Should FRS drop the D.R.O.P?

When the DROP was initiated, 6.5% was about 125% of the then 5.25% five year Treasury bond rate. With the yield on the five year T-bond down to 2.5%, the same 125% premium would put the DROP rate at 3%. If you survey other states with DROP plans, you will realize that 3% is a pretty common rate.

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Since potential legislative cuts to your retirement benefits are nearly inevitable, we thought it might be educational to discuss your Florida Retirement System Options, and what changes might be made.  More importantly, we want you to understand how they might affect you!  We will begin this week with the scoop on the Deferred Retirement Option Program (DROP).   (For an overview of the DROP program, please see FRSOptions.com)

Back in 1998, when the Deferred Retirement Option Program was initiated by the Florida Retirement System, the world was a different place!  The Stock Market was on a roll; having just completed a 10 year run that averaged 19.21% per year.  The 5 year Treasury bond was paying about 5.25% and the coffers of the Florida Treasury were flush.   Skip ahead to the beginning of 2010 and the stock market has just completed its worst 10 year stint in history, and has a net minus 2% return over the last 10 years.   The 5 year treasury is only yielding 2.5%, and the Florida Treasury is facing a revenue shortfall of some $3 billion.  A shortfall that is growing, and expected to get even more dire in the foreseeable future.

The Florida Legislature is faced with the daunting task of cutting the budget to meet the shortfall in tax revenues due to the monster recession, and the Florida Retirement System is facing its first year of underfunding in over a decade.  The”Sunshine Review” of the State Budget has a succinct outline of the budget situation.  Suffice it to say the politicians see employee pension plans as a cherry ripe to be picked.  By focusing attention on the temporary underfunding of the FRS pension plan, it seems to have made your retirement benefits an easy target for spending cuts to help balance the state budget. Despite the fact that FRS is one of the most solid Pension funds in the US.  You can expect that the legislature will be looking harder and deeper next year, and will most certainly put your retirement benefits at greater risk.

By now we all know of the myriad of bills introduced by the Senate and House, and how broad the scope of changes were.  Ultimately, the only real change for the year was a cut in the interest rate paid on the DROP from 6.5% to 3% (see the FRSOptions.info article on the cut).  While the cut will hurt future participants, it was not a fatal blow.  It was also logical.  When the DROP was initiated, 6.5% was about 125% of the then 5.25% five year Treasury bond rate.  With the yield on the five year T-bond down to 2.5%, the same 125% premium would put the DROP rate at 3%.  If you survey other states with DROP plans, you will realize that 3% is a pretty common rate.  Some programs pay as much as 4 or 4.5%, NONE as high as 6.5%.  The average is just over 3%.  Florida is just lowering the rate to a realistic rate.  Rest assured, many other states will be following Florida’s example.  While 6.5% interest is unheard of in this financial environment and the change to 3% is radical, but reasonable, the process to enact this law was anything but reasonable.  Everyone has a right to be angry about the process, and everyone should be on guard for the upcoming legislative session.

Before and after the cut in the DROP rate, there has been a lot of conversation in the press about the costs and merits of the DROP plan.  One of the best overviews we have found was in the Philadelphia City Paper in their article “The Billion Dollar Boondoggle, DROP is bleeding us dry.” While it is a complicated article to follow, it points out the obvious.  DROP was intended to be cost neutral to the Retirement System, but is not.  The actuarial work is complicated, but in layman’s math, it is pretty simple.  A participant in the DROP gets paid twice!  This “double dipping” is the crux of the problem.  As a DROP participant, you collect your full salary, plus the state pays your pension into a DROP account, and pays interest (now only 3%) on top of that.  I have tried to re-create the graph from the article below, with the average numbers for a FRS participant over 5 years.

(Assumptions $50,000 per year, special risk, age 50, DROP at 25 years or retire at 30 years.)

________________________With DROP __________ without DROP

Salary                                                    $250,000                              $250,000

Pension Contribution                                      0                                 $ 50,000

Pension paid into DROP                $199,266                                  $              0

DROP Interest paid                         $ 15,000_____________$             0

TOTALS                                              $464,000                                $300,000

Originally, DROP was initiated to keep skilled workers on the job longer.  Since the state is no longer in a position to “pay up” to retain employees, it may not make sense to have a DROP program at all.  It would be wise to follow the summer study to see how it deals with DROP.  The same newspaper did a follow up article about how other states are dealing with the problem in their article “Corrupt and Contented.”

