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Out of Control Policy Blog Archives: 2.23.14–3.1.14

Government Could Improve the Development of Vehicle to Vehicle Communication by Getting Out of the Way

Driving a car for the first time is an American rite of passage. Crashing should not be and soon it will not have to be. Earlier this month the US Department of Transportation announced that it would allow vehicle-to-vehicle (V2V) communication technology to be implemented in light vehicles. It hopes to mandate the technology in all new future vehicles.

The technology allows vehicles to communicate with other vehicles and provides drivers specific information about their surroundings including the driving speed and location of nearby vehicles. The technology should be particularly useful for those driving in poor weather conditions where vision is impaired. It should also improve safety when changing lanes, making turns, or performing other difficult maneuvers.

While the technology enables further innovations in automation, V2V communication does not replace the driver and these vehicles should not be viewed as fully automated. The technology will increase the amount of information available to drivers to enable them to make better choices, but drivers will retain ultimate control over their vehicles. V2V technology should be considered a form of driver assistance with the potential of allowing the development of greater automation.

Unfortunately, federal government involvement is limiting the technology’s potential. First, the government has decided it will allow V2V communication as long as it dictates the specific parameters. Second, the government hints that its real goal is mandating V2V technology in all cars.

The government should not be dictating the specific parameters. Instead it should be coordinating a private sector working group that determines that technology. Private companies are more effective than the government at innovating. Take for example Google and its driverless vehicles. The Federal government has been researching automated vehicles for 40 years. Yet it only took Google three years to build a semi-automated vehicle. (Google used some of the federal government research.) Then Google had to lobby several state governments to allow it its cars to be driven on public highways. If the company had waited for governments to consider the technology’s potential the idea would still be gathering dust.

Some proponents of government interference in the development of V2V communication technology argue that it is necessary to ensure that corporations do not develop propriety systems that are incompatible with one another. This argument fails to take into account the ability of private companies to enter into consortiums to develop an industry-wide standard. Consider the popular digital media medium digital viewing discs (DVDs). DVD technology was developed by the DVD Forum, an industry group composed of the largest electronic companies. It is not clear why major automobile manufacturers could not form their own consortium to ensure that V2V communication technology is interoperable between vehicles. Since the V2V technology’s value relies on the ability to communicate with other vehicles, it is in the interest of automobile manufacturers to ensure that their products share an industry-wide standard.

Let us consider the different incentives for private companies and government officials to introduce new technologies. Private companies want to make a profit and try to release their product as soon as it is effective and safe. They are not concerned with the short term; they take into account long term profits in their calculations. They have no incentive to put out a faulty technology.

Government officials do not operate with the same urgency. Even when the new technology is safe officials may still delay its release; delays will not bankrupt a federal agency but they could bankrupt a private company. If a given technology is unsafe the government can use it as an example of the need for further regulation, additional funds, and greater centralized power. Since DOT’s budget can increase when problems are found, DOT has the incentive to attack private companies even when they have a stellar safety record. ReasonTV recently covered a prime example of unwarranted government action against a safe Chinatown bus operator.

The hardest hit under a mandate would be the nation’s poorest. The selling point of V2V technology is not safety alone. Road fatalities could be reduced to near zero if everyone drove armored vehicles. Does this mean we should all drive around in tanks? Of course not. The heavy weight of tanks would quickly deteriorate the roads and road repair costs would be astronomical. Tanks are hardly known for their great fuel economy – drivers would pay both in increased fuel costs, local air pollution, and lack of vehicle choice. Those are high costs for increased safety. The selling point of V2V technology is providing an affordable increase in safety. Mandated V2V standards would raise the cost for vehicles beyond what low-income households can afford by reducing manufacturers’ incentives to innovate and reduce V2V’s costs.

We should rejoice that V2V technology is finally being introduced to vehicles, but it is unfortunate that such technology needs to be controlled by government officials.

