Baltimore Takes A Bold Step Towards Pension Reform

August 8, 2014 (PLANSPONSOR.com) - The main reason that the funding issues in the public defined benefit pension plan market have reached near crisis proportions for many public entities is simply due to lack of leadership.
By PS

The severity of issues many public employers face today is a result of decades of failed leadership by mayors, city council members, and union officials. The common practice has been to “kick the can down the road” with a lot of accounting adjustments and temporary patches that were labeled as “pension reform.” The City of Baltimore has put an end to this practice. 

Baltimore Mayor Stakes Out a Leadership Position   

Baltimore Mayor Stephanie Rawlings-Blake inherited a situation in Baltimore that was not unlike many other cities and counties. Through years of neglect and poor management, she faced a dismal fiscal outlook with respect to the cost of the Baltimore pension programs. She undertook a forward-looking financial plan that projected a $745 million budget shortfall over ten years. This shortfall would fully exhaust the City’s reserves within three years.

Contributions to the Employees’ Retirement System had grown from $22 million in fiscal year 2005 to a projected $85 million in the 2015 fiscal year budget. Pension liabilities had created a structural deficit that could no longer be “patched up” through annual furloughs, freezes, and cuts.

Mayor Rawlings-Blake made a decision to fix the problem and not pass on the growing liability to her successors, when the problems would be even worse. She wanted a real, long-term solution, which would fix the structural deficit and ensure the security of future retirement benefits for City employees. This is a refreshingly candid and tough decision that Mayor Rawlings-Blake had the courage to make.

 A Holistic Viewpoint     

In another visionary decision, the Mayor realized that pension benefits are just one part of the total benefit package (and cost) at the City of Baltimore. Making meaningful changes to the pension program would allow the City to rebalance the total compensation package and sustain incremental wage increases for City employees. Baltimore had not been able to afford such increases since 2010, due to crushing pension costs.

Taking a holistic view of the total benefits issue has been missing from most debates about public employee pensions. By focusing solely at the cost of the pension plans, it ignores the impact that soaring (or unaffordable) pension costs have on salaries and other benefits that are critical to public employees. Salary freezes, layoffs, and benefit cuts can’t be sustained forever. By taking a holistic approach to the entire benefits picture, Mayor Rawlings-Blake was able to show how meaningful pension reform can have a significant and very positive impact on other aspects of the total benefit and compensation program for City employees. Taxpayers benefit too, since long- term total benefit costs are more predictable and controllable.

Sensible Steps 

In 2010, the Mayor reformed the plan for current public safety employees. The retirement age was increased to 55 with 25 years of service, and pension employee contributions were increased. The cost-of-living adjustment (COLA) was tiered based on the age of the member. A lawsuit challenging this change was filed by public safety employees, but the change was upheld by the 4th U.S. Circuit Court of Appeals just this week.

In 2013, the Mayor reformed the plan for civilian employees. Current civilian employees were required to begin contributing to the plan by 1% per year, up to 5% by fiscal year 2018. A variable COLA, which distributed investment gains to retirees, rather than keeping them in the fund for solvency, was eliminated.

Effective July 1, 2014, new employees will have the option of a defined contribution or hybrid plan upon hire. The hybrid plan is a combination of defined benefit (DB) and defined contribution (DC):

  • DB:  5% employee contribution
  • DC:  3% employer contribution

 

The City targeted a 109% replacement ratio, inclusive of an estimated Social Security Benefit, based on a 40-year career with a starting salary of $25,000.  This demonstrates that a hybrid pension plan, when wisely structured, can provide comparable or better long- term replacement ratios than pure DB plans.  It gives employees the assurance of a fixed base pension, plus the opportunity for greater gain through the DC portion. The costs are fixed, and far more predictable than funding a traditional DB-only plan. 

Built-In “Safety Valves” Are An Incredibly Sensible Concept 

Both parts of the program have a creative “safety valve”:

  • For the DB plan, a portion or all of the COLA can be suspended depending on the funded status of the plan.
  • For the DC plan, half of the City’s contribution can be redirected to the DB plan, if needed to preserve a healthy funded status.

 

These automatic “safety valves” are very creative, and taxpayers should be thrilled that public officials have the foresight (in this instance) to actually devise a “Plan B” (safety valve) in advance. By having an automatic, pre-determined “Plan B,” the City is able to act quickly to preserve a positive funding status. This policy also tells employees, up front, what steps the City may take if another financial crisis appears. This spares employees, union officials, City leaders, and taxpayers the public angst and delay in debating what to do if things don’t turn out as planned. These types of debates have consumed so much time and goodwill in many cities, and they only serve to make matters worse by delaying critical decisions. The Baltimore reforms eliminate those costly delays and tiresome debates in the future.  

Exceptional Leadership on a Very Tough Issue to Tackle 

An engaged and obviously educated City Council passed these reforms in May of this year with a 14-0 vote. Yes, that’s right– 14-0. Aside from the Mayor’s leadership on this issue, it gives employees and taxpayers confidence in City prudence and management when all elected officials are behind such a holistic effort. These changes have not been easy, or made without the expected legal challenges, but when City leaders coalesce around sensible reform with so many long term benefits, it shows exemplary leadership.

While other cities, counties, and states may reach different conclusions on the same issue, the approach used by Baltimore can serve as a “best practice” template for a creative and holistic approach that can produce significant and positive results for all stakeholders. Mayor Rawlings-Blake, City Council members, and their associates at the City of Baltimore have shown that effective leadership makes a big difference.

 

Gregory Seller, Gregory Seller Consulting, LLC

Seller is an independent consultant specializing in public and private pension advocacy, plan architecture and design, and thought leadership for public pension policy. His practice is fostering debate about improving public and private pensions in the United States, and about the more efficient delivery of secure pension benefits to plan participants.

For more information about this topic and related issues in public plan governance, please go to: www.gregoryseller.com 

 

Provided for information only and is not legal or investment advice.  Plan sponsors should seek their own legal counsel on these and other matters regarding their fiduciary responsibility.   

Any opinions of the author(s) do not necessarily reflect the stance of Asset International or its affiliates.

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