The city of San Diego and Orange County, both with a history of well-publicized budget troubles, have adopted similar cost-cutting pension reforms — a hybrid plan combining a monthly check with an individual investment account.
The hybrid gives the employer a more stable and predictable pension cost. In the San Diego and Orange plans, there are savings because new hires receive a less generous retirement plan.
For the employee, there is the security of a guaranteed, though smaller, monthly pension check on retirement. At work, there is more take-home pay and a retirement investment account that can move with the worker in a job change.
Unions representing general employees (not police and firefighters) agreed to the hybrid plans adopted in recent weeks as Gov. Arnold Schwarzenegger and others argue that some public employee retirement plans have become “unsustainable.”
At a time when recession-ridden state and local governments are making deep budget cuts, they face mandatory increases in contributions to pension systems, whose investment funds were devastated by the stock market crash last fall.
Critics also contend that powerful public employee unions have negotiated overly generous retirement packages, particularly in comparison to the 401(k) individual investment accounts now common in the private sector.
The hybrid is a compromise in the longstanding battle between advocates of the guaranteed monthly pension check (“defined benefit” in pension lingo) and the 401(k) investment account (“defined contribution”). (See Calpensions 15 Jun 09: “Retirement’s future: pension vs. 401(k)”)
The hybrid agreement in San Diego came after Mayor Jerry Sanders threatened to put the measure on the ballot. Voters are believed to be in a punitive mood after a pension scandal caused the self-dubbed “America’s Finest City” to be labeled “Enron by the Sea” in the national media.
More seriously, the city laid off employees, cut a number of services and was unable to sell bonds for several years.
State and federal charges, still pending, were brought against eight former pension officials in 2005 and 2006 as the unfunded liability in the city pension fund ballooned to $1.7 billion.
Officials cut two deals with union officials over the years that increased benefits while reducing contributions to the pension fund. The pension officials who approved the last deal were among the city workers receiving the increased retirement benefits.
The San Diego hybrid plan for new hires is a small first step expected to eventually save $22.5 million a year. But that could be several decades from now, depending on turnover in the workforce.
San Diego already had a kind of hybrid plan. But the defined contribution portion was a supplement that replaced Social Security. Now the defined contribution is formally part of a hybrid plan.
Some think the agreement with three non-safety unions sets the stage for future contract negotiations that will try to increase the percentage of the plan that is a defined contribution.
Meanwhile, the city’s retirement contribution for a new hire was cut nearly in half, dropping from 15.92 percent of payroll to 8.75 percent. The benefit for a 30-year employee retiring at 65 would drop from 119 percent of final pay to 84 percent.
A more ambitious hybrid plan in Orange County, which declared bankruptcy in 1994 after losing $1.7 billion on risky securities, could yield significant savings in the first few years.
Both new hires and current employees would be given the option of choosing the existing defined benefit plan or a new hybrid that combines a smaller defined benefit payment with a 401(k)-style individual investment plan.
One estimate is that the hybrid plan could save $10 million in the first year. Orange County Supervisor Chris Norby has a more conservative estimate of savings: $1.4 million a year if 10 percent opt in, $3.5 million if 25 percent sign up.
The existing defined benefit for a 30-year employee retiring at 55 is a generous 2.7 percent of final pay for each year worked. The hybrid defined benefit formula would pay 1.62 percent at 65, plus the amount in the investment account.
Officials think the hybrid option will be attractive to employees wanting an increase in take-home pay, Norby estimates 7 percent, or planning to move on to other jobs.
To apply to current state workers, not just new hires, the hybrid plans needs legislation, SB 752, which has been introduced by Sen. Lou Correa, D-Santa Ana, chairman of the Senate retirement committee.
“It is a breakthrough program that both the workers, the Orange County Employees Association, and the county of Orange have agreed to,” Correa said in the Los Angeles Times. “It’s one (plan) that I think could serve as a role model for the rest of the state.”
The Oregon Public Employees Retirement System adopted a hybrid plan that won praise, before the stock market crash last fall, for helping to erase a $17 billion unfunded liability.
“Oregon did the nation’s most dramatic pension overhaul in 2003,” said an article in USA Today in June of last year. “It did what most states consider impossible: slash benefits promised to existing workers.”
Pension benefits are protected by contract law and usually regarded as untouchable. In a widely watched city of Vallejo lawsuit, a federal judge has ruled that labor contracts can be overturned in bankruptcy.
But no action has been taken yet. The judge has ordered mediation in an attempt to reach a settlement between the city and firefighter and electrical worker unions, avoiding the need to overturn the contracts.
Some of the pension cuts in Oregon, unsuccessfully challenged by lawsuits, included changing an alternative retirement plan that guaranteed retirees an 8 percent return on investments, plus any earnings above that amount.
Actuarial tables were changed to reflect longer life spans, reducing some benefits, and an aggressive drive was launched to recoup “overpayments” to a large number of retirees.
Oregon pushed the pension reforms when state general fund revenue dropped 25 percent in an economic downturn. Gov. Ted Kulongoski, a former labor lawyer, insisted on retaining a strong defined benefit in the hybrid plan.
“I like the certainty,” Kulongoski told Plansponsor magazine two years ago. “It is better for employees. A defined contribution plan is not as secure, as far as what the retirement income will be.”
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. His stories are at http://calpensions.com.