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DROP Reform

Set the Stage for Downshifting

As state college coaches stir up citizen envy with their multimillion-dollar contracts, so too do public employees who draw richer pension benefits than the taxpayers who pay for them. Add to that the DROP option — a Deferred Retirement Option Plan — and you may really be tempting citizen unrest.

In this volatile era in pension and health benefits for retirees in the private sector, the time is right for public managers to take a second look at their DROP plans and see if they are a necessary tool for managing a workforce or just a union-negotiated gimmick that is alienating the public. San Diego is taking that second look. Mayor Jerry Sanders and City Attorney Michael Aguirre want to eliminate the city’s DROP program as too expensive.

First appearing in the 1980s, DROPs were developed to retain scarce, skilled professionals such as teachers and police officers. Many pension plans capped benefits so that retirement-eligible employees had no financial incentive to keep working. But that created its own set of problems. To stop a talent drain, pension systems came up with DROP options that allow employees to extend their working years for a fixed period of time. Their pension payments are postponed until they finish the DROP period, and a separate individual DROP account is credited with employer contributions and interest — for example, 8 percent of pay with 6 percent interest. If done right, these arrangements can be actuarially neutral and financially prudent. But when they are poorly designed, they can lead to charges that they are just another giveaway to retired pubic employees who are already considered overcompensated by some.

Some DROP plans, for instance, may be Band-Aids on a basic plan that is too generous in permitting young employees to receive full benefits without a way to “downshift” — that is, to work for less pay with fewer hours or with less responsibility. If there is an opportunity for abuse or “gaming,” the problem should be fixed with a design change, even if that requires a return to the collective-bargaining table. For example, if the DROP option is enriching employees who would otherwise be inclined to keep working, save for a pension plan’s “25 [years of service] and out” provisions, then it’s probably time for a design change.

DROP plans may be an imperfect answer for retaining skilled employees — or just an alternative for baby boomers who haven’t saved enough money to be able to afford to retire. Preferably, they could lead to a new generation of hybrid plans or supplemental defined-contribution plans. This approach could enable valued public employees to “downshift” without costing taxpayers more than the costs of training a replacement worker.

Public managers would, of course, prefer to use such a tool selectively, to keep their best talent while letting deadwood employees head out to pasture. That will likely invite discrimination lawsuits, so the plan design work will require some creativity and sensitivity. For example a plan might start by allowing the employer to offer part-time employment with full-time medical benefits. At the same time, it could allow the “retiree” to draw partial pension payments for past service while the plan makes a contribution to a deferred-compensation account in lieu of additional service credits. Such a plan could be offered to selected employees who meet certain criteria. These could start with employees who have earned above-average performance evaluations for the past five years but also include only those for whom there would be a cost for recruiting and training a replacement.

Now is a good time to get ahead of the curve and start working on ways to provide financial flexibility to productive older workers. “Downshifting” will become a big word in the years to come, and it could even save your taxpayers money if it’s done right.

Last month: Wrestling with benefit issues

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Girard Miller, an analyst of benefits and investments with 30 years of experience in the public, private and nonprofit sectors, can be reached at Girardinmalibu@charter.net.
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