Early Retirement Incentives and Severance Pay Incentives

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1 Date: March 15, 2010 To: From: Re: All Recognized Employee Organizations Sacramento County Management Association Data Processing Professionals Association Steve Keil, Assistant to the County Executive Early Retirement Incentives and Severance Pay Incentives There has been considerable interest and discussion regarding both early retirement incentives and severance pay incentives for Sacramento County employees. The proponents of each believe that use of incentives that result in voluntary employee terminations or retirements are preferable to use of employee layoffs to achieve necessary budget reductions. Proponents believe that vacancies created by voluntary terminations coupled with cost avoidance of Unemployment Insurance (UI) claims will more than pay for the cost associated with either approach. Unfortunately, we are unable to find a cost effective approach for either early retirement incentives or severance pay incentives. Early Retirement Incentives: Issue: Early Retirement Incentives are commonly referred to as Golden Handshakes and for purposes of this memo refer to actions that would enhance retirement benefits as an inducement for employees to accept an earlier retirement. Two approaches have received widespread attention. The first is use of existing Government Code authority that permits the County to purchase up to two additional years of service. The second involves adding additional cash value to highest compensation for computing retirement benefits by adding the cash-out value of amounts of vacation leave. Extended Service Credits: During the spring of 2009, with the assistance of the Sacramento County Employee Retirement System (SCERS) the County engaged the Segal Company, the actuarial firm that provides services to SCERS, to perform an actuarial study on use of extended service credits by Sacramento County. This was done to determine whether we could demonstrate that extended service credits would create budget savings as well as mitigate employee layoffs. In conclusion, we could not demonstrate such savings.

2 The Segal study identified 2,965 County employees who would be eligible to apply for the extended service credits. Although there is not certainty regarding the number of employees who would have accepted the extended service credit were it to have been offered early in Fiscal Year , SCERS staff estimated it would be up to approximately twenty-five percent of that total. If twenty-five percent of eligible County employees accepted the extended service credit offer, and should their positions have remained vacant, the annualized salary savings would have been approximately $72 million. The cost of this benefit would be an employer obligation. If paid immediately by the County, the cost would have been $74.6 million. If the County decided to amortize the cost over the twenty-four year funding horizon currently available through SCERS the total cost would have increased with additional interest payments; based upon annual payments of $6.9 million, the total cost would rise to approximately $165.6 million. The Segal study estimated a significant portion of employees who would accept the extended service credits already would retire during the subsequent two years, and thus their vacant positions do not represent a true cost reduction resulting from the extended service credits. The actuaries estimated that 552 County employees will retire during the plan year and 409 will retire during the plan year irrespective of the extended service credit. Management of vacant positions to ensure adequate savings to pay for the proposed extended service credit benefit is a significant challenge. Some vacant positions must be filled due to their criticality; others provide no real savings because they are revenue generating positions; additionally, over time it becomes difficult to manage work-load shift from vacant positions to other positions. The County does not have funds to immediately pay SCERS for the extended service credits. Banking savings from vacancies to pay for this benefit faces challenges due to uncertain reimbursement from federal, state and local revenue generating revenue sources. The option of amortizing the costs over twenty-four years would provide immediate savings but poses the greatest management problems to ensure future year savings equal to benefit costs. In short, we could not demonstrate that extended service credits would cost savings to offset cost increases. The County will not be offering extended service credits for early retirement incentive. 2

3 Cash-out of vacation balances as part of final compensation for retirement benefit computation: An additional proposal to induce early retirements with enhanced benefits has also arisen. That proposal would provide for adding, on a one-time basis, the value of some cashed-out vacation accruals to final compensation for purposes of increasing highest compensation for determining retirement benefits for employees who agree to retire within a specified time period. We have not conducted an actuarial study on this proposal however we anticipate similar concerns with proceeding with this proposal as with the extended service credits discussed above and the County will not be offering cash-out of vacation balances as part of the final compensation for retirement benefit computation. Severance pay as an inducement for voluntary separation from employment: Issue: The County does not offer severance pay as an inducement for voluntary separation from employment and does not have plans to implement a severance pay plan. Severance pay involves a payment to an employee as an inducement to terminate County service. With severance pay plans, there need not be an assumption the terminating employee would be eligible to, or in fact would retire upon termination. Since acceptance of severance pay involves a voluntary employee decision, the presumption is that the terminating employee would not qualify for UI benefits, unlike a laid-off employee. Unlike the enhanced retirement benefits referenced in above, there is no additional County financial obligation beyond the incentive payment. Also unlike extended retirement service credit, severance pay generally requires a compensation payment upfront to the terminating employee. Other Agency Strategies to Implement Severance Pay Plans: Based upon a survey conducted by the Department of Personnel Services in which responses were received from twenty-three counties of which eight offer severance pay plans plus the City of Sacramento, following are the principal strategies used by the responding agencies to make effective use of severance pay: 1. Incentive: All severance plans have a fiscal incentive ranging from $7,500 to $30,000. Some plans increase payments for earlier separation, and some provide greater incentives for greater length of service. 2. Minimum service: To reduce the likelihood of providing severance pay to persons otherwise subject to layoff, some plans have minimum years of 3

4 service requirements (ranging from two to five years, or are limited to persons who submit applications for retirement). 3. Savings: Some plans require savings through position vacancies or position elimination. 4. Targeted payments: Some plans limit payments to employees in classes impacted by lay-off and/or in classes approved by the County Executive. 5. Administration: Plans have additional administrative requirements. Problems with Severance Pay Plans: Our decision against use of severance pay as an inducement for voluntary termination includes the following reasons: 1. Drawing from the conclusions of the Segal Company actuarial study regarding extended service credits for retirement, our belief is that a significant number of persons who would accept severance pay for termination would leave County service without such severance payment. 2. Severance pay is compensation and should be offered under the same conditions to all employees in a class. This will make difficult surgical severance payments exclusively used to avoid layoffs. 3. We have no certainty that non-general fund sources of revenue (including State and Federal and revenue-generated funds) could be guaranteed for payment of share-of-cost for severance payments. 4. There would be an up-front payment obligation for severance pay. To avoid necessity of yet additional lay-offs, these costs would need to be recouped during the same fiscal year by defunding positions and/or avoidance of UI costs. Many positions cannot be defunded and provide cost savings because their funding source is either non-general fund or revenue generating. 5. We cannot assume that all laid-off employees will utilize maximum amounts of UI benefits otherwise available under law due to acceptance of other employment or due to retirement. Consequently we cannot rely upon maximum UI benefit costs as an offset to severance pay costs. 6. If a severance-pay plan is undertaken with any delay in implementation (to coincide with the new fiscal year, due to collective bargaining, for administrative enrollment or other reasons) it may actually delay voluntary resignations that otherwise might occur at an earlier date. Conclusion: We face a very difficult budget problem in Fiscal Year with no available fund balance. Based upon our analysis, either early retirement incentives or severance pay would add additional costs that would necessitate yet additional budget reductions Please contact me if you have questions or comments. 4

5 cc Steven C. Szalay Nav Gill Agency Administrators Department Heads 5