Instead of building large schools accommodating hundreds or thousands of students, microschool leaders plant schools in storefronts, libraries, and empty dance studios. These small schools can range in size, serving anywhere from 5 to 100 or more students in multiple grade levels. 

Don Soifer is the co-founder and Chief Executive Officer and Ashley Soifer is the Chief Innovation Officer and co-founder of the National Microschooling Center. Their organization provides information about microschools to parents, policymakers, and school leaders, and supports founders to launch their own. In this interview, we ask the Soifers why families are drawn to this alternative education model, what challenges microschool leaders face, how they are funded, and much more.

Jude: What is a microschool and how is it different from other education models?

Ashley: A microschool school is a small, intimate, flexible learning environment. There’s no cap on a microschool and school sizes can range anywhere from eight kids sitting around the living room to over 100 in an office building. But that group of 100 is likely broken up into smaller groups for learning. 

Jude: How are microschools different than a traditional classroom? 

Ashley: As a microschooling parent myself with three children in a microschool, it’s so exciting to have that connection with the educators that are with my children and to really tailor their individual education for each kiddo. If a child is working on a particular math program and the educator decides it’s just not working as well as it could be, they can adapt mid-year and shift to a different program. Some microschools follow state academic content standards while others may focus on social-emotional learning, use a science-based curriculum or utilize project-based learning.

Christian: What are the pitfalls of trying to set a standard definition for microschools?

Don: Since microschooling is so flexible, we’re reluctant to adopt definitions that might be too restrictive down the road. Once you define something, you put a bullseye on its back and that makes it very easy for regulators to find problems with it. At the end of the day, some amount of definition sounds helpful for parents, but let’s make sure that we don’t do it in a way that hamstrings the movement’s effectiveness or its potential to grow.

Jude: Why do families use microschools?

Don: Millions of families across the country have reevaluated their relationships with the institutions that they had historically relied upon to meet their educational needs. This looks very different in different places. In rural communities, we’re seeing a lot of interest in microschooling taking advantage of this golden age of digital content. Others, like Montessori microschools don’t rely on technology. 

At the same time, the hybrid aspects of microschooling haven’t really existed before. Families realized that they don’t need to have one exclusive provider for all of their educational needs. For example, some kids are in a microschool three days a week while the rest of the time is spent with a combination of tutors or classes. In terms of microschooling’s market share and the potential for students’ transformation – the sky’s the limit.

Jude: The public-private microschool you started in 2020 gained almost instant popularity. Why do you think microschools gained so much attention during the pandemic?

Don: When the pandemic began, it became obvious that the fifth largest school district in the country and all of the other educational options were not adequate during the pandemic for North Las Vegas residents. Ashley and I worked up two briefing books, dropped them on the city manager’s desk the next morning and ran microschools for the city of North Las Vegas in their rec centers and library. The city made it free for all of their residents so long as microschools were in person every day with safe procedures in place aligned wih government mandates. Participating residents would withdraw from the school district and follow homeschooling rules.

Three-quarters of our microschool kids were more than two grade levels behind when they arrived. But the microschool we ran for the city of North Las Vegas changed all that. Academic results and parental satisfaction were through the roof because we trusted them as partners in their children’s learning trajectories.

As we got more positive press for what we were doing, we realized we had 25 microschooling leaders coming to our office regularly who were building this exciting, vibrant, dynamic sector that had never existed before. This led us to launch the National Microschooling Center.

Jude: What advice would you give someone who wants to start a microschool? 

Ashley: The first thing is to talk to people in your community, gather interested families, and hear about their children. At the National Microschool Center, we take calls from folks that are interested in starting a microschool and provide support and resources. Don’t be afraid to jump in and microschool! 

Don: Microschoolingcenter.org has a lot of resources from free training and learning tools about how to microschool. Many of our calls and emails are parents looking to join a microschool, but we often shift them into building mode. Researchers tell us that we’re at about a 2% market share nationally, which is about where Catholic schools are in this country. But I believe microschooling could get to a 10% market share. 

Jude: What sort of financial or policy barriers are there for families interested in microschooling? 

Don: Policymakers should avoid making deals that could hamstring the effectiveness of microschools. For instance, overbearing accountability provisions can make it difficult for microschools to operate. Some microschools care more about the social and emotional growth of their learners than they do about their academic growth. Some never want to subject their learners to a norm-referenced assessment, let alone a criterion-referenced assessment. Others reject their state’s academic content standards as not being entirely pertinent to the future of their own learners.

Ashley: One of the biggest barriers that microschool leaders experience is zoning because even though microschooling has been around for quite some time, local regulators don’t always know where to put microschools. They start asking questions like: Do we need to do a traffic study? Are you a school? Do we need to figure out if pickup and drop off is going to cause backups on this major road? What does your parking lot look like? When those really aren’t things that usually matter because microschools are so small. So often the barriers we encounter come from local regulations, such as business licensing.

Jude: How are microschools funded exactly?

Ashely: It varies from state to state. In the city of North Las Vegas, the kiddos withdrew from the public school system and all the parents filed out their notice of intent. So they became homeschoolers but were coming to the microschool five days a week and learning The program was funded by city appropriation, completely outside of traditional education funding streams.  

In other states, some microschools are private schools or are inside traditional public schools. And there are some really innovative things happening in Arizona and Idaho with charter schools. Bottomline, it depends on your state’s frameworks and what tools let you serve the needs of your community best. 

Don: When we did a microschool for the City of North Las Vegas, we did it in rec centers and libraries that the city owns already. While Nevada is not historically a school choice-friendly state, Nevada’s TOTS (Transforming Opportunities for Toddlers and Students) Grants gives $5000 grants to families with special needs kids that can be used broadly for education purposes. Those funds supported microschools. Another example from Nevada is a microschool that operates out of a library in a rural area. The free library building covers a major facility cost, while other library-funded services can be used for microschooling purposes. States with social impact bond programs or pay-for-performance programs that could be accessed for microschooling are another possibility.  

Jude: What are the major costs associated with operating a microschool?

Ashley: Facilities are one of the major costs. If it’s a partnership microschool and there’s an employer providing the facility or house of worship providing the facility, that cuts down a ton on cost. Independent microschool leaders should connect with underutilized buildings. For instance, dance studios that are only open in the evenings could be happy to rent their space out at a much cheaper cost during the day.

Being creative with facilities is crucial because that cuts down some of those big-ticket items. Staffing is another big ticket item. Sometimes we purchase bulk licenses for different learning tools that will also provide free training so that microschool leaders can use them. That way, we can help them keep their bottom line low.

Jude: To what extent can microschools be scaled by operators? 

Ashley: Provider networks like Prenda play a crucial role in the microschool movement making resources for microschool leaders. The independent microschool leaders really don’t want to scale. They want to create a small intimate learning environment that families love, and they often aren’t looking to add multiple campuses or to grow their existing campus. We see the answer to scale as growing more microschool leaders. By creating more leaders you can have more microschool options popping up all over the country.

Jude: Are there any states where the microschool movement has grown significantly in the last few years? 

Don: In Southern Nevada, we have about 24 microschools. Other emerging hotspots include the Atlanta area, Southern Florida, Wichita, to some extent parts of New Jersey. It’s just a matter of time until Indiana, West Virginia, and Arizona with their school-choice vehicles join the microschooling community with a big-time presence.

Jude: How is microschooling different from homeschooling? 

Ashley: Oftentimes, it depends on your state. Some are taught by parents or other family members who say, “Hey, we need a better solution for our kiddos.” Others come from a variety of career fields. In the microschool venture with the city of North Las Vegas, our star middle school math teacher ran pyrotechnics at one of the shows on the Strip here in Las Vegas. What middle school kid doesn’t want to hear how he uses math every day to blow things up? 

Others are veteran teachers. One of our best microschool leaders in Nevada taught in an independent school and got tired of shutting her door to teach the way that she wanted. So she opened a microschool so that she can now teach the way that’s best for kids.

Jude: What advice do you have for policymakers interested in supporting microschools in their cities and states? 

Don: They should call us! What’s exciting to me is that this is truly a permissionless education and systems don’t always know what to make of microschools. We can help people navigate the existing frameworks and especially those in their state, municipal, or locality. It’s time to upgrade and update the frameworks in which microschools operate.

Jude: What final thoughts do you have for readers?

Don: This is about empowering families to build and not join, and to be active partners in learning in ways that fundamentally change the relationship people have historically had with education. Microschooling represents a new frontier with some great forward-thinking people, it has diversified in ways that we maybe haven’t seen in school choice experiments during the past 15 years. We have as many microschooling leaders who are as hard left as hard right, and it brings together a community that in some way raises the ceiling on what happens when school choice becomes a possibility and families project into it their own values and what they want for their own kids. 

The post National Microschooling Center founders illustrate how microschools are changing K-12 education appeared first on Reason Foundation.

Small oversaw the implementation of an innovative public safety program that combined police, fire, and emergency medical services under the new Palmyra Department of Public Safety, with Small becoming Palmyra’s first public safety director. In the time Small has served in this role, the village’s property crime rate has plummeted by 88% to just over five property crimes per 1,000 residents. The village managed to accomplish this feat while simultaneously reducing its fine revenue by more than two-thirds. 

Reason Foundation’s Vittorio Nastasi and Austil Stuart recently sat down with James Small to discuss his successes in Palmyra which he credits to an outcome-based policing approach.  

Nastasi: Can you describe how Palmyra’s public safety agencies were performing before you were hired? 

Small: Things hadn’t gone well in public safety in general for a long time. For both police and fire, there was a real vacuum in leadership. For example, the previous police chief really struggled in his role, was removed by the board, and had not been replaced for 3 years after he was removed. So, we had a police department, we had cars that said ‘police’ on them, and we hired police officers to go out and do police things. But there was no vision beyond that. 

Without any clear leadership, the mentality was, “Okay, we’re going to go out and enforce some things.” But there wasn’t any purpose behind that enforcement effort, so officers would go out on the highway in the 25 MPH zone writing speeding tickets. But ultimately, that wasn’t doing anything for the community. There was a high property crime rate that was running about twice the state average, you weren’t seeing things getting prosecuted properly, and there was just a variety of breakdowns in the system.  

Nastasi: What was the community’s perception of the police department? 

Small: There was a real breakdown in trust in the community. I would go out to introduce myself to the community, and people would just tell me about their awful experiences with the police department. Some people described retaliation for making a complaint about an officer. I don’t think it had gotten as far as some of the excessive use of force cases you see on the news, but it was an escalation of conflict within the community. I think that is something we’re seeing in law enforcement in general, and it’s really a failure from a customer satisfaction perspective.  

Nastasi: Writing traffic tickets on the highway was bringing in a lot of revenue for Palmyra, though. Did you get any pushback when you started implementing changes? 

Small: The police department was issuing about $90,000 in fines every year, and that would account for about 10% of the village’s budget. Now, did they actually collect $90,000? That’s a different question, but that’s how much they were budgeting for. I think our number last year was about $27,000, so we’re at about 30% of where we started. The revenue issue definitely came up at points with the board. I had a village board member come up to me one time and say, “All these warnings are costing us a lot of money.” 

Nastasi: Was reducing fine revenue the goal, or just a byproduct of your mission? 

Small: The mission of our department isn’t to raise money. It is to go out and reduce victimization in the community, and we’re doing that extremely well. Reducing victimization required us to change our tactics and stop seeking out enforcement to raise revenue. Some revenue may be generated from some of our work, but it should never be the objective.  

I subscribe to what I call an ‘outcome-based strategy.’ I believe our actions should result in our desired outcomes: reducing victimization in the community, improving trust in the police, and creating a sense of community safety. We need to be focusing on facilitating those outcomes. So, we shifted into this problem-solving mindset to move the vision from the police being punishers to the police being facilitators. 

I think there is a place for tickets, but I think we’ve seen such an overreliance on punishment. We’ve forgotten that the real goal is to change behavior. We should be asking ourselves, “What can we do to facilitate changing behavior and remove obstacles from this person’s path?” 

Nastasi: What does that look like in practice? 

Small: Sometimes it involves referring people to the human services system or coordinating with a probation officer––actions you might think of as being beyond the scope of a traditional law enforcement officer. Take somebody, for instance, that had their license suspended because they weren’t paying their fines. What we do in that situation is give that person a 30-day notice from us saying they need to pay their fines. We print out a document from the Wisconsin Department of Motor Vehicles saying what they need to do to get their license reinstated, how much they owe, what court they must go to, and the court’s address. If they need to extend that 30-day notice, that’s fine. We’ll do that if they’ve made progress or set up a payment plan that might take a little longer than our initial deadline. It’s not a free pass. There are consequences on the other end if they don’t pay their tickets, but we’re giving them a chance. Most people take that chance when you tell them what they need to do.  

Stuart: Can you describe briefly the decision to consolidate Palmyra’s public safety agencies?  

Small: I was hired as the director of public safety providing administrative supervision over the fire and rescue services. I was also hired as the chief of police, and we were going to have a separate fire chief and an emergency medical service director. It was never the plan for me to be the director of all three.  

We had a very severe personnel issue in the fire department. I want to say there were eight chiefs in the 15 years prior to my arrival. My initial recommendation to the board was to dissolve the entire fire service agency. We went around and thought about partnering with one of the neighboring agencies. None of them were interested, so that wasn’t going to be an option in our case.  

One day one of our board members looked at me and said, “Well, I’ve seen you in a police car, a fire truck, and an ambulance all in the same day. Why can’t we just get more people like you?” My answer was that nobody had done it that way. I mean, this model is out there, but every example of it was created on day one as a consolidated public safety department. Previous efforts to merge two departments on the fly like that hadn’t been successful. By the end of 2017, we had fully implemented the combined public safety model. 

Efficiencies gained by consolidating the two budgets together ended up allowing us to add two additional full-time positions. Some of the freed-up funds also absorbed some of the lost revenue from traffic citations. We also trimmed down our vehicle fleet.  

Stuart: How did consolidating the departments help you implement your vision? 

Small: All our police officers have fire and EMS training, so the staff can fill multiple roles on one call. For example, they may need to take law enforcement action during an EMS call. We were concerned that the public wouldn’t want someone with a jacket that has ‘police’ written on the back in their house for some EMS calls where there might be drugs or something involved. That fear hasn’t materialized. I think that has a lot to do with how our police officers interact with people.  

When we’re on an overdose scene, for example, we’re primarily concerned with resolving the medical issue and getting the person whatever treatment they need. Some cases might involve criminal elements that need to be investigated, but by the time we get there, everyone has been cooperative, and they trust the system. Usually, when we take someone like that through the criminal process, it’s to get them to a drug court so they can get into treatment. We work with the district attorney’s office to send them to drug court because giving them a $400 ticket in municipal court isn’t going to change their behavior.  

Stuart: Do you think any of Palmyra’s experience could inform other jurisdictions? Palmyra is a relatively small town with a relatively small police force. How scalable do you think your model is? 

Small: The combined public safety model can work well in rural communities where call volumes are low enough to share personnel across the agencies. This isn’t a good model for large cities with high call volumes, but the philosophy behind it is scalable. Getting police out of this mindset of punishing people into submission is important because I think that’s one of the problems we’ve seen in the criminal justice system. There is too much emphasis on punishment and not enough on changing behavior. There are people that need to be held in prison because the public needs to be protected from them. But in most cases, we should be looking to solve problems. That’s not just a philosophy for police and fire services, it’s how we should be operating as a government generally. That’s how we build trust. I haven’t received a complaint about an officer in five years. When I first got in, I was getting several a month.  

This interview has been lightly edited for clarity. 

The post Innovators in Action: James Small, public safety director of Palmyra, Wisconsin appeared first on Reason Foundation.

The Innovators in Action 2015 series profiles released to-date are listed below:

• Taking on Infrastructure, Pension Challenges in Georgia
  Interview with Georgia State Senator Hunter Hill
  Leonard Gilroy
  July 29, 2015
• Implementing Best Value Procurement in Oklahoma
  Interview with Steve Hagar, State Purchasing Director, Oklahoma
  Leonard Gilroy
  May 8, 2015
• Reforming Public Safety Pensions in Tequesta, Florida
  Interview with Michael Couzzo, Village Manager, Village of Tequesta, Florida
  Leonard Gilroy
  February 25, 2015

Earlier editions of Reason’s Innovators in Action are available here:

• Innovators in Action 2014
• Innovators in Action 2013
• Innovators in Action 2012
• Innovators in Action 2009
• Innovators in Action 2008
• Innovators in Action 2007

The post Innovators in Action 2015 appeared first on Reason Foundation.

At the same time, Sen. Hill sponsored legislation to transition the state teachers’ pension system from a traditional defined-benefit pension plan to a hybrid defined-benefit/defined-contribution plan that would have lowered financial risks to the state and provided a more equitable retirement system for teachers of all experience levels. Like many pension plans covering public school teachers, the current system punishes younger teachers by backloading retirement benefits, pushing the bulk of benefit accumulation toward the years close to retirement.

Reason Foundation Director of Government Reform Leonard Gilroy recently interviewed Sen. Hill on his social infrastructure PPP legislation, the need to reform the state teachers’ pension system, and more.

Leonard Gilroy, Reason Foundation: During the last two legislative sessions you proposed enabling legislation to allow for public-private partnerships (PPPs) in the development of “social infrastructure,” meaning a broad array of government buildings. That legislation was ultimately enacted this year. What prompted your interest in social infrastructure PPPs?

Georgia State Senator Hunter Hill: The issue came to my attention once I got into government as I learned about how constrained our budgets are at the state level and the local level for providing facilities that the public needs. As costs have increased in health care and other human services, infrastructure dollars have really taken a downturn in terms of their prevalence within the budget. It just seemed to me that we should leverage the capital, innovation and expertise of the private sector in delivering government facilities. PPPs help the taxpayer get a better value, and they help the public side get a better understanding of how to deliver projects to meet a public need.

Gilroy: Are there particular needs on the social infrastructure front in Georgia that helped drive this legislation forward?

Hill: No, it wasn’t any one specific need. Rather, it was something I think we need to address now for the future. I think the law gives the appropriate flexibility for state and local governments to be able to address the needs that they may have now or face in the future, but it’s also constrained enough that it keeps us fiscally responsible and protects the public from any downsides or bad ideas.

Gilroy: At the same time your legislation was being debated in 2014, the legislature granted the University System of Georgia the ability to embark on a massive student housing PPP initiative across nine campuses, something that is now underway. Did this effort play into the discussion on your broader social infrastructure PPP legislation?

Hill: Not really. The Board of Regents has always been doing public-private partnerships, and they have a system in place that they’re happy with. My bill was not connected to that at all; it actually didn’t affect the Board of Regents. My bill addressed other state agencies and local governments.

Gilroy: Are there experiences in other states that you find particularly compelling on social infrastructure PPPs?

Hill: We learned from the models in Virginia, Texas and Florida, and we had a similar initial bill that we tailored specifically to meet Georgia’s needs. For example, we tightened the window for when state agencies could accept unsolicited bids or proposals. Unsolicited bids have always been legal, but there’s never been a structured framework to deal with them. Because of that, in cases where they could have been beneficial, they weren’t used, and in fact, they could have been done behind closed doors in a less vetted environment, which is not good for free markets and not good for taxpayers.

So by constraining when government will accept them, they’ll know exactly when they’re coming and will be prepared for unsolicited bids. And on the flip side, there will be more competition brought to bear when the public is telling everyone that there’s a window in which they will accept unsolicited bids.

During the study committee looking at this issue back in 2013, we actually got Virginia officials on the phone with us to talk about their experiences. It was a state agency using their PPP legislation to develop a new prison facility. We tried to learn as much as we could during the process, and it was definitely beneficial.

Gilroy: Given that the legislation creates this PPP tool for local governments too, were municipalities and school districts generally supportive? How did they react?

Hill: They were very supportive. The Georgia Municipal Association and the Association County Commissioners of Georgia were integral to getting us where we wanted to be on the legislation. Some counties will use what we’ve given them and some won’t. And some will use a modified structure, which we gave them the flexibility to do. But the main thing we were trying to accomplish in the bill for local governments was to provide them with a new opportunity for procurement for these facilities. Instead of government running the procurement process from start to finish, by opening it up to the private sector earlier in the process, you can leverage their innovation and expertise-and sometimes even their financing.

Gilroy: Even though Georgia has some experience with PPPs in transportation and higher education, social infrastructure PPPs can be a complicated issue. Was there a learning curve in terms of how to communicate the value of these PPPs?

Hill: It’s definitely a newer concept, and I think for us it was really just about repetition. That’s why it took a couple of years to get the bill done. I don’t think I necessarily got better at selling the idea over that time, it’s just that if people keep hearing the same argument for years in a row it begins to sink in.

And in terms of really understanding the value, I don’t think we’re there yet. We did pass the bill, but it’s going to take some time for this tool to be used. We passed transportation PPP legislation seven years ago, and we’re just now beginning to see the first project underway with our managed lane project on Interstate 75.

It just takes time. I’m just glad that we’re now in the queue, if you will, by having passed this legislation. I wouldn’t imagine that there would be any projects that result from it for another couple of years. We’ll learn more along the way, and if there’s a need to tweak anything, we can. But for now, we’ll just be watching it unfold and will see what the learning process looks like moving forward.

Gilroy: Social infrastructure PPPs are, at a general level, one way of harnessing the private sector to achieve public sector goals. What’s your general philosophy on how governments and private enterprise can team up to advance the public interest?

Hill: If I were to oversimplify it, I like the old-fashioned “Yellow Pages test” method. If there are three companies in the Yellow Pages that can provide the service that the government needs, then it ought to be privatized. So I’m always looking for ways to leverage the expertise and innovation of the private sector to deliver projects or services that the public sector needs. We do that pretty well in Georgia, but we can always improve.

Gilroy: Shifting gears, you also proposed legislation to overhaul the teachers’ pension system in Georgia, an effort that was ultimately unsuccessful. You had proposed legislation that would have placed new hires in a hybrid defined-benefit/defined-contribution retirement plan. What prompted your interest in reforming the teachers’ pension system?

Hill: I introduced a bill that would move our future teachers to a 401(k)-style retirement plan. Ultimately, I want to see us incentivize and reward teachers for the great value that they’re providing to our students today, instead of this very large deferred compensation that we have through our current defined benefit pension plan, where they’re not getting fully rewarded for the value brought to our students until they’re much later in their career and even into retirement. To me, that’s not a good system-one where you’re paying people a large portion of their compensation when they’re not currently adding value.

We cannot change the commitment we’ve made to current teachers and retirees, but I want to incentivize newly hired teachers in the future in their first ten years of work. Right now, we’re basically letting them work for very small dollars for 10-15 years, and then right about the time when they’re thinking they might be fed up and ready to move on, we dangle this carrot in front of them with this huge, lucrative pension to entice them to stay. It’s just how the system works, with a backloaded benefit that works against the younger teachers. We should probably pay teachers more on the front end and give them a retirement plan that provides them with a benefit the whole time they’re providing their value to our students.

We’re behind the curve on this in Georgia, but I couldn’t even get a second in the committee on my proposal. That’s because there was just a lot of misinformation amongst teachers’ organizations suggesting that I was just trying to take their retirement away. I’ll accept responsibility for the poor communication on my proposal this time around, but I’m going to continue to work on this issue because I believe it is important not only for the retention and recruitment of future teachers-we need to be more competitive on that in Georgia-but also for the long-term fiscal trajectory of the state.

Gilroy: What do you think stood in the way of your colleagues in terms of support for taking a look at the current system and proposed changes from a mathematical standpoint? It seems like doing an actuarial analysis was a very low-risk activity that would have had a lot of benefit in terms of building knowledge about the health of the system.

Hill: The way Georgia works, it’s very difficult to change a retirement system, which is a good thing overall. It isn’t something that should be easily changed. But on the flip side, to do it, you have to submit a full reform proposal to then be able to go to an actuarial study. So you have to develop a proposal to be studied, and then it gets studied, and then there’s a financial analysis attached to that bill. Then it becomes very difficult to change that, because any changes would require it to go back for another actuarial study.

So the system works in favor of not changing the retirement system. And in Georgia, we have a strong executive branch in terms of how our constitution is written, so it makes it very difficult to make these changes led out of the legislature. They probably need to be led from the governor’s office. Governor Deal has done a good job in this regard, and he’s just set up a compensation reform committee in education, so there are now people that are going to be studying the very issue that I was trying to address.

I’m not on the commission, but I’m hoping that my philosophy will find its way on to the commission. I think we need to pay teachers more for the work they’re providing today in lieu of the long-term guarantee that we’re currently offering them. My proposal was portrayed as anti-teacher, but I believe that it’s actually pro-teacher. I think it’s a good thing for teachers to pay them more for the value that they’re adding today. The teachers’ groups were opposed to it, but I think that’s because they didn’t fully understand it.

Gilroy: Beyond the policy arguments regarding fairness and recruitment of future teachers, were there other issues-like unfunded liabilities-that also played into your proposal?

Hill: While we have some long-term fiscal challenges in our pension system like every system does, the Teachers Retirement System of Georgia is actually one of the strongest. But all of them have a long-term challenge. We’re putting current and future taxpayers on the hook for past commitments. The fiscal sustainability and trajectory is always an issue, and while the system I proposed would be beneficial for improving the future sustainability of the system, that’s not why I developed my proposal.

I did it because I think we have a cultural problem in our education system that incentivizes the wrong things through our compensation system. It incentivizes length of service instead of excellence in the classroom. It’s more of the compensation philosophy that I think is problematic in terms of recruiting. That’s not to say that we don’t have great teachers-we do have great teachers, but we have them in spite of our compensation system, not because of it. We need to change this.

Even though my proposal this session wasn’t successful, I think we’ve at least started a conversation, and now we need to turn that into action.

Gilroy: Are there other legislative initiatives on the financial or regulatory front that you have pushed or plan to push for?

Hill: We worked on putting a bill forward on education savings accounts this past session, the idea being that if someone’s public school is not working for them, then they should be able to use the money that was allocated to them on the state formula side for other educational benefits, whether it be a private school tuition, tutoring, or even remedial training work out of this education savings account. It didn’t get very far in the Senate this year, but it did move very quickly in the House before stalling in the Rules Committee. But it’s still alive for next year.

I think it’s a good idea to allow people that don’t have the means to pursue a private education or other educational alternatives to be able to. We promise our children a solid education in the state of Georgia, and when their public school is not providing a solid, excellent public education, then they should have options to go elsewhere. That’s the thought process behind the education savings account bill.

On the craft brewery front, there’s a three-tier system that governs all alcohol-you’ve got the manufacturer or brewer, the wholesaler/distributor, and then you’ve got the retailer, which is the restaurant, bar or store. But any one entity can only do one of these things, and not the other two in this state. But it seemed to me that these small brewers, who are having to sell 100% of their craft to a distributor, are going to have a hard time getting their product to market, and while they’re a small business that is capital-intensive, they might not have the revenues or margins and the operating costs to sustain selling their craft at such low margins. My thought was that I wouldn’t want to take the distributors completely out of the operation, but I thought that the brewers should be able to sell a limited amount of their craft directly to the consumer so that they could enjoy higher margins, reinvest in their business, and grow their brands.

So that’s what we worked on and were able to move the ball down the field and get a bill done, which was a big win. It wasn’t exactly what we had asked for, and the distributors and retailers weighed in on that to make it a more modified approach from what we put forth. But overall I still think it’s a win for the brewers, and now we’ll get to see whether this construct will do what I wanted it to do, which was to create their revenues and allow them to increase their brand awareness in the market.

Gilroy: Social infrastructure PPPs and pension reform are two very different issues, but share two key similarities: (1) they’re complex issues, and (2) both involve paradigm shifts and a big change from the status quo. Are there any lessons you’ve learned thus far in how to communicate the value of these types of major reforms to your colleagues in the legislature, as well as constituents?

Hill: I saw my legislative session this year as being reform-minded and sometimes taking on status quo thought. And it is a challenge to effect change in any organization, but especially in government and politics because there’s a tendency among politicians to be cautious. And I think that’s a good thing. We have a fiduciary responsibility to the state, and caution is a good thing at times. But I also think that when there are proven reforms that have taken place in other states, then we should learn from that. And that’s what I tried to do with Virginia, Florida and Texas on public-private partnerships, and Arizona on education savings accounts.

We need to be innovative, we need to learn from other states, and we need to be willing to take on those large silos of support that stand in opposition to reform. Legislators usually get through the session with not a lot of contention, and so when there is an issue where you are taking on those large silos of support, legislators are going to proceed with caution. So communicating around and through the opposition is valuable.

It’s really just about letting people know what you’re trying to accomplish and who it’s going to benefit. That means challenging assumptions and challenging the arguments from people who say that a reform is going to hurt them when it will actually help them. With my craft brewery bill, in no case does it hurt distributors and retailers. I think it lifts all boats and is going to increase the energy around the craft beer industry, which helps distributors and retailers. On modifying the teachers’ retirement system, I can see why one might be afraid of these proposals but they’re going to help the education profession and teaching in general.

It’s often a matter of telling a story about how reforms are going to help everyone involved, not picking winners and losers.

State Senator Hunter Hill was elected to the State Senate for Georgia’s 6th District in 2012. Sen. Hill represents portions of Cobb and Fulton counties. In 2014, he was elected Majority Caucus Vice-Chairman by his colleagues.

Sen. Hill is the Chairman of the Senate Veterans, Military and Homeland Security Committee and Vice-Chairman of the Finance Committee. He is a member of Appropriations (Vice-Chairman of the Public Safety Subcommittee), Judiciary Non-Civil, and Reapportionment and Redistricting committees. Sen. Hill is also an Ex-Officio of the Retirement and Rules committees.

After graduating from the United States Military Academy at West Point with a Bachelor of Science degree in General Management and Civil Engineering, Sen. Hill became a 2nd Lieutenant in the United States Army. He went on to graduate from the Airborne, the Air Assault, and the U.S. Army Ranger Schools. In June 2001, Hill took command of a rifle platoon with the 101st Airborne Division, which he led into battle in Afghanistan in 2002. Sen. Hill subsequently led another platoon into battle in Iraq in 2003, and he commanded three different teams on other deployments in Iraq and Afghanistan. In addition to his combat roles, he also served as a general’s aide in Iraq, and earned two Bronze Stars, the Meritorious Service Medal and two Army Commendation Medals.

