The Governor has proposed to offer executive branch employees an Early Retirement Incentive Progam (ERIP). The program would cost half a billion dollars more than a hiring freeze and has the potential to damage the essential missions of many state agencies.
Essentially, certain employees who are already eligible for retirement would receive a boost in their future annual pension amounts if they leave before the start of the coming fiscal year. The lump sum value of those future payments is expected to average a little under $100,000 per employee.
The ERIP, although it involves a huge giveaway, is presented as saving money in the following sense: The costs of the giveaway (in cash equivalent discounted for the time value of money) become less than the payroll savings after a year or two as long as the state leaves most of the positions vacant. It also avoids the possibility of strife associated with layoffs. The question that isn’t always asked is: What are the alternatives?
The Governor expects 4500 employees to take the ERIP and the plan allows him to use 20% of the direct payroll savings to hire some new people (who might come in at lower salaries). So, the net headcount reductions would be roughly 3500 people. Coincidentally, 3500 to 4000 people leave the executive branch voluntarily every year. So, a strengthened and extended hiring freeze could accomplish the same head count reductions in roughly 12 months and save the half a billion dollars in increased pension costs associated with the ERIP.
From the standpoint of new cabinet secretaries, the attraction of the ERIP is that all the reductions would be accomplished at once and they could immediately start hiring and remaking their organizations. In addition to the 20% immediate rehiring built into the ERIP plan, there would be no need to freeze replacement of those who depart for other reasons over the course of the year.
A hiring freeze would force the new executives to move much more slowly, hiring only from within and reallocating positions over time. That’s actually a much wiser approach. In some agencies, as many as half of the employees would be eligible. The mass departures likely with the ERIP could mean a crippling loss of organizational expertise and momentum. The executives will gain a much deeper understanding of their organizations and will make much better decisions if they implement change more deliberately.
The ERIP raises very concrete fairness concerns — in many agencies, employees eligible to receive the valuable ERIP package are seated next to others who have been around a little too long to benefit or not quite long enough. And there are many who do not qualify as a result of their funding source. Those ineligible or unable to benefit will have to pick up the slack when their lucky colleagues depart. In testimony this week, some employees and unions were naturally enthusiastic about the benefit and sought to expand it. But some employees testified to express bitter reservations about the unfair distribution of largesse.
Summary Comparison of ERIP to a Hiring Freeze
|Expected net work force reduction
|3500 – 4000 executive branch employees
|3500 – 4000 executive branch employees
|FY17-FY19 annual savings
|Long-term payroll savings
|Dependent on future decisions
|Dependent on future decisions
|Annual continuing incremental pension costs
|Present value of all cash flows (relative)
|$360 million cheaper
|Risk to state agency missions
|Arbitrary distinctions among employees
The Q&A below further explores the ERIP and the alternative of an extended hiring freeze.
Who does the ERIP apply to?
The ERIP is available only to employees meeting all of the following criteria:
- They work in the Executive Branch — that is, they work for the Governor, directly or under one of the eight executive offices that serve under the governor. Employees of other branches of government, of independent agencies and of the state university system are excluded by this rule.
- They are in active service — not retired already.
- Their position is funded out of the state’s general fund, as opposed to a trust fund or a federal grant. This criterion is ambiguous in some cases as employees may receive their compensation from multiple sources and/or show up as funded from different sources at different times of the year. MassDOT employees are explicitly made eligible, even though they are funded from the Transportation Trust Fund. (In the House version of the bill, MassDOT toll-takers, who already have a retirement incentive in place, are explicitly excluded).
- They are “Group 1” employees. Group 1 is the general catch-all category for state workers. Group 1 employees are eligible to retire at their maximum possible pension at age 65 with 32 years of service. Groups 2, 3 and 4 include certain employees in dangerous or physically demanding jobs who are permitted to retire earlier.
- They are already eligible for a pension, having achieved 10 years of service and the age of 55 or having achieved 20 years of service.
- They are not elected officials.
- They elect to retire before the start of the coming fiscal year (or, in the House version of the bill, one month into the fiscal year).
How does the ERIP work?
Under the ERIP, an employee can receive:
a combination of years of creditable service and years of age, in full year increments, the sum of which shall not be greater than 5 years, for the purposes of determining his superannuation retirement allowance.
Employee pensions are computed as a Retirement Percentage multiplied times the average of the employee’s highest three years of compensation. So, for example, if in their last three years of service, they received $69,000, $70,000 and $71,000, their pension would be computed as the Retirement Percentage multiplied times $70,000.
The Retirement Percentage is determined by their age and their years of service — the longer they have served and the older they are, the higher the Retirement Percentage. The ERIP, by adding to their age and/or years of service increases their Retirement Percentage. See this schedule of Retirement Percentages from the state retirement Board.
