11-12-09,
Retirement Benefits Between a Typical Private Sector Worker and a Policeman or
Fireman
The following is an analysis of the
comparative benefits between a Private Sector Worker and a Policeman or
Fireman, each 55 years old with 30 years of service and making $100,000 base
pay plus $20,000 in overtime at retirement.
Tough Love says:
November
12, 2009 at 5:28 am
The total “value” of benefits at retirement is the present value of all
future payments, be they pensions benefits, healthcare premium subsidies, or
anything else. Some of these future cash flows are definitively known at the
time of retirement (e.g., fixed monthly pensions), and others need to be
estimated (e.g., healthcare premiums, the incremental value of future COLA
pension increases, etc.). However, all of these future payments can be
reasonably estimated (sometimes with several options such as the low, medium,
and high liability estimates routinely provided by the Social Security
Administration). Once all known and estimated future payments have been
determined, they can be discounted to the point of retirement at an assumed
interest rate and an assumed mortality rate (for those payments that cease upon
death). The interest rate used in this calculation is very important, but
actuaries routinely do calculations of this sort and the range of reasonable
interest assumptions for this purpose is fairly narrow.
The present value of all retirement pension and benefit payments can be
looked at as the answer to the question ….. How much would an insurance company
charge in a single payment at the time of retirement to take on the guaranteed
responsibility to make all future payments in lieu of the former employer.
If we examine two 30-year service, age 55 workers (one Private Sector &
one a Policeman or Fireman) making $100,000 in base pay + $20,000 in overtime
at retirement, what would these present values be?
Being somewhat versed in the subject of employee benefits I’ll describe the
“likely” pensions & retirement benefits afforded each and then estimate
their present values.
Let’s assume the Private Sector worker is one of the few lucky enough to
still have the older traditional-style defined benefit pension plan, and does
NOT contribute towards its cost (common practice in Private Sector plans). With
30 years of service and with a typical formula that takes into account wages
above and below Social Security “covered compensation”, this worker would
likely receive about 40% of final 3-year average pay at normal retirement age,
and overtime would NOT be included in benefits-bearing compensation.
Here’s how the Present value would be calculated …
Assume $95,000 is the AVERAGE of the last 3 year’s base salary, so 40% x
95,000 = $38,000. But this would be payable only if the employee waited until
his plan’s “normal retirement age”. Let’s assume that his plan’s normal
retirement age is 60. Since he will start collecting his pension 5 years early,
there would be an “actuarial reduction” of 4 to 6% per year (just like Social
Security applies when someone starts collecting early at age 62). Let’s assume
the yearly reduction is 5%. So … we now have an annual pension of $38,000 x .75
= 28,500.
Now, to convert this to a “present value” we need to apply a life annuity
factor (which incorporates the interest and mortality discounts discussed
earlier). For someone retiring at age 55 this “factor” would be a multiplier of
about 15. So … the present value of this worker’s pension is $28,500 x 15 =
$427,500.
We will also assume there are no post-retirement healthcare benefits, as such benefits are VERY rare in the Private
Sector.
Now let’s calculate the present value of the Policeman’s pension &
benefits.
The pension formula for the policeman is often 3% of the last year’s salary
(including overtime) per year of service and with no “actuarial reduction” for
collecting benefits at age 55 (unlike for the private Sector worker). So … we
have ($100,000+$20,000)x.03×30 =$108,000. But, we’re
not done …
The policeman’s pension includes a provision for post-retirement COLA increases
(while essentially NO Private Sector plans do so). Although this may surprise
the reader, the “value” of this added benefit is VERY significant. Even with a modest long-term inflation assumption of 3%/yr, the
addition of a COLA benefit for life increases the value of the pension by at
least 50%. Hence, the levelized annual pension
(with the COLA) is now $108,000×1.5=$162,000.
Using the same annuity factor of 15 (as used in the Private Sector workup
above), we have a present value of 15x$162,000=$2,430,000.
