No half measures for Baltimore pension reform [Editorial]

Our view: Effort to shield lower-income workers puts the city's finances at risk

November 13, 2013

City Councilwoman Helen Holton's proposed alternative to Mayor Stephanie Rawlings-Blake's plan to put many future municipal employees into a 401(k)-style plan instead of a traditional pension sounds, on the surface, like the compassionate thing to do. Ms. Holton wants to keep city civilian employees who make less than $40,000 a year in a traditional pension and to place those who make more in a hybrid plan, the idea being that those who earn less can least bear the risks associated with the kind of defined contribution plan the mayor proposes. As Council President Bernard C. "Jack" Young put it, "We have to make sure that when they retire they have a nice little pension."

What that line of reasoning fails to adequately address, though, is the collective risk posed by maintaining a defined benefit system for all city employees. While a defined contribution plan puts individuals at risk of outliving their savings, a defined benefit plan puts all retirees — not to mention future taxpayers and those who will one day need city services — at risk of a catastrophic collapse. Detroit may now be something of a boogeyman invoked for shock value in any debate about municipal finances, but its bankruptcy is proof of just how badly things can go wrong if officials don't take prudent steps to manage risk. With all due respect to Ms. Holton, that is not a "tired" argument. It's math.

The way a pension is supposed to work is that each year during a worker's career, an employer sets aside an amount of money that should be sufficient to support his or her benefits in retirement. That's known as the "normal cost." (In most cases, the worker is required to contribute some percentage of his or her pay, but until recently that was not the case for Baltimore's civilian employees.) But for a variety of reasons, the normal cost may not be sufficient. Workers may live longer than expected, the number of retirees may grow or, most consequentially, the pension system may fail to reach its investment target. Then the system develops unfunded liabilities that must be paid back.

In Baltimore's case, the total value of unfunded liabilities is exploding. According to the city's Finance Department, it has grown in the last five years from $188.5 million to $681.6 million. The normal cost for retirees in the current fiscal year amounts to about $26.4 million, but the cost of paying down the unfunded liabilities is $64.7 million.

The advantage of Ms. Rawlings-Blake's plan is that it would gradually eliminate the unfunded liability as a concern. New civilian city workers would be required to contribute 5 percent of their paychecks to a 401(k)-like investment vehicle, and the city would contribute 4 percent. But it would not be on the hook for pension payments in perpetuity. The plan means higher normal costs for the city but provides certainty and predictability. Ms. Holton's plan is cheaper for the city in the short run, but because more than half of city civilian employees make less than $40,000 a year, it does far less to reduce the long-term risk.

Ultimately, reducing the city's exposure to risk from its retiree benefits is one of the keys to moving Baltimore away from a state of perpetual budget crisis and into a position where it can substantially reduce the state's highest tax burden and begin providing higher quality services to a population that desperately needs them. That's a recipe for making Baltimore a more attractive place to live and work.

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