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New European Union Rules Will Hold Back Tobacco Harm Reduction

On Wednesday, February 26, the European Parliament voted to approve a new Tobacco Products Directive. The text adopted by the Parliament is expected to be rubberstamped by the Council of the European Union when it meets on March 14. Once it enters into force, EU member states will have two years to bring national laws into compliance with the terms of the directive.

The new directive contains all the illiberal strictures we have come to expect from such legislation: health warnings must cover 65% of the front and back of each cigarette pack and must be printed in black Helvetica bold type on a white background; cigarette packs much be cuboid in shape and contain no fewer than 20 cigarettes; all characterizing flavors—including menthol—must be banned.

But worse than these measures, which relate to traditional cigarettes, are the directive’s new rules on electronic cigarettes, which deliver vaporized nicotine without tobacco or smoke. A growing body of research indicates that these “e-cigarettes” are safer for users than traditional cigarettes, pose no health risk to non-users, and help habitual smokers to give up dangerous, combustible tobacco. Some analysts have predicted that e-cigarette sales will exceed sales of tobacco cigarettes by 2021.

But rather than welcome e-cigarettes as a route to harm reduction, the new Tobacco Products Directive seeks to undermine this fast-growing market. First, the directive introduces a new strength limit for nicotine-containing liquid of 20mg/ml. As Clive Bates notes:

… 25-30% of users use liquids stronger than this, and there is no health or internal market basis for preventing the trade in these products. The stronger liquids are important to heavier smokers and to people as they make their first switch into e-cigarettes. The result of this limit will be less switching and more relapse to smoking. The result of that: more disease and premature death.

Second, the directive prohibits print, radio and audiovisual communications “with the aim or direct or indirect effect of promoting electronic cigarettes and refill containers.” In other words, e-cigarette manufacturers are not allowed to tell consumers about their product. For an emerging technology seeking to disrupt a long-established industry, this is disastrous. The prohibition of advertising makes it hard for e-cigarette producers to dislodge market incumbents (i.e., traditional tobacco brands) and blunts their market incentive to come up with newer, better e-cigarettes. Why bother, when companies can’t promote new products to consumers?

Third, the directive seeks to tie the e-cigarette industry in so much bureaucratic red tape that it is all but guaranteed to reduce competition and retard innovation. Smaller, independent e-cigarette brands will be particularly hard hit by requirements that they must submit to the “competent authorities” detailed notification of all new products six months before they are placed on the market. The same goes for demands that manufacturers and importers make comprehensive annual submissions on “sales volumes,” “the preferences of various consumer groups, including young people, non-smokers and the main types of current users,” and “the mode of sale of the products.”

The only way around these regulations, according to the directive, is for e-cigarettes to be recognized by national governments as “medicinal” or “medical devices.” But such categorization comes with its own heavy regulatory burden. To put it bluntly: heads you win, tails I lose. And e-cigarette producers aren’t the only losers here. Ultimately, it is to Europe’s smokers, whose lives could be longer and healthier if they switched to vapor, that the European Parliament has done the greatest disservice.

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Detroit Plan of Adjustment Leaves Much to Be Desired on Privatization

In a new column, I analyze the plan of adjustment released last week by Detroit Emergency Receiver Kevyn Orr, specifically with regard to how the plan addresses future city government operations via the privatization of services and assets. In short, the more services and assets privatized, the more manageable the emergence from bankruptcy and the smoother the path to long-term fiscal and financial sustainability—which translate into improved quality of life for Detroit’s citizens and businesses. However, on both fronts—outsourcing and asset privatization—the proposed plan of adjustment is a mixed bag.

Here's an excerpt:

Detroit’s plan of adjustment offers a good start with regard to service and asset privatization, but at this stage of the bankruptcy proceedings, a “good start” is too little too late. The current plan leaves a lot of opportunity on the table in terms of potential revenue generation and cost savings, which does not bode well for the city’s future fiscal and financial recovery moving forward out of bankruptcy. It leaves too many pre-bankruptcy government structures in place.

