voiceofsandiego.org: Cafesandiego... No Problem with Defined Benefit

There is no fundamental problem with defined benefit (DB) plans. In fact, as I will discuss in my next post, they have two distinct advantages over defined contribution (DC) plans. The risks inherent and unavoidable in DB plans are manageable and in fact have not been the cause of the angst currently facing many municipalities. The problems they have are simply one of design and making decisions based on politics rather than mathematics. Let's look at some of those political decisions:

Giving retroactive pension increases: In lieu of pay raises which would come out of this year's budget, municipalities have often given retroactive pension increases which will come out of some other elected official's future budget. Going back to one of my original points: You can not simply print money. If it wasn't put in, it won't be there to take out.

Not fully funding the obligation: It is more politically expedient to fix potholes, build stadiums and host conventions than it is to put money in the pension fund. Again, if money is not put in, there will not be any money available to be paid out.

Allowing for the purchase of service credits: This could work, but only if they are purchased at an actuarially neutral amount and they are not used to vest someone who otherwise would not have vested. Unfortunately, these parameters are rarely met.

As for the design, I mentioned yesterday that a feature of a well-run plan would be the negotiation of the contribution, not the benefit. Let's look at some of the drawbacks of negotiating the benefit.

Added risk of predicting final salaries: There is also the potential to game the system by "spiking" an employee's final year salary in order to increase the pension.

Potential of under funding the pension obligation: This was discussed above.

Legally locking in a benefit payment years in advance: Once you promise a benefit, it can not be taken away or modified. Employees promised a benefit based on a formula consisting of years of service, retirement age and salary will be paid that amount regardless of what happens economically during his working career.

So what does my association's benefit plan look like? Actually, it resembles a very generous guaranteed annuity. Firstly, we negotiate the amount that our contractors will pay into their employees' pension fund. Currently that amount for journeymen wiremen is $4.35 per hour. This gives our trustees and our actuary real dollars on which to compute the retirement benefit. It also removes the potential for under funding.

The trustees, with the help of the actuary then set the accrual amount (the percentage the employee will receive in benefit, on a monthly basis, at retirement age). Currently, the accrual is 2.7%. In other words, assuming an employee works 2,000 hours in a year, he/she would have received $8,700 in their retirement account. At 2.7% they would be guaranteed $234.90 per month at retirement age. If the contribution and accrual percentage remained constant, a 30-year employee will retire with $7,047 per month. They will also receive Social Security and any money they saved on their own.

The beauty of this design is that only the current year and any previous accumulations are legally locked in. What has already been earned is guaranteed, but because we didn't stipulate a final benefit, the Trustees can vote to change the accrual percentage for all future contributions. Also, the employee can go online at any time and know exactly what his monthly pension would be assuming he didn't continue working. Any future accruals would simply be added to that amount.

Finally, we do not pay retroactive benefits and we do not allow the purchase of credits or make any other decisions based on factors other than the health of the plan and being able to provide our employees the pension they were promised.

-- ANDY BERG

Andy, I'm looking forward to your next post. I can see that you understand the dyanamics of a DB pension plan. The City's DB pension plan is over 87% funded, even though the City underfunded it for so many years. But, rather than keep this great pension plan, the Mayor would rather get a new one for new employees, which will not guarantee them much in retirement. The city is still blaming the employees for "their" mis-management over the years and doing everything possible to take everything they can away from employees. It's a shame because the Mayor is busy trying to change San Diego into a "Wal-Mart city". I always thought San Diego was way above that! Guess not.

Posted by Kathi Ward | reply to this comment
July 18, 2008 9:56 am

Andy: Could you please discuss how large employers have been taking back promised pension benefits from their older workers by the use of freezes and illegal conversion of their traditional defined benefits pension plans to new, lower paying cash balance plans? This has been going on since the late 1980s and has cost older workers and retirees hundreds of millions of dollars in lost pension benefits they were promised when they joined their companies. Congress outlawed these freezes and conversions last year but did nothing to help victims of earlier conversions. This is a scandal the public doesn't know about.

Posted by Watcher | reply to this comment
July 18, 2008 9:58 am

Andy spreading the typical government employment propaganda....and it is all from Fantasyland. Hey Andy, tty going out into the REAL WORLD and see how hard it is jus to find a 3% match on a 401K, and you can forget about a Defined benefit pension, the only place you find those today is int he Fantasyland of goevrnment employment. And one last thing, you might be surprised to learn in the REAL WORLD a GED does not earn $200K per year like it does in the government.

Posted by Billy Bob Henry | reply to this comment
July 18, 2008 11:23 am

I’m pretty tired of the give me more attitude. These new employees will have a choice, take the job or not. City employees sleep at night knowing that they have a job for as long s they want.Any new employee has that same comfort. They will receive a decent livable wage and then some. Let's stop assuming that the taxpayer must guarantee anyone’s retirement! For my money I want the city to be well managed-on time and on budget and the pot holes fixed. The City does not need to be in the pension business. The last thing I want is more of my hard earned tax money going to feather someone’s pension. The rest of us in the private sector understand you must invest and save as we will never see SS. So where can I sign up for the taxpayer to help me?

