seeling turned to his most pessimistic assumption: investment growth of 4.4% per year, about half the rate CalPERS was expecting.
That would be “fairly catastrophic,” Seeling said at a May 18, 1999, meeting of the board’s benefits committee.
…The discussion was over in a few minutes, and board members did not revisit the issue, according to meeting transcripts. That summer, they approved the benefits expansion, the legislature passed it by overwhelming margins in both houses and the governor signed the bill in September 1999.
We know what happened. Returns failed to meet expectations and taxpayers were on the hook.
If the board had included truly independent financial experts in 1999 — the state treasurer and controller, he noted, are elected officials dependent on campaign contributions — they might have pushed to save the extra money from the boom years for a “rainy day,” he said.
“They had that surplus, and there was an incredible push to spend it,” said Seeling who collects a $110,000 state pension after a 20-year career at CalPERS.
“Politics and pensions just don’t mix. That’s all there is to it.”
Washington state government had its own flirtation with bad pension policy in the late 1990s, as well, with an ill-advised “gain-sharing” scheme. Fortunately, the state Supreme Court upheld the Legislature’s authority to reserve the right to repeal or modify benefits at the time the legislation is adopted. The Legislature repealed gain-sharing in 2007.