One of the silver linings of bankruptcy is that it presents a major opportunity for reinvention and restructuring, but the current plan does not seem to fully leverage the transformation moment. Rather, it seems to seek to avoid pain for the city as much as possible, while inflicting more of it on pensioners and creditors to varying degrees. Ironically, internalizing more of that pain now through more aggressive restructuring of city services and assets would best protect the city from having to revisit that pain later in another bankruptcy.

The full article is available here. Also, be sure to check out Reason colleague Anthony Randazzo's analysis of the plan of adjustment's proposed pension reforms here, as well as our joint op-ed in The Detroit News last week.

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Privatization & Government Reform Newsletter #4 (Feb 2014 edition)

The February 2014 edition of the Privatization & Government Reform Newsletter is now online. Topics covered in this issue include:

  • MUNICIPAL BANKRUPTCY: Analyzing Detroit’s Plan of Adjustment
  • TRANSPORTATION: Replacing Fuel Taxes With Per-Mile Tolling
  • PENSIONS: Why the “California Rule” is Counterproductive
  • INNOVATORS IN ACTION: Pioneering Pension Reform in Michigan
  • SOCIAL FINANCE: Massachusetts Announces Social Impact Bond Program
  • PRIVATIZATION: Missouri Think Tank Examines State, Local Privatization Opportunities
  • News & Notes
  • Quotable Quote

The full newsletter is available here, and previous editions of the newsletter are available here.

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Analysis: Detroit Bankruptcy Pension Reform Not Good Enough

Detroit's proposed pension reform from last week has a chance to be precedent setting. The city's plan to "adjust" its $18 billion in debt by slashing as much as half of it before exiting bankruptcy includes cuts to already accrued pension benefits, as well as changes to how future public pension benefits are earned. The proposal also has less innovative, but important elements of good pension reform including forcing the city to use "market values" in accounting for its liabilities, using slightly more realistic investment return assumptions, and adjusting its defined-benefit system. 

Such structural changes are bound to bring criticism. Retirees have already disseminated their displeasure with the proposed pension reform. The Official Committee of Retirees claims that the proposed changes would push 20% of the city retirees into poverty, and argue that the accounting changes are overly conservative. Other retirees have asked why the city hasn't sold the pieces at the Detroit Institute of Arts in an auction, or sell Belle Isle, in order to lower the need for pension cuts.

These retires should be more concerned that the Detroit pension reform proposal in the bankruptcy plan doesn't go far enough in its changes to protect their pension benefits. The city has retained its defined-benefit structure for future earners and is proposing to have retirees bear the risk of future accrued liabilities. This means employees would have all of the risks of a defined-contribution plan without the benefits. And while representatives of the retirees are claiming the bankruptcy plan's pension reforms are too conservative, they are probably not conservative enough.

The bankruptcy plan also includes a "DIA Settlement": $365 million in donated money from a group of chartable foundations to prevent pieces at the Detroit Institute of Arts (DIA) from being sold to limit pension cuts, a promise from Gov. Snyder that the state will contribute $350 million to the pension fund, and a promise from the DIA to raise $100 million from donors over 20 years for pension funding. This idea has problems of its own, but won't be discussed here beyond a note that the money promised from the foundations is almost certainly less than could be gained from a private auction and pensioners have reason to criticize the DIA Settlement approach.

The following analyzes the details of Emergency Manager Orr's proposed Detroit pension reform for the two city pension systems: the General Retirement System (GRS) for all non-uniformed city workers, and the Police and Firefighter Retirement System (PFRS). All quotes come from the bankruptcy plan "Disclosure Statement" and its appendices.

