The centerpiece of Turner’s pension proposal is its “corridor” mechanism which supposedly caps the amount the City will ever be required to contribute to the pension plans. How the cap would actually work in reality is anybody’s guess. It is a hideously complex, completely untested, experimental model, which has never been tried anyplace in the public or private sector as nearly as I can tell.
But assuming it would be implemented as advertised, what would the effect on the City’s employees be?
The proposal provides that if the City contribution exceeds the cap, the pension plans must decrease the cost-of-living adjustments (COLA), increase retirement ages and/or increase employee contributions.
When you do the math, you find out that there is not much savings from further decreasing the COLAs or increasing the retirement age. So, most of the adjustment will have to come from increasing the employees’ contributions. The problem is that it will take huge increases in the employees’ contributions to make up even a small miss on the investment returns.
The effect on the three plans is different. Firefighters will be the most penalized. The payroll for the fire department is roughly $300 million. The firefighter pension fund has about $3.7 billion in assets. If it misses the assumed rate by one percent (6% vs. 7%), that is $37 million that would have to be made up by an increase in employee contributions. That means that the firefighters’ contributions would have to increase by 12.2% ($37 million/$300 million payroll). The firefighters are already contributing about 10% toward their retirement, so this would take the required employee contribution to 22.2%.
If you run the same calculation for the police plan you come up with 9.4%, which will take their employee contribution to 19.4%. The effect on the municipal employee plan is not as great. They would be looking at about an additional 4%. One of the perverse outcomes of the corridor is that the better funded the plan, the harder the members of that plan are hit.
If the investment returns are less than 6%, the increases in employee contributions would rise proportionately. Keep in mind that the most recent 5-year average for the three plans is in the 5-6% range.
Of course, requiring employees to contribute anything close to 20% is patently absurd and will never happen. When we get to that point, and if the City were to actually attempt to enforce the increases, there would be mass resignations, strikes and, of course, more litigation.
This is the fundamental flaw with Turner’s cap. To claim that the City’s exposure is capped, it relies on a mechanism that will never be enforced because it is impractical.
The timing of when employees will face higher contributions, and how high those increases will be, depends on how the plans do in the markets. There are also a number of dampening features and trapdoors in the corridor language that will allow the City and plan administrators to manipulate the numbers to avoid hitting the cap, at least in the short term.
But in the meantime, we are going to have to attempt to recruit and retain City employees with this sword of Damocles hanging over their heads.
The corridor mechanism has been promoted as eliminating the need to begin the transition to defined contribution plans. It does not. There is no magic formula, no secret sauce. The only real, long-term solution to Houston’s pension crisis to begin phasing out its defined benefit pension plans by moving new employees to defined contribution plans, just like 96% of the private sector has done.