Does the Scalpel Trump the Sledgehammer?



The town is confronted by the specter of three underfunded pension plans. As of yet, no one seems to know the gravity of the problem and no one appears to be particularly exercised about the enormity of the problem. But that is not the focus of this column. Instead, I want to discuss one of my favorite complaints about our form of government, and that is an unpaid town commission that relies on the town manager to formulate the commission agenda, all the way up to the actual alternatives and options that the town commission uses as the basis for its decisions. So far, the discussion of what to do about the pension plans has focused on either continuing the existing defined benefits plans or changing over to defined contribution plans. Those are the only two alternatives that have been presented so far, in a very lengthy commission discussion that has reverberated around town hall for perhaps a decade, with no resolution in sight. Perhaps the $25 million to $35 million pension buyout elephant sitting in the commission chamber may be one reason the commissioners are hesitant to really deal with the issue once and for all.

There may be several alternatives available to the town and perhaps a surgical repair of our pension system may be better for all concerned than using a sledgehammer approach to pound our existing defined benefits plan into a total defined contribution pension plan, that may adversely impact the futures of our employees. Perhaps there are alternatives to a total defined contribution plan that will serve both the taxpayers and our employees. Let's look at a few.

The material from here on out is necessarily technical. My apologies in advance but this stuff needs to be said. Much of what appears below is excerpted from information found on the internet and in not my own work.

Target-Benefit Plan - A benefit plan that is similar to a defined benefit plan since contributions are based on projected retirement benefits. However, unlike a defined benefit plan, the benefits provided to participants at retirement are based on the performance of the investments, and are therefore not guaranteed. The target benefit plan also bears some similarity to a money purchase plan as contributions are mandatory. Generally speaking, a target benefit plan is a cross between a money purchase pension plan and a defined benefit plan.

Cash Balance Plan - A cash balance plan is a defined benefit retirement plan that maintains hypothetical individual employee accounts like a defined contribution plan. The hypothetical nature of the individual accounts is crucial in the early adoption of such plans because it enables conversion of traditional plans without declaring a plan termination.

The employees' accounts earn a fixed rate of return that can change over a period of time from year to year. Although it works much like a defined contribution plan, it is actually a defined benefit plan for legal purposes. In 2003, over 20% of US workers with defined benefit plans were in cash balance plans, according to Bureau of Labor Statistics data. Most of these plans resulted from conversions from traditional defined benefit plans.

The Conversion Controversy - Cash balance conversions have been controversial and have raised the ire of workers and their advocates. In 2005 the Government Accountability Office (GAO) released a report analyzing the effects of cash balance conversions on worker benefits. They found that in a typical conversion the cash balance plan would provide lower benefits for most workers than if the defined benefit plan had remained unchanged and the worker had stayed in their job until retirement age. This decline in benefits tends to be largest for older workers. This is because in a traditional plan, where benefits are based on final average pay, the "value" of the benefits accrues much faster for older workers than for younger workers. In contrast, in a DC or cash balance plan, all workers contribute at the same rate, and a dollar contributed by a younger worker is actually more valuable because it has more time to compound before retirement.

Integrated Pension Plan - A pension plan that is tied to an individual's Social Security payments to determine the total benefit that the plan participant should receive. The actual amount sent to the recipient in a defined benefit integrated pension may be reduced by a dollar amount equal to all or a percentage of the person's annual Social Security payment. Some integrated plans have a specified total benefit in mind, and look for Social Security and pension funds to combine toward meeting that goal. In most cases, the pension amount can only be cut a maximum of 50%.

I have sited a few of many ways the town can approach our current projected pension shortfall. I suggest that the commissioners hire an expert who is not working directly for the town manager. I believe that a surgical approach to our pension plan problems is better than bludgeoning our employees into a retirement situation where some employees may not be able to retire with dignity.

We have all heard the expression that you should be careful what you wish for because you might get it. From a personnel management total compensation standpoint, an equally relevant expression in the benefits area is that you should be careful what you pay for because you might get it.

I am not proposing that any of the above variations and hybrids of pension plans are appropriate for our situation. I am trying to open the process to include an intelligent and informed decision-making process.