Pensions! They’re important! They’re expensive! But they’re boring! Admit it: When you see the word “pension” in a headline, your eyes start to glaze over. Pensions involve things like “anticipated liabilities” and “actuarial tables” and the difference between defined benefits and defined contributions. So as our local governments in both the city and county start to wrestle with the long-term implications of their bewildering cluster of retirement programs, we thought we’d try to explain the different systems as clearly and non-boringly as possible. To that end, we have enlisted the assistance of our friends at Salomé Cabaret, Knoxville’s premier purveyors of “burlesque you’ll lose your head over.” (They may or may not be certified actuaries. We didn’t think to ask.)
PENSIONS ARE FOREVER
On Jan. 9 of this year, the day before Bill Haslam resigned as Knoxville mayor, the News Sentinel ran an article with the headline, “Haslam says city needs to address pension funding problem.”
The first paragraph warned of “a looming budget crisis,” and the article cited projections from Haslam’s office that by 2020 the city could be paying more than $30 million a year just to keep its employee retirement plans solvent. That’s nearly triple this year’s amount of $11.3 million.
Meanwhile, on the county side of the local ledger, Mayor Tim Burchett has repeatedly talked about the ballooning costs of employee pensions, particularly those granted to uniformed officers of the Sheriff’s Department in a 2006 referendum. Burchett has bluntly suggested that the county needs to consider another ballot measure to reduce those obligations. “History’s a good lesson for us,” he says. “Places that have had defined benefits have gotten in trouble.”
So what's the problem? And how did it get that way?
Well, as most people who have any kind of employer retirement plan know, there are two basic kinds of pensions.
In one, commonly known in the private sector via the 401(k) model, you put some small amount of your paycheck aside each week into an investment fund, and the employer also contributes some (usually smaller) amount. In PensionLand, where they speak a language we will call Pensionese, this is known as a Defined Contribution plan. You put in x, the employer puts in y, it builds over time (or fails to, depending on the stock market), and at some point in the future you can start to withdraw it, with attendant tax obligations depending on when and for what.
Sorry, didn’t mean to say “attendant tax obligations.” See, it’s hard to even talk about this stuff without sounding like an accountant.
Okay, so, the other kind of pension is the kind people usually mean when they say “pension”: After you reach retirement, which can be based either on your age or your years of employment (or on both), you start to receive some set amount of money a month. For, usually, the rest of your life. The amount is usually a percentage of your salary at retirement, or of your highest-earning years. There’s no maximum limit on it. As long as you stay alive, you collect. Most plans also have an option where you can take a somewhat smaller amount, and then leave the pension to a spouse, child, or other beneficiary. So a pension could continue to be paid for years after your death. In any case, this is a Defined Benefits plan: You are promised a set amount, and the employer is on the hook to keep paying that to you long after you have left the payroll.
For lots of probably obvious reasons, employers really prefer defined contributions to defined benefits. Defined contributions are more predictable, because they are just part of your regular paycheck. And they are paid only for however long you are employed, whether that’s months or years. Once you leave or retire, you are off the books. Defined Benefits, on the other hand, create decades-long obligations that the employer has to make sure can be paid years into the future. Figuring out how much to set aside today to pay pensions in 2020 or 2030 or 2040 involves a lot of arcane actuarial arithmetic that might as well be black magic to your average employee (or newspaper reporter).
Defined benefits are generally more expensive, because they’re tied to an employee’s highest-salaried year and also because they have historically simply been more generous than Defined Contribution plans. In the private sector these days, you’re lucky if your employer pitches in more than 3 percent of your salary. In contrast, Knox County is now contributing the equivalent of an extra 15 percent of the Sheriff’s Department payroll to the Uniformed Officers Pension fund.
More broadly, there’s the problem of risk. Both Defined Contributions and Defined Benefits depend on the vagaries of stocks and bonds (or whatever else you choose to invest in). But with a 401(k), the risk is individual—you make your contribution, the employer makes theirs, and then you get whatever gains or losses the market gives you. With Defined Benefit plans, the employer invests the pension fund and tries to guess how well the market will perform. If it comes up short in a given year—which it has lately, as you might guess—then the employer has to put still more money into the fund to keep it afloat.
Defined Contributions put the perils of market catastrophe on you; Defined Benefits put them on you employer.
It is not surprising that when people are given a choice between the two types of plans, they tend to choose Defined Benefits.
It is also not surprising that Defined Benefits are at the heart of the long-term projected costs of both the city and county pension systems. In the city, all employees have some degree of promised Defined Benefit. In the county, most employees are on a Defined Contribution plan, but about 730 Sheriff’s Department workers have a Defined Benefit plan. (See the exciting accompanying charts for details of the differences between the city and county.)
THE WILL OF THE PEOPLE
It has become sort of standard right-wing rhetoric to blame public-sector workers and their unions for costly pension plans. But that doesn’t fly in Knoxville and Knox County for two reasons: We don’t have public-sector unions in Tennessee (except for teachers, who are covered by a separate state retirement system, and anyway their bargaining rights have recently been sharply curtailed); and our local pensions plans were established by city and county charter amendments, passed by popular vote.