Posted by Please | reply to this comment
July 18, 2008 12:17 pm

Andy - Let's look at what it would cost in the real world to get the same benefits. Assume this: E'ee retires at age 60, fully vested. "Average Salary" (here in PA, it's avg. of 3 best years) for pension caluclation purposes is $60k, and his pension is 75% of his "Average Salary". Upon retirement he'd be entitled to $3,750/mo for life. It would take a $630,000 lump sum to purchase the equivalent annuity in the real world. Even assuming the retiree earned $60k/year for all 30 years and contributed 10% of salary over that time (both unrealistically high figures), he would only have contributed $180k toward the cost of the annuity, and someone else would have to come up with the other $410k. Luckily for him, and all other govt. employees that "someone else" is the taxpayer. Not a bad deal if you can get it.

Posted by Pension Watcher | reply to this comment
July 18, 2008 1:36 pm

Very nice articles. I wish there was more discussion with some thoughtful economic basis to it. I notice that the Mayor's proposed new pension plan reduces both City and employee contributions by 50% while the reduction in benefits appears to be much less than that. I don't see how the numbers add up. Have you looked at this?

Posted by Jeff | reply to this comment
July 18, 2008 2:26 pm

Pension Watcher - Pension fund investments are supposed to make up the difference. For your example a 7.5% return would pay for the annuity.

Posted by Jeff | reply to this comment
July 18, 2008 3:31 pm

The numbers DO NOT add up-that is why NO private company in America today offers a defined benefit pension. Fact is the ONLY private employers to ever off DB pensions were the Fortune 50 companies. 95% of business in America is small business-and the majority of small business offers no pension plan at all. There has never been a defined benefit AND a SUPPLEMENTAL benefit pension (like San Diego's DB and SUPPLEMENTAL SPSP pensions) in the private sector-anywhere. BTW Andy, the SPSP did NOT replace social security for City workers in 1981, the DB replaced SS, the SPSP was a SUPPLEMENTAL pension. The SPSP offers a 6% DOLLAR FOR DOLLAR MATCH. No 401K plan in the private sector offers that. If a match is offered (very rare) it is 3% MAX. In addition, government employees today-because they do not compete in the free market-are overpaid by 15%-200%. HTH Andy.

Posted by Billy Bob Henry | reply to this comment
July 18, 2008 4:35 pm

Well BBH there you go again! GED! 200K! REAL WORLD! Here's a little glimpse of reality: As of 2007, around 30% of Fortune 100 companies still offered DB. It is true though that private sector employers ARE moving away from DBs because they don't want to be in the pension business anymore; it is expensive. However, bear in mind that employees value a pension and health insurance. This means that a wise company will get and retain good people by offering and funding attractive benefits. Until last year it was all too easy to raid those pensions by freezing them or converting them. Thankfully, Congress shut the door on that practice. People deserve security in retirement when they've given much to an organization. 401(k)s can do it, but unfortunately people seldom contribute enough, because they've got to live and eat. DBs force that ample biweekly contribution, hence better security.

Posted by Captain T | reply to this comment
July 18, 2008 6:53 pm

Andy, What a GREAT explanation of how the mechanics of a Taft-Hartley pension plan operate. I believe that if any individual that possesses a pension background would agree that a defined benefit pension is truly the superior retirement for any worker. It's really unfortunate that the uninformed and media types continue to overlook this fact. As always the employer that truly should be concerned with their employee's retirement loses sight of that fact and as soon as the employee is laid-off and that they no longer are a burden to the balance sheet. Jaime

Posted by Jaime | reply to this comment
July 18, 2008 7:24 pm

Andy, What a GREAT explanation of how the mechanics of a Taft-Hartley pension plan operate. I believe that if any individual that possesses a pension background would agree that a defined benefit pension is truly the superior retirement for any worker. It's really unfortunate that the uninformed and media types continue to overlook this fact. As always the employer that truly should be concerned with their employee's retirement loses sight of that fact and as soon as the employee is laid-off and that they no longer are a burden to the balance sheet.

Posted by Jaime | reply to this comment
July 18, 2008 7:24 pm

Hey Pension Watcher, It can be done if you calculate a 30 year average return of 6% and the employee opens with contributes $290/biweekly from day one, the ending balance is $630,000. Just hope the employee is disciplined enough to do that as it's a big part of a starting salary, but a little easier as one moves up.

Posted by Captain T | reply to this comment
July 18, 2008 7:38 pm

By raising the retirement age and reducing benefits, we will create a much older, greying city work force. That is both bad and good. Employees won't be able to afford retirement, so they will just keep working and working and working...albeit with much less enthusiasm as the years go by and their retirement eludes them because of Mayor Sander's cheap retirement poverty plan. Taxpayers may think they are getting a bargain by voting in a new pension plan, but the consequences could mean hiring from the bottom of the barrel and dealing with constant employee turnover.

Posted by Cheeky | reply to this comment
July 18, 2008 10:53 pm

Correcting my math error in Post #5 - The taxpayers contribute $450k, not $410k.

