For over fifty years, Palm Beach, California maintained a generous traditional defined benefit (DB) pension plan for its employees that based benefits on a percentage of the employee's final average pay times years of service. As employees accumulated service and their pay increased over the years, their pension benefits grew exponentially. Upon retirement, the benefit was paid in the form of a life annuity, thereby guaranteeing that participants would never run out of money.
During the 1990s, the plan was well funded due to strong returns on the assets in the pension fund. However, the financial markets experienced severe losses during 2001 to 2002 and 2008 and 2009, which required Palm Beach to make significant contributions to the plan, considerably increasing the Town's costs. In an effort to save money, the Palm Beach Town Council voted in April of 2012 to freeze benefits earned under the DB plan and, going forward, to provide retirement benefits under (i) a defined contribution plan (DC) that based benefits on the performance of assets allocated to an account for the employee, and paid only the account balance at retirement, and (ii) a much less generous DB plan. The move was supposed to cut the Town's costs by 45%.
For existing Palm Beach employees, the new retirement program meant deep cuts in their anticipated retirement income. They reacted swiftly and negatively. Twenty percent of them retired shortly after the change, and 109 of the Town's 120 trained police and firefighters left in the next four years. Many of these trained public safety employees went to nearby towns that offered more generous DB plans.
The rapid exodus of so many experienced police and firefighters from Palm Beach proved expensive for the Town, and in ways it had never anticipated. The few public safety officers who stayed had to work horrendous amounts of overtime in order to cover the gap and ensure public safety. Not only was this a disincentive for them to remain with the Town, but the increased overtime hours were an added expense for the Town's citizens. In addition, the Town's costs to train new public safety officers, estimated at $240,000 per officer, surged with some estimating the tab to total $20 million or more. By 2016, the Palm Beach Town Council was ready to cry "Uncle." It voted to abandon the DC plan for police and firefighters and enhance their DB plan benefits by enriching the DB formula and lowering the retirement age.
The failed Palm Beach experiment offers several lessons. First, before making any major changes to an existing plan, consider the possible consequences, not just the potential savings calculated by an actuary. Second, DB plans are an important tool for recruiting and retaining employees, especially public safety employees. Police and firefighters are exposed to considerable physical risks daily, often for relatively low pay compared to what they could earn in the private sector. In exchange, they expect benefits that will permit them to retire comfortably and without running out of money (a risk when the benefit is only a DC account balance). Third, replacing an adequate DB plan benefit with a skimpy DB plan benefit or DC plan benefit will not necessarily save money. On the contrary, it could end up costing more, as occurred when Palm Beach made these types of changes to its retirement program. Fourth, and perhaps most importantly, recognize that employees are not stupid. They know when a new retirement program effectively cuts future benefits and is not in their best interests.
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