A Hidden Issue in the PEB Report (In Plain Sight)

I have been posting about the recently-released Post-Employment Benefits Task Force report. If you go to the master website where the report and related documents are available, and if you scroll way down to the bottom, you will find the dissenting minority report. It is almost lost in the clutter but you can go directly there at http://universityofcalifornia.edu/sites/ucrpfuture/files/2010/08/peb_dissenting_082510.pdf On page 6 of that dissenting report, you will find a seemingly-technical discussion entitled “Is There a Need for Risk Adjustment in the Total Remuneration Study?” Don’t mistake that section for a mere dispute among pension experts.

UC has a defined-benefit (DB) pension plan. It promises future benefits geared to a formula related to age, service, and earnings history. As such, it has different consequences for different people, depending on those variables and their career profiles. In contrast, a defined-contribution (DC) plan such as TIAA-CREF is simpler to value.

Basically, the value to you of your DC plan is the money that you have accumulated in it, a combination of what was contributed and the earnings on those contributions. End of story. A DB plan, such as UC’s, is more complicated to value. You are promised a stream of future benefits which varies with the formula and how your career fits into it. You have no investment risk since the plan guarantees the stream.

In a DC plan, however, variations in financial markets cause the value of what is in your account to vary – so you do have a risk. A DB plan, in addition, has a value to the employer. It imposes “golden handcuffs” on mid-career individuals since leaving employment at that point involves a substantial cost in lost pension benefits. It also gives a strong incentive for end-of-career individuals to retire since each year that passes is one year of lost pension benefits.

Standard methodology of pension consultants that value DB plans makes an allowance for the value of the plan’s protection of participants from market risk. There can be arguments about whether that methodology gets it right – but not about whether some allowance is made. However, as the minority dissent indicates, there is a push to promote the idea that our DB plan, and any two-tier DB plan that the Regents might create, are in fact worth more than the standard methodology suggests.

Why is this important? The PEB majority report pays lip service to competitive pay for faculty and staff. But if the value of UC’s pension offerings can be inflated by an alternative valuation methodology, there is less of a salary gap against the comparison-8. (The comparison-8 universities are those with which UC compares its pay.) And whatever reduced two-tier pension plan is adopted will look better under an inflated methodology. Even a whisper to the Regents that our plans are really worth more than it appears could lead to a decision adverse to faculty and to a wider gap in the academic job market between UC and the comparison-8.

That is why this section of the minority dissent ends with the statement:

We recommend that the President declare that the University will not abandon the industry-standard total remuneration methodology that has already guided the analysis of salaries and benefits for several years, and to reiterate the administration’s commitment to competitive total remuneration as its top budgetary priority.

Bottom line: The semi-hidden issue involving the value of protection from financial market risk is a very important component of the decision process on dealing with UC’s pension dilemma.