But wait, we’re still not done (2 more items to adjust for) …
First, in fairness, the policeman contributes a percentage of his pay
toward his pension (unlike the Private Sector worker), and the accumulated
value (at interest) of these payments at retirement should be subtracted from
the above $2,430,000 for a fair comparison. For this policeman whose final
total pay was $120,000, I have calculated the accumulated value at retirement
date of his contributions to be roughly $400,000. Hence the present value of
this officer’s pension (offset by the accumulated vale of his contributions) is
$2,430,000-$400,000=$2,030,000
Second, this officer gets free or heavily subsidized retiree healthcare for
himself AND his family. Since he is not eligible for Medicare until age 65, his
healthcare premiums are very expensive and are expected to increase annually at
8-12%, triple the rate of regular (non-medical care) inflation. The present
value of this benefit and the post Medicare age healthcare subsidy is roughly $500,000.
Hence, the present value of this officer’s pension AND retiree healthcare
benefit is $2,030,000+$500,000=$2,530,000.
Now, let compare the present value for these 2 workers making the SAME pay,
working for the SAME number of years, and retiring at the SAME age.
The Private Sector worker’s EMPLOYER-PROVIDED retirement benefits are worth
(as a present value on the date of retirement) $427,500.
The Policeman’s TAXPAYER-PROVIDED retirement benefits are worth (as a
present value on the date of retirement) $2,530,000.
The crisis associated with funding Civil Servant Pensions and benefits is
NOT a revenue shortfall issue. It is CLEARLY one of EXCESSIVELY GENEROUS
pensions and benefits as the above calculations demonstrate.
For 2 similarly situated workers (in pay, years of service, and retirement
age) the Policeman’s package of retirement benefits costs the TAXPAYERS almost
SIX TIMES what the typical Private Sector employer is willing to pay.
Clearly, if the Private Sector employer provided the same benefits to his
workers that the policeman receives, his company would likely go bankrupt in
short order.
These unreasonable benefits have been provided due to a political structure
that rewards politicians for “giving-away-the-store” of not their own, but
TAXPAYERS’ money, for personal gain. This “gain” may simply be to feed their
ego, garner the union support needed to get re-elected, or perhaps worse … for
current or future personal financial gain.
In any event, the current situation is without doubt unsustainable and
without MAJOR REDUCTIONS to the benefits provided CURRENT (not just NEW) public
employees, towns, cities, and states will be filing bankruptcy with increasing
frequency.
Unfortunately, since difficult change is delayed
and delayed and delayed to avoid the confrontation (with very aggressive
unions), important public services will suffer tremendously until action is
FINALLY taken.
I’m sure there will be Civil Servants (with vested interest in the status
quo) that will say my figures are wrong. Estimates are necessary, and small
variations in assumptions will change the figures to a minor degree, but the
final relationship is quite accurate …. TAXPAYERS are forced (via their taxes)
to pay almost SIX times as much as the Private Sector employer is willing to
pay.
By-the-way … any qualified actuary can verify the reasonableness of my
figures and conclusions, …. and
I would welcome the actuary who offers to do so ……
Bye-the-way ……… I didn’t mention it above, but it’s worth a comment ……
Civil Servants often take advantage of what’s commonly called “spiking” to
unfairly boost one’s pension just before retirement. This takes many forms:
large last minute promotions and/or raises, excessive/unusual overtime, cashout of sick and/or vacation days with the payout included
in “compensation” for pension calculation purposes, or inclusion in
“compensation” of miscellaneous “allowances” (housing, vehicle, parking,
uniform, etc.).
None of this is EVER allowed in Private Sector employer-sponsored plans
(employers are spending THEIR OWN money, not TAXPAYER’S, and would never be so
foolish). For every $10,000 of “spiking” that works its way into the above
Policeman’s “compensation”, it costs the TAXPAYERS an additional
$10,000x.03×30x1.5×15=$202,500 !