By Kari Mercer, Senior Consultant
There is no question that the cost of retirement weighs heavily on the minds of public agency decision-makers. Retirement costs to public agencies have increased dramatically in the past decade. The lowering of the discount rate by CalPERS announced in late 2016, and most of what we have heard from CalPERS since then, only indicate that costs will continue to climb.
Comparing Your Costs to the Labor Market
It is understandable that management seeks to compare how agency retirement costs stack up to those of their labor market when conducting compensation studies. A balanced budget requires that high retirement costs be balanced by less money spent on other line items so agencies with high retirement costs can make the case for spending less than their labor market on things like employee salaries and other benefits. You probably sense that there is a “but” coming.
The Objective of a Compensation Study
The question must be asked: What is the purpose of a compensation study? The fundamental reason for a compensation study is to optimize an agency’s ability to recruit and retain a well-qualified workforce, and favorable pay practices play a key role to this end. Compensation studies measure the value of pay and benefits in an agency and provide a way to compare that value across the labor market. The critical element is the concept of value versus cost. One definition of the word value is, “the importance, worth, or usefulness of something.” The value of something is not always aligned with what that item costs.
Making the Case for Value Over Actual Costs
While traditional practice has been to compare actual agency costs of retirement (i.e., normal cost plus unfunded liability), an alternate and more reliable comparison is to compare the value of retirement benefits. Actual cost is driven not only by how “rich” the actual benefit is but also by how well – or poorly – investments have performed as well as the demographics of the agency’s workforce. An agency with poorly performing investments and a high number of retirements will have a higher percentage of unfunded liability and consequently a higher percentage of contribution.
Calculating the value of retirement benefits is achieved by establishing a baseline formula determined by statewide statistics and measuring an agency’s formula and enhancements against that baseline. Percentage values – either positive or negative – are attributed to each formula and enhancement based on their differential from the baseline and are used to assign a monetary value to the benefit which is then rolled up into the total compensation value for a classification.
Actual cost does not necessarily measure the value of the benefit and does not provide data that is as reliable for determining the value of a body of work across agencies. Moreover, the volatility of actual employer costs further detracts from the reliability of the data. Since actual costs can vary significantly year-to-year, compensation study data can be impacted radically. Given the significant commitment of time and financial resources required to complete a compensation study as well as the impact that outdated information has on collective bargaining, which often takes places over many months’ time, it is advisable to collect data by applying a methodology that provides for longer-term relevancy. Comparing retirement benefits value versus actual cost accomplishes this goal.
Use of Actual Costs at the Bargaining Table
Certainly, understanding how actual costs stack up against comparators is not inconsequential. This information can be critical for stakeholders on both sides of the bargaining table to help understand perceived or actual deficiencies in pay practices when compared to labor market agencies. However, for a compensation study to truly serve its purpose and provide the most meaningful data, it must measure benefit value.
Shrinking Cost Disparity Over Time
It is likely that the disparity in value of retirement across agencies will shrink over the course of time due to PEPRA. As the percentage of “classic” employees in the public service decreases, so do the more expensive retirement formulas and enhancements. However, it is likely to be many years until public agencies can disregard the value of those pre-PEPRA tiers when administering their recruitment and retention programs.