Posted February 20, 2008

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Bonus column:
· Benefits for Younger vs. Older Workers

Getting Tougher About Pension Retroactivity

Orange County, California, officials have taken off the gloves with a lawsuit challenging the award of pension benefits to a group of sheriff's deputies. These employees were granted a higher pension payout formula by the pension board, and the formula includes past service. In essence, they were given a 50 percent increase in benefits for both past as well as future service credits. So the county supervisors are calling "foul," arguing that the retroactive application of these sweeteners is a "gift of public funds" and thus unconstitutional.

It's an interesting court challenge, and will be watched carefully by employers, employees, unions and retirees as well as benefits experts.

This practice of retroactive sweeteners has long been a weak spot in defined benefit pension administration. It's one reason that private sector employers favor defined contribution plans, because they cannot be revised retroactively. There is no logical argument for making retroactive adjustments to pension benefits. Taxpayers gain nothing in return from this practice, and pay the full costs. These deals are simply a transfer of public funds to a select group of incumbent employees, often those who have voting or leadership clout in the bargaining unit. To that extent, the Orange County lawsuit has a ring of truth to it.

To put a stop to this practice, the California Foundation for Fiscal Responsibility, a taxpayers group I've mentioned in previous columns on benefits crackdowns and 2008 pension politics, has proposed a constitutional amendment to stop these "retro" awards in their tracks, among other provisions. Their 2007 draft ballot initiative, now expected to be revised for the November 2008 ballot, would prohibit pension plans from awarding benefits increases retroactively any time after voter approval.

In some states, pensions are constitutionally protected. They cannot be cut retroactively. Symmetry would require that increases should be prospective only, for work to be done in the future. Otherwise, we may as well buy the votes for union contract ratification the "old Chicago way" and dole out green cash at the ballot box.

There is another temporal aspect of this issue that also has received very little attention. Public employers and especially the politicians are reluctant to reduce benefits for future service, even though such labor is not protected by any constitution. For example, the Ohio legislature recently enacted legislation that requires higher retirement ages for certain school employees, but applied this reform only to new hires instead of the entire workforce.

The conventional thinking is that incumbent employees are voters, for the union contract as well as the politicians, so we can't touch their current benefits packages even if they contain unaffordable early retirement eligibility dates. This is flawed thinking. Unless changed, this policy of inertia means that the entire Baby Boom generation is effectively grandfathered into an actuarially unsustainable early retirement structure. Cynics would say that Baby Boom managers and policymakers are loathe to introduce changes now because it's their own ox to be gored. So much for moral authority and taking responsibility for our own generation's bills.

Nothing should stop gutsy public officials from telling current employees that they can still keep their earned service credits if they want to achieve a full retirement by working to age 65 like the rest of the taxpayers who support them. But those who want to take an earlier lifetime pension must accept an actuarial reduction — like the rest of America. The actuarial reduction can be calibrated so that it fairly compensates the employees for full service credits earned prior to the plan design change.

For retiree health care benefits, this kind of structural reform is needed immediately because it will be the single factor that impacts whether many public employees take early retirement pensions or keep working and contributing to our society. Absence of medical benefits is the chief reason that many people keep working, so reform needs to start here.

One way to do this is to raise the required normal retirement age by six months annually until it conforms with the normal Social Security eligibility age. Likewise for "age plus service" arrangements that permit earlier retirements. This gradually reforms the plan without causing unfair individual dislocations.

Nobody should ever take away money that public employees earned in the past. That's just wrong — even in states where it's not unconstitutional. But somebody has to start watching out for the taxpayers' interests, or we'll quickly see an entire generation of Baby Boomers stampeding the exits with "silver parachutes" that most working-class taxpayers never enjoy. And leaving a pile of bills for the next generation to pay.

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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. His general market observations and institutional investment strategies are his own and should not be construed as investment advice or recommendations concerning specific securities. More biographical information.

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