Posted by Pension Watcher | reply to this comment
July 19, 2008 11:47 am

Sorry, Captian T, but NO Fortune 100 offers DB today, much less 30 of the 100-but do us all a favor and PROVE ME WRONG. Post up the 30 that offer a DB. BTW 30% of the fortune 100 companies might account for 1/1,000,000,000 of working America.

Posted by Billy Bob Henry | reply to this comment
July 20, 2008 1:00 pm

Here's a link to a recent article from USNews which states over 50% of Fortune 100 companies have a form of DB. link

Posted by MT Fan | reply to this comment
July 20, 2008 6:16 pm

Well BBH? I think you need to respond to MT's link or check this one: link

Posted by Captain T | reply to this comment
July 21, 2008 7:18 am

oops, watson wyatt i mean and i stand corrected on my 30%. it's 54%. what say you bbh?

Posted by captain T | reply to this comment
July 21, 2008 8:05 am

MTFan, did you read the study?? It stated that only 26 had a DB, the other 28 had a "hybrid" and it was for "salaried workers" ONLY, which are managers-not rank and file. The vast majority of a Fortune 100 workforce are NOT managers-but rank and file hourly employees. So I will stand by my statement that no company today offers a DB pension, Fortune 100 or otherwise. You cannot cherry pick a CEO, or a COO or management to make the cliam that DB's are still being offered, they are not.

Posted by Billy Bob Henry | reply to this comment
July 21, 2008 8:24 am

MT Fan: Thanks for proving BBH wrong and shutting him up! Hurray for you!

Posted by Kathi Ward | reply to this comment
July 21, 2008 9:20 am

Andy and Captain T - I think the problem is that what if the market doesn't make the 7.5% return? And in my example, I was being extreme, as the $180k figure was based on the assumption that the E'ee was making $60k/year, every year, for 30 years, and that the contribution rate was 10%. Of course both examples bear no resemblance to reality, so the investment return would more realistically have to be somehere around 10-14% for their to be no taxpayer contribution. Captain T - I agree that if the employee is disciplined enough to put away $290/biweekly from the start he/she could have a huge lump sum. But he/she should do that in a 401(k) w/ an employer match - and not be reliant on the taxpayers.

Posted by Pension Watcher | reply to this comment
July 21, 2008 9:32 am

Andy and Captain T - While I disagree w/ you, and believe that DB's should be eliminated for new e'ees and those not yet vested, and "frozen" for those already vested but not retired, I do think much of the blame goes on the government entities themselves who made promises they couldn't, or in some cases, didn't pay for. Unfortunately hte accounting rules in place up until 2 or 3 years ago make it perfectly legal for them to contribute far less than was prudent, yet still claim that the pension was "fully funded". Here in the real world people would go to jail for similar actions, but for the governments it was OK. That's shameful

Posted by Pension Watcher | reply to this comment
July 21, 2008 9:33 am

Watcher- I agree that underfunding a pension fund is a terrible thing to do. I believe there is blame enough for everyone in our case. As for not putting the onus on taxpayers, I agree with that, too. Only 15% of SDCERS income is from tax dollars; the rest is from investment earnings and employee contributions. I disagree that DBs should be thrown out with the bath water. A properly implemented plan is good for employees and taxpayers alike. Also, our 401(k) and 457(b) plans are funded solely by employees. All of this only became an issue when the bill came due. The city used the pension system like a bank instead of charging taxpayers for pet expenses. Taxpayers would've never approved. It's like running up a credit card and then blaming the bank for expecting payment.

Posted by Captain T | reply to this comment
July 21, 2008 12:43 pm

BBH BBH BBH. You made the flat statement that "NO companies offered DBs" and when challenged retorted with your "1/1,000,000,000" hyperbolic figure. Then you changed your parameters when your face was against the concrete of facts. It's vintage BBH to which I say.....WHATEVER! LOL I do so love our little exchanges.

Posted by Captain T | reply to this comment
July 21, 2008 1:11 pm

No Problem with Defined Benefit

Published: Friday, July 18, 2008 12:46 PM PDT

-- ANDY BERG

SEDC Responds to Mayor's Inquiry:

Memo details bonuses and additional compensation of all employees. » Jul. 18 -- 6:37 pm

Board Member Blasts Smith:

'The culture of SEDC over the years has been to manipulate, cajole, ignore and intimidate the board into utter and complete silence.'

Jul. 18 -- 5:32 pm

Smith Not Resigning:

SEDC president resists the call for her to step down.

Jul. 18 -- 5:08 pm

Another Jump for Unemployment Rate :

County jobless rate nears 6 percent.

Jul. 18 -- 12:29 pm

Penchant for Secrecy:

San Diego Unified School District legal counsel Jose Gonzales must have been in a hurry to start his vacation.

Jul. 18 -- 3:27 pm

No Problem with Defined Benefit:

The risks inherent and unavoidable with these plans are manageable.

Jul. 18 -- 12:46 pm

Resign? Yeah, Right :

Why resign when you can get paid $200,000-$300,000 for being fired?

Jul. 18 -- 11:20 pm

Employment Goes More Negative :

Housing weakness spilled over into the rest of the economy in June.

Jul. 18 -- 4:31 pm