For decades smart business people, their accountants, and Republicans have been raising the alarm about the financial liabilities associated with “defined benefit” pension plans.
More than 20 years ago business leaders realized that these plans, which pay a set benefit regardless of contribution or asset growth, were unsustainable and would eventually bankrupt their companies. Any company wishing to survive had to make the tough transition to “defined contribution plans” – most notably the 401k – in order to ensure that funds would be available to pay beneficiaries and that near-certain bankruptcy could be avoided.
In fact, according to Willis Towers Watson, a leading global advisory, broking and solutions company, “[b]etween 1998 and 2015, the percentage of employers still offering a traditional [defined benefit] plan to most newly hired employees fell from roughly half to 5%.”
Over time these leaders, and their employees, began to see the benefits of this transition, often instituted against vigorous resistance from labor unions, both in financial stability for the company and asset accumulation and ownership by the employees.
Your 401k, it must be noted, is your money. You take it with you when you leave the company, and nobody can take it from you because you fail to stay on for 20 or 30 years. In the modern economy, where workers are far less likely to spend an entire career in one organization, these plans make great sense and provide a stable, sustainable, and portable benefit to today’s workforce.
Government leaders have been much slower to make this change, owing to the short term political pain associated with the transition. It is much easier to promise generous benefits today while covering up the future liability, than to buck the employee unions and partisan forces that attack any politician willing to call it as they see it. As Thomas Sowell so famously wrote, “The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.”
As a result it is estimated that the unfunded pension liability for the combined State governments of the United States may be nearing $6 Trillion (according to 2016 numbers from the American Legislative Exchange Council [ALEC]), with the Federal Government racking up another estimated $3.5 Trillion or more (according to Moody’s). And this is just pensions, total unfunded liabilities for health care, social security, and other programs are much larger than that.
The bottom line: We are massively, almost unimaginably, over-committed, and it is past time that we do something about it.
Fairfax County has unfortunately not been one of those forward-looking entities who have recognized the alarm bells and made changes. In fact, the County pension system is an outdated and ineffective system that fails to recruit, retain, and reward quality employees that has simultaneously amassed an unfunded liability of $2.4 Billion (plus an additional $70.4 Million in other unfunded benefits).
The cost of the system is cutting into both services for the community, with General Fund dollars needed to meet the basic obligations, and the pay for current workers who see monies dedicated to compensation increasingly going to “fringe benefits” (i.e. pensions and retirement benefits). By the year 2025, Fairfax faces the prospect of having more people on pensions than we have employees for the County.
Speaking at the Northern Virginia Republican Business Forum (NVRBF) on July 12, 2017, Springfield Supervisor Pat Herrity raised this alarm once again during his presentation entitled “The Pension Conundrum.” According to Herrity, who serves in his private employment as a Chief Financial Officer and who has taken a leading role in trying to get the County to acknowledge and fix the problem, the Fairfax County pension system is “outdated and financially unsustainable” and a leading cause of the 24% increase in county property taxes in the last four years alone.
Herrity’s presentation outlined some of the more shocking revelations about the County’s defined benefit program, including the “fringe benefit rate” of employee groups within the county. Most private corporations have a fringe benefit rate of between 25-35%, depending on the type of employees, while Fairfax County’s rate is 56%, with the police at 66% and other uniformed personnel at 73%. This is the direct result of a few extremely generous (shocking?) programs within the pension system, including the “Pre-Social Security Supplement” wherein the taxpayers pay a “pre-Social Security” benefit to County retirees until their actual Social Security kicks in.
Herrity believes that Fairfax is the only jurisdiction with such a program, and highlighted that the program is set up so that an employee can retire at 55 years old and receive this benefit until they reach Social Security eligibility, sometimes achieving up to 80% of their active pay in retirement. (The average length of time a retiree receives this benefit is 5.7 years.) Another problem is the paucity of the contribution by the employee, which has remained constant at five percent for years while the County’s contribution has grown to 26%.
According to Jonathan Williams of ALEC, who also presented at the meeting, another problem is “fairytale accounting” whereby localities assume unachievable investment returns on their pension funds, thereby hiding the totality of the financial crisis. Fairfax is guilty of this too, assuming a 7.37% rate of return, year over year, on a risk-adverse portfolio. If a CEO of a private company signed off on such accounting tactics, according to Williams, “they would be in jail.”
The worst thing about this entire problem was articulated by one shocked 35-year-old member of the audience. He noted that future taxpayers are on the hook for this bill, and that it is the younger generation, who will never receive such generous benefits, who are going to be the ones paying it. The exasperated audience member asked, rightly, “How could this happen?”
Some of us older folks in the audience who work in the private sector were equally as upset, not only about the extent of the financial problem, but also at the inequity of it all. How sweet it would be to retire at the tender age of 55 (and that was just raised from 50 in 2015!) with a lifetime paycheck, a Social Security supplement, and guaranteed Cost of Living increases forever. No company could afford to offer such generous guarantees; yet it is the non-recipient, i.e. the taxpayer, who is taking cash out of their wallet, food off their table, and funds from their retirement savings to fund this outrageous political promise made by past elected officials.
Sadly, our elected representatives let this crisis develop in order to appease employees, their union and association representatives, and the sector of the voting population who stood to gain from these unsustainable benefits, and there is little we can do to change the past. Citizens, for our part, have been asleep at the switch, with our eyes glazing over at the mention of “fringe-benefit rates” or “rate of return” or “defined benefit vs. defined contribution” lingo. We cannot be disengaged any longer. The crisis isn’t coming, it is here.
Without action, significant action, our current employees will be poorly served, new employees will be hard to recruit, services will continue to be cut, taxes will rise, and the County’s liability will continue to grow.
First on the list of actions should be the removal of the “Pre-Social Security Supplement,” followed by accounting reform (so that we can honestly see the extent of the problem), a rise in the age when benefits begin, ending the DROP (Deferred Retirement Option Program) program (allows for retirement payments prior to retirement – yes, you read that right!) and an eventual wholesale transition to defined contribution (i.e. 401k-type) plans.
This is not a partisan issue. Nobody wants the county to default, current employees to be under paid, services to be cut, or the taxpayers to be fleeced. Nobody wants Fairfax to go the way of Detroit or Chicago. Together we can make the hard choices to fix this problem, but the time to act is now.