The Ohio Public Employees Retirement System Board of Trustees in February updated its pension legislation proposal with an anti-spiking measure. Several of our members responded to last week’s blog on this topic with questions about how the new measure would work.
The Board acted to curb the practice of “spiking,” whereby a small number of members receive a substantial increase in pay, usually at the end of their careers, thereby attaining pension benefits that outdistance their contributions. This measure aligns with our goal to eliminate unfair subsidization of one member’s benefits by other members.
Before discussing details of the measure, we must note that it requires approval by the Ohio General Assembly. Thus, we view it as a proposal, although one we believe has merit as a potential blueprint for other public pension funds that wish to limit spiking.
In the past, the Board tried to address the practice of spiking by limiting the final average salary to a member’s three highest years. The benefit cap does not take the place of the final average salary calculation, and one of the Board’s pension redesign proposals is to increase the final average salary timeline from three years to five years.
The basis of the Board’s proposal in February relates to the member’s lifetime contributions, not to FAS. We refer to it as the contribution-based benefit cap. It is meant to reduce benefits that “spike” the system because a subset of the member’s contributions is out of proportion with his or her career-long contributions. The cap is not designed to impact members who receive typical salary increases and promotions throughout their careers.
For example, take two 67-year-old public servants who retire with 32 years of service credit. “Anna” has had steady salary increases to achieve a final average salary of $54,000 at retirement. “Bob,” who was paid at a very low salary for 27 years, then moved to a much higher-paying job for the final five years of his career, also achieved a FAS of $54,000.
In each case under the traditional benefit formula, Anna and Bob would receive a pension benefit of $38,000. However, while Anna has contributed (with interest) $102,000 to her pension over the course of her working career, Bob has contributed only $64,000. (OPERS members pay at least 10 percent of their salary toward their retirement.)
The OPERS anti-spiking proposal would reduce Bob’s annual benefit by using the following formula, which reflects his lower lifetime pension contributions:
Accumulated contribution x Annuity factor x Contribution-based benefit cap (CBBC) factor = Annual benefit
Here are the formula definitions:
- Accumulated contribution: The amount that the member paid into to the pension, plus interest.
- Annuity factor: An age-based figure that converts the accumulated contribution to an annuity payable over the retiree’s expected remaining life.
- CBBC factor: A number that reflects the size of the gap between the formula benefit and the annuitized accumulated contribution.
- Annual benefit: The amount the member receives yearly.
In these examples, the annuity factor for a 67-year-old is .08664. The benefit cap factor that the Board selected is six, which means the benefit would be capped if it were to be six or more times the annuitized accumulated contribution.
Applying the anti-spiking formula yields the following results:
Anna’s annuitized accumulated contribution:
$102,000 x .08664 = $8,837
Because Anna’s formula benefit of $38,000 is less than six times her annuitized accumulated contribution benefit of $8,837, she would receive the formula benefit of $38,000.
Bob’s annuitized accumulated contribution:
$64,000 x .08664 = $5,545
Because Bob’s formula benefit of $38,000 is more than six times his annuitized accumulated contribution benefit of $5,545, his benefit would be capped using the formula mentioned above:
$64,000 x .08664 x 6 = $33,270
Bob would receive an annual benefit of $33,270 rather than $38,000.
Using a factor of six for the benefit cap would have affected just 2 percent of age and service retirees from 2006-2010. The Board wanted to address spiking in a way that creates a measured response to the situation and would not negatively affect members that provide adequate contributions over time to help fund pension payments.
In summary, the OPERS-proposed CBBC is a new approach to address spiking because it focuses not on final average salary but on accumulated contributions by the member. It is meant to impact only those members who have a formula benefit out of proportion with their contributions.
It also is important to note that this anti-spiking measure would not be applied retroactively. It would apply only to members who retire after pension legislation becomes law.