Sen. Hill is currently the President of Tommy Newberry Coaching, where he leverages his military, real estate development and security industry experience to lead and grow his business.

Other articles in Reason Foundation’s Innovators in Action 2015 series are available online here.

The post Taking on Infrastructure, Pension Challenges in Georgia appeared first on Reason Foundation.

In 2009, the state of Oklahoma began implementing a type of best value procurement known as the Performance Information Procurement System (PIPS), developed nearly two decades ago by Dr. Dean Kashiwagi and promoted by his team at Arizona State University’s Performance Based Studies Research Group (PBSRG). Oklahoma’s Office of Management & Enterprise Services has been working with PBSRG as a research partner on implementing PIPS, which is based on identifying and leveraging the knowledge of experts in the supplier community to provide clients with a plan to accomplish their objectives.

Reason Foundation Director of Government Reform Leonard Gilroy recently interviewed Steve Hagar, Oklahoma’s State Purchasing Director, on the state’s use of best value procurement, the PIPS model, successes seen thus far and much more.

Leonard Gilroy, Reason Foundation: Can you explain the difference between best value procurement and the more traditional low-bid procurement?

Steve Hagar, State Purchasing Director, Oklahoma Office of Management & Enterprise Services: There’s a contrast between a best value process and a more traditional low-bid environment with a specification driven by minimum requirements or qualifications. In a low-bid environment, the state will establish a minimum requirement where we know we will get at least this much, and we may get more than that because the suppliers trying to get our business will probably offer us more than we would expect based on the minimum.

From the supplier perspective though, knowing that it’s a price-based award, they will see the minimum requirement as more of a maximum they can offer without pricing themselves out of the competition. They understand that if they bring their best people to the project and offer everything they can offer, they will price themselves out. So what a low-bid procurement does is cause the supplier to compress their expertise-they’ll opt to use junior people over higher performing people in an environment where they’ll be told what to do by the client. They can just send their junior staff in knowing that the state is going to be managing, directing and controlling them, locking them in at the minimum price and telling them how it’s going to be done.

That’s at the opposite end of the spectrum from a best value environment, where we encourage suppliers to use their best people and tell them that we will pay for their best people because we know that if it’s done right the first time that it will be cheaper in the long run. It allows suppliers to bring in their best people knowing that they will be in charge of the process and won’t be told what to do. There’s nothing more frustrating than for an expert to come into an environment and not be able to use their expertise due to a client that’s very managing and controlling.

We want to create an environment through the best value process that allows them to come in and actually utilize their expertise, so that’s why we work to make sure that the clients-the state agencies-understand that the supplier should lead the way. They’re going to tell us how they’re going to get there, so ask any questions you want but don’t revert back to managing and controlling the supplier, because it will drive an expert crazy.

Gilroy: What is the PIPS system?

Hagar: PIPS, or Performance Information Procurement System, is a version or hybrid of best value procurement, which has been around for awhile and is really nothing more than saying, “we’re going to tell you what we need and you tell us what you’re going to do to achieve our objective.”

Dr. Dean Kashiwagi at Arizona State University, who is the founder of PIPS, took that philosophy and expanded it such that it leverages past performance in the PIPS process to identify expertise. What he’s done in the process is incorporated elements that make it very defendable, leveraging common sense and natural laws.

Dr. Kashiwagi wrote a book that supports the PIPS process called Information Management Theory that is all about human nature and natural laws, and that how an event will turn out is predicated by the initial conditions. If you can understand the initial conditions, you can understand how it’s going to end. So there’s a lot of theory about all of this, but the bottom line is that the selection is relatively clean and easy to understand.

This best value process allows us to robustly identify an expert in the field, and the process itself utilizes what we call “dominant” information-basically, information that everyone can understand. The process has three phases, which are selection, clarification, and management by risk mitigation.

In the selection phase, we ask that submissions from vendors be written in a way that everyone can understand, and it’s based on a six-page project capability submission that the evaluation team reviews. The cost submission is shared with the evaluation team after all evaluations are completed. We really don’t get an idea of how they’re going to achieve the objectives until we get to the next phase when they convey a complete scope of work and we can ask all of the questions we need to and bring our state experts in to do a sanity check. What we want is for the evaluators, who are evaluating blindly to avoid any subliminal bias, to look at what’s submitted based only on what’s on the paper. It’s a very objective way to go about it and allows us to have a selection process that’s very defendable. Of the 20 or so projects we’ve done, we’ve only had three bid protests, which were all denied without even progressing to the second phase of the protest.

After the evaluation teams review the six-page submissions, we bring the vendors in for an interview, which is the last part of the selection process. That’s where we get a sense of who they are, and they’re able to speak candidly. We have the interview with the two or three people who will be working directly with the state and have the expertise to be able to convey to us a potentially complex project in layman’s terms. And if they’re able to lay it out for us that way-with high performance claims and validating metrics-and everyone in the room is able to understand, then they will score a “10.”

The scoring we use is either a “1,” “5,” or “10.” If the evaluators are unsure whether a vendor is a “5” or a “10,” then we encourage them to mark it down as a “5,” which means we really don’t know. “1”‘s don’t happen a lot-that’s when something is demonstrably bad-and we only get “10”‘s about 20% of the time. “10s” are awarded when suppliers give us a high performance claim that includes verifiable performance metrics that can validate the claim.

So it’s a very good way to leverage the metrics organizations have accumulated over their years of service, and if they can convey the great things they’ve done with clients that had similar projects, we’re well down the road in identifying an expert. They’re leveraging their past projects that they’ve encountered and how they’ve successfully navigated through those. We want to see a vendor with continuous improvement. If they can convey to us how they’ve matured as an organization, it’s that much better for them in terms of bringing the client-our state agencies-into a comfort area.

Once we’ve identified that expert, we go into the clarification phase, which lays out what they’re going to provide for us. The clarification phase is a little bit more difficult, because that’s where you get into the roots of the delivery. The supplier effectively writes the statement of work or scope of services, but we write the terms and conditions. So they write the specifications-the “how we’re going to get there”-which is what they present in the clarification phase. It’s a detailed picture of what’s going to happen.

The clarification phase is the first opportunity to get into the nitty gritty details of the vendor’s plan. We’re only dealing with one vendor, so we’re not wading through multiple scopes of work and trying to make basically a subjective opinion as to who’s the best. We allow the expertise to move someone into the clarification phase, and once they reach that phase they’re able to convey to us specifically how they’re going to meet our objectives.

The great thing about this is that when we go to contract award, we’ll have a very detailed plan, we’ll understand what our role is and will have very specific dates and deliverables, the cost structure and the detail of the costs-it’ll all be mapped out. Most importantly, we’ll understand what risks are involved in the delivery that could potentially derail the process. During the clarification phase, the supplier will not only provide a comprehensive assessment of risks that are outside the supplier’s control, but will also provide a mitigation plan to address them should they occur or a plan to keep them from occurring.

Gilroy: After the contract is awarded, you enter the third and final phase: management by risk mitigation. Can you describe that?

Hagar: After a contract award, there is a tendency for people to revert back to their old ways of doing things in terms of telling suppliers what to do, so we encourage and instruct the clients not to do that. Instead of telling a supplier what to do, ask them, “why they are doing that, why wouldn’t you do it this way” and have them explain to you why they are doing things the way they are. But as soon as you start trying to manage, direct and control-which is a no-no in Dr. Kashiwagi’s world, as he just doesn’t believe people can be controlled like that-you are going to bring risk back upon yourself.

In our PIPS process, one of the primary things that I will convey to a vendor is that they are to provide us a scope of work assuming a perfect delivery environment, so they are not to price in any risk in their scope of work. That’s part of the scope minimization process. Not only are they only telling us what we need to know on how they will accomplish their objectives, they’re also removing any risk that would be incorporated into a typical low-bid response. In a traditional response, if the supplier believes there’s about a 10% risk factor, they may bid 15% high to assure their margins remain intact.

Rather than do that, we tell them to eliminate that from their proposal, and we’ll give them a mechanism to come out whole, such that the margin you bid is what you can expect to achieve at the end of the day. That makes it a little bit more comfortable for them to follow us down this path.

The way they come out whole is that during implementation, there’s a component called a weekly risk report that’s designed to manage documented risks after the award is made. The weekly risk report provides transparency to the client on how the project is progressing and is conveyed in terms of metrics. The report also gives the supplier a mechanism to recover from realized risk that can be demonstrated as outside of the supplier’s control.

What we ask is that suppliers give us a heads up on project risks and what the impacts are on costs and delivery. For example, if I was a member of the client team, the report provides the transparency to hold me accountable for a deliverable that’s holding up the project. It gives the supplier a mechanism to recover if a realized risk and which may end up costing additional funds. Conveying that ability to make them whole is key, so that suppliers understand that they’re not at risk by removing risk from their scope.

At face value all of this may seem fairly straightforward, but there’s a lot of thought and theory underneath that allow it to function and to achieve the results that we’ve seen. We’ve had about $121 million worth of contract awards that had achieved about $67 million in cost avoidance, which is a result of the scope minimization process and only buying what we need to achieve the objective, as well as removing risk from the equation. This is possible by the identification and utilization of vendor expertise.

We don’t want to call it cost “savings” because we’re just minimizing scope, not getting something for nothing. There’s actually no negotiation involved in the PIPS process, and the reason is that we’ve asked suppliers to remove risk and minimize scope, so basically all they’re going to propose to use is only what we need to meet our objective. The dollars associated with that are what they are.

If we got to the final stage of the process and then told the suppliers to drop their price 10%, then now they’ve got to cut something out of their deliverables. They’ve got to cut 10% of the work they would have done out. All that does is compromise their ability to do the job well and shift risk back to us. If something falls apart down the line, then they can always come back and say, “well, we had that at the beginning, but when you asked us to cut 10%, we cut that out.” So by negotiating you’re actually bring risk back on the state. We’ve found that about 70% of the time, the best value supplier is also the lowest cost provider because they’re leveraging their expertise and they understand that by removing risk and minimizing scope, they’re able to offer us an aggressive price.

Gilroy: How did you come to embrace PIPS, and what was the transition like?

Hagar: As probably the leading state to embrace PIPS, we didn’t really have others to look to. Originally, our construction and properties administrator saw Dr. Kashiwagi speak at a conference and invited him to give a presentation in Oklahoma that we were brought into. Within the first five minutes I understood the process was about leveraging vendor expertise, so rather than utilizing a very prescriptive specification-how we want a job accomplished-we merely state objectives and let the experts in the industry provide a path to get us where we need to go.

This has proven to be a huge benefit. Experts can minimize our specifications to just what we need to accomplish our objectives, instead of what we think we need based on our limited knowledge. We try to have an understanding of what we’re purchasing, but the reality is that we will never have the expertise on everything we purchase that is available in the industry.

Before embracing PIPS, we had been living and breathing “strategic sourcing” for the four years prior. We were trying to educate our buyers-our central procurement staff-and the experts in whatever commodity that we were dealing with, and we were doing market research to figure out what the trends were and the best time to go to market. The bottom line is that we were just trying to match wits with the experts, trying to come up to speed and understand what they do as well as they do. That’s a difficult position to put yourself in.

After hearing from Dr. Kashiwagi, it became clear that we didn’t have to do that, and we could actually leverage supplier expertise. That’s what struck me, and that’s what typically resonates with the agency heads that I deal with. We’ve found a way to utilize their expertise that allows the supplier to perform more efficiently and effectively. We don’t have a dedicated project manager and the supplier doesn’t have a dedicated project manager that do nothing but communicate how the project is doing. We can eliminate those two people for the most part by leveraging transparency and allowing the supplier to convey their progress through a series of predetermined metrics that give us an idea of where we started and what we’re trying to achieve. The idea is that a client can look at a weekly risk report that includes 8-10 high-level metrics so that we can understand through numbers how they’re progressing toward achieving the goal that we’ve put before them.

We tend to look to the supplier to provide us those metrics that they would use to convey that progress because they’ve done that in the past and know what things will demonstrate their success and progress.

It’s funny-when I do the pre-education for this process, I usually get one of two responses from suppliers. The first response will come from the sales and marketing folks who lean back, roll their eyes, and say, “you’re really not going to do it this way, are you?” The second response we get is from those who’ve always wanted to be able to use their own expertise and get the opportunity to do things the way they know it needs to be done, as opposed to how we think they should be done. Those people get excited about this process; they lean forward and their eyes light up and they ask, “why aren’t more people using this?” A vendor the other day asked, “are other states using this?” And the answer is no, not really. Not a lot of them are embracing it yet. The vendors typically tell us that it’s so refreshing that you would come to us and ask us how we should do this project, rather than telling us how it needs to be done.

From a big picture perspective, when you think about how you’re treating a vendor in a low-bid environment, you’re really not wanting their best people or ideas. You only want their cheapest ideas. You’re really driving down the expertise in the industry, because if you’re not utilizing it, that expertise is just going to go away.

So in my mind, what we’re doing now is the best thing that’s happened to purchasing because we’re still able to control the process, but the actual projects are put into the hands of the ones who’ve done it before repeatedly. Before a contract award, we’ll validate that all of the references a supplier has given us are legitimate. We tell them not to include anything in their submissions that cannot be verified and substantiated by previous clients, or else they’ll be in danger of getting kicked out of the competition.

Gilroy: Given how different it was than what they had been used to, how did the state agency clients respond to the introduction of best value procurement?

Hagar: It’s a huge shift in the way that we’ve traditionally gone to market, which was a difficult thing to overcome. Basically it’s through client education that we’re able to gain buy-in on the process. I typically meet with senior agency management to give them a bird’s eye view of how the process works. Once they understand that we’re leveraging supplier expertise and utilizing their ideas and that it’s a very defendable process, they come on board pretty quickly. The pre-education is critical.

We find that often the clients are initially uncomfortable, given that this process is such a drastic departure from a traditional request for proposals process. Agencies may be uncomfortable with the short responses we require-how can you possibly know that a vendor can meet our objectives through a six-page response? How can we possibly know that they’re going to meet our objective if we’re not going to see how they’re going to do it until the clarification stage? Our interviews are typically 20-30 minutes, and the agency clients often think, “how can you possibly establish someone as an expert in 20 minutes?”

But it turns out that you can establish expertise fairly quickly. Once they get into the interview, the clients understand that someone that can take us to a 35,000-foot view of what they’re going to achieve and explain very succinctly how they’re going to march through the delivery of the objectives, it makes it pretty clear to the client that these folks know what they’re talking about.

By reducing the space that the vendors have in the initial submission and the time they have in the interview, we effectively make their time a premium, so they really have to delete any marketing and sales and cut to the chase of what they’re going to do to accomplish their objectives. That’s typically where the clients start feeling a whole lot better.

Gilroy: What kind of results have you seen thus far since implementing best value procurement?

Hagar: I’ll give a couple of very diverse examples. One of the first projects we did was a lightbulb contract, and it was one that was met with a lot of skepticism in our office. Why would you use best value for a commodity like lightbulbs? What risks do you really have with lightbulbs? And what value added is there that a supplier could possibly provide?

But we went ahead and used this best value process for the lightbulb statewide contract because we didn’t have a good idea of what our actual usage was of the various bulbs. We submitted what we thought that usage was, but one of the reasons the award was made to the vendor of choice was because they did offer a value-added service, which was that they would go around to the various agencies and would do an audit of the lighting fixtures and the bulbs being used and then make us recommendations as to how we might be able to save money. They’ve now done that for a multitude of agencies, finding ways to save through a more efficient utilization of bulbs or changing out fixtures to be able to accommodate more efficient bulbs.

Another interesting thing about that contract is that after they started tracking our usage, they found that one of the bulbs we had contracted had a much higher usage than what we had originally estimated it would be, so they actually came back and lowered their price on that. That may not exactly be a direct outcome of the best value process, but it’s a byproduct in that best value suppliers tend to look out for the best interests of their clients.

In the second example we had a project for the state tax commission, which had a multitude of disparate systems for the sales tax, income tax, tobacco tax-all of these different systems within the tax commission didn’t speak to one another, so they had no visibility of what the other systems were doing. They wanted to create a way to have consistent reporting across all of those platforms. They had a budget of $40 million on that project, and we got a multitude of responses, ranging between $16 million to $66 million. Our process found that the $16 million submission was the one that provided the best value and provided the most expertise. It was a small organization, but they were very successful in getting the work done.

They came in and told the tax commission how they were going to achieve the objectives, and while their price was $16 million, there were still a lot of other value-added services that they could offer for $8 million that were not requirements of the project but that would bring better results, if you will. So the tax commission not only got what they wanted for significantly less than they budgeted for, they also got a lot of value-added services on top of that.

That $24 million was $16 million less than what was originally budgeted, and we call that cost avoidance because it’s not really a savings-it’s just lower than what we originally estimated it was going to cost. If you look at that relative to the other bids, there’s an even bigger cost avoidance.

That project is completed now, and the tax commission became a big fan of the process.

Gilroy: What kinds of challenges do you see in implementing best value procurement and how have you addressed them?

Hagar: The paradigm shift is that while the process is quicker and easier for the clients, and the initial submissions are quicker and easier for the suppliers, it’s quite a bit more work on the procurement end. It is so much different from a traditional request for proposals, where we would receive a specification from a client agency, we would post that as a solicitation and get responses from suppliers, the responses go to the client for evaluation-and we’re completely removed from that evaluation process in the traditional scenario. Then they send back their recommendation, and if we can validate that their numbers add up, we would make the award and our buyers would move on to the next project.

That’s the mentality that we’ve had to address in the best value process. The contracting officer and the facilitator are involved in every phase of the project, from selection to evaluation to verification. All of this is monitored through the procurement office. And the contracting officers are also included in the weekly risk reports, so they watch the progress of the project too.

That’s one of the tough parts of PIPS: maintaining the actual documentation of the project. A buyer that monitors multiple projects will start getting multiple weekly risk reports in, so the projects just don’t go away like they used to. They just hang around and keep multiplying. So now we’re tracking a multitude of best value projects in various stages of delivery, and while it’s always the client’s responsibility to monitor those risk reports and make sure the project is on track, there is quite a bit more work on the procurement side in terms of education, facilitation and staying in lockstep with the client along the way. In a traditional process, the clients are left to do a lot of those things on their own.

That said, once our buyers get comfortable with the process, they tend to become big fans as well. When you work with a supplier that’s an expert, the chances of success are greatly improved.

Gilroy: Even though you have suppliers remove risk from their pricing during the procurement process, is there a threat that risks will materialize during project implementation that could significantly affect the cost of delivery after the fact?

Hagar: There’s always that potential, but I can’t think of any project we’ve done thus far where we’ve seen risks come up that have added to the price of the delivery. I think in part we’ve been lucky, but a lot of it is also because we’re doing relatively straightforward processes, as opposed to something like construction projects where there can be a lot of unforeseen risks that could affect pricing.

I’ll give you an example. We did an end-of-year testing bid where we used a traditional request for proposals and made an award, but there was a minor technicality that we missed-the award was supposed to be approved by the Board of Education before we officially made the award, and we didn’t do that. We got a bid protest, and we acknowledged that they were right and we had to go back out to bid.

The original bid took about nine months, but we had a very short timeframe to do the re-bid, so we used best value to expedite the process. The way it worked out, we ended up with the same vendor we awarded previously, but the substantial difference was in pricing-the vendor reduced their pricing by $4.9 million, on a $29 million dollar the project, by removing risk from the specification.

That’s the idea with the PIPS process. You take out some of the costs from the award that would have been associated with risk. The idea is that if the supplier issues enough of a heads up on the upcoming risks, then you’re able to take steps to mitigate the risk and keep it from impacting either the time or the cost to any great extent. I think that we’ve been very successful at that. You have to be able to identify that risk before the award is made and identify ways to control it in a risk mitigation plan. We all know moving forward that if that risk happens then there’s the plan for how to handle it. That transparency and visibility allow us to eliminate a lot of risk that might occur in a traditional project delivery.

Also, we understand that the client is usually the primary driver of risk, so if we can take the client risk out of the equation-meaning giving suppliers a mechanism to bring to our attention when we’re going awry and are doing things that might prevent them from achieving our objectives-that’s another reason why we haven’t seen risk adding costs.

Gilroy: What lessons learned would you share with peers in other states looking to implement best value procurement?

Hagar: The biggest lesson learned is that you have to have executive support and make sure that your senior leadership is on board and understands in case there’s some pushback from the vendor community in terms of what’s going on.

You also have to have what Dr. Kashiwagi calls “visionaries.” You can break the population into two groups-those that can see into the future and don’t believe in control, and those that believe in management and control because they believe they don’t really have control over their own destiny. Unfortunately, there’s a whole lot more of the folks that believe in management and control than believe in the visionary style.

So it’s important to have someone that understands how the process works and why it works, and understands the theory behind it, so that when questions come up you can address those in a manner that makes sense. There’s a lot of counterintuitive things in the process that make it work. For example, less communication is better, which is a hard thing for a lot of people to understand. But by communicating with metrics, there’s less need to communicate verbally between client and supplier. If you allow the supplier to use their expertise, then we don’t have to make a lot of decisions. Decisions inherently tend to bring risk because they are made when you don’t know where each paths leads. Experts, having been down each path, know which path to take from experience.

We tell vendors right up front, “don’t be afraid to tell us when we are creating risk.” That’s because it’s our tendency as a client-we’ll change specifications, we’ll change delivery times, we’ll just change things because as the client, we can. If the supplier has a mechanism where they can highlight that risk and how it will impact delivery of the project, then they can have a way to address it.

Education is also key. We send our people to Dr. Kashiwagi’s annual best value certification event in Arizona, and our buyers always come away from that with a better idea of what we’re trying to achieve.

The PIPS process is another tool in our toolbox. It’s not going to be right for every situation, but is something on the other side of the spectrum from strategic sourcing, for example. It’s a great tool to have as an option, particularly when you have a project that’s politically sensitive and complex, where we may know what we want to achieve but do not have the expertise to know how to get there. But there’s almost always someone out there that does have that expertise. When we write our specifications, we frame it as our objectives-we don’t tell anyone, “this is what we want you to do.”

The objective of the tax commission project I mentioned earlier was conveyed in one-page; a traditional information technology project of that magnitude would typically be 50 to 100 pages of specifications, and then we would receive 300-page responses from each supplier that we had to wade through. It becomes a very time-consuming and subjective process at that point.

With this redacted amount of information that we use in PIPS, they simply have to say, “we understand your objective, we’ve done this before, and here are the results.” We can process that very quickly, objectively, and effectively.

Steve Hagar is the state purchasing director for the state of Oklahoma. Before taking that role in February 2015, he had nine years of experience serving as deputy director of central purchasing for the state of Oklahoma and has been an instrumental part of the division’s many recent accomplishments. Most notably, he has developed the state’s best value procurement process and holds the only A+ certification in Performance Information Procurement System (PIPS) in the country.

Hagar has an extensive background in both manufacturing and government procurement. During his manufacturing career, he earned certifications from the National Association of Procurement Management (NAPM) and American Production and Inventory Control Society (APICS).

Other articles in Reason Foundation’s Innovators in Action 2015 series are available online here.

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Village officials negotiated significant reforms to police and firefighter pensions in the collective bargaining process, including a full transition to a defined-contribution, 401(k)-style system for new police officers and a realignment of benefits for new firefighters entering their defined-benefit pension system. As a result, the legacy police defined-benefit pension system has gone from underfunded to significantly overfunded, new police officers benefit from a more individualized and portable retirement plan that is less costly for taxpayers, and the firefighter pension plan is on a sustainable path.

The negotiating team-led by Tequesta Village Manager Michael Couzzo and also consisting of Finance Director JoAnn Forsythe and Human Resources Director Merlene Reid-successfully negotiated these reforms during the collective bargaining process. Couzzo recently sat down for an interview with Reason Foundation Director of Government Reform Leonard Gilroy to discuss the reforms enacted, the resulting benefits and more.

Leonard Gilroy, Reason Foundation: What prompted the push for pension reform in Tequesta?

Michael Couzzo, Village Manager, Tequesta, Florida: One of our biggest concerns was the ability to sustain the plan as a defined-benefit plan, given the fluctuations in the market, and the costs to the Village to provide those benefits to its employees. It was our desire to continue to provide those benefits as they were agreed upon at the time of employment.

We were starting to recognize that the unfunded liability in our police pension system was increasing over the years, which caused some concern for us. We wanted to make sure that we would be able to fund the promised benefits and not be so heavily reliant upon the swings in the market.

Gilroy: Can you describe the specific reforms enacted?

Couzzo: First, we wanted to make sure that the defined-benefit plan for the existing public safety-police and fire-workers remained as it was, so there’s been no change in the benefits for the employees that were with us before the change in the collective bargaining agreement.

Then what we were looking for was that when we brought newer employees into the police department specifically, that they would come in under a defined-contribution system. And we did that knowing that we would give up some money that the state distributes to municipalities under what’s known as the “185 program,” where insurance premium tax dollars the state collects from municipalities are sent back to qualifying police pension plans in those municipalities to help fund additional pension benefits. We felt like it was worth forgoing those dollars to make the changes.

In the new police defined-contribution plan that started in 2010, the village would match employee contributions up to 5%. And we recently just did another contract that also provides an automatic employer contribution of 3%. So back in 2007 before the reforms were enacted, we were contributing at a level of roughly 26% of payroll, and now we can predict where we’re going to be and our exposure is no greater than 8%, which is the 3% automatic contribution and our employer match up to 5%. Our police and fire workers also get social security.

We negotiated changes to our firefighters’ contract at roughly the same time. Again, we did not change the benefit levels for the current employees at that time, and instead of moving them to a defined-contribution plan like the one for police, we chose to move to a different pension multiplier. For the new employees that come into the fire department, the multiplier went from 3.3 down to 2, which is the same multiplier that our general employees have.

We focused on public safety and not our general employees because the contribution rates and the multipliers for the public safety pensions are significantly different than those for the general employees. And in our general employee defined-benefit plan, the funded ratio was 105% at the time we did our reforms in 2010, and the return on investment assumptions were being met, so we didn’t feel that reforms to that system needed to be done.

But in the public safety systems, there were unfunded liabilities. And the cost to continue to provide those kinds of benefits well into the future just seemed to be multiplying.

Gilroy: What results have you seen thus far since your reforms went into effect in October 2010?

Couzzo: On the police side, our reforms have exceeded our expectations in realizing a significant reduction in the cost to the taxpayer to provide pensions to the police. The reforms have been in place for a little over four years, and the funding ratio for the police pension plan has gone from somewhere in the mid-80’s in 2010 to what the latest actuarial statement shows as almost 132% funded now and projected to rise to 134%. So there’s been a significant change in the funded status, and the contribution rates for the employer as a percentage of payroll have dropped from around the low-20% range to around 11% now.

On the fire side, it’s a little longer of a process, but in the years to come we’re going to see a similar improvement, and in the future we’re not going to need to be funding their pensions at the rates that we were previously and at the rates that many other jurisdictions in Florida are facing.

And overall we’re going to be able to assure workers that they are going to be able to receive the pension that was agreed upon at the time of their employment.

Gilroy: To what do you attribute the dramatic reversal in the funded status of the police pension system since the Village Council enacted the reforms in 2010?

Couzzo: It was a combination of factors. We certainly didn’t predict that that turnaround would happen as soon as it would happen, but there were some changes in personnel. We’ve only got about 20 sworn officers to begin with, and we had a few people retire and a few others relocate-about eight total-so when you had the people replacing them coming into the new defined-contribution plan, that made all the difference in the world. Now when the actuary does their study, some of the people they had projected being there for 25 years are now gone, which had a big impact.

Gilroy: How did you build the case for reform?

Couzzo: We knew that we were changing what was near and dear to the unions, but we made reasonable arguments that helped us get it done. We made it clear that the unknowns and fluctuations in the marketplace potentially jeopardized our ability to provide our public safety employees what we agreed upon when they were hired. And there was also the inability to continue to fund the increases that we predicted were going to come. Given the level of benefits we were providing, the defined-benefit systems were in need of modification.

Fortunately, we have a good rapport with our unions here, and once we laid out the situation, they understood it and realized that it was time to make the changes. And the current workers were kept intact, and their benefits were better insured, so to speak, as a result of the changes. Everyone saw the handwriting on the wall that something needed to change in order to be able to pay for those benefits down the road.

There were some concerns raised that we might be selling out the future employees, but we felt like in the long run, we were actually helping them because somewhere down the line they would have had to find a mechanism with which to fund retirement benefits. In some jurisdictions, that means letting go of law enforcement personnel, for example, in order to fund their existing pension plans. That doesn’t help workers down the road, and it certainly doesn’t help their communities.

Gilroy: How do you think the reforms will affect your ability to attract and retain future workers?

Couzzo: That argument was raised, and there’s a potential for that to happen, but we really haven’t seen that here. Agencies like ours always have to be thinking about how to make themselves competitive in order to attract highly qualified personnel. You may have to give them a better salary structure, and if you’re paying that up front, it doesn’t have the same impact on the bottom line that a pension does. And we have had pay increases for our public safety workers, and during the entire recession we did not have one layoff.

Also, most people in today’s society are going to have seven or eight jobs in their careers. So the old notion of “cradle to grave” employment is a thing of the past. One of the things that I emphasized was that given the fact that you may not be here forever, the defined-contribution plan gives you the flexibility of managing your money on your own. And in a defined-benefit system, your retirement benefit isn’t really going to be affected by increases in the market, which it would be in a defined-contribution plan. And I think that a lot of people would rather manage their own money. If that’s explained correctly, people will be willing to listen to that argument.

Gilroy: What are some of the lessons learned from your pension reform efforts that you would offer to peers in other jurisdictions contemplating similar moves?