New Funding Ratio Target

Detroit aims to achieve a 70% and 75% funded status for GRS and PFRS, respectively each pension plan by June 30, 2023. Funding ratios will be based on the market value of assets, not a smoothed value of assets (Detroit currently determines its liability by "smoothing out gains and losses over a seven year period). -- See p.5 of "Disclosure Statement"

Analysis: These funding targets are still rather low to be considered a well-funded system, even on a market-value basis. GRS is presently 59% funded on a market-value basis and PFRS is 78% funded by the same measure. Given that Detroit should not have to go through bankruptcy pain again, the city should consider reducing future benefits more rather than have such underwhelming funding ratio targets.


Changes to Actuarial Assumptions

GRS will lower its assumed investment rate of return from 7.9% to 6.25%. PRFS will lower its assumed investment rate of return from 8% to 6.5%. The bankruptcy plan defends these changes as follows:

 "The use of these investment return assumptions is consistent with the trend by governmental entities to reduce pension funding assumptions, and the particular rates used in the Plan - although lower than most jurisdictions - nonetheless align with the unique financial inability of the City to weather unanticipated pension investment loss. These conservative assumptions are also appropriate given the large percentage of investments held by the pension funds that do not have a readily determinable market value and the uncertainty to actual asset values held by the pension plans as a result." -- See p.6 of "Disclosure Statement"

Analysis: The new discount rates of 6.25% and 6.5% may be lower than most municipal assumed rates of return, however, that shouldn't be a cause for concern. Most assumptions are unrealistic, and these rates are at the top of what should probably be assumed.


Cuts to Retiree Benefits

GRS retirees and their beneficiaries will see a 34% reduction in their monthly pension. PFRS and their beneficiaries will see a 10% reduction in their monthly pension. And there will be no cost-of-living-adjustments (COLAs) for the next decade.

If the Detroit pension board agrees in a "timely manner" to the plan of adjustment, then the GRS retiree pension checks will only be cut 26% monthly, with no future COLAs. PFRS pension checks would only be cut 4% monthly, with no future COLAs. -- See p.7 of "Disclosure Statement"

Gov. Snyder has offered state funds as a part of the DIA Settlement in exchange for a guarantee that no retiree would see their benefits cut below the federal poverty line. The bankruptcy plan does not yet detail how this would work, but does say "additional benefits will be provided to [GRS and PFRS pensioners] who... have household income less than a threshold amount to be determined pursuant to further discussions between the City and the State and tied to federal poverty levels." -- See p.8 of "Disclosure Statement"

Analysis: It is a positive sign that the city is proposing cuts to both current and future benefits. This is unfortunately the only way that most benefits for retirees can be preserved while also balancing the need to use tax dollars for city services. Whether or not the state's bailout funds for the art are approved, the cuts to retiree benefits should certainly be means tested so that no retiree currently receiving a pension is pushed below the poverty line. However, even with these positive marks, the city should consider additional cuts in order to improve the targeted funding ratio.


Cuts to Active Worker Accrued Benefits

GRS retirees and their beneficiaries will see a 34% reduction in their monthly pension. PFRS and their beneficiaries will see a 10% reduction in their monthly pension. Plus, any additional unfunded liabilities added in either system during FY2014 will be also cut from accrued benefits. Also, for any active workers who retire in the next decade there will be no COLAs.

If the Detroit pension board agrees in a "timely manner" to the plan of adjustment, then the GRS accrued benefits will only be cut 26%, with no future COLAs. PFRS accrued benefits would only be cut 4%, with no future COLAs. -- See p.7 of "Disclosure Statement"

Analysis: Having active workers share in the cuts at the same level as the retirees is likely a good public relations step. Making active workers responsible for additional liabilities is also likely to be a good way to align incentives of all parties involved to ensure the system is properly funded.

From the initial reaction, the tacit bribe of lower cuts if retirees accept the plan without further litigation is going to be a no-go. However, Detroit retirees should consider the fate of other cities where retirees rejected reforms only to be forced into deeper cuts later on, such as Central Falls, RI.


Cuts to Future Benefits & New Risk Management

Future benefits for active workers will be earned via a new formula (the details are slightly different from GRS and PFRS, the later of which gets a better pension -- see p.18, 22 of "Disclosure Statement").

