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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.