Couzzo: I think reform is essential and is achievable if you maintain a good relationship with the affected parties and collective bargaining units. That’s going to go a long way towards getting you there. And honesty is really important. You have to show them the numbers and show them that you’re not out to hurt them. They have to be part of the process.

What we’ve done for the residents is taken a lot of risk away by going to a defined-contribution plan. We know exactly what to expect, and we can predict what the costs are going to be. The costs don’t vacillate with the market.

And even with our defined-benefit plan for police, now that we’ve made the reforms, the plan is so strong now that it can easily weather any future adverse market conditions and still provide the benefits for the employee who has possibly dedicated their whole working life to us. Retirement is important, and people have a right to retire with decency, and it’s incumbent upon us to provide that for them. They’re out there ensuring public safety, so we have to ensure that their needs are being met down the road.

Michael R. Couzzo, Jr., is the village manager of Tequesta, Florida and has over 30 years experience in local government covering contract negotiations, finance and budgetary oversight, public works, planning and development, parks and recreation, utilities, engineering and public safety. Couzzo has a B.A. in Professional Studies and an M.P.A. in Public Administration. He has been with the Village of Tequesta for 14 years.

Along with Couzzo, the other members of the team that negotiated the pension reforms discussed in this interview included Village Finance Director JoAnn Forsythe, CPA, who has over 25 years experience in governmental accounting, auditing and management, and Human Resources Director Merlene Reid, who has over 20 years experience in human resources, contract negotiations and risk management.

The Village of Tequesta is located in northeast Palm Beach County with an estimated 6,000 residents. Tequesta was incorporated in 1957, occupies 2.28 square miles (1,456 acres), and is surrounded by the northwest fork of the Loxahatchee River, the intracoastal waterway, Jonathan Dickinson State Preserve and the Atlantic Ocean. The Village of Tequesta maintains a council-manager form of government, currently led by Mayor Abby Brennan, Vice-Mayor Vince Arena, and Council Members Tom Paterno, Steve Okun and Frank D’Ambra.

Other articles in Reason Foundation’s Innovators in Action 2015 series are available online here.

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First, he sponsored legislation in 2014 to facilitate “best value” procurement in Missouri. Best value procurement would give the state more discretion in its procurement decisions by allowing officials to consider a wider array of criteria (e.g., quality, vendor experience and qualifications, etc.), rather than simply selecting contractors based on “low bid.” He also sponsored legislation to enable the use of public-private partnerships for the private financing and development of “social infrastructure,” such as higher education facilities, schools, public health facilities and other public buildings. Though neither bill passed in 2014, Rep. Curtman undertook a considerable amount of outreach to legislative colleagues on these issues and plans to pursue similar legislation in the 2015 session.

Earlier this month, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Rep. Curtman on his interest in best value procurement and social infrastructure PPPs, the work of the House Downsizing State Government Committee, and more.

Leonard Gilroy, Reason Foundation: Since 2013, you’ve served as chairman of the House Downsizing State Government Committee. Can you describe the committee’s charge and your goals for its activities?

Missouri State Rep. Paul Curtman: “Downsizing” state government is quite a broad mission. When the committee was first formed, and before I was chairman, its basic charge was to find statutes that could literally be removed because they were obsolete or otherwise unnecessary.

My approach has really been two-fold. First, we want to seek out those bureaucracies or laws that needlessly burden the people. Our governments should cooperate with the people, not compete against them for their time, labor or treasure. Secondly, my approach has been to thoughtfully explore ways the government can run more efficiently. Good government isn’t always about budget cuts; sometimes it’s about making sure taxpayers are getting the best value for their tax dollars.

Gilroy: In the 2014 session, you proposed legislation that aimed to amend Missouri’s procurement laws to provide for best value procurement. What prompted your interest in this issue?

Curtman: I came across an interesting article on Best Value-specifically, the Performance Information Procurement Systems-Best Value (PIPS-BV) model-that appeared to highlight a complete paradigm shift in the way bureaucracies were evaluating bids and awarding contracts. It was the first I’d heard of the idea of “best value” but the concept was appealing. Government doesn’t usually innovate and this seemed to be a departure from that norm.

Gilroy: Are there other governments that have served as a model for you on that issue?

Curtman: From what I’ve learned, there are several governmental units using the PIPS-BV model, even entire countries. Oklahoma has been a go-to example considering their proximity and similar scope of procurement. They have several years of experience utilizing PIPS-BV and have even participated in a policy forum on the topic I held at the University of Missouri recently. The savings realized in Oklahoma are incredibly promising and hopefully inspiring to those within Missouri’s bureaucracy.

Gilroy: In the 2014 session, you also proposed enabling legislation to allow for public-private partnerships (PPPs) in the development of “social infrastructure,” meaning a broad array of government buildings. What prompted your interest in social infrastructure PPPs?

Curtman: Missouri is in a similar situation as many other states. We have a billion dollars of deferred maintenance, needs for new facilities on our public higher education campuses, a crumbling state mental health hospital, and plenty of other projects that are on hold, but in demand. We have zero appetite for new taxes, and new debt outlays are equally unpalatable. The PPP concept is one I came across in my research-I believe it may have even been in a Reason Foundation publication-that is both smart and pragmatic in taking advantage of private sector business acumen while protecting taxpayers from risk.

Gilroy: Are there experiences in other states that you find particularly compelling on social infrastructure PPPs?

Curtman: Florida and Virginia are the two examples I often cite when I visit with legislative leaders and other stakeholders. Both have years of combined experience and several projects in which to showcase the value PPPs are affording these states’ respective taxpayers.

Gilroy: Do you plan to bring these issues forward in the next legislative session?

Curtman: I do. I filed the “Partnership for Public Facilities and Infrastructure Act” (HB 206), which models Virginia and Florida PPP legislation, and House Bill 205 allows for “best value” to be utilized in lieu of “lowest and best” bid. I expect both bills to come before my committee for a vote expeditiously.

Gilroy: Both best value procurement and social infrastructure PPPs are, at a general level, different ways of harnessing the private sector to achieve public sector goals. What’s your general philosophy on how governments and private enterprise can team up to advance the public interest?

Curtman: This is an interesting question to respond to since differing political philosophies might dictate the definition of “public interest.” Generally speaking, however, I’m in favor of mitigating as much taxpayer risk as possible. I believe a tried-and-true method of doing so is to rely on the private sector as much as possible. If a privately held company is doing it better, faster, and otherwise more efficiently, government need not apply.

Gilroy: Are there other types of PPPs that you could foresee addressing in future legislation (e.g., social impact bonds, etc.)?

Curtman: I will continue to advocate for free-market solutions to public problems as long as public problems remain. Social impact bonds are another emerging tool tapping private sector skill sets and leveraging competition in order to reduce demand on limited public dollars. When they work, they are remarkable, and I think Missouri should take note.

Gilroy: Though it’s still early, are there any lessons you’ve learned thus far in how to communicate the value of PPPs to your colleagues in the legislature, as well as constituents?

Curtman: It has been interesting to see what it is about PPPs that piques the interest of legislative stakeholders and the constituency. Of course, many in the legislature and executive branch are intrigued because of the renewed ability to deliver public projects, which in turn aids the private construction, finance, and related markets.

Constituents are most inspired by the overall value appeal. That is, they want to know that when we are spending what really is their money, we’re doing it as carefully and pragmatically as possible. That’s a charge I take very seriously.

The fact that these two interests are intersecting at the same point is what makes this type of proposal so unique and consensus-driven.

Paul R. Curtman is a Missouri State Representative who chairs the House Downsizing State Government Committee and serves on the Joint Committee on Government Accountability, the House Ways and Means Committee and the House Economic Development Committee.

Curtman graduated from Pacific High School in 1999 and subsequently enlisted in the United States Marine Corps, serving his country as an infantryman with Golf Co., 2nd Battalion 3rd Marines. While stationed in Hawaii, he became a Marine Corps martial arts instructor and was instrumental in teaching infantry Marines hand-to-hand combat. As a Sergeant in the Marines, Rep. Curtman deployed to the Middle East in support of Operation Enduring Freedom.

After leaving active duty, Rep. Curtman continued his service as a Marines Reservist for six years. During that time, he attended the University of Missouri-St. Louis, where he earned a bachelor’s degree in Political Science. Upon graduation, he became licensed as a Series 7 Investment Representative and was employed at a major investment firm.

Rep. Curtman currently lives in Union, Missouri with his wife Ruth, a public school math teacher.

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

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A looming pension crisis began to emerge in Oklahoma in the mid-2000s due to a combination of inadequate funding of state pension plans and a ratcheting up of cost of living adjustments to pension benefits. By 2010, the state’s pension systems faced an estimated $16 billion in unfunded liabilities, and the Pew Center on the States ranked Oklahoma in the bottom five of all states in the nation with a 56% funded ratio.

The financial threat posed by the growing liabilities in the state’s main pension fund for general state employees-the Oklahoma Public Employees Retirement System-has prompted the state legislature to enact two waves of pension reform in recent years:

• First, in 2011, the legislature enacted House Bill 2132 to rein in runaway COLAs and benefits by mandating that any future pension benefit enhancements had to be concurrently funded with cash prior to the granting of the benefit. This legislation significantly reduced the system’s unfunded liability, though it still remained high at $10.6 billion, rising again to approximately $11 billion by 2014.
• Second, in May 2014, the Oklahoma legislature took a more ambitious step toward addressing the state’s looming pension challenges by passing House Bill 2630 (“Retirement Freedom Act”), legislation that will phase out the state’s defined benefit pension system for general employees by requiring all new state workers (except hazardous duty employees) to enroll in a 401(k)-style defined contribution retirement plan starting in November 2015. From that point forward, new hires will contribute between three and seven percent of their salaries into the defined contribution system, with an equal employer match from the state. The new law is estimated to produce $3.8 billion in savings over 30 years. However, the law does not affect the benefits received by current employees and pensioners.

As the chair of the House Pension Oversight Committee and author of HB 2132 and HB 2630, Oklahoma State Representative Randy McDaniel has been the primary architect and champion of Oklahoma’s pension reform efforts. Earlier this month, Reason Foundation Director of Government Reform Leonard Gilroy interviewed McDaniel on what prompted him to take on the issue of pension reform in Oklahoma, how he made the case to policymakers and stakeholders, the specifics of the reforms enacted, pension reform challenges and more.

Leonard Gilroy, Reason Foundation: Can you describe the financial health of the Oklahoma Public Employees Retirement System (OPERS) prior to the two waves of reform in 2011 and 2014, respectively? What prompted the push for reforms?

Randy McDaniel, Oklahoma State Representative: OPERS is the state’s second largest retirement system. In 2010, the system had a $3.3 billion unfunded liability, and we decided to focus on this system for the new plan design for several reasons.

There had been requests from new members indicating the desire for more mobility and freedom. Historically, the system has experienced a higher turnover ratio than other systems, and the funding sources are clearly defined. Moreover, not only is it a large plan, but it also has a solid funding status, which is important in transition costs debates.

Major pension reform in Oklahoma started in 2011. The signature accomplishment that year was the Truth in Funding Act (HB 2132). In the 1970s, Social Security started granting cost of living adjustments (COLAs), and most states followed suit promptly thereafter. Over time, the issue has become the lack of funding for those new enhancements. Most often, there has been no new funding. As a result, COLAs have been a major factor in the growth of unfunded pension liabilities across the country.

My proposal that became law required any future COLAs to be fully funded upfront. In Oklahoma, the cost for a two percent COLA for all state pension systems is approximately $350 million per authorization. The new funding requirement has obviously made it much more difficult to grant a COLA because the funds have to be appropriated within a balanced budget.

The big picture is the state had over $16 billion in total unfunded liabilities. The actuaries had been correctly assuming that we would pass on an unfunded mandate to the pension system. The costs of the new benefit would then be absorbed by the assets of the system and would make the debt larger.

With the new requirement that COLAs had to be fully funded, the actuaries could remove that assumption. The financial condition was improved by $5.5 billion. All of the systems were greatly improved as a result. When looking specifically at OPERS, it went from a $3.3 billion unfunded liability down to a $1.5 billion unfunded liability by 2013.

Gilroy: From your vantage point as chairman of the House Pension Oversight Committee, the looming pension challenges facing the state may have been relatively clear, but that may not have been the case for many of your colleagues in the legislature less versed in such a complex issue. What steps did you take to build the case for reform?

McDaniel: The first step was the acknowledgment of the problem. For many decades, the majority of members took an “out of sight, out of mind” perspective. The costs were growing and the impact on other funding priorities could not be ignored.

Then there’s the realization that teamwork is needed. Leaders had to work together to find real answers. I focused more on the numbers and the facts as opposed to complaining about the abuses that have taken place. We can’t do anything about the past, but we can prepare for the future.

I aim to treat everyone with respect. We’re talking about people that are serving the state. It’s not any one group’s fault; it’s a combination of everyone involved, as well as the demographics and investment conditions that we face in the modern world. If you explain all the factors, it becomes self-evident that reforms are necessary.

The final issue is tenacity. Reforms were required if we were going to have a sustainable Oklahoma. We could no longer make excuses and turn our backs on a problem that was impacting all of our other funding priorities. There is no substitute for hard work and dedication to mission accomplishment.

Gilroy: Moving to the 2014 reforms, HB 2360 created a defined contribution system for most new state employees starting next year. Can you explain the rationale behind the legislation?

McDaniel: The key attributes are more freedom for employees and less long-term debt for the state. When we break down some of the related issues, I wanted to have a retirement system that was very attractive, but also sustainable. A comprehensive analysis of not only state retirement plans, but also private sector plans, was conducted. The plan has a matching schedule that is competitive with the biggest and best companies in the country.

Since the costs are certain and affordable, this will allow us to continue funding the current defined benefit plan to ensure its financial viability until its debts are paid off.

Gilroy: How will HB 2630 benefit taxpayers and reduce the state’s financial risk? What were the most effective arguments in favor of reform?

McDaniel: When you have a defined contribution plan, there are no new unfunded liabilities created from that point forward. The argument becomes what happens to the existing plan, and we were able to overcome that concern with data illustrating the financial commitment to the existing defined benefit plan, as well as the new retirement system.

An issue that is overlooked in the mathematical data is the issue of political incentives to harm the system by making unsustainable financial promises. Unfortunately, those incentives are real, and they greatly impact the situation we face today. It’s easy to make promises when someone else is going to have to pay for those promises at some point in the future.

So the two great benefits to the taxpayers are: (1) we know what the costs of the new system are going to be and we can plan for it; and (2) it greatly reduces the political situation that has led to the condition we’re in today.

Gilroy: Across the nation, government employee unions tend to line up in opposition to pension reform as a general rule, but in your state, the Oklahoma Public Employees Association did not actively oppose your efforts to reform pensions through HB 2630. How would you explain their position?

McDaniel: We worked diligently to build support with all the groups involved, including the leadership and members of the Oklahoma Public Employees Association. At one point, they opposed the bill which led to other unions joining together in opposition. But in the end, when it became clear that we were willing to fulfill the agreed-upon pay raises, OPEA agreed to not actively oppose the final passage of the bill. This made all the difference in the world because the other groups decided not to get in the way of their pay raises.

Gilroy: What types of opposition to reform did you run into along the way, and how did you address those challenges?

McDaniel: All of the other special interests involved were following the lead set by OPEA. There was initially some great opposition, and every group was ready to join OPEA. But we had a great relationship with OPEA. We met often and listened to their concerns and viewpoints on what it would take to make this an amenable situation. In the end, because we reached an agreement, the other groups backed off.

Gilroy: Some policymakers resist the idea of shifting from a defined benefit to a defined contribution system over fears of high transition costs involved with the switch. Did you have to confront this concern in Oklahoma, and if so, how did you respond?

McDaniel: If a plan is 100 percent funded, it is difficult to argue there are transition costs. The lower the funded ratio of a plan, the more debatable the issue becomes.

When I first authored legislation to move to a defined contribution plan in 2011, behind the scenes we were presented with an outside analysis stating there would be heavy transition costs. We debated the issue, but at the end of the day, it did stop the momentum. Members wanted to wait and take a further look at the issue.

I was well prepared the second time around and had my arguments ready, with an actuarial study supporting our case. If we continued funding at the existing level, there would actually be savings of $3.8 billion over the actuarial amortization period. No one could make a convincing argument otherwise that any alleged transition costs would be harmful to the long-term strength of the system.

Transition costs can be a debatable issue, but I believe the private sector provides a case in point. Private companies wouldn’t be consistently moving to defined contribution plans, if the transition was harmful or costly to their business. That was my defining argument on the subject. Why would thousands of companies be deliberately switching from a defined benefit pension plan to a defined contribution plan if it was costly to their business, or if it was harmful to their recruitment and retention efforts?

Another powerful argument against the reform was the argument that similar reforms did not work in other states like Alaska, West Virginia and Michigan. The actual financial situation was improved in those states because of a transition to a new retirement plan. Other political and funding decisions are separate issues.

During the final debate, I quoted Reason Foundation’s work to rebut the opposition’s claims. In Alaska, for example, the system would have been worse off if the state had not closed their defined benefit plan to new members. I am greatly appreciative of the analysis done at Reason on this issue. There were a lot of important studies that helped along the way, and this report was one of them.

Gilroy: You mentioned having actuarial studies supporting your case for pension reform. Can you describe the role they played?

McDaniel: Our state’s independent actuary has decades of experience with the plans, which leads to credibility since he wasn’t hired by the new majority party. At the end of the day, his office was not prepared to have a full-blown actuarial analysis of the bill, but his decision on whether our legislation was either fiscal or non-fiscal is the legal and binding opinion. Let me explain.

The legislature’s independent actuary makes the official determination of whether legislation affecting the state pension system is fiscal or non-fiscal. With HB 2630, our actuary delivered us a bullet point saying that our legislation would not have a fiscal impact. Still, to win the debate, you need more than a bullet point stating a proposal is non-fiscal. We still needed to convince members to vote for it and to counteract what the opposition was saying.

I’m very thankful that the Oklahoma Council on Public Affairs (OCPA) provided a key document-a full-blown actuarial report that members could review that outlined the findings of their independent actuary. Consequently, it allowed us to counteract what those opposing the bill had produced. The local leader for Americans for Prosperity was prepared to produce another independent actuarial report, if needed.

It was useful to be able to counteract the opposition claims and come back with an independent analysis showing that there would indeed be savings-approximately $3.8 billion over a 30-year period, according to the report requested by OCPA.

Gilroy: From a human resources standpoint, how do you think HB 2630 will affect the state’s ability to attract and retain future workers?

McDaniel: Young workers are most interested in pay. That drives their decisions, even more so than in the past. As we look at an increasingly mobile society, people want to have their retirement plans move with them throughout their careers. Overall, I think it will be helpful if we can reduce pension costs and make them sustainable, thereby allowing pay to become more competitive with the private sector. I call it the “prosperity gap” in my new book. I contend that the very reason we have stagnant pay in the public sector is because of social insurance programs that are absorbing a growing share of the resources available.

Gilroy: What’s next in terms of pension reform in Oklahoma? Are additional steps needed to reduce unfunded liabilities in the legacy pension system and reduce risk for taxpayers? And what about the teachers’ pension system, which has the largest unfunded liability of Oklahoma’s state systems and was not affected by HB 2630?

McDaniel: I will continue looking for solutions to improve the financial security of the system. There are a couple of issues involved in what we do moving forward. One issue is the new Government Accounting Standards Board rules and what impact they’ll have on the system. That’s relevant because those in opposition to reforms look for reasons to say that the reforms already enacted aren’t working. So we have to be mindful that as new accounting rules are implemented, that could create the appearance of a worse financial condition, which presents a potential timing issue for future reforms.

In the case of Oklahoma, the teachers’ retirement system is our largest pension plan and it is more underfunded than most of our other plans. There are issues to consider, such as debatable transition costs as well as the diverse funding mechanisms that have been implemented to shore up that system.

Overall, my goal is to make all of our pension systems sustainable. We’re going to look at each situation separately and evaluate the numbers and needs. We have been very diligent over the last four years and have made great strides, with each step building on the last. I will continue in that manner, trying to find fair solutions to one of the state’s greatest financial challenges.

Gilroy: What are some of the lessons learned from Oklahoma’s pension reform efforts that you would offer to peers in other states who may be contemplating similar moves?

McDaniel: I’m very thankful for the relationships I have with my colleagues in the House and Senate, and the leadership from the governor and other top officials. Major reforms do not happen without key leaders making the issue a top priority. In Oklahoma, it took a teamwork approach to get things done.

Also, there is no substitute for hard work. Hard work includes not only a willingness to boldly advance reform ideas, but also a tireless commitment to bring people to the table to hear all sides of the issue. I’ve learned over the years that sometimes you can find support in very unlikely places. Plus, there may just be one small flaw in a proposal that can be the game changer, making the difference between success and failure.

The most important lesson I’ve learned is to never give up. The issue is too important to the future financial health of the state.

Oklahoma State Representative Randy McDaniel received a bachelor’s degree in Economics from the University of Oklahoma where he was selected as the Outstanding Senior Man. He graduated from the Institute on Business and Government Affairs at Georgetown University prior to earning a master’s degree from Cambridge University in England.

McDaniel served in the military before being elected to the Oklahoma House of Representatives in 2006. In the House, he has served as the Chairman of the Economic Development & Financial Services Committee and also as the Chairman of the Pension Oversight Committee. As a successful financial advisor, he has worked for more than 20 years in the financial services industry.

McDaniel has served in leadership roles with the Southern Legislative Conference and national legislative organizations regarding state pension systems. In 2014, he authored the book Pensions and Prosperity, which details the history of pensions and solutions for reform. He and his wife Julie have two wonderful children: Grace and John. They attend Crossings Community Church in Oklahoma City.

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

The post Advancing Pension Reform in Oklahoma appeared first on Reason Foundation.

As a city councilman, Scrivner spearheaded Measure D, a ballot measure approved by Bakersfield voters in 2010 that reformed the city’s pension system for newly hired public safety employees. Scrivner continued those efforts at the county level after being elected to the Kern County Board of Supervisors in 2010, having successfully negotiated for comprehensive pension and healthcare contribution reform with county public employee unions in 2012.

Reason Foundation Director of Government Reform Leonard Gilroy recently interviewed Scrivner on the rationale for the city and county pension reforms, the similarities and differences between them, lessons learned, and much more.

Leonard Gilroy, Reason Foundation: You were ahead of the curve on reforming public sector pensions, starting to raise the issue in Bakersfield back in the mid-2000s before many people had any idea that public sector pensions were posing such a challenge with regard to their long-term solvency. Further, Bakersfield is generally considered to be fairly conservative, so many might be surprised that pensions were an issue there. What prompted you to initiate your push for reform?

Zack Scrivner, Kern County (CA) Supervisor: Really it was on the campaign trail. The most important part of the campaign is when you’re meeting with people and asking them for support, and you start to get an idea about what people are concerned about. When you’re going door to door, you’re talking to the residents in the district you’re running in about issues that are important to them around the dinner table-things like crime, graffiti, and potholes.

Likewise, when you’re meeting with people in the business community, you have similar conversations about the things that they’re concerned about. A supporter of my campaign who was a long-time friend of the family was having breakfast with me one day and suggested that I should really start digging into the public pension problem if I won. I knew a little bit about that issue, because at that time, in 2004, I was working for the Assembly Republican leader Kevin McCarthy in the California state legislature. I was aware of some of the issues with the California Public Employees’ Retirement System (CalPERS) at the state-level and how the public employee pension costs were impacting the state budget at the time.

So when I got elected to the Bakersfield city council, I asked for the city manager to give me some information on the city’s CalPERS pension costs. What I discovered was pretty startling. It was something that I later learned was the norm for other cities and counties that had followed the state’s mistake in raising public employee pensions to the “3% at 50” [Editor’s note: a retirement benefit plan in which public workers are able to retire at age 50 with the percentage of final pension compensation being calculated as 3% per year multiplied by the number of years of service] for public safety employees and “3% at 60” for non-safety employees.

Back in the mid-1990s, the city’s retirement costs were overfunded. In June of 1999, the pension fund had an excess of $94 million, and we weren’t having to make payments to CalPERS. But by the time the city council had raised those pension benefits in 2002 from “2% at 50” to “3% at 50” for public safety employees and “2% at 55” to “3% at 60” for non-safety employees, that surplus of $94 million turned into a $27 million unfunded liability.

And that number kept rising. By the time I was in office in 2005, that unfunded liability had reached $93 million. So there was a complete swing of over $180 million as a result of the increased pension benefits.

And in terms of the costs-what the city was paying into CalPERS-the city went from paying nothing to making a $4 million annual payment in the early 2000s. That rose to an approximately $15 million annual payment by the time I got into office in 2005, and when I left six years later, that payment was in the neighborhood of $25 million per year. That was impacting our budget tremendously, despite the fact that we had had a housing boom and the economy was robust at the time.

When I saw that, I thought back to all of the people I had talked to on the campaign trail and the issues they were concerned about-graffiti in their neighborhoods, the potholes, and the fact that there weren’t enough police officers on the street. And I saw this as directly impacting the city’s ability to provide a level of service in government that my constituents expected and, I felt, deserved.

I remember one time when I went on a Monday morning news show where we were talking about city budget issues, and I said that one thing we needed to do was to get to get a handle on these public employee pension costs. And I gave them the same numbers I just discussed, and the next thing I knew, the public employee unions were after me big-time. They had not supported me in my race, but the extent of the vitriol was pretty astounding. I suppose I was naïve in thinking that you could kick a hornets’ nest like that and not get that sort of backlash. But I kept at it.

You mentioned how Bakersfield is conservative, and that’s true. But politicians who touted themselves as being fiscally conservative-up and down the state-they also curried union support, especially the public safety support because they want to be able to claim that the police and firefighters support them. So even though we had a city council that had five out of seven of the members as Republicans, you had Republicans that were closely tied to the unions that had helped them in their campaigns, and they wanted to keep it that way.

So I got a tremendous amount of resistance, and there was no one else on the city council that wanted to talk about pension reform. They just wanted to blame it on the stock market, claim that at some point it was going to turn around, and argue that these safety workers were putting their lives on the line and so they deserved the benefits they were given.

And while I appreciate as much as anyone the kind of work that a policeman or firefighter has to do, to me it’s not a question of what these workers deserve in their retirement, but rather it’s a question of what we as taxpayers can afford. And it was clear to me that we couldn’t afford it, and we were going to have to change it.

Over the course of the next six years I kept banging that pension drum, and I started to get more and more support from people in the community, because at the same time there were news articles coming out in the Wall Street Journal or columns by Dan Walters in the Sacramento Bee where they were talking about pension problems in Sacramento or other places around the country. The public awareness started to increase.

So I continued with what I was doing. Whenever we were in budget discussions I’d raise the issue. And we also had opportunities along the way during contract negotiations to start talking to the unions. We were actually able to negotiate a contract in 2008 with our SEIU (Service Employees International Union) that reduced the pensions from “3% at 60” to “2.7% at 55,” which wasn’t a huge change, but it was certainly a big step in the right direction. It was the first time to my knowledge that any public employee union contract was negotiated in the state that actually dialed back retirement benefits.

But the police officers’ union and the firefighters’ union-which were the other two unions we had in Bakersfield-refused to budge on the “3% at 50” issue, so we reached an impasse with them. At that time, we had another election, and we got a new councilman who was very fiscally conservative, and he had realized that we needed to do something about the pensions as well. So then I had an ally, and we continued to beat that drum. And as we did that, two other members out of a seven-member council gravitated towards us on the issue. With a majority of the council interested in reform, we were then able to make some progress.

Ultimately, in 2010 I proposed to the council that we put a measure on the ballot-Measure D-to scale back the public safety pensions to what they had been before the benefits had been increased a few years earlier. Given the impasse we had with the safety unions, we felt like we were in a good legal position to go to the ballot.

There was a nonprofit group that started called Kern Citizens for Sustainable Government made up a few young, successful businessmen that ran a small campaign and spent about $6,000 or $7,000 talking about the pension crisis in general. Separately-we weren’t coordinated-we spent about the same amount of money advocating for Measure D. By contrast, the unions spent $60,000 against the measure, doing radio ads and placing signs around town, etc. But by that time, the public was very aware of the pension problem, and the measure passed by a 55-45 margin.

Gilroy: Can you describe the key components of Measure D?

Scrivner: Measure D only affects newly hired public safety employees, and it says that any employee hired after January 1, 2011 would be in the “2% at 50” retirement tier-instead of the “3% at 50” tier that we had previously.

And it also said that they were required to pay the employee’s share of their retirement costs for their entire career, which is 9% of payroll. Before that, employees would start by paying 4% for the first five years-with the city picking up the other 5%-and then after five years the city would pick up the entire 9%. Measure D required that new hires would be responsible for picking up the full 9%.

I wanted to be thoughtful in selecting the actual reforms. We could have gone to “2% at 55,” which is the lowest pension tier for public safety allowed by CalPERS. But I didn’t want to do that because we were going to the voters with a ballot measure-which meant that public perception was going to be a factor-and I didn’t want the unions to be able to say that they were going to have the lowest pension benefits in the state of California if the measure passed. Had that been the case, they still would have had a very good retirement plan, but technically speaking, they would have the lowest one offered by CalPERS.

Instead I advocated for “2% at 50” because we could then make a strong argument that all we were doing was going back to what we had before the pension costs and the unfunded liability skyrocketed. We had a pension plan back then that the city was able to afford, and it’s a very good pension plan. So we were just proposing to go back to that plan for just the new hires; we weren’t going to touch the existing employees’ and retirees’ plans. That was one thing that the unions always tried to do-they tried to say that we were going to “take their retirement away,” which of course wasn’t the case, because state law and contract law would preclude us from being able to do that even if we wanted to. That’s not what I was proposing. The other advantage was that the 2% at 50 minimized the risk to the city for a collective bargaining violation.

After Measure D passed, the police union filed a lawsuit claiming that we had violated the collective bargaining rules by making these changes, but that challenge was ultimately dismissed.

Gilroy: How much of an understanding of the pension situation did your council colleagues-who put Measure D on the Bakersfield ballot-have when you started talking to them to make the case for reform? What convinced them to ultimately support your efforts?