The future benefit formulas would be for defined-benefit pensions, like the old system, but at reduced rates. Active workers would therefore be put into a "hybrid" system, but one that is still completely defined-benefit (unlike hybrid defined-benefit/defined-contribution systems found in Indiana or Rhode Island).

The system contains rules that "shift funding risk to participants in the event of underfunding of hybrid pensions" and creates new minimum retirement ages for accrued benefits under the old system. 

Analysis: This "hybrid" approach does not go far enough to reform Detroit's pension. The bankruptcy process is the perfect time to put Detroit on a path to ridding taxpayers completely of pension liabilities by freezing the defined-benefit system to new members. A defined-contribution system like a 401(k) would also be more portable for workers and enusre their benefits are not subjected to political underfunding of pensions.


Possibility of Restoring Benefit Cuts

If the pension systems recover at a greater rate than expected, benefit cuts can be restored under certain conditions: not until at least FY2024, only if the funding level of a system is above 80% based on market value of assets using a 6.25% discount rate for GRS and 6.5% discount rate for PFRS, and only if the pension board approves the restoration benefits. -- See p.7 of "Disclosure Statement" and "Exhibit A, Article I" items 138-143 & 192-198

Detroit will also be recalculating the allocation of resources to the GRS Annuity Fund and any determined "excess allocations" will also be available to restore some benefit cuts. -- See p.7 of "Disclosure Statement"

Analysis: This is a helpful public relations element of the plan, but the cuts are already likely not enough. Further, even if the systems did become better funded after a decade, the threshold for restoring some benefits should probably be 95% or 100% instead of 80% funding on a market-value basis


Changes to Contributions

The City of Detroit will save cash by not making any annual contributions to GRS or PFRS for the ten years after the plan of adjustment. As a replacement, pension funding will come from the DIA Settlement

Pension funding will come instead from the DIA settlement. The Detroit Water and Sewage system will also contribute $675 million to the GRS fund over ten years. After FY2024, Detroit will need to start making contributions to the pension funds again.

Analysis: This approach is primarily aimed at freeing up cash to invest in city infrastructure and services over the next decade. The idea is that public works projects to improve the city would help Detroit grow again, expanding the tax base so that there will be more available cash to make pension contributions down the road. But Detroit's challenges are because of aging infrastructure. Improving services, particularly security, would likely keep more people from leaving, but the real reason why the city isn't expanding has more to do with the tax and regulatory code.


Health Care Changes

The city would create a Voluntary Employees' Benefit Association to take over the health care liabilities of GRS and PFRS. This fund would be started with $526.5 million.  It would replace all life insurance and death benefits. -- See "Exhibit I.A.182.a".


No Changes for a Decade

The bankruptcy plan also would require no changes to the terms or assumptions over the next decade.


DIA Settlement

The bankruptcy plan is explicitly using monies promised to the city through the DIA Settlement to lower the cuts needed for retiree pensions. If the foundations do not follow through with their committed contribution, then pension benefits will be cut by the same dollar amount. -- See p.6 of "Exhibit A"

These commitments will be spread out over 20 years. In exchange, any assets that the "City holds title to" would be considered transferred to DIA under the same "perpetual chartable trust" that the bulk of the art in the museum is held under, and would be required to remain "within the City limits, for the primary benefit of the residents of the City and the Counties and the citizens of the State." -- See p.98 of "Settlement Disclosure" and p.5 of "Exhibit A".

Gov. Snyder proposed $350 million state bailout for DIA would come from the state's tobacco settlement fund, but has not been approved yet by the state legislature.

Approximately $50 million can go to GRS before FY2024, and $195 million will be paid to GRS after FY2024. Approximately $175 million can go to PFRS, before FY2024. This would leave up to $395 million in proceeds from the DIA settlement without specific distribution outlined in the plan.