Participants have come to rely on, and perhaps feel entitled to DROP as a retirement enhancement.  Legislators representing ALL taxpayers will be asking, “Does this justify the expense of the DROP program.  There has been a lot of bad press in regard “double dipping” lately.  Most of it has been aimed at re-hiring, but more currently the entire DROP is being called into question.  It would not be a surprise if the DROP program goes away, particularly for new hires.  Several states, like Texas, have already discontinued DROP for new participants.  More will surely follow.

Even without DROP, FRS participants have one of the finest retirement plans in the country. We will be exploring how it compares in upcoming posts.  As much as we don’t want the plans to change, it is possible some changes are prudent.   I urge you all to be prepared for tedious legislative session next year.  Your benefits are at risk!

  • 1abcde

    I don't think any reasonable person would fault some common sense reform. However, some of what these legislators have proposed is “radical” and unfair. I have about 1 and 1/2 years left to complete my 25 years. Any proposed changes shouldn't effect employees with a certain amount of time in the system. If changes are to be made it should be for new hires or those not vested.

    I'm 46 yrs old with a wife and two kids. I can't do my life over. It's too late to start over. So, for these legislators to even hint at making changes to employees with over 10 or 15 years is borderline criminal.

    Now, if legislators want to implement reform for new hires or those not vested at least these employees would be young enough to make and educated decision to stay in the system, leave or go a different career path.

    From what I gathered from some friends in the unions the legislators are looking to go after employees with less than 10 yrs of service. However, who can believe anything these legislators say?

    If I get wind of changes in pension reform that will effect employees with my amount of time in I will have no choice but to go into the investment plan.

    I've also researched other states and cities who have already introduced reform such as Ill and NJ and their pension reform is for new hires. Let's hope our Fl legislators have some common sense.

  • http://www.floridaretirementsystem.info Mark Davy

    I totally agree.  Changes should come in for the next crop of hires.  Taking back benefits promised is just flat out wrong!
     Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida  34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • bollgator

    The example given is a false comparison. The State will have to fill my position. Since I'm now making near beginner's pay after thirty years (and 40% less than 3 years ago, after being “let go” because I was making too much, then picked up by another agency at a bargain rate), the State benefits by getting a whole lot of experience for slightly above a beginner's salary. So if the State is paying twice, it still is once into an earned pension and once for a present work producer, just as it would if I retired without DROP. With or without DROP, the State has to decide if it wants to reward experience and loyalty, or fire the 25 year veteran to replace him with a 23 year-old at a third the money and constantly be getting inferior work.

  • http://www.floridaretirementsystem.info Mark Davy

    I guess the position replacement issue is subject to debate, but there has to be a presumption that the position will be filled by the person the would best fill it, at the cheapest possible cost. Figuratively speaking,  I have to believe that a Captain is replaced with a lieutenant, not a Private.  Your situation seems to me to be somewhat unique.
     Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida  34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • bollgator

    But the Lt. replaces the captain (in today's economy, without a raise), the Sgt. replaces the Lt., the corporal replaces the Sgt., the private replaces the corporal. The original captain's salary is replaced by a private's. So the State has replaced a captain, hired a private and saved the difference in pay…and lost a well-trained and experienced soldier in the process (not to mention demoralizing the Lt. who is now looking over his shoulder wondering if he is next).

  • http://www.floridaretirementsystem.info Mark Davy

    In that case, it would seem DROP is even more expensive.  The employer is double paying the more expensive employee.
     Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida  34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • 1abcde

    Mark,

    Interesting how the pension rose 34% and is almost 100% funded. Since this was a highlighted reason by some in the legislators for reducing benefits, since they couldn't sustain paying out benefits when the pension was slightly underfunded, I wonder if they will back off a little now?

    I'm sure this was brought to the attention of the legislators. Maybe they will take a softer stance. What do you think?

  • http://www.floridaretirementsystem.info Mark Davy

    Unfortunately, the legislators are more concerned with a balanced budget than current funding. They have to cut costs to match the reduced tax revenues, and the pension plan seems to be easy picking for them – because it is such a healthy plan!
    Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida 34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • Kirbert

    Is there going to be a special session in June? And, if so, what are the odds that the Legislature will take five minutes and override Crist’s veto of HB 5607?

  • Kirbert

    As I understand it, DROP was not instigated to retain skilled employees; it was instigated to encourage high-paid employees to go ahead and retire, making way for lower-paid new-hires. When you sign up for DROP, you *have* to quit working within five years. Without DROP, some of these people stayed on forever, until they died on the job.
    It's also a bargain for the employer. He gets to keep this experienced employee on board for another five years, but he no longer has to pay retirement benefits! And I believe the health insurance benefits drop a bit, too.
    The interest rate cut sounds reasonable if it were considered “variable”, but it's not. It's supposed to be a fixed rate. It's supposed to stay at 6-1/2% when you can get 10+% in the stock market. It doesn't go up then, it shouldn't go down now. When T-bills are back at 5-1/2%, do you think it'll go back up?
    Either way, perhaps the most heinous part of this legislation is the short notice. Retirement programs are people's lives, and people spend years carefully planning for their retirement. Changing the rules with two months' advance notice is just mean. Any changes to any retirement plan should have several years prior to implementation so that it doesn't affect people who don't have time to adjust. Of course, that wouldn't help *this* year's budget, would it?