Scrivner: In the beginning, there was very little understanding of it. I don’t think you really had members who understood what kind of financial crisis it really was, but there were a couple of members on the board with financial backgrounds who understood the issue. And there were others who didn’t really have much understanding of the issue at all, and even less understanding of the complexities of it and how certain things in the actuarial process affect the ultimate bill that we had to pay.

But by banging the drum and having more and more people in the business sector of the community showing their support for what I was trying to do, the political pressure started to build on the council. And once I got that second person on the council who joined me in talking about this issue, then we were able to get a majority on the council who saw it as a problem.

When I was elected in 2004, I was only elected to a two-year term because I was finishing the term for someone who had retired. So I had to run again in 2006, and my campaign was almost entirely about the pension argument. The unions actually put an ad in the newspaper soliciting an opponent for me. Three people answered the ad, and they picked one of them. I got over 60% of the vote in a district that is only 39% Republican. The other councilman I mentioned who joined me as a champion of pension reform was also elected at the same time, and despite the unions spending over $100,000 against us, we both won. So that was a real test case for where the public is on this issue, which made a big difference.

That really changed the way the council looked at the issue because most politicians felt like you really needed to have the unions’ support or else you just weren’t going to win. That’s changed now as people have started to understand that the unions are out for pay and benefits for their members, and taxpayers have soured to their arguments with the economic recession.

Gilroy: How did you make the case to voters?

Scrivner: I felt the most effective thing to do was to talk to voters about the things that were most important to them and how these pension costs were impacting our ability to deliver those services to them. You started to get a realization that there were these public employees now retiring with well over $100,000 per year in pension payments and that the costs of the benefits had skyrocketed so quickly. We were in a situation where it was virtually unsustainable. I talked about the way in which we went from a $94 million surplus to a $100 million deficit in 10 years since the benefits were increased by 50%. That’s what you get when you go from a “2% at 50” to a “3% at 50”-that’s a 50% increase in benefits.

And we talked about how much we expected to save from the ballot measure and how much we thought we’d be able to deliver for public safety, roads, parks and other critical services. I think that people also liked the idea and could relate to employees actually having to pay into their own retirement. When the average taxpayer in a regular retirement plan-who has to contribute to their retirement every month out of their paycheck-finds out that government employees didn’t have to pay anything into their retirement, there’s obviously some fairness issues that creep into the voters’ minds.

Gilroy: Many pension reform efforts across the country exempt sworn public safety officers, with politicians fearing a backlash from safety unions and the general public. But in Bakersfield, Measure D was aimed at scaling back the pension benefits for new hires in public safety. Can you explain the rationale for that? What resistance did you encounter?

Scrivner: As I explained earlier, we had already negotiated some pension reforms with the unions regarding general employees, but not for the public safety employees. And I knew that it was going to be harder to address public safety because the public tends to view police and firefighters as heroes.

But we had already gone through the collective bargaining process with the public safety unions and had declared an impasse, and that’s the point at which you can even make a decision to actually impose pension reforms on the employees. But I preferred to take the issue to the voters instead, because I was concerned about what would happen on the city council in the future. Let’s say the unions successfully ran people for city council that got elected and were able to undo everything we did. By taking the issue to the voters, in the future if you want to change it you have to take the issue back to the voters.

Look at San Francisco, which people tend to think of as a very liberal city. But many years back, their voters passed a measure saying that you had to go to the voters to raise retirement benefits for city employees. It’s my understanding that San Francisco hasn’t seen the same kind of problems with pensions that other places have had. So I wanted to have that same kind of safeguard, the assurance that you’d have to go back to the taxpayers if you wanted to undo the reforms we were seeking.

I should also mention that one of the arguments you tend to hear from the unions is that we won’t be able to hire qualified people if you reform pensions because we won’t be able to compete. Well, the year after Measure D passed and after I had become a Kern County supervisor, the Bakersfield city manager told me that they had just completed their first police recruitment since Measure D and that they had 1,000 applicants. So much for the argument that pension reform was going to discourage people from applying for the job.

People want to be cops because they want to be cops, and people want to be firefighters because they want to be firefighters. You obviously have to have a pay and benefits package that will allow you to recruit and retain, but you don’t need to make people millionaires when they retire, and that’s essentially what “3% at 50” does.

Gilroy: What have been the key outcomes so far?

Scrivner: Before Measure D passed, we had an analysis that showed that the measure would save about $1.5 million, but by year 10, the cumulative savings would be around $7.5 million.

After the measure passed, we found out that the projected savings would be much higher. In November of 2010, I received a memo written by our city finance director citing data that had come from CalPERS. That memo basically said that CalPERS had looked at the savings from Measure D-going to the lower benefit tier and also requiring that the new hires pay into the system-and the cumulative effect of that was somewhat modest in the beginning, but after the first 10 years was projected to save the city $10.5 million. After 20 years, it was projected to save the city over $50 million in total cumulative savings. And after 30 years that total cumulative savings was projected to be $129 million.

So because of Measure D, the city will save nearly $130 million over the next three decades. Those are big dollars in this type of fiscal climate for a city whose general fund operating budget is not that high.

Gilroy: Let’s fast forward to Kern County, where after you became a county supervisor in 2011 you were able to achieve some reforms to public safety pensions not at the ballot box, but rather through direct negotiation with unions. Can you describe this process?

Scrivner: I was running for the county Board of Supervisors at the same time that the Measure D campaign was going on. The public safety unions-spearheaded mainly by the Kern County firefighters’ union-they spent a quarter of a million dollars against me. And that was more than all five of my opponents combined. When I ran, the issue that I ran on was pension reform, as well as the fact that my general election opponent-a former sheriff’s deputy and president of his union who had served as a supervisor back in 2000 when they voted to increase the retirement benefits-was closely tied to the public safety unions.

When I won, I had a meeting with one of the public safety unions, and they said, “Measure D passed, you won, we see the writing on the wall.” They acknowledged that “3% at 50” was no longer supported by voters in Kern County,and they asked what I was after. I responded that I wanted the same thing as with Measure D-to have new hires back at the “2% at 50” tier. It took us a year of negotiations to get there, and there were a lot of issues to address. For example, we wanted all employees-even current ones-to pay into their own retirement, and we also wanted them to pay the employee’s share of the healthcare premium, which was 20%.

So, that’s what we ultimately got in the three-year contract. We went back to “2% at 50,” we got employees contributing about a third of their retirement costs, and we got the employee contribution to healthcare premiums. We got that agreement with the nine public safety unions serving Kern County, and we got it in return for a 2% pay raise in the second year of a three-year contract.

I think that you had a dramatic shift in what the unions believed to be public perception. For a long time, they were able to get pretty much whatever they wanted because they had a good reputation with the public and politicians more than eager to give it to them. I think that’s changed now.

Gilroy: Looking back, would you have done anything differently in either Bakersfield or Kern County? Are there additional reforms that were left on the table that you think still need to be put into place?

Scrivner: Now that things have changed here in Kern County, and new hires have to pay into their retirement, I believe that we have our retirement system in a position where it’s sustainable. It will take about a decade to see substantial improvements from our reforms, but the improvements in our costs and funding ratio will surely happen. You would certainly have impacts if there was a stock market crash, but actuarial smoothing and blending helps to cushion that blow.

We have a big issue that we still need to address here at the county within our own retirement plan-the Kern County Employees’ Retirement System-with a provision called the supplemental retirement benefit reserve (SRBR). We’re one of only three counties that adopted SRBR back in the 1980s. If your retirement plan performs above the expected rate of return-which for us is 7.75%-then about 40% of the excess earnings gets siphoned off into that SRBR fund. What that does is provide for additional cost of living increases over and above the normal rate, which I believe is 2% a year. The retirement board can make a determination from year to year on whether or not they want to allocate a supplemental cost of living increase.

But the effect of SRBR is this: in good years, 40% of excess earnings are siphoned off, and it doesn’t go in to bolster the main pension fund. But in bad years where you perform below the rate of return, the SRBR isn’t affected at all. The result of that is that the SRBR is currently 170% funded, yet the regular retirement fund that goes to pay the benefits to retirees every month is only funded at 61%, and it’s projected to drop. But the SEIU-our main union-will not agree to let us shift funds from the SRBR to the main fund. So we would have to go to Sacramento to change that, and SEIU won’t support it unless we give them a pay raise, and we can’t afford to do that right now. So the struggle goes on. I should note that the other unions are generally supportive, and our firefighter union has been publicly supportive of the change, which I applaud and appreciate.

SRBR reform is the next thing that we really have to fix for the overall health of the fund, and we’re going to continue to try and talk to the unions and get them to see that it’s for everyone’s benefit that we fix that. The way we want to fix it is to say that if SRBR is 120% funded, then all excess earnings go into the regular fund to try and shore it up. And if that drops below 120%, then it reverts back to the old system. Another option-which another county did-is to eliminate SRBR for all new hires, so if we continue to get nowhere on this issue that’s something we could consider.

Gilroy: What lessons learned would you offer to those officials looking to make similar reforms in their jurisdictions?

Scrivner: They need to be ready for a struggle, because the unions are a powerful force within this state with collective bargaining and the way in which they’re able to raise money out of the paychecks of their members for political purposes. They’re a force to be reckoned with, so that part can be very difficult unless you’re somehow able to get the unions on board with the reforms you’re trying to achieve. But that’s going to impact how dramatic those reforms would be.

You have to be prepared for a potentially long and dedicated effort at public education to inform your voters. Trying to explain the issue in a way that’s simple and easy for folks to understand is very important, but it can also be very hard for a subject as complicated as pensions.

I also think that explaining to voters what they’re not receiving in government services because of the costs of public pensions is effective-those services that voters and families are concerned about when they’re sitting around the dinner table talking about what’s going on in their local government.

Zack Scrivner is Kern County’s Second District Supervisor, proudly serving the communities of Bakersfield, Boron, Caliente, California City, Mojave, Rosamond and Tehachapi. Elected to the Board in 2010, Zack served as Chairman of the Board in 2012, and represents the Board of Supervisors on Kern Council of Governments, Kern Land Agency Formation Commission (Chairman 2013), and the Kern Economic Development Corporation. Before his election to the Board of Supervisors, Zack served six years on the Bakersfield City Council, representing Ward 7.

Zack’s priorities are economic and private-sector job growth, in the areas of aerospace, alternative energy, manufacturing and logistics, as well as tough fiscal management of taxpayer dollars in county government.

Zack is a member of the Rotary Club of Tehachapi and is a founding board member of the Kern County Wounded Heroes Fund, a non-profit volunteer organization that provides support to wounded service members and their families.

Zack and his wife, Christina, live in Tehachapi with their four children, Zachary (7), Robert (4) and Jane (2) and Jacqueline (6 weeks).

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

The post Reforming Defined-Benefit Pension Systems in Bakersfield and Kern County appeared first on Reason Foundation.

The Innovators in Action 2014 series profiles released to-date are listed below:

• Reforming Defined-Benefit Pension Systems in Bakersfield and Kern County
  Interview with Zack Scrivner, Kern County (CA) Supervisor
  Leonard Gilroy
  April 28, 2014
• From Traditional to Contract City: Navigating Financial Distress in Pontiac
  Interview with Louis Schimmel, former Emergency Manager, City of Pontiac, Michigan
  Leonard Gilroy and Michael LaFaive
  March 25, 2014
• Pioneering State-Level Pension Reform in Michigan
  Interview with Douglas B. Roberts, Ph.D., former Michigan State Treasurer
  Leonard Gilroy
  February 21, 2014
• Pioneering Road User Charges in Oregon
  Interview with James Whitty, Manager, Office of Innovative Partnerships and Alternative Funding, Oregon Department of Transportation
  Leonard Gilroy
  January 27, 2014

Earlier editions of Reason’s Innovators in Action are available here:

• Innovators in Action 2013
• Innovators in Action 2012
• Innovators in Action 2009
• Innovators in Action 2008
• Innovators in Action 2007

The post Innovators in Action 2014 appeared first on Reason Foundation.

Louis Schimmel was a natural choice to serve as the third emergency manager in his hometown of Pontiac upon his appointment in 2011, having previously served as a court-appointed receiver in Ecorse in the late 1980s and as the emergency financial manager in Hamtramck in the early 2000s. Schimmel’s work helped yield a number of notable accomplishments during Pontiac’s time under emergency manager control, including a reduction in the city workforce from over 500 non-court employees down to just 20 (a 96% reduction), the reduction of city debt from $115 million to $28 million, and lowering general fund expenditures to $30 million, which is half what the city was spending six years ago.

Such achievements required Schimmel to implement a variety of government downsizing strategies between 2011 and 2013, including the contracting out of dozens of services through privatization and intergovernmental agreements, the sale of major city assets, the restructuring of the city’s retiree healthcare plan, the elimination of the city’s fire department through merger with an adjacent municipality, and much more.

In August 2013, the city’s progress prompted Gov. Rick Snyder to remove Pontiac from emergency manager control, and to appoint a four-member Transition Advisory Board-which includes Schimmel-that is now overseeing the city’s finances and progress at restoring its fiscal health.

Reason Foundation Director of Government Reform Leonard Gilroy and Mackinac Center for Public Policy Fiscal Policy Director Michael LaFaive recently interviewed Schimmel on his experience serving as emergency manager in Pontiac, the role for privatization and asset sales, the city’s financial restructuring moves, lessons learned, and more.

Leonard Gilroy, Reason Foundation: Can you describe the fiscal situation you walked into in Pontiac upon becoming its emergency manager?

Louis Schimmel, former Emergency Manager, Pontiac, Michigan: There were really two fiscal situations. One, they had an enormous amount of debt, and two, they were in a situation where they were underwater every year in terms of an operating budget. So they were just losing money every year, and the debt kept getting worse and worse.

As many troubled municipalities do, they played about every financial borrowing game you could play. And finally there were just no more games that could be played, and it ended up in a situation where I was appointed the emergency manager-actually, the third emergency manager, as there were two previous managers before me.

My approach was probably different than a lot of emergency managers, because I felt like I knew everything that I wanted to do before I even arrived. And I thought that my job was to get in, fix it, and get out as fast as possible. And I believe that I did that.

Gilroy: Privatization played a major role in your efforts. Under your watch, Pontiac contracted out roughly 20 city functions-ranging from services like trash collection, building services, and road and streetlight maintenance to administrative support functions like IT, auditing and budget administration, and legal services. Can you describe the rationale for such large-scale privatization and offer a perspective on how things went, in retrospect? Has the private sector delivered?

Schimmel: The rationale was two-pronged. One goal was obviously to save a lot of money, and another goal was to improve services. There were services that just weren’t being delivered or were being delivered very poorly.

In some cases, we had services where we wouldn’t necessarily save money through contracting, but rather we were spending money but not getting very much for it. So we contracted a lot of those things out, and though we didn’t save money, we did get the service quality that we weren’t getting before.

For example, the city had been paying for public works and building department services, but we weren’t getting the work done. The difference under contracting is that while we’re still paying for it, the work is actually getting done today, and the services are being delivered.

I took a similar approach in the other cities where I’ve served as emergency manager as well, because I’m a great believer that we can deliver services cheaper and better through contracting.

That said, of the 20 services we contracted out, we did have one contract for winter streets maintenance where we thought the vendor would be great, but they just did a terrible job for a couple of months, and they’re gone now. With contracting, you’ve got to have a good administrator over it, or it can become a nightmare. But we had a very good administrator overlooking our public works contracts who determined that the vendor was not performing.

So we made a change on that one contract, and that service is now being delivered with good performance.

What is often not considered with contracting out services is the immense amount of time and money spent dealing with unions-in the contract negotiations, all of the time that the administrative staff spends on personnel problems and labor union negotiations, with grievances and arbitrations, that sort of thing. When that’s gone because you’re contracting out, it doesn’t necessarily show up on the balance sheet, but it certainly frees up time to spend on other efforts in running the city. The legal costs alone are staggering when you’re dealing with union issues.

Michael LaFaive, Mackinac Center for Public Policy: Private sector firms haven’t been the city’s only contracting partners. Pontiac also entered into agreements with Oakland County and other public entities to take over some major functions, including police and fire services, 911 dispatch, water and wastewater operations, and animal control services. Can you describe some of these efforts, in terms of the rationale and the results achieved?

Schimmel: The reason that we did a lot of contracting with other governments like Oakland County is that there are certain functions of government that you really can’t contract out to a private company. Police work is one of them. Also, there really was no good alternative for providing fire services other than to partner with a neighboring community, which we did.

For other services, we have the luxury of being in a well-run county that runs some of these functions very, very well. I sat down with a lot of the county leaders, and they were very interested in helping Pontiac. We just found it so easy to go with the county on some of these services instead of going out to the private sector.

Let me tell you a little more about our fire contracting. At one point prior to my arrival, the fire department was costing the city as much as $14 million per year for fire service. Fire service was in some ways the Achilles’ heel of the city of Pontiac. Firefighters had language that was written into the city’s charter instead of its labor contract, which means that it was very difficult to change it. You had to go to a citywide vote to change some provisions that should have just been part of the labor contract and dealt with in negotiations-things like minimum manning.

I knew I had to address that one right up front, and the latest state emergency manager law (Act 436 of 2012) allowed for me to deal with that situation. So I negotiated a contract with a neighboring municipality for fire services-Waterford Township-that the city of Pontiac now pays just under $6.5 million per year instead of what used to be $14 million. When I came in as emergency manager, that cost had actually dropped to about $9.5 million, so in that one deal we created about $3 million per year in savings. That’s why I did it, and that’s also why we did the police contract and the other ones.

We have a very interesting fire department as a result of the negotiations with the neighboring community. In Pontiac, I actually did away with the EMS service. And if you know fire services, you know that that’s one of the sacred cows because it calls for a lot of employees in the EMS service.

But you can get EMS service for nothing, as we did in Pontiac, instead of having the fire department provide it. That’s the direction I went. We have a very good provider of EMS service-a private company called Star Ambulance-and we went out of the business of providing EMS ourselves in the fire department. The company recovers their costs through direct charges to the users, which means we pay nothing.

The combined fire department is interesting because the other municipality (Waterford) still provides its own EMS service. So we have a dispatch that dispatches both private and municipal ambulances, and though they’re handled differently in the two areas, they’re still the same fire department. Of course, I was told that you could never do anything like that-that from a dispatch standpoint it just couldn’t be done-but we went right ahead, did it anyway and proved otherwise.

If you were in the city of Pontiac today, you would have a very hard time finding anybody that does not think that the sheriff’s department, for example, is doing a fantastic job compared to when they had their own local police force. Police and fire response times improved dramatically as a result of this. We created the third-largest fire department in the state of Michigan with the merger of Pontiac’s department with the neighboring community of Waterford. And they have advantages with that size as well. Certainly from a management standpoint it helps, because you don’t have to have two fire chiefs, and they’re better able to get grant funds, buy equipment on a larger scale, and those sorts of things.

LaFaive: Rather than a contract with another unit of government, had you considered an entirely private service provider like Rural Metro, or perhaps turning Pontiac’s fire department into a largely volunteer one? Troy, another Oakland County city, operates a largely volunteer force and services 33.6 square miles.

Schimmel: One of the reasons that we went with a municipality was that in places where you’ve always had unions there delivering services-in urban areas especially-it’s very difficult to go from that situation to a private model. For example, in the area of fire services, here in Michigan you could probably use a private or volunteer entity if you’re in a more rural area, but in a heavily urbanized and unionized city, your best bet is to stick with the full-time, public sector fire department model rather than part-time or contract. So the best thing for us to do there was to contract with another municipality, which worked out terrific for us. We’ve provided a more efficient combined force.

In addition, regarding Troy, that city has always had a volunteer fire department. But the word “volunteer” is not entirely correct because they are paid something. And it’s also a situation in Troy where they have a much better building stock, sprinkler systems and the like. Pontiac is an older city and more urban, so it would be more difficult to have a part-time fire department.

Gilroy: Overall, private and intergovernmental contracting have played a major role in the dramatic downsizing of the city workforce. As a result, Pontiac is effectively a contract city today. Though there are many contract cities in places like California and Georgia, they usually start that way from their incorporation, as opposed to transitioning from a “traditional” city to a contract city as Pontiac did. Skeptics often claim that a traditional city cannot or should not move in the contract city direction for fear of what would happen to existing employees. How would you respond to those fears, based on Pontiac’s experience?

Schimmel: Let me tell you what I’ve always felt in all of the municipalities I’ve been in. I became aware of how quickly attrition happens in a municipality’s employment force. For example, in police and fire, their careers are pretty short when you think about it-20 or 25 years. The same thing happens in other departments, like public works-there’s just a relatively quick turnover.

So I used attrition and buyouts heavily in the privatization of services of all three municipalities I’ve been in. And as a result of doing that, the layoff of employees have been almost zero. In Pontiac, there were really only two people in the Department of Public Works that lost their jobs. They were simply there too short a period of time, and there wasn’t much I could do for them.

And in the fire department, we had 13 employees that were close to retirement, and I gave them the extra time they needed to give them an early buyout so that they could leave early. There were younger firefighters that lost very little money and were hired by the newly combined fire department, and there were some middle-range workers who kept their jobs, but they did have to take a reduction in wages.

But overall, including police, fire, public service and administration, very few jobs were lost because of contracting. Also, several employees were hired by the contracting companies.

So yes, you have to do some negotiating and work with attrition and buyouts, but becoming a contract city isn’t what people think, in terms of wholesale layoffs and that sort of thing.

Gilroy: Was there a learning curve for how to handle such a large degree of contracting, from an administrative standpoint?

Schimmel: There was certainly a learning curve for myself over the years. It became very obvious to me after my first municipal experience that you cannot simply contract out with someone and walk away. The fact that contractors turn over from time to time is a good thing, because you’re letting everyone know that you expect results and you expect them to perform. It’s important to bid out contracts every few years to make sure the price stays right.

You also learn that you have to have someone on board as a city administrator that really knows what they’re doing in terms of oversight of contracts. For the winter street maintenance contract I mentioned-the one where we had problems-we discovered that the company was billing us for a certain amount of cold patch, and the city’s person overseeing that contract realized that there was no way they could be using the amount of material they were reporting. He had several meetings with the company, and went out to review the actual work, and it was clear to us that they were basically just billing us but not really doing the work they claimed.

So if you don’t have someone overseeing contracts, it can turn out poorly.

I think the city is well set to continue contracting out into the future. Now that all of these contracts are in place, it would be difficult to go back to direct city operation. For example, we sold the city’s fire engines when we did that contract, and we even sold off the city’s public works department building, so it would be a challenge for the city to get back into that business. You’d have to have a lot of upfront money, and you would have to demonstrate that the cost of doing it yourself compared to the contractor would be at least equal or lower, which I consider at this point to be nearly impossible to do.

So I see the contract city model staying in place in Pontiac indefinitely. And in my opinion, the citizens have accepted that and are very happy with the services provided today. Some of the politicians are probably not as happy with some of the contracting on employment grounds because-let’s face it-they don’t get to put their friends into a city job. Of course, my response to that is that contractors have to hire people too. But from the politician’s standpoint, that’s not the same, and some of them might feel a loss of power as a result of not having the same number of city employees that they used to have.

Gilroy: You also sold off some of the city’s assets, including a golf course, city land and buildings and excess water/wastewater capacity. Can you describe some of these efforts and the results you achieved?

Schimmel: There were a couple of different reasons for doing the asset sales. In the case of selling the excess capacity of the water and sewer system, it was strictly a way to monetize the system. We had a tremendous amount of capacity that was just sitting there, and I put together a deal with the county that got us a $55 million upfront payment. This was badly needed in order to deal with trying to fix the city financial problems, and it was also a way of getting even better management of the system than we had ourselves.

A lot of the asset sales were done simply to get them off the books of the city and into the hands of some private owner who might do something with it. I recently got a call from a local reporter asking if I remembered the day that we had gone through one of the community centers that I ultimately sold. It was in deplorable condition after it had sat idle for eight years, and it had been heavily vandalized. I sold it, and the new owners completely renovated the building, which is now being used to teach music, art, sports and for afterschool tutoring programs for Pontiac kids. Unlike the water system capacity, I didn’t sell that facility to make money, but rather as a way to stop losing money through things like vandalism, police calls, and maintenance.

We had another closed community center that was in similar condition and that I took a lot of heat for selling. I sold it to a private developer who is turning it into one of the largest outdoor grass court tennis facilities in the United States. We’re going from something that was a derelict eyesore into something that’s going to be a terrific community asset.

Similarly, we also had an old theater in the downtown area that was just sitting there costing money. The city spent a lot on it, and it never did get opened, so it was money that was just thrown away. We sold that to an individual that’s putting $4 million into the facility, and when it’s done it will be a great entertainment center.

One I’m particularly proud of is the sale of our Department of Public Works building, which was an environmental nightmare. It was formerly a creosote plant for Consumers Power, a utility company. When we did away with the public works department operations, I sold that building back to Consumers for $1 in order to get a major environmental liability off of the city’s hands.

So we had several of those kinds of sales-those that got major costs and liabilities off of our books.

I also sold the golf course, which was losing money and decreasing in value because nothing was being done in the area of making needed capital improvements. So we put that into the hands of a private owner who is already spending a lot of money to fix the water sprinkling system, upgrade the clubhouse building, and make other capital improvements that couldn’t be done by the city because we didn’t have enough money.

We sold a number of vacant parcels too. Every time you sell a vacant residential lot, you have one less thing that you have to take care of in terms of maintenance, mowing and all of the other costs associated with a vacant lot.

So overall, for our assets sales, we were either looking to generate revenue or do away with problems that cost the city money.

LaFaive: Can you describe the debt reduction aspect of your financial restructuring?

Schimmel: : I was being criticized for taking the savings that we were getting from not only privatization, but also the sale of the sewer system capacity and using the revenues to pay off millions of dollars of city debt. The reason for that was that the cost out of the general fund to pay interest on all of the bonded debt was a large item. With that debt gone, it freed up $3 million to $4 million each year going forward that is now being used to spend on city services rather than debt interest. That was very contentious, and I was sued over it and fortunately prevailed.

Overall, we reduced the debt from $115 million down to $28 million by the time I left.

LaFaive: You took a vast array of different city retiree healthcare plans from more than 80 to just 1 during your tenure. Can you describe the one that remains? Is it competitive? Is it tied to a high deductible policy and Health Savings Account?

Schimmel: For retirees, we’ve gone to a system where the city’s General Employees Retirement System pays a $400 monthly benefit amount to the retirees, which can be used to purchase their own healthcare or to purchase the plan provided by the city. We were fortunate enough to have an overfunded General Employees Retirement pension plan-it’s 150 percent funded-to be able to afford to make the $400 monthly payment to the retirees. By paying the retirees from the pension plan it saves the city $6 million annually.

With our retirees, you had 87 different plans with 87 different sets of benefits, depending on which labor contract you retired under. To me it was nonsense-and we needed to have one plan that fit all. So we eliminated the 87 different plans and consolidated into one very good plan that all of the retirees have access to. That made it easy for us to competitively bid out the one healthcare insurance plan. Blue Cross is the current provider of the one plan of insurance to the city’s retirees.

While $400 a month does not cover the full cost of buying healthcare insurance for a two-person family coverage, it is better than no coverage and the most the city can do with its current available revenues.

LaFaive: Do you worry that existing tax and regulatory burdens in Pontiac might otherwise thwart growth in the city going forward?

Schimmel: I’ve always wanted to do away with the income tax in Pontiac, but there’s no way we could do away with it right now, given what’s happened with the economy, and property valuations, and with the city’s revenue picture. But I do believe that the income tax is a big detriment to the city of Pontiac. No one wants to go into a town that has an income tax.

That’s my only worry though. I’ve got a lot of optimism given the improving financial picture as a result of what the three emergency managers have accomplished here. We’ve had a lot of economic development as a result. I’ve always said that cities do not need economic development directors-just clean up your own mess and businesses will show up. That’s been the case in Pontiac, and I think a lot of it has to do with cleaning up the financial picture of the city.

LaFaive: Where does Pontiac stand today in financial terms as a result of your efforts and those of the emergency managers that preceded you?

Schimmel: As a result of all of our work, we were able to right the ship. We’ve downsized the expenditures and improved the services. We’ve gone from spending $57 million per year-and not having the greatest services-to spending $30 million per year and having much better services. So I think it’s a rosy picture from that standpoint.

However, the general fund is razor thin, and there’s no room for mistake at this point. I think that $30 million is about as low as you can go and still run the city effectively. Everything that can be done to save money has just about been done, so if revenues drop below $30 million then it’s going to get very dicey. I don’t think it will-I think we hit bottom, and the revenue picture will improve. But there’s no money in the general fund to have what I would call a reasonable general fund balance, with about 10-15 percent of a balance for cushion. If we had another downturn in the economy, I’m not sure what we would do. We’d probably have to head the route of Detroit and start talking about things like bankruptcy.

LaFaive: What are the major comparisons or contrasts that you would draw between doing business as a court-appointed receiver, an Emergency Financial Manager under Public Act 72 and as an EM under the latter two laws (Public Acts 4 and 436). How does one prevent a city council from undoing all of the work that was done by an EM?

Schimmel: Before there was an emergency manager law, there was really no dialog with the state of Michigan whatsoever. For example, when I was in Ecorse, Michigan before there was an emergency manager law, I was working for the Wayne County Circuit Court. I resolved their problems with much of the same strategies as we’ve discussed here, but after I left, it didn’t take too much time before they just fell back into the same problems again.

I later went to Hamtramck, and at that time there was an emergency manager law called Act 72, but there were no provisions in the Act other than “when you’re done, you’re done.” After I left Hamtramck, the same thing happened-they fell back into their old ways.

Under Public Act 4-and now Public Act 436-the emergency managers have more power than under Act 72, which gave me the ability to do a lot of the things we’ve talked about in terms of righting the ship. And now, all major moves-things like asset sales over $50,000, contracts negotiated with unions, and so on-all go through a process of having the state treasurer grant approval before these actions are taken. So there’s oversight of emergency managers now by the state, which is a good thing.

