JMI Capital Report
Slowly, Then All at Once
By Will Patrick – December 29, 2011
TALLAHASSEE – “Slowly, then all at once,” is how Ernest Hemingway explains bankruptcy in his classic novel The Sun Also Rises. These were also the words Rep. Jeff Brandes, R-St. Petersburg, used to describe what could happen toFlorida’s municipal pension plans if left in their current form. As of year-end 2011,Florida’s 100 largest cities oversee 208 separate pension plans for their employees. Of these, only 14 percent received a grade of “A,” or were at least 90 percent funded; 62 percent received a grade of “C” or lower, and 15 percent were woefully underfunded. The grading system used to calculate pension funding was formulated by professional actuaries hired by pension plan governing boards across the state, and their findings were based on those boards’ assumptions – including some based on optimistic scenarios concerning their future return on their pension funds’ investments.For many Florida taxpayers, these problems mean that they will be receiving less and less in the form of government services in return for their money. That’s because tax dollars will have to be diverted from other budget priorities so that municipal governments can cover the gap between existing funds in a particular pension account and the amount needed to fully fund it. The more underfunded the pension plan, the more taxpayer cash will be needed to keep the commitment.Unfortunately, the funding gaps are not static. As pension plans — particularly the traditional “defined benefit (DB) plans” — become more generous, cover more participants, and even lower the age of retirement, the funding gaps continue to grow. Indeed, the DB plans are a huge drag on public finances. These plans promise specific benefits to retirees. Most private businesses have long since shifted from DB plans to defined contribution (DC) plans — 401(k) type plans to which the employer and employee both contribute. Only 13 of Florida’s 100 largest municipalities have switched to DC retirement plans, though more now provide both DB and DC plans for employees to choose.Many public employees rely on pension income after they stop working and typically plan their public sector careers taking their pensions into account. So it’s not entirely surprising that many are reluctant to risk what they view as secure retirement income by switching to a 401(k)-style plan that entails investing in financial markets.Public employees’ general reluctance to switch has been evident in the relatively low number of state government workers who have chosen to participate in a 401(k)-style DB plan since it became an option for them a decade ago. This reluctance has persisted despite the potential for higher returns, the availability of safe forms of investment, and the DC funds’ portability – an advantage for those who do not remain in government service long enough to earn a traditional pension. In the 401(k) plans, the money the employee contributes belongs to the employee.Even so, the well-publicized volatility of the stock market has created a climate of fear that makes the DB plans’ “guarantee” of a secure pension more attractive. The problem, however, is that many of the traditional DB plans funded solely by the taxpayers are no longer sustainable.According to Representative Brandes, there are only two ways to solve the municipal pension problem in its current form: increase funding or reduce benefits. Increasing the funding would require raising taxes, increasing employee contributions, or both; decreasing benefits could be perceived as violating contractual obligations – and even ignoring a moral obligation to long-time municipal employees who had counted on a certain amount of income when they retired.All of these are politically polarizing options that still fail to address the underlying structural problem: The incentives leading to a solution are not as strong as the political incentives to “kick the can down the road.” Rep. Fred Costello,R-OrmondBeach, explains:“If DBs go bust and need more funding, the bargainers of DBs will feel no pain.” In other words, those advocating larger government-guaranteed pensions stand to lose nothing if the pension plans go bankrupt. Unless the municipal governments go bankrupt, they will be obliged under the law to fulfill their pension commitments, even if it diverts scarce funds from other important municipal priorities.As a result, the taxpayers will lose. They’ll pay more but receive less in return for their tax dollars. While these defined benefit plans are slowly straining municipal budgets and have the potential to break many of them all at once, the defined contribution plans are working quite well in the private sector.