Atlanta’s pension problems can be solved through defined contribution plan

By Guest Columnist JOHN MATTHEWS, a commercial real estate investor and an MBA graduate of Goizueta Business School

Atlanta’s public employee pension system is a structurally flawed retirement program that does not serve taxpayers, does not serve city workers and puts our city at risk of financial insolvency.

Significant changes will have to be made to the pension plan in order to prevent the city from entering either permanent economic decline or outright failure. If the city wants to put itself and its employees on a permanent path to long-term fiscal security, our city employees need a “defined contribution” retirement plan.

How did Atlanta get into this perilous condition?

First, our mayors and City Council in general unanimity passed large benefit increases for city, police, and fire workers in 2001 and 2005. The stated premise was that the benefit increases would facilitate the retention and hiring of quality employees.

Second, lax government accounting rules (that Atlanta followed) permitted pensions to be significantly underfunded, but have since been made more restrictive.

Third and finally, the financial markets severely declined.

Combined with other minor factors, the city itself now estimates the unfunded liability at $1.5 Billion. By way of comparison, this is four times the annual general fund budget (excluding current pension costs). Indeed, the deficit could be as much as 50 percent larger depending on a variety of assumptions.

The most pressing fact is that the pension is already 20% of the city budget, and growing at 21 percent annually. If this continues without large tax increases, the city will not be able to pay for any general fund items in nine years time.

Among the few important things we could no longer afford: interest expense, parks, a planning department, an accounting department, a city council, or the actual police, fire, and municipal employees themselves.

Why and how does this happen?

Across the country, city and state governments are increasingly run for the financial benefit of the city workers, not the taxpayers. With low voter turnout, government employee unions – who do vote and donate to politicians in a unified manner – wield immense clout with elected officials, including city councils.

In addition, politicians generally like to be re-elected and advance their careers. With little incentive to deal with difficult or unpopular problems, kicking the can down the road is far more expedient.

Most importantly, pension funds are prone to a problem called “asset-liability mismatch” (or perhaps more accurately, an uncertainty mismatch). The assets (investments) may or may not be available in sufficient quantity at the time the future liability occurs (payment of the promised retirement benefits).

In between the time a portion of the required money is set aside and the liability occurrence, events can and will happen. Financial markets can decline, life expectancy increases, people could move out of the city — reducing fee revenues, property values and property tax revenues.

To compensate, a city might increase the tax rate, but there is a limit to such increases. Eventually, people would move somewhere else and the city falls apart (like Detroit).

If you prefer an analogy, this is like running up your credit card to $500,000 when you have $100,000 in the bank, but you don’t know for sure what your future job prospects. Our city’s metaphorical credit card has been run up too much, so one of two things must happen: the city financially fails or benefits are changed.

Taxpayers are right to be outraged; and pensioners are right to be confused and upset. However, hindsight is 20/20. Unfortunately retirement programs (like Social Security) have been run in this fashion for the last 60 years.

Taxpayers presumably want a plan ensuring we have a prosperous and low-tax future. One hopes our city employees want a plan which isn’t constantly renegotiated and from which they will actually get paid, in comparison to the “pretend pension” they have now.

Both the employees and taxpayers presumably have some of the same objectives: for the city to hire and reasonably compensate good workers who can protect and efficiently run our city, save for retirement and ensure that Atlanta is a financially viable city where businesses can grow. A defined contribution plan can serve all these needs.

What are the other possible alternatives?

Most solutions, including implementing a defined contribution plan, will likely require the cooperation of not just city council, but also the state legislature and the employee unions.

Small changes to the current plan (a “defined benefit” plan) can only have limited impacts at solving the problem, have unintended consequences and do not solve the “asset-liability matching” problem. A possible solution is to enroll retirees in Social Security. But switching one insolvent retirement plan for another insolvent retirement plan doesn’t seem to be the best approach.

A defined contribution plan (plus Social Security) is what employees in Fulton and Gwinnett counties receive, which is what most non-profit employees receive, and what 85 percent of for-profit workers receive.

In contrast to a “defined benefit” plan, in a “defined contribution” plan you don’t receive promises, but you do receive cash: retirement funds are set aside every month you work in an account you own and largely control.

The benefit of this for the city is there is no asset-liability mismatch problem. No one, including the city employees, need to worry the city is going to go bankrupt (at least because of pensions) or that they’ll lose all or part of their retirement funds.

What are the advantages and disadvantages for a defined contribution plan?

Firemen and police officers would likely need to work some beyond the current retirement age of 55. A job training or education fund for employees in the high-risk business of public safety and fire protection would be an intelligent investment.

Employees should be automatically enrolled to ensure they are saving the necessary amount with annual consultations to review their retirement plans. Finally, to mitigate the potential risk associated with managing one’s own funds, guidelines should be designed such that as city employees approach retirement, they are more heavily invested in fixed income assets.

City workers should take note that a pension fund guaranteed by an insolvent city would likely be worth significantly less than what they would receive from a defined contribution plan.

The advantages for employees are many. They would own their retirement funds — meaning they can pass them on to their children or grandchildren, who can start a business or go to college. How much you receive has more to do with how long you work rather than just how long you live.

The vesting period is significantly shorter, often less than a year. City employees can take their hard earned savings with them rather than losing them if they decide to change jobs or move, thus enabling them to further their career interests.

Employees and taxpayers both would no longer be depending on the quality of the city government’s crystal ball that indicates they can make an 8 percent return annually every year.

For the city, the most important advantage is the elimination of the aforementioned asset-liability mismatching. But there are additional benefits.

Managers would be able to make more rational hiring and firing decisions. And employees themselves could make more rational career decisions. The city would also be placed in the positive situation of improving employee quality, but not with out-sized compensation promises.

Instead, city management would need to give employees fair compensation, but also what surveys show most motivates employees: the opportunity to make a difference, positive recognition for their achievements, and a high-quality work environment with good leadership.

Our city can and will fail, at some point, if pensions are not reformed. If you don’t believe it’s possible, please don’t take my word for it. Google “Vallejo California Bankruptcy”, “Los Angeles Pension”, “Pittsburgh Pension”, “California Pension”, or “New York State Pension” and examine their coming financial challenges from their under-funded pensions.

Our city can put itself on a sound fiscal footing with the due attention this issue is already receiving from Mayor Kasim Reed and from the involved parties. However, while the city employee unions already have the ear of City Hall on this issue, voters and taxpayers must also make their voices heard with their city council members and the mayor.

Our city government must be reminded that the voters and taxpayers are their ultimate customers.

For more information, please click on these links to read the City of Atlanta’s reports on Pension Assessment – Final Report & Recommendations and the city’s Retirement Review — Phase II and III, Plan Design and Financial Impact.

4 replies
  1. Burroughston Broch says:

    What’s proposed is entirely sensible, but has a potentially fatal flaw. The City worker’s unions will fight to the death because their employees aren’t getting an almost-free pension. A City worker contributing 8% of his pay to a defined benefit plan for 30 years will get a much smaller retirement income than from a City pension that pays for the rest of his life 90% of his average compensation during his last three years on the job. A worker retiring at $50,000/year salary would receiver $45,000/year pension; to fund that amount from a defined contribution plan would require accumulating a $1,125,000 nest egg.Report

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