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Cutting Benefits: The Wrong Way
and the Right Way
Must politicians always find a way to dig a deeper hole?
Questions, success stories or anecdotes about benefit issues in government? Girard Miller wants to hear from you.
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The national economic crisis has now landed squarely in state capitols, county courthouses and city halls. As tax revenues shrink rapidly with the decline in income, sales and property values, public officials are scrambling everywhere to make ends meet. Although federal aid to state and local governments from the Obama administration seems likely in January, painful cutbacks are inevitable.
In this context, we are now beginning to hear about cutbacks in employee benefits. Up until now, this was a topic that wasn't up for discussion in most governmental circles. Now, benefits rollbacks are on the table, but not all proposals are truly "above board." Some are just political gimmicks to avoid biting the bullet, rather than real reforms and real cost reductions.
Here's my favorite example of political double-speak: New Jersey Governor Jon Corzine (whom I genuinely admire as a competent and honest governor) has publicly called for labor groups to sacrifice their benefits while simultaneously calling for pension holidays for local governments.
Although he deserves credit as a rhetoretician for suggesting common sacrifices, his scheme to skip pension payments will only put the state's troubled pension funds into deeper deficits — without doing a thing to reduce actual costs. And there is chatter that he would have the municipalities pay 8.5 percent interest if they don't pay their bills on time, in which case they would be far better off selling pension obligation bonds in the capital markets. (A topic for another column in future months!)
At least some other governments are talking about real cutbacks, including local officials in Nevada and Carlsbad, California, where a gutsy mayor has proposed pension rollbacks. In Colorado, the 400,000-participant statewide public employee pension plan is deliberating benefits reductions that potentially could impact new hires or the future accruals of incumbent employees. These public officials evidently understand the difference between real reductions and cosmetic bill-skipping. They are willing to "bite the bullet" to invoke necessary cost reductions.
Nobody ever wants to cut costs or make hard decisions. But this recession is nastier than many because the eventual recovery is not likely to solve the financial problems facing many state and local government benefits plans. That's especially true when it comes to benefits for public sector retirees: We can't lay them off or ask them to pay more now that they're retired.
Investment losses will force some pension funds to bill their sponsoring public employers 2 to 4 percent more in payroll contributions in 2010. And unfunded retiree medical liabilities are expected to require many governments to begin making actuarial contributions to those plans for the first time in the range of 5 to 10 percent of payroll. The bottom line: There simply won't be enough new tax revenue in the next economic cycle to make ends meet.
Almost every governmental HR director, budget director and labor relations director needs to start work immediately to develop a sensible plan to reduce employee benefits costs immediately and long-term. Here are the top 10 strategies they must inevitably consider:
1. Reduce retiree medical benefits for new employees and/or establish a mandatory defined contribution retiree medical savings plan for new employees.
2. Require employee contributions, or higher contributions, for pensions and retiree medical plans as well as for traditional benefits like health insurance.
3. Establish an annual cap (either in hard dollars or pinned to the Consumer Price Index) on increases in retiree medical benefits plan benefits.
4. "Tier" the retirement systems so that younger workers and new employees receive limited benefits and/or make increased contributions.
5. Shift costs to employees with increased deductibles, co-pays and monthly insurance premium payments, to better align with local labor market practices.
6. Raise retirement ages, especially early-retirement ages.
7. Reduce or phase out dependent coverage for retiree medical benefits.
8. Increase vesting requirements for pensions and retiree medical benefits.
9. Replace the pension plan with a new, lower-contribution defined contribution plan for new employees — or offer a voluntary optional DC plan.
10. Issue pension obligation bonds or OPEB bonds for retiree medical plans, to replace the actuarial contribution with a lower-cost debt service payment.
None of these strategies is painless nor riskless. None of them will help stimulate the national economy — in fact, they work the other way.
But after deferring action to control mounting benefits costs in the past decade, public officials now have little choice but to dig deep into this grab-bag of ideas for genuine cost reductions. As my previous column on the labor relations environment in 2009 suggested, there will never be a better time to bargain fiercely for needed changes in benefits cost structures.
If you want to see a preview of where runaway benefits costs could take us, just take a look at the current plight of America's autoworkers.
NOTE: This column has been updated to clarify the potential impact of benefits reductions being considered by the Colorado public employee pension plan.
Girard Miller, a senior strategist for retirement plans and investments at the PFM Group, has 30 years of experience in the public, private and nonprofit sectors. He can be reached at millerg@pfm.com. More biographical information