Real cost of OT abuse? Pension spiking

Overtime abuse by public employees has a hidden cost that far exceeds the overtime pay they receive. The Hawaii Employees’ Retirement System (ERS) determines the pension benefit for public employees based upon a percentage of their Average Final Compensation (“AFC”). A retiring employee’s three highest years of compensation is selected in calculating the AFC.

For public employees hired before July 1, 2012, under the current formula, compensation includes not just the annual base salary of an employee but also supplemental compensation such as overtime. As a result, overtime pay can substantially increase an employee’s AFC resulting in a sizable boost in the pension annuity a retiring employee is entitled to receive.

For example, assume a retiring employee provides 30 years of service and enjoys regular pay increases without any extraordinary supplemental compensation. Upon retirement, if the highest three years of compensation resulted in an AFC of $60,000, the employee would be entitled to a pension annuity of $36,000 for life (before cost of living adjustments, or COLA).

However, if that same employee receives overtime pay during the final years before retirement that boosts the AFC to $200,000, the employee’s pension would be $120,000 a year for life (before COLA adjustments). So from a $60,000 annual base salary, the employee retires and immediately enjoys a retirement benefit that far exceeds his or her pay as an active employee. The circumstance described in the fact pattern is commonly referred to as “pension spiking.”

As ludicrous as the example may seem, it parallels an actual situation that confronted the ERS. The enhanced retirement benefit for a single employee increased the retirement cost to the ERS by more than $1 million in excess of the career pension contributions for that employee. The contribution shortfall adds to the unfunded liability of the ERS. Although the cited example is an extreme situation, it doesn’t take many less extreme cases of overtime abuse to add millions of dollars in enhanced pension benefits for which the ERS accrues liability and taxpayers must fund.

The reality is that pension spiking is an aberrant practice exploited by some employees for their financial gain. Theoretically it is within the scope of management to control overtime abuse. However, if management lacks the ability to curtail spiking or, worse yet, if management is complicit, then the system is unable to protect itself from abuse.

Certain government agencies are particularly susceptible to overtime abuse and spiking. Those with operations that extend beyond a normal workday have chronically suffered from the highest level of overtime among all agencies and disproportionately impact the pension liabilities of government. Collectively the cost of spiking has increased the unfunded liability of the ERS by tens of millions of dollars over just a few years.

Serious policy examination is warranted regarding whether any reasonable justification exists for awarding employees spiked pensions because of episodic increases in their compensation during a fraction of their years of career service.

Past initiatives promoted by the ERS to curb this abusive practice have been rejected. Instead the law was changed to exclude overtime in determining AFC only for new employees hired since 2012 — a small fraction of all public employees. Without effective reform measures enacted into law, spiking is likely to continue to further burden the pension system and taxpayers with rising financial costs for decades.

Public officials and public employee unions must acknowledge the need for meaningful change and collaboratively work toward a rational and sustainable financial solution. Failing to do so will only worsen the widening fiscal gap that flaws in the design of the public employee pension system currently enables.

Wesley Machida and Colbert Matsumoto are trustees of the Hawaii Employees Retirement System; Machida also is Hawaii’s director of Budget and Finance.