The way the numbers work, an employee eligible for the ERIP will receive a pension that is increased by an amount that is somewhere between 7.5% and 20% of their highest three years of salary. For example, checking the schedule, if an employee were 55 years of age and had 20 years of service, the ERIP would raise their Retirement Percentage from 30% to 40%. If their highest three years of compensation averaged to $70,000, the ERIP would be worth $7,000 per year every year for the rest of their lives — ( 40% – 30%) x $70,000 ).
The ERIP cannot be used to increase the Retirement Percentage above the 80% maximum level, so employees who are already at or near that level cannot benefit from the ERIP, although they would be technically eligible.
How much is the ERIP worth to each employee?
The ERIP will give each employee $93,200 cash equivalent on average. The value of the ERIP is a function of age, years of service, compensation level and also life expectancy. The actuaries at the state’s Public Employment Retirement Administration Commission have computed — very roughly — that the average retiring employee will have an average compensation level of $68,100 and that the cash equivalent of the ERIP will average $93,200. The employees will receive the payments over the rest of their lives. Those payments over time could total as much as $200,000 for some employees. The $93,200 is the average “lump sum” or “cash equivalent” or “present value” — as if they could receive all the ERIP money in a single payment of immediate cash which they could invest and make a return on so as to generate the same stream of future payments. The rate of return assumed by PERAC in making its estimates is 7.75%.
How much would the ERIP cost the Commonwealth?
$419.4 million — present value. In making an estimate of total cost, the estimated average per employee is multiplied by the expected number of employees who will take the incentive. The Governor is hoping for 4,500 takers. $419.4 million = 4,500 x $93,200. The final value could be higher or lower. Over time, the undiscounted outflow will add up to over $700 million.
How will the cost of the ERIP be absorbed?
The ERIP will actually be paid out over the lives of the retiring employees. The actual budgetary impact of the cost depends on how far we are willing to “kick it down the road.” The administration proposes to amortize the cost over 15 years, making a down payment of $48.8 million in Fiscal 2016 to the state’s pension fund. At this rate, in total, the Commonwealth would need to contribute 15 x $48.8 million or $732 million over the next 15 years. (The computations are exactly like mortgage computations — $48.8 million is roughly the annual payment amount on a 15 year fixed-rate mortgage for $419.4 million at a 7.75% interest rate. PERAC uses the 7.75% interest rate because that is the rate they hope to achieve on their investment portfolio, which is in the equity markets. PERAC recommended using a 10 year amortization schedule, which would require annual contributions by the Commonwealth to the pension fund of over $60 million.)
Mechanically, how does the ERIP fit into the Fiscal 2016 budget?
In outside section 29 of his proposed budget, the Governor creates a mechanism whereby the secretary of administration and finance can recognize the payroll reductions resulting from the ERIP by adjusting allotments to individual line items.
Whenever the secretary of administration and finance determines that an early retirement incentive program has resulted in cost savings for an agency of the executive department during fiscal year 2016, the secretary may reduce allotments under section 9B of chapter 29 of the General Laws to reflect some or all of the amounts saved.
The ERIP payroll reductions will, of course, be spread unpredictably across multiple line items. They are therefore not estimated or budgeted in individual line items (although I understand verbally that a couple of A&F line items do assume ERIP related headcount reductions). In the Governor’s pro forma financial statement the full amount of the projected ERIP payroll savings appears as a lump sum of $325.1 million which is subtracted from appropriated expenditures of $38,387.4 million to reach net total spending of 38,062.3. $325.1 million is equal to 4,500 (number of employees expected to take the ERIP) x $72,244 ( the average salary apparently estimated by A&F — a little higher than PERAC’s estimate of $68,100 ).
So, once the payroll reductions from the ERIP are known, they will be apportioned across all affected line items by the Secretary of Administration and Finance. The language of the section gives the Secretary discretion to not make the full downward adjustment in affected line items, in effect, allowing rehiring in those line items. The Governor’s budget also includes a reserve account that is intended to “to fund the direct payroll costs of employees who fill positions vacated pursuant to the employee retirement incentive program.”
So, in a crude accounting sense, the $325.1 million is a negative budget account and when payroll reductions are achieved through the ERIP, they will reduce both the affected line item and the magnitude of the negative account. When people are rehired, they will increase the affected line items and reduce the salary reserve.
The amount of the salary reserve is $63,340,000 — roughly 20% of the projected ERIP payroll savings, consistent with the administration’s representations that they want to be able to rehire against up to 20% of the salary savings.
What is the FY16 budgetary impact of the ERIP?
The budget impact in FY16 is $177.9 million:
|Projected Payroll Savings
|Less: First year pension cost reserve
|Less: 20% reserve for back fill of employees
|Less: Reserve for nonpayroll costs
|Net FY16 Savings
The FY16 savings associated with the ERIP may be reduced as a result of amendments to section (g) which spreads over 4 years the normally immediate payout of any accrued sick leave or vacation. The House version adjusted this to 3 years which would require an increase in the necessary reserve for FY16 non-payroll costs.