Also, the law now provides for a Transition Advisory Board that meets monthly. I currently serve on that board in Pontiac now. For the first two years, we oversee the budget that the emergency manager creates as part of the departure plan. Then after two years, we continue to oversee the budget that the mayor and council put together from that day forward. So the law now provides for oversight powers to ensure that what we’ve done in Pontiac is not lost like it was in the previous two cities I served in.

So as long as the city performs correctly, I don’t think they’ll fall back, certainly as long as there’s a transition advisory board. If, after the board’s work is done, the city falls back into fiscal crisis, then I suppose that they would simply face the prospect of having an emergency manager come in again.

I don’t think that will happen anytime soon because now we’ve all learned that you can’t simply fix the city and walk out. You have to fix the city and have some close monitoring afterward to make sure that it sticks.

Gilroy: Based on your experience in Ecorse, Hamtramck and Pontiac, what are some of the lessons learned in solving fiscal crises that you can share with other city leaders, whether they’re emergency managers troubleshooting existing crises or elected officials trying to avoid them?

Schimmel: When I was approached for the emergency manager role in Pontiac, I made it very clear to the state that I would not be a babysitter. I was going to use the emergency manager law to its fullest, make the necessary changes, and then leave. In places like Pontiac, Flint and Detroit, the people in power want to talk about everything else other than the real problem issues. They want to talk about getting grant money, having the state kick in more money, economic development, etc. I’ve always said that before you do any of that-begging for money from other places-you really need to fix what you’ve got, because nobody wants to help you until you do that.

You have to make all of the types of changes that we’ve done in Pontiac first. Then, if you get to the bottom of that list of doing what you ought to-which is running an efficient city through privatization, asset sales and other fixes-and just deal with providing the basic services that cities need to-like police, fire, trash and public works-once you’ve done all of these things, then you can see where you are and what else may or may not be necessary.

That’s what’s happened in Pontiac from my standpoint. After we did all of these things, we realized that you could run this city for $30 million. Now, if the city wants to go out and pursue grants and that sort of thing, they’ll be able to demonstrate that they’ve done everything that they can locally first.

For a new emergency manager, I’d advise them that one thing to expect when they step in is a lot of people telling them what they cannot do-you can’t privatize, you can’t sell assets, you can’t consolidate a fire department, etc. My response to that is-yes you can, and I believe we’ve set up a good template to prove that in Pontiac. You’ve got to have the conviction that these things can be done and can’t let yourself be talked out of it. I did it all, so I know it can be done.

Louis Schimmel was appointed the Emergency Manager of the city of Pontiac, Michigan by Governor Rick Snyder in September 2011, serving in that role until August 2013, when he resigned and was appointed by Governor Snyder to a four-member Transition Advisory Board to oversee the city in the coming years.

Prior to becoming the city’s Emergency Manager, Mr. Schimmel was the executive administrator in the city of Warren. While in Warren he negotiated eight union labor contracts and was involved in management decisions of every city department that resulted in a more efficient city operation and significant savings in tax dollars.

In February 2001, Mr. Schimmel retired as the executive director of the Municipal Advisory Council of Michigan (MAC), a statistical clearinghouse for investment bankers located throughout the United States who underwrite and/or invest in Michigan municipal bond issues. Mr. Schimmel has a vast background in municipal finance, has served on numerous boards and commissions, has authored several articles and trade publications and continually advised state and local officials on fiscal matters. He is recognized in the municipal bond industry as an authority on the creditworthiness of Michigan municipal debt issues.

In December 1986 the Wayne County Michigan Circuit Court appointed Schimmel to be the Receiver for the debt-ridden city of Ecorse. He served as the city’s Receiver for nearly four years, during which period he completely eliminated the city’s $6,000,000 deficit by negotiating unique labor union contracts and by privatizing nearly all services provided by the city. In November 2000 the state of Michigan appointed Schimmel to again bail out a financially troubled city-this time the city of Hamtramck. During his five years as the state-appointed emergency financial manager in Hamtramck he sold unused assets, out sourced services, resolved numerous long-standing legal matters and streamlined city government operations.

In 2008 Mr. Schimmel was appointed a member of the Legislative Commission on Statutory Mandates. In 1999 Schimmel was appointed by Governor Engler and served on the Michigan Commission on Public Pension and Retiree Health Benefits. In 1992 Schimmel was appointed a member of the Michigan Public-Private Partnership Commission, which submitted an extensive report to the governor for improving service delivery and increasing efficiency in state government. In 1990 he received the “Outstanding Service and Leadership in the Public Sector” award from the Michigan State Chamber of Commerce and in 2005 he was awarded the Mackinac Center for Public Policy’s “Lives, Fortunes and Sacred Honor Award” for his successful and energetic management of two financially distressed Michigan cities.

In the past Mr. Schimmel served on the Waterford, Michigan School Board for eight years-two years as board president. He is a past president of the Bond Club of Detroit. He also served on the Board of Directors and Executive Committee of the Pontiac State Bank from 1972 to 1988. He is a graduate of Michigan State University.

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

The post From Traditional to Contract City: Navigating Financial Distress in Pontiac appeared first on Reason Foundation.

Michigan’s pension reform efforts were a major policy initiative developed and promoted by the administration of former Governor John Engler. Former state Treasurer Douglas B. Roberts, Ph.D. led the administration’s policy development, from crafting the details of pension reform legislation, to meeting with relevant stakeholders, educating the legislature, and engaging in activities critical to its successful enactment. Roberts also played a similar, major role in the passage of Proposal A, a 1994 constitutional amendment that overhauled school finance in Michigan.

Reason Foundation Director of Government Reform Leonard Gilroy recently interviewed Roberts on the factors that prompted Michigan’s historic pension reforms, how proponents made the case for reform, lessons learned from the reform effort, the rationale for Proposal A, and more.

Leonard Gilroy, Reason Foundation: You served as Michigan’s State Treasurer from 1991-1998 and again from 2001-2002, and that’s a fairly unique position in Michigan relative to other states. Can you explain why?

Douglas B. Roberts, Ph.D., former Michigan State Treasurer: In most states, the state treasurer is an elected position. Some state treasurers who are elected often later run for higher office, such as governor or senator. In Michigan, the position is appointed by the governor. As a result, it’s a fundamentally different job and a very special position. The Michigan treasurer is constitutionally the sole fiduciary for the pension system. In addition, the position is responsible for all of the tax collections, for all cash management, all bonding activities and even things like Pell grants. Michigan’s treasurer also represents the governor to promote the governor’s policies before the legislature. The position functions more like the U.S. secretary of the treasury. When I spoke or testified before the legislature, I represented the governor and his positions. Michigan’s treasurer holds a completely different job than in most states, and that continues to this day.

Gilroy: Michigan was the first state to take on the issue of reforming public sector pensions-enacting reforms back in 1996-and you were Governor Engler’s point person on the issue. Can you explain what factors contributed to the push for reform?

Roberts: The single most important factor is that we had a very strong, extremely knowledgeable, and extremely policy-interested governor in Governor John Engler. That makes all the difference in the world. At that time, both the school employee pension system and the state employee pension system in Michigan were fully funded. The change was therefore not driven by an immediate financial crisis, but instead by the vision that the state could, and in time, face one.

It was an issue driven entirely by the knowledge that over time, the system did not benefit taxpayers, in our judgment, nor did it benefit most of the public employees themselves. The idea was to move away from an outdated system-and by that I’m talking about a system where you work for an employer for 30 years, then you retire and collect a pension. Even in the late 1990s, it was clear that society was changing. Our technology and our workforce were changing. People were no longer working for a single employer over their lifetime, but taking advantage of our strong sense of upward mobility. An individual might change jobs five, six, or seven times over a career. It’s very difficult to vest in a pension system when you’re changing jobs so frequently, assuming that your workplace requires 10 years of work to qualify for pension benefits.

Michigan’s pension system, which was very similar to other pension systems in the country, required a vesting period of 10 years. This is a very important point. According to information that I developed while state treasurer, 50 percent of state employees who worked for Michigan government didn’t work the necessary 10 years to vest in the pension system. This meant that 50 percent of state employees who ever collected a state paycheck at any point in their lives did not receive pension benefits at all. That was one of the drivers of reform.

Another driver was the uncertainty of market performance. If the state was responsible for investing all of the money-which it was- and if we invested wisely and returns exceeded the amount of money necessary to cover the pension benefits, which had happened in the past, then additional benefits were paid. Conversely, benefits did not decrease when markets went down. The only ones to lose were taxpayers, who paid for the increased benefits.

With those factors in mind, the issue became how to shift from a defined-benefit system to a defined-contribution system. To gain support for our position, we proposed that state employees should have a choice: those currently in the defined-benefit system could stay within that system OR could choose to move to the new defined-contribution system.

This choice did not apply to future employees. That limited the impact. If people were close to their 10-year vesting period, then I’d tell them “for goodness sake stay and get vested.” But for those recently hired, I’d advise them to consider their next few years of employment status and make a decision based on that. Those who were going to leave state government before vesting would find the defined-contribution system to their benefit. They would at least leave with retirement benefits.

There was yet another position. Our research determined that, at that time, there were about 14 major public pension systems run by about 200 individuals within the U.S. Those 200 people controlled pension funds with a total value in excess of $1 trillion. That gave them the opportunity to exercise influence over the private sector via proxy voting. Should the public sector have such influence over the private sector? Large mutual funds can exercise similar influence over pension systems via proxy voting. However, the heads of those mutual funds are seldom concerned with political outcomes such as who is elected governor.

In leading the campaign, Governor Engler insisted on high standards. He asked the executive staff to draft all the bills necessary to implement such a proposal-down to every detail of every statute that had to be amended. He also wanted those drafts on his desk before he would go public with the proposal. That way, when questions and opposition were raised, questions could be answered and objections could be countered.

I would tell anyone looking to do this that they need to assign someone to sit down with a roomful of pension experts and lawyers to go line by line over everything that’s changing. There are often hundreds of pages of pension laws, and it took a long time to go through every one of them. But once we did, those changes became the basis of the reforms we ultimately enacted.

All of these things combined to create the momentum we needed to propose-and win-the reforms.

Gilroy: The reforms enacted consisted primarily of closing the defined-benefit (DB) pension system to new hires and launching new defined-contribution (DC) system for state employees. Can you describe the rationale for shifting from the DB to DC system?

Roberts: The model for shifting from defined-benefit to defined-contribution was already in place-in the private sector and in several university systems. Governor Engler’s goals were to create a fiscally sound retirement system to the benefit of the taxpayer and the state employee, and one that protected the state’s assets regardless of market performance. He also sought a system in which state employees weren’t bound by “golden handcuffs.” He wanted them to be able to leave state employment when they wanted and to keep their retirement savings whenever they left government employment.

At the same time, he sought a retirement system the state could afford for the long term, regardless of market ups and downs and one which would relieve future leaders of constant worry about pension liabilities.

Pensions represent future costs, and the future can be unpredictable. Forecasting future costs can be imprecise. You can change the assumptions upon which actuarial decisions are made. Accounting assumptions can change. As we know, economic conditions can change. But short-term decisions made in the past don’t always fit the longer-term view of the future. The administration’s goal was to leave office without leaving problems for future leaders to solve.

Gilroy: What steps did you take to build the case for reform?

Roberts: We first built a base of arguments. Would the transformation be a benefit to the taxpayer? I think the answer is clearly “yes.” Is it a benefit to the employees? We built the case that reform would be in the best interest of a majority of employees.

We also built a coalition. For example, at the time we were proposing the pension reforms, we were also proposing an “early out”-an incentive to retire early from the existing defined-benefit system. State employees close to retirement in age and in years of service were provided the opportunity to retire early. That way it was easier for some state employees to testify before the legislature that they were in favor of the early retirement option and that the transition would not affect any current employees.

Even with all our hard work, passage in the legislature wasn’t easy. We weren’t able to win legislative approval for a shift in benefits paid to school employees, and the measures barely passed to make the change for state employees. At the time, Republicans controlled the governor’s office, the House, and the Senate. In my opinion, such reform was passed, although narrowly, because of two facts-the system was fully funded and the new system didn’t affect any current employees.

But I think we ultimately made the case that in the long run we took great care to design a new system that would benefit the state and current state employees. We met individually with state legislators, mostly Republican, to win their support. We met with legislative leaders and didn’t take votes for granted. We had support from the business community, and business leaders contacted legislators as well. Our story was always one of positive benefit to current state employees. It’s hard to generate opposition from those who aren’t affected by a change.

Gilroy: How much of an understanding of the pension situation did the legislature have when you started talking to them to make the case for reform? What convinced them to ultimately support your efforts?

Roberts: This reform came at a time in Michigan before the state enacted term limits. Michigan now has one of the strictest term limit laws in the country. At the time, we had a number of legislators who’d been on the job for a while, and we had chairs of committees covering pension issues who were really knowledgeable and understood the proposal. That did help in terms of trying to convince those who may have been undecided.

That said, it did ultimately become partisan, meaning that Republicans were for it and Democrats were against it. One of the most helpful things was that Governor Engler had proposed similar measures once before. It took two legislative sessions for the changes to be enacted. The administration tried not to offend anyone in the earlier effort. How you win is important. How you lose is also important. When you’re losing on an issue, don’t offend the other side. Sooner or later you’re going to need to convince your opponents all over again. How you lose can be as important as how you win.

We had lost the first time around. So we backed away and made a few minor changes. One of the things that we learned was that we had to make sure that we could answer all the questions and all the objections. We didn’t want to get beat up for not having answers. Somebody has to be saying that you can agree or disagree with my answer, but here it is.

We didn’t give up. We were one vote away from approval in the legislature. We worked to get the vote and the measure passed. It was close, but let’s face it, an awful lot of things in history happen by one vote.

Gilroy: What types of opposition to reform did you run into along the way, and how did you address those challenges?

Roberts: We all have different views of investing. We know that personal investments can be challenging and even professional money managers can be wrong. One of the arguments was that we are not all equally good at managing finances. The argument was that the employees would make unwise investment decisions with their retirement money. Our response was to have confidence in people’s ability to take personal responsibility and to welcome the freedom to manage their own finances. We also pointed out that private industry and university staff and faculty members have long been successfully managing their own personal defined-contribution plans long before the state had established its system.

Gilroy: Some policymakers have shied away from pension reform, fearing high transition costs involved with the switch from a defined-benefit to a defined-contribution system. Was this an issue in Michigan?

Roberts: Transition costs often refer to the fact that if a defined-benefit system is underfunded, then replacing it with a defined-contribution plan increases total costs. During the transition period, both systems must be paid for, which is an added cost. In Michigan, the system at the time was fully funded. However, if the system to be reformed is not fully funded, then costs can be an issue. Some will argue that they can’t afford reform. I would argue that that represents only a short-term horizon. If you’ve already made a commitment to a defined-benefit system, then you have to cover those costs. And if you shift from a defined-benefit to a defined-contribution system and the defined-benefit system is underfunded, then you are going to have to continue to pay into the defined-benefit system and you’re going to have to pay into the defined-contribution system at the same time. That’s absolutely true.

Here’s one potential way to handle that: I would propose closing the defined-benefit system, issuing pension bonds, and putting that money into your pension system to make it 100 percent funded. You do have to pay off those bonds, but given the current interest rates-unless the whole system collapses-you will find this is a much lower-cost way to manage the transition. Your payments to secure total funding will then be at a fixed, known rate. You can now set the defined-benefit system aside as fixed, close it off and shift to the defined-contribution system.

Most pension systems today are still assuming a seven to eight percent rate of return. States can borrow today at a much lower rate. Now of course this has to be through taxable bonds, not tax-exempt, because of arbitrage laws. New Jersey and other states have chosen similar solutions. You issue the bonds and put the money into the pension system, where it will earn interest at a greater rate than the interest you’re paying on the debt.

Gilroy: What have been the key outcomes of the reform? How would you assess the financial risks that Michigan taxpayers face today, post-reform, with regard to the state’s pension system?

Roberts: Consistent with the system’s design, when examining the current total state employment, the number of people on the defined benefit system is shrinking and the number of people in the defined contribution system is growing. I don’t think that there’s any question that as markets go up and down, this is a major plus. The new plan has continued in effect for almost 20 years. Ultimately, all of those who elected to stay in the defined-benefit system will retire and following that, there will be no new retirees in the system.

In addition to the “early out” adopted in 1997, another was adopted in 2002. The two offers together did increase the state’s costs. As of the end of September 2005, there were 45,800 retired state employees in the state employee pension system. Out of that number, 8,000 retired early. That’s 17 percent of all retirees at that time had opted for an “early out.” They retired earlier than the actuaries expected, and they earned an increased benefit to do so. Therefore the “early out” provisions were an added cost. Without these added costs, the benefit to the state of moving to a defined-contribution system would have been more apparent.

Another issue I want to raise concerns the investments of the $40 billion fund. The benefit of this fund is for current retirees and future retirees. It is not state money. Let me repeat: it is not state money. People do not understand that concept. The money belongs to the retirees, and a state official-the state treasurer-is responsible for investing the retirement fund. But people will come to the pension system and ask the fund to invest money in economic development. I’m not against that if it’s a good investment, but if it’s a bad investment I’m not going to invest in it because it’s the retirees’ money. A fiduciary is a legal term that means that you must act in the retirees’ best interest, not in the best interest of the state or taxpayers. But you have problems with pension systems being abused and people making investment decisions because of political considerations.

Over time, I was asked to review external investment proposals that would tap the state’s retirement resources as though they were fully a state-only asset. Those proposals viewed the retirement resource as taxpayers’ money. While it’s true that the taxpayers did contribute to the revenue for state government employee retirement, once that money was moved into the pension system, then the fiduciary is in a very difficult position. The fiduciary also has to say, “Yes, I am a state employee,” and “Yes, I want to promote economic development in Michigan.” But the fiduciary must also say “I have a legal, moral and ethical responsibility to protect the people who this money now belongs to.”

That’s the same philosophy that questions whether the influence of large pension systems is positive or not. As I mentioned before, in 2004, 14 public pension systems controlled $1.256 trillion in assets. Those assets were controlled by 210 people. Once again I ask: Is such influence positive?

Gilroy: Are there any other lessons learned from Michigan’s pension reforms that you would offer to those in other jurisdictions who may be contemplating similar efforts?

Roberts: Do your homework. Do your research. Know the laws. Design your system for the broadest possible benefit, to deliver responsible government and to see your community well into the future. Don’t give up if at first you don’t succeed. Keep your allies-and your opponents-on your best side. Be a leader who leads, who isn’t afraid to be the first to innovate.

States aren’t the only ones with unfunded accrued liabilities-also called legacy costs-to consider. For example, in Michigan-and it’s different in other states-there are numerous local pension systems. In Michigan, we have a state employee pension system, a school employee system, and a couple of smaller systems for state judges and state police. But we also have numerous pension systems covering people employed by local governments.

Your state may have numerous pension systems but not great oversight over them. As a result, if they run into problems the state may be placed under tremendous pressure to either bail them out or to solve problems for them. So you need strong oversight, or at least an early warning that problems are coming.

Keep looking ahead. Technology, our modern workplaces, new devices, communications, pinpoint decision-making and world-wide competition make it imperative to assure freedom in retirement investing. As new generations of workers move from one job to another, the idea of defined benefits with 10-year vesting requirements is out-of-date.

The last thing I would say is that if your first proposal loses, be aware that the battle’s not over. Pensions are a long-term issue that need a long-term solution. And in politics, those are the toughest to pass. Politics is often about “what have you done for me lately,” and pension issues that stretch 10 to 20 years out, especially in states with term limits, may not command the serious attention they deserve.

Gilroy: You’ve said that in addition to pension reform, you’re also very proud of achieving major school finance reforms. Can you explain the nature of those reforms?

Roberts: In 1994, Michigan-without a court order-adopted a major constitutional change in the way we financed schools in the state. We called this Proposal A, and it was adopted by a vote of the people. Michigan had been trying to address school finance since 1972. I was part of six attempts to amend the state’s constitution to reform school finance that failed up until 1994. In Michigan we had 550 school districts, and each district was required to gain voter approval for property tax votes. Therefore, some districts that valued education voted higher property taxes. Some districts were home to more valuable property and were able to collect higher property tax revenues. Some districts didn’t have as much high-value property and relied on state subsidies. However, the disparity between the haves and have nots was large and was growing worse.

We substantially removed property taxes from school financing and imposed higher sales taxes. Sales taxes at the time were constitutionally limited to four percent. We voted to raise sales taxes to six percent and, in exchange, to reduce property taxes significantly. The result is substantial state control over what school districts collect in taxes and have available to spend. Today, we still have a disparity in spending among various districts, but not nearly the disparity that existed in 1993. And just as important, that disparity isn’t growing.

We also substantially reduced property taxes, which were always a major impediment in the state. I think that people voted for Proposal A to some extent because of the school finance aspect, but in larger part because we were reducing property taxes.

That particular proposal also included major changes to the way we deliver education in this state. That was the beginning of charter schools in Michigan, and it was the beginning of schools of choice. If you live in one district and another district is willing to accept new pupils, then parents can send their children to another district’s school.

We changed so many things. They were major, major accomplishments. I’m thrilled to have been a part of it. I think the system is fairer for the state. There are still a lot of people in Michigan who don’t like the reforms, but my response is that it was 20 years ago. The beauty of our government is that we can change for the better of all.

Gilroy: Is there any other advice can you offer to policymakers looking to tackle reforming large, entrenched systems?

Roberts: What you need is a very strong leader who is basically willing to go where other people haven’t gone. And let’s face it: for a lot of politicians, if someone else hasn’t done it, then they want to wait until someone else goes first. Not only was Governor Engler willing to go first, but he was extremely knowledgeable about government, extremely interested in policy, had spent years in the Michigan House of Representatives and the Michigan Senate, and had a deep understanding of the budget-better than anyone. When you have someone like that who’s interested in policy, they become an integral part of the policy decisions-not just at the end but during the development. That is huge. I recognize that you can’t just go out and find that, but when you do have it, take advantage of it for goodness sake.

The other thing I would say is that you should push your initial proposals a little bit further than you think is possible.

Douglas B. Roberts, Ph.D., is the former Michigan state treasurer and currently serves as the director of the Institute for Public Policy & Social Research (IPPSR) at Michigan State University. He holds more than 28 years of experience in Michigan government, including 10 years as state treasurer, time as director of the Senate Fiscal Agency, deputy superintendent of the Department of Education, deputy director of the Department of Management and Budget (DMB) and acting director of DMB. He also served for two years as a vice president with Lockheed Martin IMS. He holds doctorate and master’s degrees in economics from Michigan State University and a bachelor’s degree in economics from the University of Maryland. He has been affiliated with IPPSR since April 2003.

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

The post Pioneering State-Level Pension Reform in Michigan appeared first on Reason Foundation.

The Oregon legislature approved the creation of a Road User Fee Task Force in 2001 to explore potential replacements for the gas tax, and since then the state has embarked on several successful pilot projects to demonstrate the viability of the mileage-based road user charge concept. The state is now preparing to embark on a larger-scale demonstration project in 2015 as authorized by Senate Bill 810, a law enacted last year. Senate Bill 810 created the Road Usage Charge Program, which authorizes the Oregon Department of Transportation (ODOT) to assess a charge of 1.5 cents per mile for up to 5,000 volunteer motorists participating in a road usage charge program, while giving them a refund on their gas taxes paid.

Reason Foundation director of government reform Leonard Gilroy recently interviewed James Whitty, manager of the ODOT’s Office of Innovative Partnerships and Alternative Funding, on what prompted Oregon policymakers to explore road user charges, the evolution of the state’s pilot programs, how Oregon has addressed the public’s concerns over protecting privacy, and much more.

Leonard Gilroy, Reason Foundation: Since the early 2000s, Oregon has been a pioneer in advancing the concept of road usage charges-also known as mileage-based user fees or vehicle-miles-traveled fees-as an alternative to the traditional fuel tax as a way to generate revenues for transportation infrastructure. Can you explain what’s prompted the interest in road usage charges?

James Whitty, Oregon Department of Transportation: Oregon was the first state to adopt the gas tax in 1919, and you could say that we were also the first state to notice it going awry. We had some legislators in the 2001 legislative session who were prescient. They had the opportunity to drive some concept-type vehicles early in the session-things like natural gas, fuel cell, electric and hybrid electric vehicles, which were just coming out then. They were excited about these new types of vehicles, but realized that if the marketplace decided to choose these vehicles as preferred models in the future, then they would not be tied to a gas tax very well-or not at all. And that’s the principal source of funding we have for our road system in Oregon. So they thought that we should prepare for this and put together a plan for resolving the problem before it becomes severe.

They passed a bill that year creating a Road User Fee Task Force with 12 members-four of them were state legislators, with one from each of the four caucuses-with the charge of creating a new revenue system. The task force came up with the per-mile charge as the most viable alternative to the gas tax.

Gilroy: For our readers who may not be familiar with them, can you briefly explain the rationale for road usage charges and how they work?

Whitty: The anticipation of the legislature is that the gas tax will not be a true user fee in the future for a number of reasons, but particularly because future vehicles-especially electrics-will not pay any gas tax. Electrics currently aren’t paying a user fee. If you own a Tesla, you’re not paying a gas tax.

But even more so, while the gas tax is a user fee, it is no longer a fair user fee because some vehicles pay a large amount per mile through a gas tax, and other users pay very little or hardly any in a gas tax per mile. A vehicle that gets, say, 12 miles per gallon is going to pay a lot more gas tax per mile than a vehicle that gets, say, 65 miles per gallon. Yet, both types of vehicles use the roadways, so the gas tax is no longer fair as a user fee.

Then the question becomes how do you collect a per-mile charge? Oregon’s original Road User Fee Task Force was interested collecting the mileage data through technology. They innocently chose a GPS device to identify whether a vehicle was inside or outside the state for the purposes of paying the user charges on only in-state miles. I say “innocently” because they didn’t realize that the public was going to be concerned about the use of a GPS device, which of course the task force later abandoned as a mandate. But at the time-back in 2002-the task force thought it was a great idea.

So we’ve been working in Oregon on getting the mileage data transferred electronically, but I want to be clear that the manual reporting approach could be viable in some states. The electronic reporting of miles driven is not required for per-mile road usage charges. For example, I believe that in Wisconsin, Texas and Hawaii, there’s an annual vehicle inspection, and they record mileage data then. That mileage number could be used for a road usage charge. Of course, there would be no differentiation of mileage based on location to identify miles driven out of state so they would not be charged-that’s a disadvantage of the manual approach, except in Hawaii, where people don’t drive out of state.

While the task force in Oregon was originally interested in electronic collection, we’ve changed the system since our original pilot project in 2006 and 2007-where we used a GPS box-to an open system where any type of mileage-reporting device that’s available in the marketplace could be chosen by a motorist as long as it met the requirements for our system. And the device wouldn’t have to have GPS capability at all. In fact, our second pilot of 2012 and 2013 had an option for reporting all miles driven, and there was no GPS in that device. We also had a flat-fee option where people could assume a maximum number of miles driven where they wouldn’t have to use any technology whatsoever.

So the new approach in Oregon is to have mileage reporting be electronic, but leave the choice to the motorist on how to report using technology already available in the marketplace and deciding who to get the mileage reporting technology from. Once those data are transferred, then the mileage charge processor-which could be the government, or it could be a private company under contract with the government to do the mileage charge processing-the bill would come in the mail or e-mail or any number of ways at the choice of the motorist. And the billing probably wouldn’t occur every month in most cases-instead most likely quarterly or semi-annually because the net billings are so small-and the motorist would simply pay it like paying any other bill. So it’s actually a fairly simple system.

Gilroy: You’ve been through several experiments in implementing road usage charges, starting with limited pilot programs in the mid-2000s that evolved into the latest program enacted by the legislature last year. Can you explain the evolution?

Whitty: Because the first pilot involved the use of a GPS box-and it also had payment occur at the fuel pump-a lot of people objected to it or found flaws in it, because it would have been expensive to outfit the fuel pump, and of course people were afraid for their privacy because of the use of the GPS system for reporting. So after defending that approach for years although we were not actually tracking anyone-we didn’t have an interest in doing so and we designed the system so it wouldn’t happen-we realized that perception of tracking was still important to people, so we started to design away from it.

We moved to the open system model, allowing the marketplace to provide the technologies and giving motorists choices for how they report their miles-not only choices of devices but also choices of methods. Some people could choose to report all of their miles without any kind of vehicle location capability, others could use GPS if they wanted to, or they could use a switchable back-and-forth methodology, or even a flat fee. In 2012 I spoke to about 25 to 30 private groups around the state prior to the 2013 legislative session, and choice mattered to them. The fact that we weren’t trying to push any particular kind of technology on them-and that the government wouldn’t be collecting any kind of location data-that really mattered, and it helped us move forward.

So it was that realization-that we couldn’t impose a particular kind of box, especially a GPS box, on the citizenry-that really helped us. The “ah ha moment” actually came when I tried to sell the idea of GPS to a group of architects at an Oregon design conference in 2010, where they actually agreed with the idea of a mileage fee but at the end they asked, “do we have to use a GPS?”

I was brokenhearted because I had been defending GPS reporting for so long, but I realized that I had to let it go. On the way home that night I looked in my passenger seat and saw my Blackberry and my iPhone, both of which had GPS in them. And I remembered a young man at a talk I had given a few years earlier. I had told him that he had a GPS in his hand right then-it was an iPhone-and he responded, “I chose this, but I did not choose your box.” That came back to me, and I realized that government couldn’t choose the technology-we had to let the motorists do it. That moment changed everything.

Gilroy: What kinds of technology options exist in the market today?

Whitty: There’s a robust marketplace of options today. The pay-as-you-drive insurance industry uses various types of what’s known as a “dongle.” It’s a very small mileage-reporting device that plugs into the car’s diagnostic port. It’s no bigger than an inkjet cartridge for your printer. We used dongles in our second pilot. Navigation units can also report miles. And then there’s in-vehicle telematics, which we’re seeing in a lot of higher-end and electric vehicles-in a showroom they’d call these “infotainment systems”-these can also report mileage. There are just a lot of ways for reporting miles already out there in the marketplace.

