Reason Foundation

The San Diego pension fund is to be applauded for its recent 10-2 vote to reject proposed changes to the city's annual pension payment requirements. The changes would have manipulated the amount the city is required to pay into the pension system, allowing it to reduce payments by tens of millions of dollars--at least, in the short term.

The proposals included altering the plan to pay down the city's $2 billion-plus pension deficit by stretching payments over 30 years, instead of 15, and relaxing the requirements of a payment trigger that kicks in when the market value of the pension fund's assets falls by more than 20% from an actuarial value based on the fund's average value over a period of several years. Now that the pension fund's assets have fallen dramatically and the trigger has come into play, the board had considered changing the trigger from a 20% shortfall to a 40% gap, as the California Public Employees' Retirement System (CalPERS) did in June. Of course, there is a reason the trigger was created in the first place: to serve as a stop-gap and prevent the city from letting the pension fund become too underfunded and the its long-term liability from getting too high. To simply ignore this and rewrite the rules for political expediency would have been fiscally irresponsible.

Critics of the proposals had argued that they sounded eerily like the kinds of ill-fated measures adopted when the city first got into trouble with its pension system when it intentionally underfunded the system by increasing pension benefits while reducing the city's contributions in 1996 and 2002. When the accounting changes were first proposed in July, Councilman Carl DeMaio cautioned in a San Diego Union-Tribune news article that "The retirement system is going down a path--a very dangerous path--that it's been down before, which is the manipulation of financial forecasts to allow the city to intentionally underfund the pension system." Added San Diego County Taxpayers Association president Lani Lutar, "Our concern is that any adjustments to these actuarial assumptions and formulas would result in underfunding of the pension system, which would be repeating a very recent mistake." Finally, former pension board member Bill Sheffler spoke to the motivation for the changes. "There's no doubt in my mind that this is politically motivated," Sheffler said. "The city wants relief so that they don't have to make the hard, structural changes that city finances have to eventually recognize."

Those "hard, structural changes" include recognizing that the city's pension system is unsustainable at current benefit levels, and that this means city services will be negatively and significantly affected in order to pay for government workers' retirements. Government pension benefits are excessive and must be brought back into line with compensation received in the private sector but the city made its bed by agreeing to those excessive benefits and now it must lie in it. Those benefits cannot be reduced for current employees and must be paid in full, unless, perhaps, the city ultimately declares bankruptcy, which seems increasingly likely.

Another lesson is that this just illustrates the manipulation to which "defined-benefit" pension systems are open. When contributions are based on actuarial assumptions about how much the average pension fund returns will be, how long people will live, how much salaries and inflation will go up, and so forth, and these assumptions are projected decades into the future, it all becomes educated guesswork. Furthermore, by fiddling with the assumptions, governments can significantly reduce the amount that they must contribute to the system in the near future. If their projections then prove to be completely wrong and the system becomes drastically underfunded, oh well, they'll probably be long gone from office by then.

By contrast, some of the biggest benefits of a 401(k)-style "defined-contribution" retirement plan are that there is much greater transparency and employer contributions are very stable and predictable, since they are just a fixed percentage of an employee's salary (with some small variation based on whether the employer kicks in a little more if the employee matches a certain level of contributions). This is why the private sector started switching to defined-contribution plans 30 years ago and hardly any defined-benefit plans have been started in the private sector in the last decade or more. It is time that state and local governments follow the private sector's lead and switch to defined-contribution retirement plans for all new employees.