  • http://www.floridaretirementsystem.info Mark Davy

    I believe you will find that DROP was instigated to begin “the the normal retirement date” to retain skilled workers to keep them from taking a retirement benefit, and moving to the private sector. It might not be such a bargain, because the state pays both an experienced employees normal salary, plus they must pay the normal retirement benefit also. In the case of special risk, it is 100% of their salary, plus at least another 75% of their salary PLUS interest into the DROP program, thus, the “double-dipping” label. In reality it is double paying for the same job.

    You are absolutely correct, if the interest rate was pegged to something variable, it might be fair, but to arbitrarily and in such a covert manner attempt to cut it so radically can not be construed as fair. If history is a guide, once the rate is cut, it is highly unlikely they would raise it again if and when interest rates go back up. It might not be fair to relate it to the stock market – one is a guaranteed rate, the other assumes some risk and volatility. It all comes down to the state reneging on promises and commitments made to those who have worked hard for their benefits, and then have politicians yank them out from under them at the last minute.

    Details of the “summer study” are not available, but you can count on it being about HOW to cut, not IF to cut. It would require a special session of all of the House and Senate to over ride the veto, but it is certainly possible. The interesting thing to me is, the budget is balanced without the cuts, so their argument about the budget is invalid. I agree, any cuts should not affect those that have their time in, and should only affect those hired under those new terms!
    Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida 34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • Janet

    DROP was created to get long-time employees off the payroll with a specific date of retirement, and at that time the thought was the savings on filling the vacant position with a low entry salary, or not filling the position at all. That hasn't happened as those in political leadership placed the new employees at the high salary. Add another political manuever by elected officials who took advantage of a loophole and entered DROP, retired for 30 days, and then came back to their existing position at their same salary (some specific high profile cases have been the State Attorney for the 2nd Judicial Court, Sheriff for Wakulla County but there are plenty of others) and you have taxpayers and legislators crying foul. The timespan a retired employee must sit out after DROP has been changed to six months now and that seems to have helped curtail the abuse of the intent of the program.

    To the Legislature: close the loophole, make changes for new non-vested employees but allow those vested into the program to retire wtih the DROP, AND pay the retirement benefit based on the top five years of earnings as has been the benefit for decades; no new version of math should be created to balance other areas of the budget. As others have said, switch to a variable rate if need be; there were earnings beyond the 6% that were re-invested and should be used for any shortfall currently experienced with the current market place.

  • Dcostin

    In reference to the above mention about skill workers to stay in place and on the job longer, I happen to be one of those skill workers with the promise of the drop progam, I have a few years ahead of me to opt for the drop program and I’m looking forward to joining the ranks that have taken the offer. Now, If I thought ten years ago that this program would not be available then I would have choosen a different route with better income to secure my retirement years when I’m to old to work. You mention the since of entitlement, please excuse me but this was a promise. I’m not a child, I do work hard for a living in a very difficult job and how dare you imply that the hard worker bees of America, being vested and qualified for the state retirement have somehow not fullfilled our obligations and you title us with the tag entitlement. We stayed in our jobs to maintain stabilty (had we not stayed in our jobs and the least experiance took over, just how many law suits would have been paid out for carelessness or lack of experiance) and now the legislators that we voted into office and pay through hardworking taxes want to cut and drop a decison and promises. We are being taxed almost 25 to 30 percent of our income, just how much more do you folks want. Most of us live pay check to check. How many of you are living off of a 6 figure income and voted pay raises for yourself this year? Most of us are not. Perhaps our focus is in the wrong direction!

  • Don

    You’re wrong.

  • http://www.floridaretirementsystem.info Mark Davy

    It is possible, but we have taken the information directly from FRS.
    Mark A. Davy

    SouthBay Investment Group, llc
    665 S. Orange Avenue, Suite 4
    Sarasota, Florida 34236

    941-951-1977
    941-952-1937 (fax)

    ________________________________

  • Roy Marks

    I thought the retirement fund pays DROP, not the state. Also a Tampa Bay newspaper said DROP was put in as an enhancement to pay double, but did not explain that it was mostly to keep teachers and troopers at a time of shortage.
    Roy Marks