Pension Reform Spotlight on Los Angeles

Earlier this week the Los Angeles Times ran an article entitled “Signature gatherers duel over Riordan pension initiative.” In the article’s introduction, the Times reporter quoted a voter opposed to the initiative, writing “The Tarzana grandmother thinks younger generations shouldn’t have to worry about a retirement tied to the ups and downs of the stock market.”

Instead, apparently, grandmothers in Tarzana, along with public employees, their unions, and a critical mass of journalists and opinion makers, believe that taxes should be tied to the ups and downs of the stock market. That is, when the stock market goes down, taxes go up, so public employee pensions can stay intact.

If you read former Los Angeles Mayor Riordan’s pension reform proposal (download title & summary, download full text), there is a lot to recommend it to voters, at least those voters who are tired of shouldering the risk not only for their own retirement security, but through their taxes, the ample retirement security of Los Angeles city workers.

For starters, unlike the statewide pension reform legislation signed in September by governor Brown, this initiative calls for Los Angeles city workers to immediately begin contributing more to their pension plans through payroll withholding. At increments of 3% of payroll per year, their contributions will quickly increase until they are paying at least half the cost to fund their pensions. And also unlike Brown’s statewide reform, covering half of the costs means covering half of all the costs, including liquidation of unfunded liabilities and administrative costs.

Riordan’s reform also requires city workers to fund through withholding from their pay at least half the cost to fund their retirement health and welfare benefits – also unlike Brown’s statewide reforms. And Riordan’s reform implements transparency requirements so that the city shall make publicly available information on the budgetary impact, and the impact on pension funding requirements, of all changes to compensation through collective bargaining and cost of living increases. These transparency requirements even include making public a sensitivity analysis showing the impact of lowered rate of return projections on pension funding requirements.

As we explain in “A Pension Analysis Tool for Everyone,” because of underfunding, retroactive benefit enhancements, and the high percentage of participants either retired or nearing retirement, the required pension contribution is extremely sensitive to changes in the rate of return assumptions. A 1.0% drop in the projected return will increase the pension contribution by at least 10% of pension eligible payroll.

For new employees, Riordan’s plan is tougher. Because it puts all new employees into a 401K program where the city makes a matching contribution to whatever the employee contributes via payroll withholding; up to 10% of pay, 12.5% for public safety employees. The plan also includes the option for the City Council to include social security in the retirement package for city employees, something they don’t currently pay into or receive.

Notwithstanding the usual union blather that suggests Los Angeles is not on the brink of bankruptcy – because it is, or that pension reform should be negotiated at the bargaining table – because they didn’t, it is fair to wonder why Riordan didn’t include in his reform the “third leg” of the stool, i.e., a scaled down defined benefit to go along with reentry into the social security system and a defined contribution plan. This so-called three legged approach was one of the premises of Brown’s initial reform proposals, and it’s a good idea.

At the risk of muddying the waters is a very polarized debate, it is important to recognize the virtues of defined benefit plans. Defined benefit plans can be sustainable if they embrace three key provisions, (1) that the participants contribute at least half of the costs through their own payroll withholding – costs that can fluctuate upwards when investment returns drop, (2) that caps are put onto the maximum employer contribution as well as onto the maximum pension benefit possible, and (3) if the plan’s annual percentage returns on investment do not meet expectations and the plan becomes underfunded, retirees collect proportionately lower monthly pension checks until the plan returns to solvency. One might suggest this isn’t a defined benefit at all, but it is, because it includes the most important element of a defined benefit, which is shared risk. With 401K plans, you can only hope your investment choices won’t fall victim to a seismic shift in the market, where even conservative bets get wiped out. With 401K plans, you also have to hope you die before your declining balance annuity reaches its prearranged final year of solvency. None of this is fair or humane. Only a Darwinian brute can sincerely believe that individual savings accounts, and nothing more, are the most equitable way for our nation to guarantee the retirement security of its aged citizens.

The grandmother in Tarzana has a point.

If the unions who oppose Riordan’s plan are serious about stopping it, or modifying it, they might consider abandoning all their lavishly funded harassment of signature gatherers and rich-bashing rhetoric, and instead return to the bargaining table with a sober recognition that the current system is broken. They might accept all of the changes being proposed to the defined benefit plans for existing employees including the requirement that the employee pay 50% of the total contribution and the required employer contribution ceiling of no more than 15% of payroll. Then, if they want to keep a defined benefit plan for new employees, they might also accept a provision to lower pension payments to existing retirees whenever investment returns for the fund at-large fail to meet projections. And they might, in a manner consistent with social security, place a cap on the maximum pension benefit, a floor on the minimum, and raise the retirement age. They might not like how low that cap has to be to ensure solvency, but it would be consistent with their allegedly progressive principles.

