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Wednesday, September 12, 2012

The folly of the DROP, part two

The most compelling argument for the Deferred Retirement Option Plan (DROP) is that it is a win-win proposition for employees and employers.  The DROP allows an employee to "retire" out of PSPRS but continue working for up to five more years.  The employee's monthly retirement payments accumulate tax-free while in the DROP and are paid out with interest when the employee finally leaves the job.  The final lump sum payout to the employee can be hundreds of thousands of dollars.  It proves to be such an attractive idea because it contradicts the old adage that there is no such thing as a free lunch.  Is it really possible to create a program that earns PSPRS members a large end-of-career bonus and save taxpayers money?

Of course not. Many years ago Fram had a commercial that highlighted the importance of preventive maintenance through the use of its oil filters.  Mechanics would contrast the cost of regular oil changes versus the expense of rebuilding an engine.  They would end the commercial by saying, "You can pay me now or pay me later."  This sums up the problems with the DROP.

The DROP was sold to politicians as a money-saving measure because, while an employee is in the DROP, the employer does not have to contribute anything to PSPRS for that employee.  This can save an employer thousands of dollars a year for just one employee and free up money for other purposes.  If hundreds of employees are in the DROP, the savings can be in the millions.  So far, so good--sounds like a great idea.

The problems begin when we consider that an employee enters the DROP at his highest earning years.  When both the employer and the employee should be making their greatest contribution to PSPRS, they both pay nothing.  Furthermore, those in the DROP were guaranteed an interest rate as high as 9% on their accumulated retirement payments.  This interest was paid even in years when PSPRS suffered huge losses on it investment portfolio.  The DROP not only starves PSPRS of funding but can rob principal from PSPRS when investment returns are bad.

That should be enough to make the DROP unworkable, but it gets worse.  Employees have a fixed contribution rate, which limits their liability.  Taxpayers, however, have an open-ended commitment to PSPRS.  After employees have paid their fixed contribution, taxpayers must pick up whatever else is needed to make up for shortfalls in PSPRS.  Taxpayers never received any true savings and just deferred costs they could have paid in the past (during a better economy) until now.  "You can pay me now, or you can pay me later."

Politicians look only to the next election, so of course, they approved the DROP.  It freed up money they could spend immediately at the expense of the future.  Those who pitched this to politicians selfishly helped themselves to a huge windfall.  While this was supposed to benefit taxpayers by saving money and retaining experienced personnel, taxpayers ended with nothing but debt.  Somebody won with the DROP, but it certainly wasn't the taxpayer.

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