What alternative inducements could be offered for retirement?
In testimony this week, the Secretary of Administration and Finance stated that she had not reviewed alternative models from the private sector, but had instead simply implemented the ERIP model previously used by the state over a decade ago. There are, of course, many types and levels of inducement towards retirement that could be offered, some of which might be much more cost-effective in reducing payroll. As noted above, the particular form of the ERIP tends to target those employees that are not on the cusp of retirement, but are a couple of years away from retirement. A cash incentive could accelerate departures all up and down the seniority scale, including younger employees, mid-career employees and the late career employees who are too close to retirement to benefit from the ERIP. The per employee cost of the ERIP is close to $100,000 — a much more modest cash inducement might have a big impact.
Is the ERIP necessary at all — would an extended hiring freeze suffice?
According to the Commonwealth’s Human Resources department, roughly 3500 to 4000 people leave the executive branch every year — a little less than half through retirement, a little less than half through resignation and the rest through death or discharge.
If the legislature mandated that the Governor limit replacements of departing positions to promotions and lateral transfers, the headcount reductions that the Governor seeks would be achieved within one year. Of course, there would necessarily be some exceptions to a freeze and the volume of permitted exceptions would slow the reductions resulting from the freeze.
How would an extend hiring freeze be implemented in the budget?
There are at least two alternatives:
- The legislature could simply budget slightly less than the Governor in most major payroll-driven line items. The Governor would then have to manage those line items downwards through expected attrition and possibly a few layoffs. To match expected attrition, the legislature would budget approximately 4 to 5% less than maintenance funding — by the end of year, a little less than 10% of employees will depart, but the full year savings will be a little less than half that level.
- Or, the legislature could assume in, its proforma financial projections, a fixed amount of savings (as the Governor did for the ERIP) and rewrite outside section 29 — the ERIP savings section — to give the Secretary of A&F the authority to reduce allotments as departures occur. The legislature could take a further step and allow the Secretary to reduce some allotments and make necessary layoffs if sufficient savings do not materialize — as in the current version of Section 29 for the ERIP.
How does an extended hiring freeze stack up next to the ERIP in FY16?
|Less: First year pension cost reserve
|Less: 20% reserve for back fill of employees
|Less: Reserve for nonpayroll costs
|Net FY16 Savings
Notes to freeze savings estimates:
- The freeze payroll savings of $114,000,000 are computed as follows: 3,800 ( employees departing ) x 0.5 ( assuming that they depart randomly through the year, on average half way through year ) x $60,000 (average compensation per employee).
- The $60,000 estimated payroll per employee requires some refinement. It may be overstated, but could also be understated: The per employee estimates used by PERAC and A&F for the ERIP are closer to $70,000. Among the routine annual departures, a little less than half are through normal retirement — that means they have more seniority and are making more than those who might take the ERIP. The resignations, deaths and discharges among the routinely departing employees will include some younger employees. The younger employees are presumably making less, but, on the other hand, when they depart, their health insurance costs end, while all the employees leaving with the ERIP will have continuing retiree health insurance costs.
- Note that other termination costs related to routine departures need to be built into the budget regardless of whether one has an ERIP, so they are not a cost factor attributable to a freeze.
How does an extended hiring freeze stack up next to the ERIP in FY17, FY18 and FY19?
|Less: Continuing pension cost amortization
|Less: Retained backfilled employees
|Less: Deferred nonpayroll costs (4 year amortization)
|Net savings in each of next three fiscal years
In summary, what is the cost comparison between a freeze and the ERIP?
The freeze saves, very roughly, $360 million in cash equivalent present value over the ERIP. There are lots of uncertainties, but it appears that the ERIP would save roughly $60 million more in FY16, but save roughly $50 million less in future years. The salary savings and other costs in the two approaches will equalize over time, but the pension amortization cost difference will endure. So, it appears fair to claim that the freeze would save approximately $360 million as compared to the ERIP (the ERIP pension amortization present value cost of $420 million less the $60 million savings advantage of the ERIP in the first year).
What are the management issues associated with the two alternatives?
Clearly, the ERIP gives managers much greater flexibility to hire and reshape their organizations. Not only will they have the 20% backfill authorized by the ERIP, but they will not necessarily be subject to a hiring freeze — all of the targeted head count reductions will have been achieved by the ERIP.
However, there are huge risks associated with ERIP. Some departments could experience sudden unmanageable losses of client relationships, contextual knowledge and/or expertise through the ERIP. The option of bringing ERIP employees back as consultants may offer a partial solution in some cases, but is offensive financially. When asked this week whether she had target levels in mind for particular agency headcounts after the ERIP and subsequent back fill, the Secretary of Administration and Finance said she did not. So clearly, the administration has not fully reflected on the consequences of the ERIP.