Is Reform Necessary?

In a recent post for Out of Control, I outlined the case that Detroit's pension systems are not as well funded as some claim. On the surface the numbers look okay, but the actuarial assumptions are hiding huge losses, which if reflected on the books would reveal a pension system that is not capable of paying out all of the benefits promised to retirees.

Opponents of the Orr bankruptcy plan proposal are acting rationally, but only based on their presumption that the pensions are in fine shape. If, on the other hand, the systems are not well funded than opponents of reform are not acting in the interests of pensioners who have been promised benefit distributions 10 and 20 years from now.

The bankruptcy proposal includes a discussion of how the funds are in trouble, and concurs with our analysis from earlier in February. Here are some highlighted admissions in the plan:

"The City believes that the UAAL figures reported by the Retirement Systems were substantially understated because they were based upon various actuarial assumptions and methods that served to substantially understate the Retirement Systems' UAAL. The assumptions and methods included: (a) annual net rates of return on investments (GRS -7.9%; PFRS - 8.0%) that were unrealistic in light of the Retirement Systems' demographics, the targeted mix of the Retirement Systems' assets and the inability of the City to budget for and fund pension investment loss in the event the sought-after returns were not achieved; (b) the "smoothing" (reallocation over a period of years) of asset gains and losses over a seven year period, which masks the funding shortfall; and (c) the use of 29 year (PFRS) and 30-year (GRS) amortization periods for funding UAAL - which is applied anew each year to the full amount of unfunded liability - that allows unfunded liabilities to continue to grow rapidly as a result of compounding. In the List of Claims, the City set forth what it believes is a more realistic total UAAL for the Retirement Systems of $3.474 billion, consisting of $2.037 billion in UAAL owed to the GRS and $1.437 billion in UAAL owed to the PFRS... If one were to apply even more realistic assumed rates of return of 6.25% for GRS and 6.50% for PFRS, respectively, the UAAL totals increase to $2.299 billion for the GRS, and $1.588 billion for the PFRS, as of the end of Fiscal Year 2012." -- See p.5 of "Settlement Disclosure"

I would argue that even more realistic assumptions should be used, but even by these moderately conservative standards there are clear underfunding issues. Why should investment losses be spread out over seven years? Why should payments be amortized over such a long time period? Fixing these practices, which would highly suspect in private sector pension accounting (if not illegal), is necessary. And once that process begins it is clear that serious reforms are needed.

The case for reform is even stronger once you consider the suspect practices of the pension funds over the past decades. Even if the reform assumptions were overly conservative, that would not change the actual practices of the funds that have contributed to the low funding levels when measured at a market-value rate (instead of the funding-value level using poor actuarial assumptions). Consider the following list from the bankruptcy report:

"In the past, the Retirement Systems engaged in a variety of practices that contributed considerably to the underfunding of the pension plans, particularly with respect to the GRS pension plan. As more fully discussed in Section III.B.5, these practices included: (a) consuming pension fund assets to pay promised returns under the separate "annuity savings plan," (b) dissipating pension fund assets during the years when returns on investment exceeded expectations through the so-called "13th check" program, (c) deferring required pension fund contributions from the City each year and financing the deferred amounts at a rate of 8%. Serious allegations also have been made that various former officials of the Retirement Systems accepted bribes and/or misappropriated assets of the Retirement Systems for their own personal gain. In addition, the Retirement Systems have made many poor investments that have reduced the funded status of the two pension plans. Finally, it appears that a large portion of the assets of the respective Retirement Systems is invested in alternative investments for which no recognized market valuation exists. As of June 30, 2013, approximately 24% of PFRS assets and 33% of GRS assets had estimated, rather than readily ascertainable, market values." -- See p.5 of "Settlement Disclosure"

Combined, the history of Detroit's bad actuarial assumptions and its poor operating practices more than make the case for reform. And the Detroit plan of adjustment makes steps towards the needed reform, though there is more to do.

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