Thursday, April 30, 2009

City Pensions—a couple of quick fixes

City pensions consume $13 million a year. That is a huge piece of our $212 M City budget and almost as much as the city collects in ad valorem (property) taxes. (This doesn’t count the money going for the new employees who are going into FRS.) There are no easy answers, no silver bullet, but there are meaningful measures we can take to curb this growing liability. And we don’t need a consultant to point the way...

Why does the city offer pensions at all?

Pensions offer one tool to attract and retain the best employees we can. And we must be fair. If we are perceived as an organization that doesn’t honor commitments to employees, we will be unable to attract and retain the best talent to serve this city.

But we also have an obligation to the taxpayers—to deliver high quality services at the lowest price.

When our benefits threaten to decrease the quality of city services, we must take action.

What can we do?

I believe we have two options that could improve the pension picture immediately, changes that will both save money for the taxpayers and improve the fairness to city employees.

Five year averaging

The headline-grabbers are the handful of folks on the high end of the salary range who will receive large pensions. But there is a second group of retirees who receive disproportionately high pensions: The end-game over-timers. . .

Currently, the city pension plans calculate an employee's salary based on the best two out of the last five years. Some employees have used this provision as an opportunity to pad their pension-basis through stepped-up overtime during their last two years. Instead of rewarding steadfast service, this provision rewards those creative employees (something we usually encourage) who can game this system in the final innings. And it unfairly penalizes those employees whose jobs do not provide opportunities for overtime.

By switching to a calculation based on the average salary over the last five years, we can get a better picture of an employee’s work history and reward each employee based on his or her work.

The savings? According to our finance director, making this change in all city pension plans could save us $1 million a year.

Spousal benefit

Today most people subscribe to the concept of “equal pay for equal work.” Yet the seemingly antiquated city pension system violates that goal. . .

Today the city pension is paid to an employee until he (or she) or his spouse dies. This system presupposes that 1) people marry within their own age group and 2) that they stay married. And it is based on a by-gone era when the social norm was one bread-winner/pension-earner per family.

But look what happens when a retiree violates the Leave-It-To-Beaver social more:

A Tale of Two Officers
(Not to pick on police—just easier with a pension that is 100% of salary to make this illustration)

For the sake of simplicity, let's make the following assumptions:
  • Both join the force at 20 years old.
  • Both officers serve the city admirably, receive the same base pay for their equal work for 35 years.
  • Both retire at 55 and receive a pension paying 100% of salary.
  • Both officers earned the same, constant amount of $40,000 every year on the force.
  • Everyone (pensioners and their spouses) lives until they are 80 years old.
Let's look at their compensation while on the force:

Officer AOfficer BDifference

Years on Force3535--

Total Salary Payments While on Force$1.4M$1.4M--

So far so fair.

Now let’s say that Officer A is a devoted husband who is married to a woman of his age. Officer B has a midlife crisis at 50 and marries a woman half his age. Let's see happens to their pension compensation:

Officer AOfficer BDifference

Years of Pension Payments255025

Total Pension Payments $1.0M$2.0M$1.0M

As you see, there is a difference of a million dollars between these two employees. Equal pay for equal work? Not.

This inequity not only costs the taxpayers, it violates the fairness principle. A simple change could repair this inequity. The technical name for this change is “life annuity normal form.” In practice it means that upon retirement, the employees must choose whether to receive benefits only until they die or until their spouse dies. If they choose to include their spouse, then the benefit level is adjusted based on the age of the spouse, dividing out the pension expectation of the employee over the life expectancy of the youngest partner.

This is a standard practice with other pension plans and provides equitable payments with respect to different life choices. According to the city finance director, making this change for all city pensions would result in a $1.7 million a year savings.

Action now

By making these two changes for all of our employees, the 5 year average and the spousal consideration, we can create a pension system that treats our employees fairly and equitably. These changes also bring our system more in line with other local governments and the FRS system, our main competitors for top talent.

These changes will should save the city an estimated $2.7 million a year. The city should move forward with these changes now.