Defined benefit plans can be dangerous, but there are advantages

Our recent elections for county commissioners brought to light differences in thinking about providing pensions as an employee benefit for the people who serve us as county employees. That includes the entire Sheriff’s Department, courthouse employees, administrative employees and road crews.

We know that Social Security provides a monthly pension. That pension was designed in large part to keep us out of abject poverty in our old age, and it is barely sufficient to live on. Employers pay 6.2 percent of payroll to cover that, plus disability and survivors’ benefits in the event of premature death. (If more of us knew more about Social Security, we’d appreciate it more.)

What Social Security provides to us in our old age is a defined benefit pension plan. The monthly benefit we get is defined in the Social Security Act.

An employer trying to attract and retain employees has to face the question of whether these monthly benefits ought to be supplemented through an employer-sponsored pension plan. Then the plan has to be crafted to fit the employees’ needs, the competitive situation, and the employer’s budget.

At election time, everyone is an expert, and everybody claims to be sweating over taxes, this despite the fact that Georgia voters actually vote to increase their sales tax (through SPLOST) almost every chance they get. So the more ideologically minded will scrutinize any attempt at change or progress in public employee relations for its fiscal implications.

The fact is that defined benefit pension plans are dangerous and have been abused in the public sector. So for Fayette County to adopt one for its employees can be dangerous. There are good reasons to avoid these plans.

Defined benefit pension plans are inherently unfair as they favor older employees over the younger ones, and they favor women over men.

Let’s consider a plan which provides a pension of 1 percent of salary for each year of service and two employees earning $48,000 in 2008, thus each accruing a $480 annual pension as a result. One is 64 years old and the other is 34.

The 64-year-old may start collecting in 2009, while the 34-year-old may start collecting in 2039. Obviously, the employer need set aside much less (about 80 percent less) for the younger employee, with the expectation of earning interest for 31 years on the amount set aside for him, than for the older one, who’ll be collecting soon.

As for women, all the statistics we have show them (as a group) living longer than men, meaning they can collect pensions longer than men. Thus there is a built-in unfairness in the entire system.

Some of that unfairness can be tempered by making a pension a percentage of the highest or last five years of salary, but that obviously creates great cost uncertainty when the benefit is earned 30 years in advance.

Some people have taken advantage of plans like this by loading up their final years with lots of overtime or arranging for undeserved promotions. Then there are always demands for cost-of-living adjustments, which we now have under Social Security, so there are always pressures to escalate the benefits and thus the costs.

The burdens of maintaining these plans are considerable. After employees leave, the employer must still keep track of them, no matter how small their pension. Defined benefit plans require extensive (and expensive) actuarial valuations and reports from time to time, though computerization and plan standardization can help reduce the cost. The assets of the plan need to be invested and managed wisely, and that’s a source of expense.

The real cost of a plan is unknowable until the last retiree has drawn his or her last breath. Actuaries can use different methods for computing the annual cost of these plans, but the cost always remains an estimate, no matter how scientific it is. Anything else is (in the words of a U.S. Supreme Court case) delusional accuracy.

Some cost methods produce a lower initial cost than others, and quite often actuaries will express the cost as a percentage of payroll. That percentage is likely to change over the years. It smoothes out a cost that’s a moving target, as the workforce changes, salaries change, and investment returns change.

Employees are seldom satisfied for long with their defined benefit pension plan. With inflation, they want cost-of-living adjustments, with pressure to make them retroactive.

One can expect that in future years a lot of pressure will be exerted on elected officials to “improve” the plan. One can also expect medical advances to help people live longer, giving rise to greater pension costs.

There are a lot of negative aspects to defined benefit plans, some of which I have not touched upon. But the issue is not entirely one-sided.

Some people’s opposition to defined benefit plans can be dismissed as mostly ideological: they believe these plans to be paternalistic and think people should learn to fend for themselves.

Other people believe these plans are still well suited to maintaining a stable workforce in departments such as the judiciary and law enforcement, which are generally career jobs.

Quitting one’s job and walking away from a defined benefit pension plan is more costly for an employee than walking away with a defined contribution plan account balance: that can make an employee think twice before quitting.

Georgia has enacted a Public Retirement Systems Standards Law which affords the public many protections from incompetence and abuse in the management of public defined benefit pension plans.

When dealing with these plans there’s so much to consider it’s overwhelming. Some people, like pension actuaries, devote their entire career to that subject, and it is not possible to do the subject justice in an article like this one.

As best as I can determine from the information disseminated at the occasion of our recent elections, it seems our commissioners have elicited sufficient expert advice and done sufficient homework to satisfy themselves that their proposed defined benefit pension plan for county employees is sound.

One has to realize that you can’t make an omelet without breaking some eggs. Defined benefit plans can be dangerous, but they can also be useful tools for attracting and retaining employees and providing for their income security in their old age.

If we’re satisfied our county commissioners have done their homework and received competent actuarial advice, as seems to be the case, we shouldn’t let the issue bother us. Progress means change.