Gilroy: Though it had previously passed legislation to create a task force on the issue, in 2013 the state legislature passed Senate Bill 810 to create the Road Usage Charge Program. Can you explain this program?

Whitty: Senate Bill 810 demonstrates that the legislature is willing to go forward on this topic. They want one final demonstration with 5,000 volunteers, and when that works, they’ll be willing to go forward with mandatory mileage charges where people are obligated to pay. We are currently designing and implementing all of the systems and processes for the 5,000 volunteers to enter the system on July 1, 2015. It will look a lot like our second pilot, which means that there will be three types of mileage reporting. There will be the basic type, which is for all miles driven. The second type is advanced, which would have a GPS component. And there will be a switchable option-back and forth between basic and advanced at the preference of the driver. And there will be various market-provided devices in each of those three categories.

The volunteers will choose which one of those options they want to use and use the type of mileage reporting device they prefer. If the device is already in their car, they’ll activate it, and if the device is not, they’ll install it. In the 2012-13 pilot, people were able to install the pay-as-you-drive insurance dongles themselves-it was very simple to do. If it’s something like a navigation unit, they may have to have the dealer install it for them.

They’ll need to get set up with an account manager. That could be the government, or it could be a private sector account manager licensed by the government to provide this service. Then they will simply drive and get a bill in the mail or by email that they’ll pay, probably quarterly. They’ll be able to use all of the types of payment options that are available in the marketplace today.

They’ll also get an automatic fuel tax refund because the mileage reporting devices also read fuel consumption. With that, you can apply the gas tax rate to the amount of fuel consumed to calculate a fuel tax credit that will appear on the bill.

We’re envisioning a system down the road where there will be much more than 5,000 volunteers-there will be hundreds of thousands or millions of motorists requiring these services, and probably not just in Oregon, but also in other states.

We’re getting a lot of interest in Oregon’s system from other states right now. We’ve actually formed a group with Washington State called the Western Road Usage Charge Consortium for the western states, and so far seven states have agreed to put money into the system and work together on this topic, sharing knowledge and transferring information. All of the states know that they have to do something because the gas tax is failing, and they’re hoping that Oregon’s per-mile charge is the way to go.

Gilroy: What role do you see for the private sector in developing and implementing your system?

Whitty: We want to use the private sector to take on the bulk of the collection of the road user charges, as well as the account management services for the system. The reason is that over time, we can drive down system costs if we access the capabilities of the private sector. The private sector will be able to bundle the per-mile charge billing along with other types of services that also have billings. For example, the mileage charge could be included as part of someone’s communications billing for television, Internet and the like. When you’re able to allow the bundling of the collection of the per-mile charge with other types of services someone might want, then collection costs drop considerably since the mileage charge would not require an expensive stand-alone billing. We want to drive down system costs, because that will generate more revenue for the roads, will minimize administration costs, and will ultimately have lower costs for motorists too since it will minimize the portion of the per-mile charge that goes to administration costs.

That’s our strategy. We’ve tested the market on this twice. The first was in 2012 when we were preparing for the pilot project to start later that year, and we invited companies from around the world and saw 19 firms show up in Portland. We did a request for information and had 28 vendors respond. In our procurement, we found firms that could operate the pilot, so that was the first indication that the marketplace was willing to help us.

We just did a road usage charge summit in November 2013 in Portland because we wanted to tell the marketplace that we had a new effort with the 5,000 volunteers that would come online, and 38 vendor companies showed up for that. We had one-on-one meetings with 22 of those firms over the following two days, and because some of them were involved in the earlier pilot, those conversations were very practical because they knew our program.

I can tell you that there are going to be some firms very interested in providing the services that we will request. We will issue a request for proposals for the government side in the spring of this year, and a request for qualifications (RFQ) for the commercial side. The RFQ will not choose winners-applicants will simply meet our qualifications and they’ll be able to compete in the marketplace. We might not have a big group of firms to start with to compete with each other, but we think we’ll get what we’re asking for, and the system will work.

And once a contractor signs on to the Oregon system as a service provider, if another state wants to use Oregon’s platform to provide those services to taxpayers another state, they’ll be able to do so.

Gilroy: Can you explain the difference between the government side and the commercial side in terms of the three types of mileage reporting you mentioned as part of the current demonstration program?

Whitty: The government contract will be minimal, as we have no interest in competing with the commercial side. It will be the basic plan, with no GPS capabilities. That’s a nod toward the sensitivity of the public; they don’t want to have the government tracking them. So under the basic plan, the only information we want will be miles driven. And the government’s basic plan will not include other services, so we’re not going to provide services that connect to the car’s engine to report its health or that it’s time for new tires, for example. All of that will happen under the private sector plans, where contractors are working on all sorts of value-added services. But the government plan will be quite bare.

The government plan will most likely work only with those people who don’t fit in the marketplace for various reasons, maybe because they don’t pay their bills. But if there’s a mandate later on, then there has to be someplace for those people to go, so the government plan would be the one to serve them.

Gilroy: What have the results been from ODOT’s work on road usage charges thus far?

Whitty: First, I’d say that both of the systems that we’ve piloted so far have worked. The first pay-at-the-pump model was a bit more complicated technologically because it required a transfer of the mileage data several ways at the service stations.

The second pilot was much simpler, and is more a product of the age we’re in with iPhones, Wi-Fi, 4G and cloud-based computing. It is simple because it relies on machine-to-machine communications. Hopping on the “internet of things” is essentially what it is, and that’s more acceptable to people. They understand it, they’re using it now with their current personal technologies, and they require choice with regard to what type of device to use and who to manage their account. Those concepts work, and the second pilot was very successful. We learned some things operationally, but those were easy things to fix. For the most part, it worked perfectly.

We even had some state legislators participating in the pilot, because we wanted them to understand the system before they voted on the legislation in 2013. That part worked because they didn’t have any problems; they simply got an invoice that was accurate, and they paid it online or by check. So overall, we learned that the second pilot’s approach was the way to go forward.

We did have Nevada and Washington motorists participate in that pilot too as a way to demonstrate a multi-state system, and my understanding is that it worked for them quite well.

Gilroy: What kinds of challenges have you run into along the way, both in terms of the politics and public acceptance? Privacy is a commonly cited concern with regard to road usage charges, with some fearing “black boxes” with ubiquitous tracking that can create massive historical databases of one’s personal travel. How does Oregon’s Road Usage Charge Program address privacy issues?

Whitty: Politics and public acceptance are almost the same thing in this case. Legislators both in Oregon and across the country-I’ve spoken on this in a number of states-can understand intellectually what we’re doing along the way, but they want to know what the public thinks. Anyone who just jumps out on this issue without doing their homework learns quickly the public tends to react quickly and negatively toward the idea, largely because they are apprehensive about the idea of government tracking them. Once we demonstrated that the government wouldn’t be tracking them and that they had choices to avoid anything like that, then it calmed everything down.

When the legislation was worked on in the Oregon House of Representatives and we sat down to work out the protection of personally identifiable information provisions of the bill-with the American Civil Liberties Union agreeing to them-that really calmed the issue down. The ACLU said that the provisions protecting personally identifiable information met their requirements.

We had worked out some privacy provisions for a different tolling bill in 2011 that never got through the legislature, and we pulled those provisions out and adjusted them for the per-mile charge for the 2013 legislation. At the first hearing on the bill, the ACLU stepped forward and opposed the bill on the grounds that the privacy provisions were not good enough. The chairman of that committee told me that I should go talk to the ACLU and see if we could work something out. We had several meetings with them, and it actually became very easy to work on these adjustments because ODOT recognized that we have no problem at all protecting personally identifiable information-we just had to make sure the system was operational. The ACLU was very practical and understood that we had a legitimate objective.

It turns out that though we made a number of tweaks, the most important tweak was that they wanted the destruction of the mileage data within 30 days. We worked out that it had to be 30 days after payment, dispute resolution or noncompliance investigation, whichever is later. Once we resolved that, the ACLU agreed that we had good privacy language in the bill. Having their endorsement of the privacy language was a big deal in terms of helping the bill move forward. The legislators then realized that they could actually pass legislation to prove that the system would work with the 5,000 volunteers. But for the agreement with ACLU, we would still be stuck on the privacy issue.

Privacy is both the biggest public concern across the country and the chief political conundrum to solve-it’s what stops this issue from going forward across the country. Everyone has to abandon a GPS mandate if they want to see the per-mile charge become policy across the country-the public won’t accept a GPS mandate. But if we abandon a GPS mandate and go with motorist choice instead, under an open system, you can go forward with policy on this topic. Now that we’ve addressed the privacy issue here, we’re able to move on to assess whether the system is viable economically, which is where we are now.

Gilroy: What’s been the public reaction? People aren’t used to seeing what they actually pay in gas taxes today since it’s not shown on gas receipts, and the shift is to a system where what people pay to use the transportation system becomes very transparent. How have the people involved in the pilot programs thus far responded to the concept?

Whitty: There are some members of the public who would prefer to not know what they pay, which is very interesting, and I’ve not heard any member of the public think of making user fees transparent as an advantage. Policymakers certainly see it as an advantage-some are philosophically inclined towards transparency.

One of the biggest problems with transportation funding in this nation is that people actually don’t know what they pay for road use. I’ve read about surveys where people guess what they pay in gas taxes, and they’re usually very high-on the order of $1,000 per year. That’s far higher by an order of magnitude than they’re actually paying. The idea is that if they had a mileage charge, they would know what they’re paying, would know that it’s small, and might be willing to support periodic increases in the mileage charges because they see that the increase will be a small amount and that they will get something for it.

Transparency works on a number of levels. It works to inform the motorist, and it may work to increase transportation funding in the United States.

Beyond that, Oregon’s original pilot program had a congestion pricing component built in to it, and we did see some evidence that it changed people’s travel behavior in terms of times of day for driving and that sort of thing. Our second pilot did not have congestion pricing, and we didn’t see any difference in travel behavior there. The demonstration program we are developing now also does not have a congestion pricing component. The state of Oregon decided to focus only on revenue generation at the moment, and congestion pricing is something that may be considered later. But that’s a separate policy, and there’s more support for revenue generation as opposed to congestion pricing in the Oregon legislature right now.

Gilroy: Do you see this program expanding in the future? Will road user charges ultimately replace fuel taxes in some foreseeable future?

Whitty: I believe they will, but it will take many years. The legislature would not have passed the 5,000 volunteer bill unless they considered this the last step before implementing a mandate for some motorists to pay the mileage charge. The next question will be: how would the legislature start with a mandate? There’s reason to believe that they would start with a small group. The legislature considered another bill last session-House Bill 2453-as an alternative to Senate Bill 810, that nearly passed. That bill would have imposed a mileage charge for vehicles rated at 55 miles per gallon and above-this was the group the legislature was considering starting with.

Going into the future, I can see the legislature choosing a group like that, or perhaps even starting with a vehicle model year. They may even decide that the least efficient vehicles-those under 22 miles per gallon, for example-should just continue paying the gas tax, only switching vehicles above 22 miles per gallon to the mileage charge. But I don’t see the legislature imposing the system on every motorist in the first instance. That would be too complicated and difficult. I think the legislature would rather phase the per-mile charge in over time.

Legislatures have a lot of options in how to proceed, and I think that over decades they’ll make a switch from the gas tax to the mileage charge.

Gilroy: Other states are starting to explore similar concepts. What are some of the lessons learned from Oregon’s experience that you would share with peers in other states looking to implement road usage charges?

Whitty: They have to realize that this is a policy decision. The legislature has to understand the issues at hand, so I suggest a policy body like Oregon had with its Road User Fee Task Force that can work through the issues. And if you have legislators on that policy body, then they can take those concepts back to the legislature to help policy development.

I also think that doing a demonstration pilot project is worthwhile because the legislature needs to know that the department of transportation has the institutional chops to pull it off. A successful pilot program will help demonstrate that.

I would also suggest that if a state wants to make progress quickly, a state could just access the Oregon platform because the system we’re putting together is entirely scalable and flexible, as well as geographically unlimited. In the first pilot, it took Oregon three years and $3 million to develop and operate the pilot, and it took Minnesota five years and $5 million to put their pilot together and operate it. But our last pilot in 2012-13 took us less than a year-10 months-and it cost us about $1 million, and that included all of the procurement costs. So states can run pilot programs a lot less expensively now than they could back then if they’re willing to use the Oregon platform.

One thing I’m excited about moving forward is that we’re going to be able to develop a communications program for the public on this topic. Because the legislature has now adopted this as policy, legislators now expect ODOT to advocate that policy. Up to this point, we haven’t been able to sell the program to the public. What that means is that before, we may have been out there talking about it without knowing the proper language to use and arguments to make to be effective in communicating. Now we’ll be able to understand what the questions are in, say, an urban area versus a rural area and address those questions directly in a way that people understand. Being able to use precision communications will help us moving forward.

James Whitty is the Manager of the Oregon Department of Transportation’s Office of Innovative Partnerships and Alternative Funding. By leading Oregon’s efforts to develop and implement a new revenue system based on vehicle-miles traveled, Mr. Whitty has achieved recognition as a national leader on road use charging policy and system development in the United States. His work in this field culminated in the successful completion of two per-mile charge pilot programs completed in 2007 and 2013 that led to the passage of road use charging legislation in Oregon in 2013 enacting implementation of a road usage charge system for 5,000 volunteers.

Mr. Whitty currently oversees development of a permanently operational road use charging program which will deploy cutting-edge approaches to road use charging under an open technology platform with motorist choice and implementation through public private partnerships as central features.

Mr. Whitty is a co-founder of the Western Road Usage Charge Consortium consisting of states engaging in road usage charge information transfer and joint research on the topic of mileage charging. Mr. Whitty is a co-founder and vice chairman of the Mileage Based User Fee Alliance, an entity with a mission of educating policymakers on road use charging and headquartered in Washington DC.

Mr. Whitty brings a private sector perspective to his role in transportation policy. His prior experience includes 10 years working with transportation finance and environmental public policies for Associated Oregon Industries, the Portland Chamber of Commerce and six years in private law practice. He obtained his bachelor’s degree and Juris Doctorate from the University of Oregon.

Other articles in Reason Foundation’s Innovators in Action 2014 series are available online here.

The post Pioneering Road User Charges in Oregon appeared first on Reason Foundation.

Edited by Reason’s Leonard Gilroy, the Innovators in Action 2013 series profiles a range of innovators who have demonstrated leadership through action on privatization, competition, government re-invention and other market-based policy reforms designed to reduce the costs of government and deliver more value to taxpayers. Innovator interviews or self-penned articles will be added regularly throughout the year, so be sure to check back frequently for new content.

The Innovators in Action 2013 series profiles released to-date are listed below:

• Pursuing Fiscal Self-Reliance in Utah
  Interview with Utah State Representative Ken Ivory
  Leonard Gilroy
  November 27, 2013
• Advancing Pension Reform in San José
  Interview with Pete Constant, San José (CA) City Councilman
  Leonard Gilroy
  October 31, 2013
• Closing the Gap: Designing and Implementing Pension Reform in Utah
  Interview with Dan Liljenquist, former Utah State Senator
  Leonard Gilroy
  September 17, 2013
• Pioneering Social Impact Bonds in the United Kingdom
  Interview with Jane Newman, International Director at Social Finance UK
  Tom Clougherty
  August 13, 2013
• Colorado’s Contract City, Part 2: Innovation and the Future of Public-Private Partnerships in Centennial
  Interview with Centennial, Colorado Chief Innovation Officer David Zelenok
  Leonard Gilroy
  July 29, 2013
• Colorado’s Contract City, Part 1: Public Works Contracting 2.0 in Centennial
  Interview with Centennial, Colorado Mayor Cathy Noon and City Manager John Danielson
  Leonard Gilroy
  June 24, 2013
• Building Jacksonville’s Public-Private Partnership Program to Drive Efficiency, Quality of Life
  Interview with Renée Finley, Commissioner of Public-Private Partnerships, City of Jacksonville, Florida
  Leonard Gilroy
  May 7, 2013
• Breaking the State’s Control of Municipal Pensions in Massachusetts
  Interview with Barry Greenfield, Town of Swampscott, Mass. Selectman and Founder/Publisher of EfficientGov.com
  Leonard Gilroy
  April 8, 2013
• Creating a Managed Lanes Network in Atlanta
  Interview with Georgia Department of Transportation Deputy Commissioner Todd Long, incoming SRTA Executive Director Chris Tomlinson and SRTA Director of Operations Steve Corbin
  Baruch Feigenbaum
  March 19, 2013
• Using Innovative Policy Tools to Rebuild Colorado’s Infrastructure
  Interview with Michael Cheroutes, Director, and Nick Farber, Enterprise Specialist, of the Colorado Department of Transportation’s High Performance Transportation Enterprise
  Harris Kenny
  January 2, 2013

Earlier editions of Reason’s Innovators in Action are available here:

• Innovators in Action 2012
• Innovators in Action 2009
• Innovators in Action 2008
• Innovators in Action 2007

The post Innovators in Action 2013 appeared first on Reason Foundation.

Utah is also among those western states that, unlike their peers in the East, see an extensive degree of ongoing federal land ownership-well over 50 percent of the total land area in several states-primarily through national forests, Bureau of Land Management properties, national parks and monuments, and other types of lands. Such vast federal land holdings reduce the amount of land available in the western states for commerce, taking it off the tax rolls and presenting a challenge for these states to generate funds for education and other priorities, relative to their eastern peers.

Utah State Representative Ken Ivory has been a leader in the pursuit of fiscal self-reliance in Utah, with regard to both issues-federal fund transfers and land ownership. Ivory was a primary sponsor of the Financial Ready Utah bills, as well as the 2012 Transfer of Public Lands Act, which establishes a framework for the transfer of certain federal lands to the state of Utah in the coming years. Ivory also serves as president of the American Lands Council (www.AmericanLandsCouncil.org), a nonprofit composed of state officials, local governments, businesses, organizations and individuals interested in advancing the cause of local control of land access, land use and land ownership.

Earlier this month, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Rep. Ivory on the rationale behind the Financial Ready Utah bills and the Transfer of Public Lands Act, the history of federal control of western lands, and much more.

Leonard Gilroy, Reason Foundation: Can you describe the thinking behind the Financial Ready Utah initiative?

Utah State Representative Ken Ivory: In my first session in the Utah House in 2011, I was concerned we didn’t seem to know exactly how much federal funding came into Utah. I heard a variety of guesses, but as we really started to look the numbers, we discovered that as much as 45% of our total revenue in the state of Utah comes from a federal government that is broke. The federal consolidated financial statement from the Government Accountability Office reports annually that federal finances are unsustainable. The GAO will not issue an unqualified financial statement on the United States. So, nearly 45% of Utah’s revenue comes from a federal governing partner that is fiscally reckless, as repeatedly demonstrated with each new debt ceiling or continuing resolution debacle.

So, we began looking at how to attain a level of economic self-reliance, and given increasing federal uncertainty, how do we assess the immediacy, severity and probability of the risk of a reduction in the amount or value of federal funds-what do we do at the state level? Also, how can we foster community preparation for the fiscal earthquake that is, in all likelihood, more probable than the physical disasters that we spend millions of dollars preparing for?

Gilroy: Once you had a sense of the scale of federal funds as a percentage of state revenues, what legislative actions did that prompt?

Ivory: The legislation started in 2011 with a fairly simple bill-it was called the “Federal Receipts Reporting Requirements” (2011 House Bill 138). This bill required all state agencies to disclose total federal receipts, what percentage of their budget that represented, and then what their contingency plan would be if there was a reduction in federal funds of 5% or 25%. What this did was get our state agencies to begin the exercise of thinking about what would happen in the event that federal funds go away. This was in 2011-pre-downgrade, before the first debt ceiling meltdown, before the Budget Control Act. Some looked at our efforts and felt that we were a bit crazy in trying to prepare for federal funds going away. Well, fast-forward seven months from the passage of that bill, there was the looming shutdown, the downgrade of the credit rating of the United States, the debt ceiling meltdown, and sequestration-which materialized into serious cuts of the federal funds flowing to states, counties, cities, schools, etc.

Following the 2011 U.S. credit downgrade, credit rating agencies began revisiting the credit ratings of the various states because of their dependency on federal funds. When our Utah finance folks met with the ratings agencies they were asked what Utah was doing to deal with this risk. They referenced the bill we just passed and that Utah was already starting to engage on this issue. The ratings agencies responded that Utah was the only state in the nation taking such a proactive approach, so they weren’t even going to review Utah for downgrade.

HB138 started the ball rolling. Under this bill, we are receiving reporting from all of our agencies regarding what their percentage of federal funds is and what they would do in the event of a reduction of federal funds. This is a good starting point for information. But we realized that we needed to stitch this information together into a more comprehensive plan.

During the 2012 legislative session, Senator Deidre Henderson and I, working together with our Utah Association of CPAs (UACPA) and local chambers of commerce, put together a package of about seven different bills that came to be known as “Financial Ready Utah.” In addition to the UACPA and chambers of commerce, business groups, school districts, cities, etc. began passing resolutions of support encouraging state and national leaders to take action to control our own destiny because of the very definite sense that this flow of federal funds comprising the single largest revenue line item in Utah’s budget is unsustainable.

The package of bills passed with overwhelming support. The first was a resolution that outlined the gravity of the problem. For example, former Clinton White House Chief of Staff Erskine Bowles said that we face “the most predictable economic crisis in history.” Admiral Mike Mullen, former Chairman of Joint Chiefs of Staff under President Obama, said that the greatest threat to our national security is the national debt. David Walker, the former head of the Government Accountability Office under both Clinton and Bush, warns that we’re facing a meltdown-we have a crisis of leadership, a fiscal crisis, a monetary crisis. When you look at knowledgeable people like this issuing such stark warnings, it would seem irresponsible to not take serious action to prepare. So a resolution sponsored by Sen. Aaron Osmond laid out these facts.

The second bill sponsored by Sen. Henderson formed the Federal Funds Review Commission. The Commission is made up of legislators, governor’s staff and private members. We have a couple of members from UACPA, as well as some city managers, county representatives and others on the commission. We are starting to look at-number one-how do we assess the immediacy, severity and probability of a reduction in the amount or value of federal funds and what that impact would be? And then how do we at the state level undertake this fiscal disaster preparedness, if you will? Our UACPA, business groups and cities are looking at how we take this Financial Ready Utah message out to the communities and make the case for fiscal earthquake preparedness to homes, businesses and municipalities.

A couple of the other bills in the package this past session require the governor in his annual budget to account for the risk of a reduction in the amount or value of federal funds, and for the legislature to do the same thing and to have our legislative fiscal analyst to advise us on the probability and risk of a reduction in federal funds.

Gilroy: Now that agencies are actively accounting for federal funds in the context of contingency planning and the like, what sort of reaction have you seen from them? Have they been resistant or are they surprised?

Ivory: I think in 2011 when the serious likelihood of a reduction in federal funds was probably not as apparent, there might have been some reticence. But as we’ve seen things unfold-we now have three years of reporting from agencies-and now they’re seeing that this is an exercise that we really needed to go through. This is the result of the first bill from 2011, HB138.

With our federal funds commission, now we’re looking at how we take all of that information and stitch it together into a comprehensive plan. We’ve got working groups for local government, education, health and human services, public safety and risk assessment. Now, we’re taking this information and assessing comprehensive action steps, possibly including getting some professional assistance on large-scale enterprise risk management planning. But we’re moving forward in looking at the problem. You can’t solve a problem unless you’re willing to examine it.

So that’s step one, and now we’re figuring out how to take on this huge exercise of enterprise risk management at a state government level.

Gilroy: Do you see more Financial Ready Utah initiatives coming in the future?

Ivory: There’s a lot more to come. This is a big exercise. The name “Financial Ready Utah,” comes from a natural disaster preparedness initiative in Utah called “Be Ready Utah.” We look at this as the financial disaster preparedness, so it is called “Financial Ready Utah.” Our Utah Association of CPAs formed a 501c(3) entity called Financial Ready Utah to educate and work with their members throughout the state and work with our disaster preparedness teams to tackle these issues.

When you look at how do you broaden your tax base, how do you look at emergency reductions in spending, how do you look at delivering services in a different manner when you’re talking about a potential hole on the order of $5 to 6 billion in a state budget of $13 billion-it’s a huge undertaking for part-time legislators and executive staff. So we’ve been outlining the pieces that need to happen and the future legislation that needs to go forward, and then looking at the professional help and other advisors that we can bring in to really hone a cohesive plan.

This is a great example of a bottom-up effort to drive policy, because people, businesses and organizations on the ground understand that we can’t pretend to print and borrow our way to prosperity. They understand that at some point this ends badly, as it has throughout all history.

Gilroy: Have you gotten inquiries or interest from other states in what you’re doing?

Ivory: We’ve gotten inquiries from all over the nation. I think that states and cities are realizing that we’re in a very serious time. To think that as a nation, we’re perpetually pretending that we can print prosperity-it simply defies reality. We’ve got to prepare, because no matter what happens at the federal level, we still have to educate children, we still have to take care of sick and poor people, we have to take care of roads and public safety. Only in Washington D.C. can they pretend to live in such a bubble.

Take the recent shutdown of the national parks. There was no communication from our governing partner at the federal level, no coordination as to how we could mitigate the pain and the damage a shutdown would cause-meanwhile, tourism is an $8 billion per year industry in Utah. From vindictive and arbitrary actions by our federal governing partner, we had families completely out of work, businesses shut down, entire industries threatened. We’ve offended travelers from all over the world; many of them were turned away at national parks. The ramifications of that are likely to go on for years and even decades, when you think of how fickle tourism dollars are.

We hadn’t even considered such vindictive political risk, but now that’s a reality that we are going to have to plan for as well. It was a very serious, very tangible wake-up call that Financial Ready Utah isn’t just some future planning exercise-this is happening right now.

Gilroy: You’ve also been engaged on issues related to western lands-specifically the large amount of federal ownership of land in western states-which plays into this state self-reliance concept as well. How did you get involved in that?

Ivory: They evolved simultaneously. In the 2011 session-when we realized that over $5 billion of our state revenue comes from a federal government that’s broke-that’s when we started to flesh out how serious those numbers were. Something on the order of 40% of our state revenue comes from an unsustainable source in our federal governing partner. We looked at the magnitude of this risk and started to think about how we could broaden our revenue base and get to a point of economic self-reliance.

You’re not going to close a revenue gap in the billions of dollars by tweaking the tax code with minor adjustments; you’d have to more than double the income tax and kill the economy. You’d have to increase corporate taxes by more than 1000%, again, killing the economy in an attempt to close that gap. On top of the general fiscal gap, in Utah we are $2.6 billion below average in annual per-pupil funding. There’s no amount of nipping, tucking and tweaking in the tax code that even closes decimals on that gap. The magnitude is tremendous.

Yet, what we know from the U.S. Government Accountability Office is that there’s more recoverable oil in Utah, Colorado and Wyoming than the rest of the world combined. There’s a study from earlier this year by the Institute for Energy Research that there’s $150 trillion in mineral value locked up in the federally controlled lands throughout the West. Right now the forests-which were a renewable resource, with the revenue funding schools, roads and public safety-have been shut down to timber harvesting, and now they’re basically tinder boxes. We’ve got so much dead wood standing in the forests that, in fact, the FBI is even warning our state foresters that terrorists are encouraging wildfires as a form of jihad. The forests are so dense now that the trees can’t defend themselves and fend off natural diseases and pests, so forests throughout the West are largely dead or dying just waiting for any spark to ignite the next catastrophic wildfire.

So we looked at these conditions. And as you pointed out, more than 50% of all land in the western United States is owned and controlled by the federal government. This is in a nation that was founded on the principles of inherent, inalienable rights to life, liberty and property. World-renowned economist John Kenneth Galbraith made a statement in the mid-1980s that “where the socialized ownership of land is concerned, only the U.S.S.R. and China can claim company with the United States.”

So we started asking, why is the federal government in control of all of this land? Immediately after the 2011 session, I met with Roger Barrus, then chairman of our House Natural Resources Committee, and Kevin Carter, the director of the School and Institutional Trust Lands Administration, and we discovered a very recent, unanimous Supreme Court case from 2009-Hawaii vs. Office of Hawaiian Affairs. This case declares that Congress does not have the authority to change our rights of statehood in our statehood enabling act-the promises made at statehood between sovereign entities-particularly where all of the state’s public lands are at stake.

We looked at that case and went back to have a fresh look at our statehood promises. It’s fascinating-when you ask people the very simple question, why the difference? Why is it that the federal government controls less than 5% of land in the states east of Colorado but more than 50% of the land between Colorado and California, plus Alaska, and yet not Hawaii? In Utah it’s almost 70%, and in Nevada the federal government controls almost 90% of the land.

If you think about Nebraska and Nevada, which one would you think was made a state first? You’d likely think Nebraska, but you’d be wrong. In 1864, their enabling acts-their statehood contracts-were written at the same time, less than 30 days apart. Nevada became a state in 1864, and Nebraska didn’t become a state until three years later. And yet, the terms of their statehood enabling acts-which the Supreme Court has called a “solemn compact”-the terms for disposing of the public land are virtually word-for-word the same. And yet Nebraska goes from roughly 25% public land down to 1% today, while Nevada goes from 86% down to just 81% during the same time.

If you look at North and South Dakota, the boom that’s going on in North Dakota right now is because they control access to their lands and resources, and they’re the ones regulating what happens on their land. They get 100% of the mineral royalty, and they’re putting billions of dollars directly into classrooms and billions more into school and road infrastructure. They’ve got thousands of jobs open just looking for people, and yet the statehood enabling act for North and South Dakota is the same document that created Washington State and Montana. Not just the same language, but the same document created those four states. However, Montana and Washington State have nearly 40% federally controlled land. North and South Dakota are 3% and 5% federally controlled, respectively.

