Is Detroit's Pension Deal a Game-Changer?
Detroit's municipal employees and retirees made headlines last week when they accepted a pension cut to help reduce the city's debt. Is this agreement a game-changer, as some contend? Now that some retirees have agreed to forgo already earned pension benefits -- once considered sacrosanct -- will unions across the country follow suit? Don't count on it.
Many state and local employees and retirees have already shouldered significant pension cuts, and it's unrealistic to expect them to absorb any more. Rather than relying on givebacks from public servants, policymakers must commit themselves to paying the benefits they promised.
Like most public-sector employees, city workers in Detroit who spent their entire careers on the city's payroll receive generous pensions. Benefits equal a fraction of employees' final average salaries multiplied by years of service. Before the city's finances collapsed, that fraction rose over employees' careers, reaching 2.2 percent of salary after 25 years on the job. Employees with 30 years of service could retire as early as age 55. Once retired, their benefits automatically rose 2.25 percent a year.
Over a lifetime, these benefits add up. Consider a Detroit municipal employee making $50,000 a year. Under the old rules, after 30 years on the job, he could retire at the age of 55 with an initial pension of $27,500, worth more than half a million dollars over his lifetime (assuming a 2 percent real interest rate and 3 percent inflation).
As the city prepares to enter bankruptcy, however, that pension has been slashed. First, the city cut the benefit-formula multiplier for years worked after 2011 to just 1.5 percent. That change trimmed lifetime benefits for newly hired city workers by about a fifth. Last week's agreement further reduces annual benefits by 4.5 percent and eliminates the automatic benefit escalator in retirement, reducing lifetime benefits for new retirees by another quarter. New hires who eventually retire at age 55 after 30 years of service will receive pensions worth 40 percent less, in inflation-adjusted dollars, than their counterparts who retired in 2011.
New Jersey Employees Have Already Taken on the Burden of Benefit Cuts
These cuts may help get Detroit back on its feet, but don't expect similar retiree givebacks elsewhere to solve the nation's public pension problem. Many state and local retirement plans have already substantially cut benefits. Most of the benefit formula changes apply only to new hires, but current workers and retirees have not been spared.
As the Center for Retirement Research points out, between 2010 and 2013, 12 states reduced or eliminated cost-of-living adjustments for current retirees as well as current employees and new hires. (Another five states reduced COLAs but shielded current retirees). Many jurisdictions have also raised the amount employees must contribute to their plans.
New Jersey, with some of the worst-funded plans in the nation, is a good example. In 2011, lawmakers eliminated COLAs for state retirees, whose benefits had increased each year by 60 percent of the change in the consumer price index. That cut shaved 25 percent off the lifetime pension of a newly retired state employee with 35 years of service. The state also increased mandatory employee contributions from 5.5 to 7.5 percent of pay, reducing what retirees get from the state by another eighth. Additionally, the 2011 reforms boosted the retirement age and reduced the plan multiplier.
All told, New Jersey state retirees will receive pensions only two-fifths as large as what they would have been paid under the rules in effect before 2008. Yet, New Jersey's pension plan is in worse financial shape today than it was in 2007. Because of these benefit cuts, state employees hired at age 25 must now work 28 years before their future payments are worth more than the value of their required plan contributions. Those who leave state employment earlier end up financing their entire pensions themselves, without any state contributions. In fact, they would be better off if they could opt out of the state retirement plan and invest their required contributions elsewhere.
States Should Fully Fund Their Retirement Promises
Most troubled public pensions are financially distressed because states and localities have not contributed as much as their actuaries say they must in order to pay the future benefits they've promised, not because their benefits are too generous. Our recent comprehensive analysis of state plans graded many plans poorly because they failed to provide employees with adequate retirement security, especially those who spent less than a full career in public service. If policymakers want to fix the public pension mess, they must dedicate themselves to fully funding the retirement promises they've already made.
Richard Johnson is a senior fellow with the Urban Institute and director of the organization's Program on Retirement Policy. This piece originally appeared on the Urban Institute's MetroTrends blog.