The chart below shows the number of employees eligible for the incentive by department. It presents one of three different department-level estimates I have seen from official sources. All of them involve some uncertainty, but they are all broadly consistent in identifying certain large agencies as having more than 40% of their employees eligible to leave under the proposed ERIP. Certainly, not all those eligible will take it, but the risks are clear.
ERIP Eligible Employees as % of Total by Department
|DEVELOPMENTAL DISABILITIES COUNCIL
|DEPARTMENT OF AGRICULTURAL RESOURCES
|ADMINISTRATIVE LAW APPEALS DIVISION
|EXECUTIVE OFFICE FOR ADMINISTRATION AND FINANCE
|APPELLATE TAX BOARD
|BOARD OF LIBRARY COMMISSIONERS
|BUREAU OF STATE BUILDINGS
|EMERGENCY MANAGEMENT AGENCY
|SOLDIERS' HOME IN MASSACHUSETTS
|CRIMINAL JUSTICE INFORMATION SERVICES DEPARTMENT
|MUNICIPAL POLICE TRAINING COMMITTEE
|CHIEF MEDICAL EXAMINER
|CIVIL SERVICE COMMISSION
|CAPITAL ASSET MANAGEMENT AND MAINTENANCE DIVISION
|DEPARTMENT CONSERVATION AND RECREATION
|DEPARTMENT OF FIRE SERVICES
|DEPARTMENT OF MENTAL HEALTH
|DEPARTMENT OF DEVELOPMENTAL SERVICES
|DIVISION OF BANKS
|DEPARTMENT OF CORRECTION
|DEPARTMENT OF ELEMENTARY & SECONDARY EDUCATION
|DIVISION OF INSURANCE
|DEPARTMENT OF REVENUE
|DIVISION OF STANDARDS
|MASSACHUSETTS DEPARTMENT OF TRANSPORTATION
|DEPARTMENT OF PUBLIC HEALTH
|DEPARTMENT OF PUBLIC SAFETY
|DEPARTMENT OF PUBLIC UTILITIES
|DEPARTMENT OF CHILDREN AND FAMILIES
|DEPARTMENT OF YOUTH SERVICES
|EXECUTIVE OFFICE OF EDUCATION
|DEPARTMENT OF EARLY EDUCATION & CARE
|EXECUTIVE OFFICE OF ECONOMIC DEVELOPMENT
|EXECUTIVE OFFICE OF HEALTH AND HUMAN SERVICES
|DEPARTMENT OF ELDER AFFAIRS
|DEPARTMENT OF ENERGY RESOURCES
|EXECUTIVE OFFICE OF ENVIRONMENTAL AFFAIRS
|EXECUTIVE OFFICE OF LABOR AND WORKFORCE DEVELOPMENT
|EXECUTIVE OFFICE OF PUBLIC SAFETY & HOMELAND SECURITY
|DEPARTMENT OF ENVIRONMENTAL PROTECTION
|DEPARTMENT OF FISH AND GAME
|GROUP INSURANCE COMMISSION
|CENTER FOR HEALTH INFORMATION & ANALYSIS
|SOLDIERS' HOME IN HOLYOKE
|HEALTH POLICY COMMISSION
|HUMAN RESOURCES DIVISION
|MASSACHUSETTS OFFICE OF INFORMATION TECHNOLOGY
|GEORGE FINGOLD LIBRARY
|MASS COMMISSION FOR THE BLIND
|COMMISSION FOR THE DEAF AND HARD OF HEARING
|MASSACHUSETTS MARKETING PARTNERSHIP
|MASS REHABILITATION COMMISSION
|DEPT OF HOUSING AND COMMUNITY DEVELOPMENT
|MASSACHUSETTS OFFICE ON DISABILITY
|OFFICE FOR REFUGEES AND IMMIGRANTS
|DIVISION OF OPERATIONAL SERVICES
|PUBLIC EMPLOYEE RETIREMENT ADMINISTRATION
|DEPARTMENT OF STATE POLICE
|DIVISION OF PROFESSIONAL LICENSURE
|DEPARTMENT OF HIGHER EDUCATION
|OFFICE OF CONSUMER AFFAIRS AND BUSINESS REGULATION
|DEPARTMENT OF BUSINESS AND TECHNOLOGY
|SEX OFFENDER REGISTRY
|STATE RECLAMATION BOARD
|DEPARTMENT OF TELECOMMUNICATION AND CABLE
|TEACHERS RETIREMENT BOARD
|DEPARTMENT OF VETERANS SERVICES
|DEPARTMENT OF TRANSITIONAL ASSISTANCE
|Executive Branch Total