Utah has the exact same language for the transfer of public lands-not the same document-but the same language as North and South Dakota, yet Utah has 70% federally controlled land, with trillions in mineral value locked up that could be used to close that $2.6 billion gap in our education funding, to create tens or hundreds of thousands of jobs throughout the West. Unlocking these lands could actually provide forest management where we actively tend the forest garden again rather than burn up millions of animals and destroy the watershed for generations…and where we use our abundant renewable resources again to educate children and provide for roads and public safety in our communities.

So we look at this as the only solution big enough to solve these pressing issues. All we seek is for the federal government to honor the same statehood enabling act promise to transfer title to the public lands that it already kept with all states east of Colorado.

Gilroy: If you were trying to explain this to people in Cleveland, Chicago or Charleston that aren’t familiar with the issue, how would you explain what happened? If the enabling language is basically the same, why does the federal government still own so much of the West?

Ivory: That’s a great question. There actually came a time when the western states got fed up with this. They couldn’t educate their kids or grow their economies. So they got together and mobilized on Washington, mobilized their courage and knowledge and refused to take no for an answer. One man of courage stood up and led the fight. Those “western” states were Illinois, Missouri, Arkansas, Louisiana, Indiana, Alabama and Mississippi-and of course that great “western” state of Florida. In fact, in its resolutions to Congress, Florida said it was the worst off of all of the western states in terms of the federal government controlling all of their land. That one man of courage who stood up was Thomas Hart Benton, a Democratic U.S. senator from Missouri.

He said that his election to the Senate found him doing battle for changing this system of disposing of the public lands. He said, “I went to battle … and ran a bill every single year, but more so in educating the general public.” He said that no one was raising their voices against this hard policy when he was elected in the 1840s/50s. Illinois had been as much as 90% federally controlled for decades; it was the same in Missouri. They have less than 5% federally controlled lands today.

Back in 1915, Utah’s state legislature passed a resolution telling the federal government that it needed to keep its promise and dispose of this land. In the 1920s, the western states started coming together to push the federal government to finally honor the promise to transfer the public lands. The federal government’s response was basically that western land was more arid and rugged, so it was going to take longer to sell. Right in our enabling act it says that, “5% of the proceeds of the sale of public lands … which shall be sold … shall be paid to the states … for the support of the common schools.” So the idea was that the federal government would sell the land and keep 95% of the proceeds, and states would keep the other 5% to educate their children. This happened with all newly created states east of Colorado.

The duty of the federal government was to relinquish title, not set up a system of socialized land ownership on a par with the Soviet Union and China. The original idea, stemming from 1780 through the creation of all new states and beyond, was that the federal government was nothing more than a trustee over the lands for the purpose of disposing of them. As the federal government disposed of the public lands, if it was able to sell them, then 5% of the proceeds were to be paid to the states for the purpose of educating their children.

President Hoover convened a commission on the subject of disposing of the public lands. That led to congressional hearings in 1932 that were titled, “Granting Remaining Unreserved Public Lands to the States.” Not if, just how. The Administration and the agencies came up with a proposal that would have transferred all the surface lands to the states, but proposed in their draft bill to keep all of the mineral rights. The states banded together in the midst of the Great Depression and told Washington that this was not going to work-the federal government had to keep the whole promise just like it did with the other states, disposing of both the surface and sub-surface, because it’s the mineral estate where all the value is in the western lands. The states banded together to defeat this inequitable treatment of disposing of the public lands.

Two years later in 1934, Congress passed what’s known as the Taylor Grazing Act as a stopgap for managing the public lands. The very first line of the Act said that this was just to promote the highest use of the public lands “pending its final disposal.”

Let’s go back to why the federal government held these lands in the first place. At the start, when the original states declared independence, there was no national government. Then came the Articles of Confederation, but the states, not the national government, held the lands. Going back to 1763 in the colonial charters of the original colonies, the king granted to seven of the 13 colonies claims to what then were known as the “western wastelands.” Six of the colonies had no claims at all. Later, during the Revolutionary War, the states were broke and fighting the best-funded, most well-equipped army in the world. Well, they weren’t going to go and raise taxes on the original Tea Party crowd-good luck with that. So the seven states said that they would just sell some of the claims they had to the western lands, and the other six were going to be left having to try and tax their citizens to raise their share.

The six states balked at this -if they raised taxes then people were just going to leave and go to the other seven states. This became a huge impasse during the revolution; they called it the “Great Embarrassment.” The Continental Congress stepped up and proposed that the collective group of states hold these lands in trust for two purposes only-(1) to create new states “with the same rights of sovereignty, freedom, and independence as the other states,” and (2) to use the proceeds of any sales of the lands to pay off the debt of the war. On that basis, states began ceding their land claims to the Continental Congress.

After they won the war, Thomas Jefferson drafted a land ordinance reiterating this trust obligation. The idea is incorporated in Article Four, Sector Three of our Constitution, which says that, “Congress shall have Power to dispose of and make all needful Rules and Regulations respecting the Territory or other Property belonging to the United States; and nothing in this Constitution shall be so construed as to Prejudice any Claims of the United States, or of any particular State.” Remember, the claims were to only use the western lands to create “distinct republican states” and to use the proceeds of any sales of these lands to pay the war debt. Congresses, presidents and supreme courts, all the way up to the statehood agreements of the western states reiterated this trust responsibility.

Fast forward to 1976, when Congress passed a federal lands policy where they say for the first time-after nearly 200 years-that it’s now their intention to just retain these lands in federal ownership. They said the federal government would still let states manage the lands locally-they said they would protect the multiple use, sustained yield, local planning of the public lands…so don’t worry. But since 1976, local planning has gone out the window. Public access and roads have been shut off all over the West. The forests, that were a renewable resource, are burning to the ground, killing millions of animals, destroying critical habitat and decimating watersheds. Trillions of dollars in resources are locked up in these federally controlled lands. Economies are stagnating in the states and the nation. So that’s how we got to where we are.

So why would a person in Cleveland or South Carolina care? Right now, they’re spending about $13 billion per year to pay western states and communities to not use our own land and resources to care for our own kids and communities. That’s in addition to about $15 billion in deferred maintenance on the national parks. The other thing they should care about is that, according to the Institute for Energy Research, there is $150 trillion in mineral value locked up in the federally controlled lands. Where does the heavy equipment come from? Where does the information technology, financing, legal and accounting come from when those resources are responsibly unleashed to sustain a productive economy? Where is the revenue going to be spent and generated, because that’s the kind of thing that benefits the entire nation.

Gilroy: Utah passed legislation you sponsored called the Transfer of Public Lands Act (2012 House Bill 148) that takes a stand on this issue. Can you describe the Act?

Ivory: Knowing that the only solution big enough to close the severe education and general state government funding gaps is to have access to our land and resources, we passed the Transfer of Public Lands Act. What this did was first, and most importantly, set a deadline to work with our federal governing partner on a orderly transfer of the public lands whereby they honor to us and our children the same promise they kept with all states east of Colorado. We set a deadline of December 31, 2014 to work in an orderly fashion on this, but so far we’ve seen little action from the federal government.

Some of the things that are critical in the bill include taking national parks off the table; we’re not talking about those. However, in light of the recent shutdown-where the federal government is demonstrating that it can’t or won’t manage the national parks-I think that in the next legislative session we’re going to have very serious discussions about this issue. But in the bill, national parks are off the table.

Similarly, Indian reservations, military bases, congressionally-designated wilderness and national monuments in Utah are also off the table-with the exception of the Grand Staircase-Escalante National Monument created by President Clinton without talking to a single Utahan, locking up as much as $2 trillion in estimated coal resources.

The bill also sets up a process to determine the economic viability of-and establish guidelines for-multiple-use/sustained-yield with local planning, where federal public lands become state public lands. This never has and never will be just some effort to sell off all of the public lands. The reason being is that after 117 years of statehood, various rights and expectations have built up-and our very livelihood in the West has developed-around this system of public lands. To simply come in and say we’re going to sell all of that off would upset rights, expectations, cultures and ways of life in the West that legally, practically and politically would be a non-starter. So federal public lands would become state public lands, managed by the state just as we manage millions of acres already much more effectively than the federal government.

We passed the bill, and we’re now in the process of doing the in-depth economic feasibility analysis and transition analysis on how to effectuate the transfer. It’s such a huge undertaking that we’re taking a very measured approach to lay the foundation and groundwork on this.

Since we passed our bill last year, four other states-Nevada, Idaho, Montana and Wyoming-have passed various versions of public land transfer or analysis legislation. Arizona passed a bill that got vetoed by the governor, but their bill went more to a straight privatization, so I think they’ll have a bill coming back that’s more in line with the other states. New Mexico is working on legislation, as are folks in Colorado, Washington and other western states. The idea is to analyze and study the transition, understanding that we developed rights and expectations over more than a hundred years of this being public land and to honor those rights as federal public lands become state public lands.

It’s also really fascinating that the South Carolina legislature passed a resolution supporting a transfer of public lands to the western states. Why would they do that? Number one, it’s the right thing to do to keep the same promise with all states. But it’s also the $13 billion dollars a year that other states are spending to keep us from using our own land and resources to educate our own kids and care for our own communities, as well as the $150 trillion locked up in our lands that could create jobs and expand local, state and national economies.

Gilroy: So then your efforts are not seeking to purchase the land back from the federal government, since these lands were held in trust for the states to begin with? And on the other hand, this would then not present the federal government with an opportunity to generate revenue from the sale of these lands, right?

Ivory: Yes and no. It’s not about buying the land, because as you said, the federal government is only holding the land as a trustee just like it did for all other states east of Colorado. That obligation goes back to 1780. Think about what happened with Hawaii. If you look at the Hawaii state enabling act from 1959, it says that the federal government grants directly to the state of Hawaii all of the federal lands that are held by the federal government. Why? Because the native Hawaiians understood that that was their right and the duty of the federal government, and they mobilized politically to demand and compel the federal government to do the same thing compelled by Illinois, Missouri and others in the 1850s-honor their statehood promise to transfer title to their public lands. In Michigan, the federal government granted 13 million acres to the state. So there are all sorts of precedents for disposing of the land in that fashion, because the duty of the federal government is to dispose of the land. If the federal government can sell it, great, then sell it. But if it can’t sell it within a reasonable amount of time, then it was bound to grant title to the states. So we’re just simply asking to be treated like all of the other newly created states east of Colorado.

Now as to the federal government generating revenue, think about the homestead law. That was just one of many ways that it disposed of land. The homestead law said that if you go on the land-if you’ll make it productive-we’ll give it to you. Why would they do that? Because they understand that if people are productive on the land, then you build a strong and vibrant economy that grows local, state and national economies. It’s not about selling the land, but rather about the revenue that’s generated from it-the tax revenue, the productive revenue, the multiplier effects of people being productive in a thriving economy.

Today, many of these federal lands in the West are just sitting unproductive, costing tens of billions of dollars in revenue to mismanage the forest and manage other lands in ways that aren’t productive. So the federal government would be saving tens of billions by transferring those responsibilities to the state.

There’s a study from the Nevada Public Lands Management Task Force that found that an acre of public land under state management yields a positive $6.29 an acre while an acre of public land under federal management loses $1.86 per acre. There are all kinds of studies that reach similar conclusions on how the state governments outperform the federal government on land management from grazing, to timber production, from recreation to mining, etc. In terms of environmental quality, on state lands you’ve got forests that are being actively tended-they’re not disease ridden or burned-and thus animals and watersheds are being protected as well.

Gilroy: Since the overarching goal here is to transfer federal lands to state control, how would you respond to those that say that states are having fiscal difficulties of their own and may not be in a good position to take on the responsibility for managing more land?

Ivory: I posed that question to Dino Falaschetti, an expert at the Property and Environment Research Center, and without missing a beat, he responded, “we can’t afford not to.” In state hands, research and on-the-ground practical experience shows over and over again that the public lands are a very productive asset that is kept in a better state of environmental quality in state hands. In the federal hands, it becomes a liability. In a state’s hands, it puts money right into schools, right into communities for public safety-we really can’t afford not to.

Gilroy: In addition to your legislative work, you’ve also taken a leadership role in an organization called the American Lands Council (www.AmericanLandsCouncil.org). Can you describe the Council and what its goals are?

Ivory: After I passed the Transfer of Public Lands bill, I had a number of county commissioners come to me from, at the time, three western states. And they said, “you’ve gone on offense. We’ve been playing defense for decades and have been losing ground.” We talked about what to do and where to go, and these counties in Utah, Nevada and New Mexico decided to form the American Lands Council and asked me if I would set aside my law practice and livelihood and go on the road messaging these issues. The opportunity is so tremendous right now-we’ve got counties all over the West, with businesses and individuals joining and supporting this effort to secure local control of land access, land use and land ownership.

Education is the foundation. When people realize that the statehood promises are the same for states both east and west of Colorado, that other states have compelled the federal government to dispose of the public lands in their states, and that it’s the only solution big enough to fund education, better care for the environment and grow economies locally and nationally, that changes things. That gets us to the point where our leaders start to have the knowledge and the courage-just like Sen. Thomas Hart Benton-to compel Congress to honor the same promise for our kids and our future.

Next year with the 2014 elections, we see an exciting opportunity. As people are considering who to hire to represent them at the local, state and national levels, we submit that the questions to ask those seeking to be hired for these positions are if they know why the difference in the federal government’s control over more than 50% of the land in the western states, and why these lands have $150 trillion in economic potential locked up instead of being put to responsible use to fund education, create jobs and grow local and national economies. And if they don’t understand these critical issues, we shouldn’t hire them.

You want somebody who really knows what’s at stake. You ask them what specifically they’ll do and what they’ll bring to the table to help make this happen. So we see that job interview process next year as being absolutely critical, and at a critical time for our nation. It’s a solution that’s not Republican or Democrat. We’ve got people across the spectrum endorsing the transfer of public lands bills, sponsoring the bills, supporting the bills.

It’s something we can battle for-we’re not battling against anyone or anything on this. We’re battling for a solution for funding education, and better caring for the lands, and growing jobs and economies.

The opportunity is for people to get engaged, go to our website, and get informed, and take action to build the knowledge and courage among those you hire at the local, state and national levels to represent you. The wonder of our system of government is that the power still resides in the people to hire representatives that have the courage to battle for this only solution big enough to fund education, protect the environment and grow our local and national economies. For those already in office, it’s a matter of the people who hired them previously demanding that they get the knowledge and the courage to move this forward.

Once a general knowledge has been established, then there are two tracks. There’s a litigation track and a legislation track. Our attorney general’s office has been building the case on this, and it’s a matter of first impression-this has never been heard before at the Supreme Court level. There are a lot of cases from the Supreme Court saying that these statehood enabling acts are “solemn compacts,” with enforceable rights and obligations on both sides. But the Supreme Court has never considered this direct question on the duty of the federal government to transfer the lands, so it’s a matter of first impression.

The Federalist Society, an organization of 40,000 constitutionally focused lawyers, scholars and professors, did a full legal analysis of this question that is available on our website and their website-a full analysis of the Transfer of Public Lands Act. They conclude that it’s legally, historically and constitutionally based that the federal government has a duty to honor its promise to transfer the public lands just as it did with all the other states.

So you’ve got the legal avenue, but you’ve also got the pure political avenue. There’s nothing illegal or unconstitutional about Congress changing this failed lands policy that it adopted in 1976. That’s just a matter of mustering the political courage to compel Congress to change that failed policy and honor the very same statehood promise to transfer the public lands that it kept with all states east of Colorado.

Ken Ivory (R-UT, District 47) was elected to the Utah House of Representatives in November of 2010. Ken campaigned as a candidate of the “Dad Party.” Ken and his wife, Becky are the parents of four children. Given the daunting challenges that face the state and the nation, Ken took time from his business, mediation, and estate planning law practice to “secure the blessings of liberty” to his posterity.

As the current president of the American Lands Council (www.AmericanLandsCouncil.org), Ken dedicates his time to educating legislators and community leaders throughout the states about their jurisdictional rights and duties to manage, protect, and care for the lands within our borders. Ken is the author of Where’s the Line? How States Protect the Constitution.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

The post Pursuing Fiscal Self-Reliance in Utah appeared first on Reason Foundation.

This situation came to a head in June 2012, when 70 percent of San José voters passed a ballot measure-Measure B-to reform the city’s pension systems and put them back on a path toward financial sustainability. Among Measure B’s provisions:

• Current employees are required to pay a larger portion of their salaries to maintain their existing pension benefits.
• Current employees can choose to avoid the higher contribution rates by shifting to a new, less generous pension plan. New employees are also automatically entered into a less generous pension plan and must cover half of the cost of annual pension contributions.
• The city’s practice of issuing pension “bonus payments” to retirees when pension investment funds have higher-than-expected returns is discontinued.
• The measure lowered pension benefit levels and increased the retirement age for both current and future workers.
• The automatic annual cost of living adjustments (COLAs) paid to retirees were reduced from 3 percent to 1.5 percent for new employees and current employees that opt into the newer, less generous plan. Further, COLAs may be suspended for up to five years in the event of a fiscal emergency.
• Voters must approve all future increases in pension or other post-employment benefits for government employees.

One of the leaders of the pension reform movement in San José was City Councilman Pete Constant, a retired police officer and former board member of the San José Police Officers’ Association, the union representing the city’s law enforcement officers. Constant worked with Mayor Chuck Reed to design the language in Measure B and was a leading advocate of the measure prior to voter approval. Constant was also the sponsor of a separate policy initiative that ultimately ended the provision of lifelong pension benefits for San José elected officials.

In September, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Constant on what prompted him to take on pension reform in San José, how he made the case to policymakers and citizens, the specifics of the reforms enacted, and more.

Leonard Gilroy, Reason Foundation: Can you describe the financial situation that drove San José voters to approve sweeping reforms to public employee pensions in 2012?

Pete Constant, San José (CA) City Councilman: The City of San José found itself faced with a decade of general fund budget shortfalls, and the shortfalls were very large in scope. If you were to take all of our budget deficits over the past 10 years and add them together, they would exceed $670 million, with two individual years that topped $115 million each.

And when a city is faced with such incredible budget challenges, it really has a limited scope in how it can respond, because as we all know, local governments have to balance their budgets every year. You don’t have the luxury of borrowing money or deferring like the federal government does-you have to deal with it in the year that you face it.

The city had to severely reduce the number of services that it provided to its residents, and we did that across the board. That involved everything from having our libraries closed half a week each, having new facilities like a police substation and four brand new libraries closed-we never opened them and had fences around them-not opening parks, deferring maintenance and slashing our workforce. We went from well over 7,000 employees to around 5,000 employees. And it really was a severe case of service reductions-everything from police officers and firefighters right on through the organization.

What that did is it put San José in a place where these budget difficulties were not just something that people were reading about in the newspaper. They were seeing, touching and feeling these service cuts close to home. They felt them when they drove down the road and saw unpaved roads. They saw it and felt it when they called police or fire and they experienced extended response times. They felt it personally when they went to take their children to the library and found it closed.

So that really was the situation, where there was not much that San José could do and still keep a city operating and functioning.

Gilroy: San José had experienced a dramatic ratcheting up of retirement benefits in the years, and really decades, before Measure B passed. Can you speak to that? What impact did this have on current city services?

Constant: The City of San José had a number of factors that collided to significantly contribute to this financial crisis and the pension crisis. First, there was a series of escalation of pension benefits provided to not only our current, working employees but also to people who had already been retired. Mayors and councils made promises that really didn’t take into consideration the future cost implications.

For example, people who had been hired on by the city with pensions that were a maximum of 75% of final salary saw some of those pensions escalate to 90% of salary. People who had retired in a pension plan where their annual cost of living increases were tied to the consumer price index found that the city had increased that benefit to the point where it was a 3% guaranteed annual increase. We also saw an increase in our retiree health benefits when our city council provided 100% paid healthcare-not only for the member, but for their entire family-upon retirement.

All of these individually might have seemed like minor adjustments-like taking a pension from 75% to 80%, or subsequently from 80% to 85%, and ultimately from 85% to 90%. But what we found was that these increased benefits were given at a time when salaries increased a very significant amount at the same time. For example, if you were a police officer working in this city in the year 2000-without supervisory rank, just an officer on the street patrol-the money you would make would have been $72,000 per year. And in 2000, that came with an 80% retirement. So someone who had served for 30 years would retire and get approximately a $58,000 per year pension for the rest of their life.

Fast-forward just a decade later to the year 2010, at a time when the pension benefit was only increased from 80% to 90%. At the same time, wages were increased by over 50%. So that same officer who had worked for the city for 30 years was making a salary of approximately $118,000 per year at a 90% pension. As you can see the simple math shows that that’s now a $106,000 pension a year for the rest of your life, plus the 3% guaranteed cost of living adjustments compounded every single year.

So for that period of 10 years the actual cash retirement benefit nearly doubled from $58,000 per year to $106,000 per year. It’s that exponential factor that we found-that by increasing salaries and benefits along the same track-that resulted in these huge unfunded liabilities that we now see top $3 billion in San José.

Gilroy: How did you get involved in this issue? And how did you educate yourself on the pension issue, given the typically steep learning curve?

Constant: I’ve always had a keen interest in retirement and pension systems. When I was a police officer-I was a police officer in San José for 14 years-I had run to be a pension board representative. Unfortunately that didn’t pan out for me, but that interest was something that was sparked early in my career.

When I decided to run for city council, one of the main reasons I ran was that I was concerned about the financial future of the city of San José. At that time I was out talking to people explaining what I felt was this impending financial disaster coming around the corner. And a lot of people looked at me and thought I was exaggerating a little bit or just looking for some explicit topic to run on. But we found a short time later that the fears I had were real and had actually come home to roost.

When I ran and ultimately got elected I asked Mayor [Chuck] Reed if he would assign me to be a pension board trustee. I really wanted to see how the pension boards operated, what types of decisions were being made and how we might be able to approach this.

As you know, the business of pensions is a very complex business. So I took it upon myself to seek out a number of educational opportunities-going through certificated course work at the University of Pennsylvania’s Wharton School of Business, the University of Chicago graduate business school, Stanford University’s fiduciary college, and a host of other trainings that were specifically designed to educate pension board trustees. And I felt that that really would allow me to make better policy decisions.

As I worked on these pension funds as a trustee, I immediately saw issues that needed to be addressed. Number one was the inherent conflict of interest when you have a majority of board members involved in the plan as members or retirees who have a direct stake in outcome of how contribution rates are going to be calculated or what benefits may ultimately be paid. With that, I launched an effort to change the governance structure of our pension boards that was actually successful. We were able to change the governance structure of our two independent pension boards to where now we have a majority of each board that are outside experts in the field and have no direct ties to the city’s pension plans.

I believe that was a critical first step in us addressing the issues. It also allowed me to have contact and deep discussions with peers who were entrenched in the investment world and really understood some of these complex issues around pensions, calculations and actuarial science.

All of this has led me to the point that now I’m studying at the University of La Verne in southern California pursuing a doctorate degree, and my field of study is focused on public pension systems and the decision-making that goes along with running these plans.

Gilroy: Was the pension crisis something that the city’s elected officials had been focused on prior to the passage of Measure B in 2012? What steps did you take to build the case for reform?

Constant: Initially, the city council had not been officially and directly engaged in pension reform, but as we were struggling to find solutions to the budget shortfall, we really started to assess where these drivers were in our budget that were causing us to have these increased costs throughout our organization. So we did a number of things.

First, the mayor put together a structural budget deficit elimination task force, which he asked me to chair. We convened a group of stakeholders from management, elected officials, union officials and residents to start taking a critical look at the city’s budget and see if we could identify those driving factors that caused the structural deficit, which did not seem like it was going to go away anytime in the future. That was the first step moving forward.

From there, we asked our city auditor to conduct an audit of our pension system to look at the actual contribution costs and how those costs could be attributed to the different areas of the pension system. Were the costs being driven by the administrative expenses, by the investment losses-which categories really had the effect? And that was a really illuminating audit, and we were able to see that it was the formula and the young age of retirement-where people could retire as early as 50 or 55 years old-that was really driving these costs. And it also really put a highlight on the fact that the 3% annual cost of living adjustment was one of the strongest driving factors in causing our contribution rates to go up at such a steep curve.

So we worked with a number of stakeholder groups and got out in the community through budget surveys, priority-setting sessions with our neighborhood associations and youth commission, and budget sessions held in each of the 10 council districts. The mayor, city manager and each council member in each district went out to the community and talked to their constituents about the structural budget deficit, the main driving expense-which was retirement contributions-and then within those retirement contributions what were the driving expenses. We went to great lengths as we spoke to these residents to tie a direct line between these escalating costs and the elimination of services that they were seeing on a daily basis in and around their homes, their communities and their businesses.

I think it was the education plan that we used going from neighborhood to neighborhood that helped us explain to people the complex problem that we had in very simple terms.

Gilroy: Actuarial assumptions and assumed rates of return play a key role in the outlook for government pension systems, and overestimating the assumed rates of return-making pension systems appear more solvent than they really are-is a fairly common problem with state and municipal pension systems. Can you describe the steps you took to get a more realistic assessment of the pension picture in San José?

Constant: Actuarial assumptions are really complex and key to understanding a lot of the dynamics behind pension systems. The one actuarial assumption that gets the most attention is the assumed rate of return, but there are a number of other assumptions related to issues that really drive costs. In fact, the typical actuarial evaluation will have a couple of dozen assumptions built into them. So we took a critical look at those assumptions and how they drove costs.

And what’s interesting to see is that our pension systems-like many others-were using a fairly high assumed rate of return. One of our plans was at 8.2% net, which means they really had to receive about a 9.25% return in order to net out all of their expenses and realize an 8.2% return, which is not only very high but is also very unsustainable over long periods of time. When you have a pension system investing over long periods of time, the goal is to have an assumed rate of return that will hold true of periods of 10-, 20-, 30-years and beyond. Historically these high rates of return might have made more sense than they do today for a number of reasons.

One reason involves the correlation or relationship between the risk-free rate of return that’s available out in the market and the assumed rate of return. Back when our retirement board was hoping for an 8.25% return, the risk-free rate of return in those years was in excess of 4%, sometimes higher. The difference between the two was about 4.25%.

But as you fast forward to today, you see that the risk-free rate of return is about 1% or even lower during some periods. And when you now look at an assumed rate of return that’s 7.25%-what our boards are using now-you’re looking at a difference that has to be made up in market gains of over 6%. And the profile of risk and the investment returns needed to bridge that gap have increased. I think a lot of it was a lack of recognition by pension boards across the nation that this one fundamental change was putting them in a position where they would have a very difficult time of ever catching up with their rate of return.

This is a very common problem in all pension systems, both local and state, and what we’ve done here in San José with our pension board-especially now that we have the outside experts-has been to slowly ratchet down that rate of return to bring it to a more realistic rate. In fact, many of our board members have expressed that they’d like to see that rate of return drop into the mid-to-low 6% range so that we are getting something that is realistic and sustainable over long periods of time.

Gilroy: Can you describe the key components of the reforms contained in Measure B?

Constant: Measure B is a very comprehensive reform. In fact it’s probably the most comprehensive reform package that’s been proposed or passed by voters. It can basically be broken down into four major categories.

The first major element involves new employees; that’s probably the easiest area to address. In fact, as you look at government agencies that have talked about pension reform, what they’ve mostly done is address the pension benefit for new or future employees. While this is very important, these changes don’t do anything to address your unfunded liability. But we know that it needs to be done.

So for new employees in the city of San José, they have a new pension formula. It remains a defined benefit plan, but the formula is 2% for each year of service. We increased the retirement ages so that people have to work longer before they’re eligible for retirement. We took the salary component and instead of being their highest one-year salary as the basis for their pensions, we changed it to a three-year average salary. And most importantly, we’ve made sure that the cost of providing the pension-both the normal cost of funding the pensions and the unfunded liability costs-are shared on a 50/50 equal basis between the employee and employer.

Why this is so important is that this really creates a shared risk perspective. So now when the pension board trustees are making their decisions, they not only have to keep in mind the city’s ability to pay-we know that many people look at governments and see deep pockets that can afford an extremely large amount of money when needed-but also take into account how the average city employee bears the cost of different decisions. On top of that, we also took the cost of living adjustment-which was 3% compounded-and changed it to tie it to the consumer price index and put a cap on it of 1.5% per year.

That’s what we did for new employees. The next category of employees is the current employees. For current employees, we clearly said that we recognize that the pension you have accrued and earned to date is yours-that’s a vested benefit-and we do nothing to take that benefit away at all. Everything you have is yours.

But if you want to go forward and stay in the pension plan that you’re in, you have to understand that the costs have far exceeded our ability to pay. So if you want to stay in it, then you must increase your contribution to the system to the system so that your contribution comes in at 50% of what’s needed to meet the unfunded actuarial liability. We did put a cap on that of 16% of pay, and we used a phased-in approach where it would phase in at 4% per year for four years.

We added a caveat that if the courts rule against the increased contributions, then we would reduce pay along those same lines so that we have the money to pay these unfunded liabilities that have been crippling the city. And of course when the unfunded liabilities are reduced, the amount of money that will be needed to pay the amortized unfunded liability will decrease, and then the employees’ contributions will decrease as the city’s does.

We know that’s an expensive plan, because we’ve been paying the price for these exorbitant pension costs for a number of years. So what we say to our current employees is if you can’t afford it-and I don’t believe that many can-then you have the opportunity to opt in to the lower-tier benefit that we are providing to new employees. And if you do that, everything that you’ve already earned is protected, and going forward you will earn the reduced benefit formula of 2% per year. And the higher retirement ages will be phased in over an approximately 15-year period. So if you’re close to your retirement window, you don’t suddenly see the age jump five or 10 years.

And if the employees agree to that, then they’ll have no responsibility for any existing unfunded liability. But like new Tier 2 plan members, they will have a responsibility for 50% of any future unfunded liabilities.

Our third element was retirees who are out there drawing a paycheck and getting their cost of living adjustments every year. Measure B clearly recognizes the fact that these are vested benefits that have been earned, so we do not take any benefits away from any retiree. But there is a provision that if the city council declares a fiscal state of emergency, then the council can reduce or suspend cost of living adjustments for up to five years or until the fiscal emergency has passed. And then going forward after that the cost of living adjustments would be reinstated.