The city’s plans were changed most recently in 1996, 1998, and 2000, making benefits more generous and easily accessible. At the time, in the midst of a stock market run-up, they were presented as essentially cost-free. The city’s pension funds were making plenty of money to cover their obligations. Then-Mayor Victor Ashe stumped hard and eloquently for the changes: “Mayors and City Councils come and go,” he said in 1998, “but it is the long-term rank-and-file employees who clear the streets of blizzards, who clean up after floods, who give you police and fire protection and who keep the city working. They deserve the brighter future these amendments will bring.” City voters were happy to oblige.
The county, meanwhile, actually got out of Defined Benefits completely in 1991, shifting everyone over to Defined Contributions: All employees automatically put aside 6 percent of their paychecks, and the county matched with another 6 percent. But as one of his last major acts in office, longtime Sheriff Tim Hutchison helped push for a 2006 referendum that brought Defined Benefits back to the employees of his department. (Part of Hutchison’s argument was that city police officers had a defined pension, so county officers should, too.) Hutchison’s power was already waning then, and voters’ moods had started to shift, but the measure squeaked by with 52,013 votes in favor and 51,516 against.
The measure those voters approved noted that the new Uniformed Officers Pension Plan would cost the equivalent of 8 cents on the county property tax rate. But then-County Mayor Mike Ragsdale, with his eye on a gubernatorial run and determined not to raise taxes, instead created the fund by issuing $57 million in general obligation bonds. And to pay the increased benefits, the county also had to start putting nearly $2 million more a year into the pension system. On top of that, to try to even the scales a little for other county employees, County Commission sweetened the Defined Contributions pot, matching up to 12 percent for the longest-term workers. (This is called the Asset Accumulation Plan, which as far as these plan names go at least sounds almost sexy.)
All those changes in both systems are now adding up. On the city side, the cost-of-living increases passed in those referendums and the earlier retirement ages they made possible have produced that $30 million annual budget projection by 2020. For the county, the Uniformed Officers Plan by itself is costing an extra $4 million a year, counting the debt on those bonds.
WHAT’S TO BECOME OF US?
City Council recently appointed a task force to study its pension plans and, maybe, make recommendations for changes to them. Even getting the task force together took a few months, because there was some disagreement about whether its meetings should be open. Council, with encouragement from interim Mayor Daniel Brown, decided they should be. “I am glad they made them open to the public,” says Anita Cash, who is on the task force as president of the city’s Employees Association. “Not that I expect masses to attend.” Probably not. It would be interesting to see a scan showing how many areas of the brain immediately shut down on hearing the words “pension task force.” (No, there will be no burlesque dancers at these meetings.)
The task force held its first meeting this Tuesday. Vice Mayor Joe Bailey, who helped organize the group but doesn’t serve on it, says it hasn’t been given any particular mission or deadline. “They could have a report, they could have a majority report, they could have a minority report, they may recommend things, they may not.” The original idea was to have some kind of recommendations in hand by the time the next mayor takes office in December, but now even that is not promised.
Cash expects it will take several meetings just to get all the task force members up to speed on how the city’s plans actually work,
never mind studying the different ways they could be altered (most likely by shifting new employees to some kind of Defined Contribution plan). She says the approximately 1,500 city workers she represents are nervous about all the pension talk. “Most everybody’s afraid that they’re going to reduce our benefits,” she says. But of course, she notes, that wouldn’t be easy to do: Changes would have to be proposed by City Council and then placed on the ballot in an even-numbered election year. Which means the earliest anything could even be approved is November 2012.
That’s true in the county, too, and there’s not even a pension task force there. (Not even an open-ended one without a clear mission or deadline.) But Burchett would also like to see a referendum next fall on returning new Sheriff’s Department employees to the Defined Contribution plan. “It’s going to have to get before the voters,” he says. “But we’re not trying to take it away from the current deputies. It’s been promised.”
It would take a two-thirds vote of County Commission or a citizens petition drive to put a charter amendment on the ballot. The Sheriff’s Department is likely to oppose any such effort. Burchett says he and Sheriff J.J. Jones have “agreed to disagree” on the issue. Capt. Richard Trott, who represents uniformed officers on the county’s Pension Board and is also chairman of the board, says it might not even save much money to shift future employees back to Defined Contributions, depending on how the county’s funds perform in the market. “I think the money in the end will probably come out the same, regardless whether we have part of our employees on the Defined Benefits plan or part on the Asset Accumulation Plan.”
Trott also says the new pension plan has been a boon in recruitment and retention, encouraging officers to stay with Knox County rather than leave for other departments with better pay or benefits. “If the mayor’s successful in what he is trying to do,” Trott says, “more than likely see our retention go down, recruiting go down, you'll see our morale drop."
One more wrinkle: Mike Cherry, executive director of the city’s Pension Board (i.e., the guy who keeps the books), says that converting from a Defined Benefits plan to Defined Contribution can actually cost money in the short term. That’s because you have to keep paying out, usually for decades, to anyone covered under existing Defined Benefits plans, while also making the matching contributions to new hires covered under the new plan. So any savings from the switch could be years in the future. “In the short term, you end up doubling up,” Cherry says.
In other words, he says, gesturing at the projected costs of the city’s plans over the next 10 years, “There’s still a long time for these numbers to be the numbers.”