Despite the economic hard times
there is a large class of Americans for whom there is no retirement crisis, no
health-care crisis, and no employment crisis. Federal, State, and Municipal
employees have no reason to worry. They all have defined benefit retirement
plans that are guaranteed against market loss by taxpayers. They all have
excellent medical insurance at virtually no cost. After a short period of
employment, their jobs are virtually guaranteed and it is only with great
difficulty that they can be terminated or laid off.
This class constitutes a kind of
aristocracy that is entirely supported by the rest of the population that has
nowhere near the benefits enjoyed by its members. The Federal government is the
largest employer in the Nation and its size gets bigger every day no matter
which party is in office. State and Municipal employees include police
officers, firefighters, teachers, as well as an army of civil servants.
Retirement benefits are the least
understood part of the compensation of the government class but they provide a
good example of the disparity between the two classes. Virtually everyone in
the government class enjoys the benefits of what is known as a defined benefit
pension plan. These plans, which have largely disappeared in the private
sector, provide a guaranteed lifetime income at retirement.
For example, in my home state of
Connecticut a teacher can retire after 35 years of service on 70% of their
final average pay. Final average pay is important. In Connecticut it means the
average of the highest three years earnings, not an average of lifetime annual
earnings. Teachers whose final average pay is $90000/year could retire as early
as age 56 on $63000/ year for the rest of their lives.
Unlike the 401k plans prevalent in
the private sector the defined benefit plan income is guaranteed by the State’s
taxpayers no matter what return is achieved by the underlying pension assets.
The town of Fairfield recently lost $40,000,000 on a Madoff investment and has
just raised taxes in order to cover the expected shortfall. Although not the
victim of a scam, the neighboring city of Bridgeport experienced such losses in
the recent downturn that it had to come up with $25,000,000 to cover its
shortfall.
The very generous pensions enjoyed
by members of the government class in Connecticut seem miserly compared with
some other states. On a recent visit to San Francisco I read the local paper and found it full of news of the
draconian budget cuts proposed in that nearly bankrupt state. San Francisco
itself was being forced to cut essential services to balance its budget.
Nevertheless, buried inside the paper was an article detailing the incredible
pension benefits of its municipal employees.
The article referred to over 480
retired city workers and their survivors who are “knocking back $100,000 or
more a year in pension money.” To keep it simple, if 480 people receive
$100,000 per year, that’s a minimum of $48,000,000 a year in pension benefits.
At 4% interest it would take $1.2 billion to provide $48,000,000 per year.
However, in a low interest rate environment such as we’ve been through in the
last few years, the pension actuaries must demand that even more be allocated
to fund plan benefits. That is why so many of these plans are underfunded.
Budget difficulties in New York
State and City have led to new taxes and fees. However, the generous pensions
of retired New York State and City employees are not subject to either State or
City income taxes. Could there be greater proof of the disparity between the
two nations?
A call for pension reform does not
imply criticism of government employees and their work. Like the rest of us
most of them work hard at their jobs and deserve to be financially secure in
retirement. Nevertheless, their defined benefit pension plans are dinosaurs
that are crushing the rest of us under foot. They even prevent cities and
states from hiring much needed teachers, police, firefighters, medical, and
social workers.
How did such a disparity come
about? Basically, defined benefit plan formulas were designed to protect
employees, who were typically underpaid, from being destitute in old age. Until
the last decade or so government salaries were too low to allow employees to save
for retirement on their own. However, recent increases in salaries were not
matched by modifications in retirement plan benefit formulas. In Connecticut an attempt to change the
average pay calculation formula from a 3-year average to a 5-year average
failed largely through the efforts of the teacher unions and their friends in
the legislature. Minor modifications in pension benefit formulas can produce
millions in savings and still provide adequate retirement income for state and
municipal employees.
Basing final average pay on the
last 5 or 10 years of service would produce significant savings. Just ask the
actuaries. Of course, the Social Security system, the primary source of
retirement income for the rest of us in the private sector, uses 30 years to
calculate final average pay. Using more years to calculate final average pay
would also eliminate a common form of abuse where municipal employees find ways
to significantly boost salaries in the last years of service.
A first step in the reform process
should be the removal of elected officials, especially members of Congress and
State legislators, from any future participation in these retirement plans.
Their current pension benefits should be frozen, and future payments placed
into a defined contribution retirement plan. Otherwise, they would have no
incentive to modify the existing arrangements.###
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