By Jack Pladziewicz
For the Chippewa Valley Post
Employment compensation – both public and private – consists of three elements: wages, benefits (primarily health insurance and pension) and job security. Historically, public employment has offered higher job security, better benefits and lower wages than comparable private sector employment.
While Wisconsin’s Act 10 fundamentally changed this balance in the state, significant differences remain. This analysis and two succeeding articles will not debate Act 10, but rather will examine the current balance of the benefits portion of compensation in public and private sector employment. The goal is to outline a plan that will improve the quality and lower the costs of benefits in both sectors.
Public Employee Benefits
Over the past several decades the portion of total compensation committed to benefits for public employees has increased to a significantly greater degree than in the private sector. There are several reasons for this.
First, collective bargaining resulted in public employers across the board picking up what had initially been employee contributions to pension costs and health insurance – often in place of wage increases. The result was that wages were suppressed in favor of benefits, which made benefits a larger and larger fraction of total compensation.
Second, healthcare costs grew at rates greater than inflation and came to dominate benefits costs. At the same time, public employees were successful in consistently negotiating for expensive low or no deductible “Cadillac” insurance plans.
Third, private employers moved away from defined benefit pension plans to defined contribution plans, most of which required employee matching. These defined contribution plans cost less than the defined benefit plans they replaced.
Finally, private employers, if they contributed to employee health insurance, usually did so by matching employee contributions and for much lower-cost, higher-deductible plans. These trends held benefits costs in check for private sector employees relative to public employees.
Act 10 dramatically changed this relationship by requiring an equal match on pension plan payments and a 12.5% minimum contribution to health insurance costs for most Wisconsin public employees. Nonetheless, significant differences remain in benefit packages between public and private sector employees.
There are important lessons to be learned and potential economic gains to be found by examining the remaining differences and the relative strengths of the approaches that public and private employers take to funding and structuring benefits.
Pension Plans
Over the past several decades, private employers moved away from defined benefit pension plans primarily because the costs were seen as either too high or too uncertain. Predicting how much to invest for each employee to meet the needs of a lifetime guaranteed monthly benefit required making estimates of the return on pension investments and longevity of employees that were highly uncertain.
Even for large employers, the costs of investment and management are significant and for a small employer they are nearly impossible. Moreover, there is always the possibility that a private employer will fail, leaving unmet pension obligations.
Defined contribution plans are clearer since the money needed to fund them is exactly known. If the company fails or the employee leaves, the growing pension can easily be rolled over to the next employer. These plans have worked well for employers because they contain costs and remove uncertainty, but they do not appear to be working very well for employees.
Numerous studies have highlighted the degree to which most defined contribution pension plans in the private sector are inadequate to fund retirement – even when combined with Social Security. In addition to being underfunded, these plans frequently rely on voluntary contributions from employees that require sustained discipline over a working lifetime.
As important, few employees, even with professional investment help, are prepared to make the investment decisions necessary to achieve gains that will build their portfolio to levels sufficient to support their retirement years adequately. And many of the most productive investment instruments are simply not accessible to the small or even the intermediate investor. They are only available to the largest pooled investment funds, such as Wisconsin Retirement System’s (WRS) Employee Trust Fund (ETF) or exceptionally wealthy individuals.
In contrast, the defined benefit pension plan enjoyed by all of Wisconsin’s public employees is a national model and continues to provide a lifetime benefit to tens of thousands of retirees. When combined with Social Security, that benefit provides a well-funded retirement.
What Does WRS Cost?
A widely held misperception is that WRS is unconscionably expensive. But when considering the benefit that results, the cost is both reasonable and sustainable.
Currently, the monthly retirement benefit for long-term employees is approximately 50% of final average earnings. This, combined with Social Security payments – and because retirees are no longer burdened with such things as payroll taxes and contributions to pension funds – produces an aggregate retirement benefit greater than 90% of final average take home pay.
The current cost of this benefit is 13.6% of wages contributed equally, i.e., 6.8% each by employer and employee. The State employer’s contribution is not that much larger than many private employers now contribute to various defined contribution or profit sharing plans. However, the eventual retirement benefit achieved with these private plans is often half or less of the defined benefit attained by WRS employees at retirement.
The primary reason for this striking difference is the cumulative effect of sustained, required annual payments to the retirement fund; professional management and investment; and the advantages that accrue to large investors over small investors. Moreover, a large aggregate pension fund like WRS’s ETF can continue to employ a long term investment strategy, while individual investors are forced to more conservative investments and lower returns once they approach, and continue through, retirement.
The perception is that Wisconsin taxpayers – which includes public employees, of course – are paying a very high cost for the retirement benefits of the state’s public employees and that is the reason for the generous defined benefit. The truth is that, as of early 2015, of the more than $96 billion in the ETF, nearly 80% comes from investment returns, according to Investment Board Executive Director Michael Williamson.
One dollar in five paid to retirees comes from employer and employee contributions; four in five come from investment returns. As currently configured, the WRS is a bargain – both for the State and the employee.
Given the success of the WRS why not extend it to private employees whose taxes support it? It only seems fair that the state’s private employers and employees should have access to the system they fund for their public employees. What would it take? Is it feasible? These questions will be explored in the second part of this series.
About the Author: Jack Pladziewicz was a member of the chemistry faculty at UW-Eau Claire from 1973-2002 and is Professor Emeritus. Between 2003-2014 he worked in various capacities for Research Corporation for Science Advancement (rescorp.org), a private foundation dedicated to funding basic scientific research in the United States since 1912. He retired as president of the foundation in 2014.
For a list of sources consulted for these articles, Click Here