4 replies
  1. Avatar
    Tough Love says:

    Excellent article overall. A few comments:

    (1) Quoting …”And also unlike Brown’s statewide reform, covering half of the costs means covering half of all the costs, including liquidation of unfunded liabilities and administrative costs.”

    This is a biggie, because if the Unions/workers KNOW that their half INCLUDES underfunding (FUTURE as well as PAST), it significantly lessens the incentive to push for very high Plan valuation discounts rates that low-ball true Plan costs.

    (2) Why be vague, with a DC Plan the allows “up to” 10% (12.5% for safety) and “allows” inclusion in SS. The Plan should be designed to be comparable with that offered Private Sector workers by their employers. I suggest mandatory SS participation (a good backstop) plus a 5% of pay DC Plan, noting that few in the Private Sector get more today. Are Public Sector workers “special” and deserving of MORE than those that pay their way?

    (3) Although I strongly feel DB Plans cannot work in the Public Sector (primarily because our elected officials are too self-interested and cannot be trusted), a modest DB Plan of say 1% of pay + SS + availability of a DB Plan with NO Taxpayer “match” (similar to the current Plan for Federal employees) is not a terrible idea … as long as the 1% can never be raised, is based on the average of the last 5 year’s BASE PAY only, and with only calendar years in which the worker actually worked a minimum of 1000 hours counted as service years (the Private Sector/ERISA-allowed standard used to eliminate all the game playing and “spiking”).

    (4) You said …”Defined benefit plans can be sustainable if they embrace three key provisions”, the 1st calling for workers paying for half the the total cost of their pensions. This is the wrong goal. The correct goal should be equal Private and Public Sector “Total Compensation” (cash pay plus pensions plus benefits) in comparable jobs (or jobs with comparable risks and skill sets if not directly comparable). My objection to the “half” suggestion, is that in many cases it results in far greater Public Sector compensation (particularly for safety workers with the richest pensions). Numerous studies have shown that in most occupations, “cash pay” in the Public and Private Sector are quite close. Such studies also show that (on average), and in addition to the employer’s contribution to SS, Private employers contribute 6-8% of pay towards their workers’ retirement. With Equal “cash pay” (and where the Public Sector employer also participates in SS), then that same 6-8% of pay should be the boogie for Taxpayers %-of-pay contributions to Public Sector worker retirement packages. But, due to the richness of most Public Sector Plan designs, the cost (expressed as a level % of pay) to fully fund a worker’s pension over his/her working career ranges from 25-40% for miscellaneous workers, and 40-60% for safety workers …. depending on the richness of the Plan. Half of those %’s are MUCH greater (especially for the safety worker group) than what Private Sector workers get from their employers. Again, with Public Sector workers earning no less in “cash pay”, why should Taxpayers contribute MORE to their retirement packages than what they get from their own employers?

    (5) Your 2nd key provision to embrace suggest (a) maximum employer contributions and (b) a maximum benefit cap. While interesting ideas, they are fraught with problems. A Maximum employer contribution is generally inconsistent with the very nature of a DB Plan. I suppose it COULD work if it is made VERY clear to the employees that THEIR contributions “WILL” (not “may”) annually pick up the the contributions that would otherwise have been made by the employer. As to the a Maximum benefit cap, with rich formulas, many employees (especially safety) will hit that cap at young ages and with lesser service. This will encourage early retirement and added pressure to cover the VERY expensive Pre-Medicare age health costs. It would be MUCH better to have less rich formulas that together with SS (and personal savings) yield sufficient retirement income ONLY after a full 35+ year career, and age 62 (at the minimum).

    (6) you 3rd key to embrace … lowering retiree payouts when Plan returns are low is a good idea in the sense of risk transfer (to the workers), ala what is routine for Private Sector workers in 401K Plans, but again departs materially form classic DB Plan design. You assert it remains a DB Plan because if the inherent risk transfer, referring to the mortality-sharing nature of all DB Plans. While true, you’ve cheating a bit here, as “risk transfer” when discussed in the context of Pension Plans almost always refers to the INVESTMENT risk, not the MORTALITY risk.


    Bottom line …. Public Sector pension reform (meaning significant reductions in the accrual rate for FUTURE service for CURRENT workers) is needed everywhere as such Plans are now universally too great when compared to what Private Sector Taxpayer get, especially with the now equal Public/Private Sector cash pay.

    The Unions/Workers will continue to resist (only allowing financially immaterial changes if any) at their own peril. In the end game, reality and the MATH always governs, and that end won’t be pretty without substantive structural (and painful) revisions pretty soon.

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