The fourth main element involves a number of changes to the overall pension system. First, it redefines “disability.” We had a definition of disability that’s very broad that allowed people that have injuries that may or may not actually be disabling to receive full-disability retirements. What it says now is that you have to be unable to work in any function in the city before you’re eligible for disability. And if you’re eligible for a service disability-say you’ve already put 30 years in the department-you get your service disability but no additional retirement disability benefits on top of that.

And it codifies an agreement that the employees will share the costs for that retiree health benefit on a 50/50 basis. That’s really important because back in 1986, the city council came to an agreement with its labor unions to offer this really rich increased healthcare benefit as long as employees were paying 50% of the costs. Unfortunately the city never required those contributions, so two decades went by in which time we found this huge unfunded liability in our retiree healthcare-to the tune of about $1.4 billion-without having employees contribute. We’ve now codified that so that contributions must be made moving forward on an amortization schedule so that we can once and for all reduce this unfunded liability related to healthcare.

One of the other elements in our pension reform is that it eliminated the “bonus” checks that were being paid to retirees. We had a system that would pay out bonuses to retirees when the plan had a good year, even if the plan had unfunded liabilities overall. So we found ourselves in a year where we were approaching a $2.5 billion unfunded liability, and the pension fund was paying out bonuses to retirees. That was really important to eliminate because you’ll never become fully funded if you’re always skimming off the top. And there are a number of pension systems have these “13th check” bonuses that really should not be paid out, even when a plan is fully funded. Those funds should be used to drive down contribution rates and drive down the costs.

And importantly, any future increases to pension benefits will require a vote of the residents for approval.

So as you can see, Measure B is comprehensive in the sense that it has provisions that apply to current employees, new employees and retirees, along with a number of governance changes to solidify the system.

Gilroy: Pension reform is a complex issue. How did you make the case for reform to city voters? What were the most effective messages?

Constant: There were a number of things we did to inform the voters, and most of it started a number of years before we actually brought this ballot measure to the voters. I mentioned earlier that we implemented a change to the governance structure of our pension boards, and we talked with the community a lot about why that was important.

Then we went to the voters two years before the pension reform and asked them to change the charter, because our charter had very strict provisions on minimum pension benefits. We felt it was important to remove those charter limitations so that we could look at all of the driving costs behind pensions and have a comprehensive package of reforms. So we took that to the voters and had an education campaign around the need for that, and that gave us an opportunity to have a deep discussion with the residents about the pension problem and how we were looking to address it.

And then as we moved towards the actual pension reform ballot measure, we went to great lengths to talk to residents throughout the city about our budget and service delivery model and make direct connections between the cost of pensions and the impact it was having on the city to provide the services that the residents were looking for-and often not finding-simply because we could not provide them.

As we crafted our pension reform ballot measure, we went neighborhood by neighborhood as individual council members and talked to them about why these provisions were important, what they meant to voters, and quite frankly, what they meant to the future of the city.

So by the time we actually got the ballot measure on the ballot, people were very well informed about the impacts it would have and the great need we had for it in the city of San José.

Gilroy: What types of opposition to reform did you run into along the way, and how did you address those challenges?

Constant: There were a number of challenges. We had put together stakeholder groups where we got our union leadership together with our administrators and residents to talk about the pension reforms. Unfortunately we had the leaders of our employee unions not contribute anything of substance during these stakeholder meetings because they didn’t want to give any credibility to the fact that there was a problem. In fact, some of them went so far as to write editorial pieces for the newspaper that said that there was no problem-that this was a make-believe problem-and that it was something that we did not need to address.

Every step along the way, we found interventions by special interest groups-unions or employees. We had a local member of our state Assembly who called on the state auditor to audit our pension systems because he was convinced that what we were saying was not truthful to the voters. We had a number of competing actuaries present reports on what the pension system was and wasn’t in public meetings. There were just a lot of people blocking us at every stage of the game, but the mayor and city council members stood firm and moved forward on educating the public on what the real issues were. We told the public that we were not just making this up-we have a decade of history that we can show you to prove that this is a real and tangible problem.

When we actually got the measure on the ballot, it was interesting that all the unions took a step back, and no one publicly, aggressively fought the ballot measure. I think it was because at that point, we knew from our polling that this was a clear winner with the residents, who knew that it was something that had to be done-and had to be done soon.

So many of the unions at that point gave up and said that they were going to put all of their eggs in the basket of lawsuits, saying that when it passes we will fight it at every step through the legal process and try to have it overturned.

Ultimately, it went to the voters and passed with over 69% of the vote, a very strong statement by the residents that we need to implement this.

Gilroy: Measure B has faced a number of lawsuits that are currently being decided in the courts. If the courts rule against Measure B, what would be the effects, both with regard to the reforms themselves and to the ability to fund city services into the future?

Constant: You’re correct in saying that there have been a number of lawsuits. We’re fortunate in the fact that we got all of the lawsuits consolidated into one case, and that case was heard in Superior Court in July, so now we’re awaiting a ruling from the judge.

Initially there were some complaints filed with Public Employees Relations Board in the state of California, as well as a number of other unfair labor practice charges that have been filed as well.

The threat of Measure B being overturned is serious, and it’s real. But it is important to note that not all of portions of Measure B were challenged. In fact, the portions of Measure B that apply to future employees was not challenged at all, so we know that at least that element will survive.

But this current budget year, we were able to balance our budget primarily because we identified $20 million in immediate savings from the portions of Measure B we were able to implement right away. That’s $20 million that helped us to restore services throughout the city-getting our libraries open, keeping police and firefighters on the street and the like.

If Measure B were to be overturned by the courts, it would shoot an immediate $20 million hole in budget this year, and it would also ensure there’s no slowing of the increases in pension costs going forward. This year we already have over 20% of our operating budget being paid directly out to pension contributions. We can see that number increase steadily, passing the one-third mark and approaching half of our operating budget, going just to making these pension contributions. If the courts overturn it, then we will have to get back to work immediately to figure out another way to approach pension reform, because without it, you’ll see San José go the way of many other cities, like Stockton, San Bernardino, Detroit, Vallejo and others that are plunged straight into bankruptcy.

Gilroy: If Measure B is upheld by the courts, how would you assess the financial risks that San José taxpayers face, post-reform, with regard to the city’s government pension systems? How much would implementation of Measure B address the city’s current unfunded pension liabilities, as opposed to preventing the accumulation of future liabilities?

Constant: The financial risks to city will go down considerably once we are able to fully implement Measure B. We know that full implementation of the pension reform will allow us to realize a significant amount of annual savings to our general fund. It will provide a savings of approximately $68 million per year in contributions to our pension system going forward. Those millions of dollars can immediately go directly to restoring those services that have been cut over the last decade. That has to be our number one goal moving forward. There are a lot of things that need to be done in the city, but first and foremost, we need to restore services to residents who have been faithfully paying their taxes to the city and seeing fewer and fewer services provided.

I want to be clear that we might not be done with our reform-there are still things that need to be done. We still have a number of structural reforms in the area of governance of our pension systems that can be made. We just worked in conjunction with our two pension boards to have another study of our governance system for even more ways to be accountable to the public, to work more efficiently and to minimize the number of conflicts of interest. We just received that report, and we’re working with the pension boards to bring a ballot measure forward to the voters to change the charter to strengthen our governance system so that we don’t find ourselves looking at this same problem in another decade or so.

The structural reforms that we want to make to our pension systems are designed to ensure that, as we move forward, our pension systems are governed by people with a deep understanding of the complex issues that face our pension board members. We have an independent board of experts that are able to make decisions in a manner that will continue to minimize the risk to taxpayers and participants in the plan, to ensure that in the future we don’t build a new set of unfunded liabilities because of poor decision-making at the governance level.

Gilroy: What are some of the lessons learned from San José’s pension reforms that you would offer to peers in other states that may be contemplating similar efforts?

Constant: I think it’s important that government agencies across the nation, big and small, take a critical look at their unfunded liabilities and how those liabilities are affecting their contribution rates. We often see small jurisdictions that participate in larger state pension systems like CALPERS, and really don’t make that connection between their contribution rates and the unfunded liabilities that lie underneath those rates.

When these agencies analyze this and really see the problem that is facing them not only now, but in the near future, I hope that they strive for reform measures that will allow them to address not only the future liabilities for new employees, but also address those liabilities for the current employees-hopefully in a comprehensive manner like San José has been able to do.

Bringing pension reform to a city is a very difficult thing to do. It’s something that takes a lot of hard work, a number of years, and a very strong fortitude to bring forward, because it’s not a popular thing to do with the employees, nor is it a popular thing to do with the unions. And oftentimes, it doesn’t start to be a popular thing with the residents, but it’s necessary.

We have to remember that every time we create or perpetuate an unfunded liability, we’re taking today’s debt and assigning it to our children and grandchildren to pay. And we just cannot keep doing that. We have to find a way to bring some intergenerational equity to these bills that we’re paying, and we need to stop creating pension plans where we’re making promises without looking at the long-term implications associated with these promises.

Once a board or an agency is able to put together the pieces of a pension reform measure that it wants to implement or take to voters, it’s really important to take these complex issues and break them down into bite-sized chunks that the residents can understand. And in addition to that, you need to make a direct linkage between these complex issues and their everyday life.

Once you can make that connection between the city’s annual bill of X millions of dollars to the library around the corner from their house-or the response time it takes a police officer to come when they need you, or the number of potholes they hit on their drive to work-that is when the public really grasps the importance of this and the impact that it’s having upon their community.

Pete Constant was elected to the San José City Council in June 2006 and was re-elected in June 2010. San José, 10th largest city in the U.S.A. and the Capital of the Silicon Valley, is located in Northern California in the San Francisco Bay Area. Prior to his election as City Councilmember, Constant served for 14 years as a San José Police Officer.

Constant maintains one of the heaviest workloads on the City Council serving as chair of the Public Safety, Finance, & Strategic Support Committee, and as a member of the Rules & Open Government Committee. Constant also serves as the City Council representative on the City’s two retirement boards that govern the City’s pension funds.

Throughout his time on the City Council, Constant has led the effort to address San José’s structural budget issues that have contributed to 10 consecutive years of budget deficits. This work led him to reform the City’s pension system, which has been one of the main contributors to the City’s structural deficit problems. Constant worked to change the retirement boards’ governance and replaced members of the City’s retirement boards with financial experts. His continued work with Mayor Chuck Reed on this issue paved the way for a citywide ballot initiative in June, Measure B, that will significantly reform the City’s pensions, which passed with nearly 70% of the vote.

Constant is an Adjunct Professor of Leadership at St. Mary’s College, where he earned his B.A. in Management and his M.A. in Leadership. He has received extensive training and earned certifications on Pension, Benefits, Hedge Funds, Investments, and Management programs from the University of Pennsylvania, Wharton School of Business and Stanford Law School. Constant is currently studying at the University of LaVerne pursuing a doctorate in Organizational Leadership. He is also a Senior Fellow at the American Leadership Forum-SiliconValley, and a long-time member of the San José Rotary Club.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

The post Advancing Pension Reform in San José appeared first on Reason Foundation.

Utah became an early leader in the pension reform movement when it passed Senate Bill 63 and Senate Bill 43 in the 2010 legislative session, which together shut down the state’s existing defined-benefit pension plan to new entrants, created a defined-contribution style retirement plan for new state employees, ended the practice of retiree “double-dipping,” and other critical reforms.

As the sponsor of Senate Bills 63 and 43, former Utah State Senator Dan Liljenquist has become known across the nation as the architect of Utah’s pension reform efforts, earning him plaudits from Governing (which named him one of 2011’s Public Officials of the Year), The Wall Street Journal, and many others. He has been sought out by policymakers in dozens of states to advise them on pension reform issues, and he recently authored a new report-Keeping the Promise: State Solutions for Government Pension Reform-that outlines principles and concepts that policymakers can use to advance pension reform in their jurisdictions.

In late August, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Liljenquist on what prompted him to take on the issue of pension reform in Utah, how he made the case to policymakers and stakeholders, the specifics of the reforms enacted, and more.

Leonard Gilroy, Reason Foundation: You have become known as the architect of Utah’s pension reform effort in 2010, which is frequently cited as a model that other states can follow in terms of getting a handle on their unfunded pension liabilities. But as recently as 2007, Utah was seen as having the nation’s most well-funded public pension system, funded at a level of approximately 100 percent. What happened to Utah’s pension system between 2007 and 2010 to prompt the drive for reform?

Dan Liljenquist, former Utah State Senator: We had the best-funded pension system in the country going into the 2008 downturn, but during the downturn we lost about 22 percent of the value of our pension fund almost overnight. It was the biggest loss we’ve ever sustained as a system. As we started looking at it, we realized that even though we were well-funded, that the 22 percent loss in value actually opened up a 30 percent gap in our pension funding ratio-our funding ratio dropped from about 100 percent in 2007 to a projected 70 percent by 2013-even though we had paid every penny that the actuary had asked us to over the previous several decades. So one market crash opened up a 30 percent gap in our pension funding ratio.

When we looked at that gap-and it took some time to figure out what it really meant as far as what our increased contributions would need to be-we realized that if this system was dependent on stock market returns-with the legislature and taxpayers required to come back and cover any funding gaps if the markets do poorly-then we felt like it was a risky proposition and one that we wanted to try and mitigate moving forward.

Gilroy: You were appointed chairman of the Senate Retirement and Independent Entities Committee shortly after entering the state legislature in 2009. Was the pension crisis something that the Committee had been focused on? What steps did you take to build the case for reform?

Liljenquist: When I first got to the state Senate, I sat down with the Senate president and he asked me what I wanted to do. And I told him that I wanted to be close to the money-I’m a finance guy by background-but that I didn’t really have a specific committee preference.

And he came back and said that he was going to make me the chairman of the Retirement and Independent Entities Committee, but not to worry because nothing ever happens over there. So when I took my seat in 2009, it was right after the crash-or really as the crash was happening-and clearly we looked at our pension system and realized about halfway through my first legislative session that we were in serious trouble. The pension fund leaders came to us and said that we had problems, and it was territory that we’d never been in before with the state pension system. The legislature had not been seriously considering reform beforehand because we had a well-funded system and always paid our bills, and this shock to the market took us all by surprise.

So what we did from there was that we took what we felt was a very measured approach, and before jumping to conclusions as to what to do about the situation-if anything-we felt it was important to get with our pension plan actuaries to understand what the effect of the 2008/2009 market crash really was.

I think this is where we had our initial win and were able to help build the case for reform. When I sat down with the actuaries, it was pretty clear that our contribution rates for the pension would have to go up significantly and stay for quite some time to pay for the market crash. And when I asked the question of how long would our rates have to stay high, our actuaries didn’t feel like they could give a solid answer because they did not know what the markets would do in the future. So instead I asked them to model out various scenarios that would show us how high our pension contribution rates would have to be, based on the 2008 market crash, to be able to make the full actuarially required contribution. We then had the actuaries model different scenarios around that situation.

Our assumed earnings rate at the time was 7.75 percent; that’s what we assumed we would earn in our pension system year over year through our investment portfolio. So I had them model the effects of the 2008 market crash based on that 7.75 percent return for a 40-year look going forward. And then I also had them model a 6 percent return, a 7 percent return and an 8.5 percent return, just to see what the sensitivities were around that assumed 7.75 percent rate of return.

The actuaries came back with a report that demonstrated that doing nothing was not an option. If we decided not to make the increased contributions to the pension system, then in every scenario-even the 8.5 percent return scenario-then within 30 years we would be in severe financial distress, and even in some cases would have a bankrupt pension system on our hands.

So we realized that we needed to at least pay the actuarially required contribution, and when we looked through the five-year smoothing period and saw what those contribution rates would be, it equated to a 75 percent increase in contributions toward the pension system over 25-year amortization period. That amount of money equated to approximately 10 percent of our general fund spending.

So that’s how we started building the case for reform. We realized that just one year’s worth of market losses wiped out 10 percent of our general fund tax revenue for 25 years. We felt like that was too much risk for the state and taxpayers to be bearing.

Gilroy: That’s interesting, because actuarial assumptions and assumed rates of return play such a key role in the outlook for government pension systems, and overestimating the assumed rates of return-making pension systems appear more solvent than they really are-is a fairly common problem with state and municipal pension systems. Can you talk a little bit more about the process you used to work with the actuaries to get a more realistic assessment of the pension picture in Utah?

Liljenquist: In August of 2009, the pension plan representatives came to me and said that they had good news: that our four-year contribution rates for the pension system were only going to have to increase by two percentage points. And by that point I had learned a bit about actuarial smoothing, and I asked “don’t we have a five-year smoothing period to smooth into higher rates,” which they confirmed. So I asked what it meant that our rates are going to only go up two percent, because if that’s two percent per year over five years, then that’s a 10 percentage point increase. And they responded that they did not know what that was going to look like and that they would need to talk to the actuaries.

So I requested to talk with our actuaries, and we brought them in to testify in front of an interim committee. They came in and sat down with me the day before that meeting, and I was able to ask that question: what’s going to happen to next year’s rate? And they responded that they were uncomfortable giving an exact answer not knowing what the markets would do, but that in general our contribution rates were going to go up and stay up for a very long time to cover these losses.

I asked them for modeling so that we could see the various scenarios I mentioned earlier, with different assumed rates of return on our pension portfolio, and no one had really asked them for that before. I actually flew down to Dallas where our actuaries-Gabriel, Roeder, Smith & Company-reside and sat down with them and had them project their models on a screen, and we walked through the different models and scenarios I wanted to see. And when they came back in November of 2009 with the modeled scenarios, that’s when we started drawing the lessons-that one, you’d have to increase funding to the pensions and couldn’t ignore that, and two, just how much risk there was to the existing system and how long it would take to pay off a year like 2008.

So that’s how we got the actuaries engaged. They were fantastic and were legitimately interested in helping us find the right policy answer.

Gilroy: How much of an understanding of the pension situation did your legislative colleagues have when you started talking to them to make the case for reform? What convinced them to ultimately support your efforts?

Liljenquist: Pensions are a tough issue. When I went into the legislature, I knew absolutely nothing about pensions, and I had to educate myself first. And this is a complex issue, and it took some time to understand what actuarial rates of return are, for example, or what actuarially required contributions are, what the different rules around smoothing gains and losses are, et cetera.

But by the time we got to the fall of 2009 though, I felt like I had a pretty decent understanding of it, and we began to lay out-with some allies, including the Utah League of Cities and Towns-some principles for reform.

Our first goal was to make sure that every penny would be paid to current employees and retirees. And we weren’t entirely sure we could do that if we had another year like 2008, which could cripple the pension plan and make it very difficult to operate state and local governments while still providing the committed benefits that our public workers were counting on. So our first goal was making sure that we meet every penny of the commitment we made to current employees and retirees.

Our second goal was in line with that, and it was to reduce and eliminate the pension-related bankruptcy risk over time. We saw just how much of a risk that actually was and that there was far more uncertainty than we realized.

So those were the two broad principles we laid out. The first thing we did in explaining the situation to legislators was to explain that this is going to get very expensive very quickly, and we need to take action to make sure that this doesn’t happen again. The seeds of the pension problem that we were facing were sewn decades ago when these programs were set up, and while we needed to make sure that we could come up with the money to pay for the existing liabilities and existing required contributions, maybe we should also look at a new system for new workers that didn’t put us in that spot down the road.

Those are the ideas that we started bringing forward, and those two principles-to meet every commitment we’ve made for current employees and retirees and to reduce and eliminate the pension-related bankruptcy risk-naturally led to a discussion on how we should provide for retirement. Where we came down was that we had to have predictable costs-that’s the policy objective that’s worthwhile.

So we went forward with those principles to find a way to close the old system down in terms of new enrollment and create a new system with predictable employer costs that provided adequate retirement security for future public employees. And then we went legislator by legislator to explain the situation and some ideas for how to proceed. Before we actually proposed any policy recommendations, I went and met with every member of the House and Senate in various caucus meetings over the summer and fall to explain the situation and why we needed to make some changes, laying the foundation by really helping them understand what the problem was.

So by the time it came to December 2009, that’s when I moved forward with my proposal to close down the defined-benefit pension system to new employees and begin a new retirement system for the state with a statutorily-prescribed contribution into the system, allowing new employees the option to choose to invest their retirement compensation in either a 401(k) plan that was professionally managed-but which also does not allow borrowing against the plan-or in a hybrid defined benefit/defined contribution plan where they could pool their retirement resources together with other employees, with the understanding that the state’s commitment toward that hybrid retirement plan was set and defined. And if the actuarially required contributions for that plan exceeded the amount that the state had budgeted per individual, then the individual employees would have to automatically pay the difference.

We moved forward with those principles as we engaged the political process.

Gilroy: Can you describe the key components of the reforms contained in Senate Bill 63 and Senate Bill 43?

Liljenquist: Senate Bill 63 is our new two-tier retirement system, and again, that is a system where instead of making a commitment to a certain size of benefit and then accepting all of the risk that the state and taxpayers pay for that benefit if the market doesn’t do well, we set in statute the principle that the state is going to pay-and we were a non-contributory system beforehand, meaning the employer, the state, paid the entire freight of the defined benefit-moving forward we were going to pay 10 percent of an individual’s salary toward retirement plan on top of Social Security (depending on the jurisdiction, most people are on Social Security). We were going to contribute 10 percent towards retirement for rank-and-file workers, and for public safety the rate would be 12 percent.

And through this legislation we were going to allow our employees to choose whether they wanted to take that 10 percent of their salary in a 401(k) plan professionally managed by Utah’s state retirement system and that completely prohibited borrowing-even in a hardship situation-from that retirement system while they work for the state.

Or, they could choose to take their 10 percent, pool it with other employees and create themselves a pension-albeit a reduced one. We made it very clear in statute that new employees would get 10 percent toward retirement, and out of that 10 percent if you choose a pension, then you have to make the full actuarially required contribution, and if there’s any money left over, then you get that additional money into a 401(k) plan. That way if the markets performed well-and the contribution rates towards that new hybrid pension go down-then the employee automatically gains because the contributions towards their 401(k)s would go up. The vice versa was true as well. If the markets do poorly and contribution rates were required to go up, employees would have to make the full actuarial required contribution, which would come out of their 10 percent retirement contribution first, and if contribution rates exceeded 10 percent, the remaining amount would automatically come out of that employee’s paycheck.

So through this legislation we essentially created a defined-contribution plan in which the state’s contributions towards the retirement system were clear and defined. There were a number of other nuances in Senate Bill 63, but that was our primary objective.

Senate Bill 43 was the legislation that I sponsored to end the practice of double-dipping in the state of Utah. Back in the year 2000, the Utah legislature made what I think was a terrible mistake that resulted in people inappropriately taking early retirements to benefit from a loophole that cost the pension system a lot of money.

This is how it worked. In order to attract retired teachers back into the workforce, the legislature passed a statute that allowed someone when they retire-if they decided to come back to work-allowed that individual, in addition to their salary, to continue to receive their pension checks, with the state also contributing the equivalent amount of money going to the pension system per employee into a 401(k) for that individual. And that included not only the nominal cost of the pension plan, but also the amortization expenses for the pension plan.

For example, police officers realized that they could retire right at 20 years, but they could leave one city and go to another city, get hired back at virtually the same wage, begin collecting the pension checks-which would give them roughly a 50 percent boost in their income-and then at the same time still be receiving a growing size of the pie for their retirement with these additional contributions.

What that did is that it changed the behavior of these police officers, where the average retirement years of service had been around 25 years. But within about 8 years of this program being put into place, the average retirement years of service dropped to about 20 years. Our actuaries came back and looked at that situation and realized that about 3,000 employees were projected to cost the state of Utah close to $900 million over 10 years to provide that benefit. The longer someone works and doesn’t retire, the less expensive the cost of the pension is. The converse is also true-the earlier someone retires, the more expensive the pension. So if people retire significantly earlier it puts a strain on the pension system by forcing resources ordinarily compounding and growing in the investment portfolio to be transferred into liquid assets to pay the current pension benefits. Our actuaries did an analysis of that and came back and told us that early retirement is costing a significant amount of money, and in addition you’re paying this really expensive benefit that no other state in the nation does.

So of that approximately $900 million, about half of it was coming from police officers and others retiring earlier than expected, and the other half was coming from the direct 401(k) contributions that the statute passed in 2000 required paying to the retirees returning to work. So we made the choice in Senate Bill 43 to end that program for future retirees, while meeting the commitment we had already made to existing retirees. But we changed that going forward.

Senate Bill 43 says that if you retire, you’re retired. If you come back within a year, then you would suspend your pension payments and go on as normal. But if you come back after a year, you get a choice: you either keep your pension payments coming and collect your wages-but you don’t get a penny more toward retirement-or you could suspend your pension payments, receive your salary and receive additional contributions into your pension plan, so when you make the final decision to retire then you have an enhanced retirement over where you were originally.

So we gave them a choice, and what we were trying to do was stop people from gaming the system by using this loophole to get benefits from the state that weren’t adequately planned for. To be honest, this was probably the most contentious part of our pension reform because it had become an expectation, even though it had only been in place for about nine years, and people were upset about that. But when the regular public realized what was happening, it didn’t seem fair. In fact, the younger public employees that were early in their careers were frustrated by it as well because it encouraged people to retire but then come right back into the workforce, which frustrated the people who wanted to move up.

Gilroy: What types of opposition to reform did you run into along the way, and how did you address those challenges?

Liljenquist: We had a fair amount of opposition. The weekend before the session began, I got a phone call from one of my Senate colleagues from the Capitol saying that, “there are a lot of people down at the Capitol that are chanting your name, and it’s not good.” I loaded my kids up in the car and drove to the capitol, and there were 4,500 people protesting me on the Capitol lawn. So it was a little bit nerve-wracking getting this started; here I was a freshman legislator trying to move this thing forward.

But there were some things that my colleagues and I did to lay the foundation throughout the summer that we were trying to do the right thing for the right reasons, that we were looking at data, and that we were trying to be respectful. I met with every union leader I could find in the state of Utah just to talk about the situation before moving forward with any proposals. And the feedback was that they were grateful that I came to talk with them, but that they didn’t know what to do and didn’t like what I was thinking, even though they didn’t really have a solution on their end.

And then as we went forward, I personally received about 3,500 emails from people who were pretty upset with me claiming that I was taking away their retirement benefits, when in fact the opposite was true. I responded personally to each one of those emails, and I responded with kindness. It’s very important to point out that public employees did not cause the situation we were in. Even with the double-dipping challenges, the employees were responding to the incentives that the legislature put in place, and these were rational economic decisions they were making. I don’t begrudge them at all for making those decisions.

Again, you’ll remember that our first goal of pension reform was to meet 100 percent of our commitments to current employees and retirees. So when I responded to each one of these people, I laid out for them the situation we were in, what happened in 2008, how much it was going to cost the state, and basically said to them that I wasn’t sure that we could go through that again. In order to meet the commitment to each of them, we’ve got to have flexibility moving forward in terms of meeting commitments to new employees. That was the primary message, and being consistent in reiterating that message and not deviating from it or vilifying public employees was critical-they don’t deserve it. That tone started to come through in this process.

I’m glad those people sent me those emails. It was a good avenue for me to be able to communicate directly back with people that were interested in the situation, and I think it helped soften a lot of the opposition.

And I was very careful, as were my colleagues, to speak about the reality of the situation we were in-not about partisan politics. We did not have an axe to grind against the unions or the rank-and-file public employees. They had a reasonable expectation; the state had made a commitment to them, and meeting it was our main objective.

From there, where we really had a breakthrough in communication was when we were able to translate what the expense was, what it really cost the state of Utah. We would have had to come up with roughly $500 million per year over 25 years to pay off the liabilities, plus the actuarially assumed four percent growth of payroll, which was incomprehensible to most people. And our breakthrough-when people really started to understand the situation-was when we told them what it meant: we will not be able to afford 8,000 school teachers that we otherwise would have been able to afford over 25 years. Once the reporters got a hold of that, in the news coverage it started to become clear that this was a serious situation and the downturn cost us a lot of money-and a lot of teachers. That helped us break through on the messaging.

And we also went back to public employees and made the case to them that the reforms to the pension system should be informally called the “Wage Liberation Act” because these pension cost increases were really coming out of employees’ pockets because we didn’t have the ability to afford cost-of-living increases, raises and other things for current workers, nor could we continue to offer the benefits for healthcare coverage at the same levels we were doing previously. So we would really have to shift these additional costs from public employees to help balance the books. If you wanted wages to increase and catch back up to the private sector, you had to control runaway pension costs to do that.

We had an imbalance. While total compensation for public and private sector workers was on par with each other, wages for public sector workers were much lower because benefit costs were so high. And so we made a commitment as part of the intent language of our bill that when costs begin to come down-when we get through the amortization period and rates start to tick down-we would use those additional freed up funds to systematically repair wages. That was a commitment we made, and expect that the legislature will live up to that commitment.

Gilroy: Some policymakers have shied away from pension reform, fearing high transition costs involved with the switch from a defined-benefit to a defined-contribution system. Is this a legitimate fear? How did Utah handle this issue?

Liljenquist: Transition costs are a tricky argument. There are GASB rules that say that when you close down a pension plan entirely-meaning that there are no new employees to come into the plan that allow you to pool investments-then there are costs that you need to account for when you close down that plan. At the tail of the plan, you’re not going to have a pool of investments growing when you have to wind down the plan. So there are some legitimate concerns about transition costs.

But most of the transition cost concern comes from a GASB recommendation that when you close down a pension plan, you have to move from what is called a graduated amortization schedule to a level-dollar amortization schedule. A graduated amortization schedule-what most people are on-says that when you have market losses, the amount of money you have to pay back into your system is calculated based on a percentage of total payroll. The thing about payroll though is that it grows over time. The actuaries and the payment schedule assume that the employees continue growing and that you’re going to have a larger and larger base of employees contributing towards paying off the pension losses.

But when you close a pension plan there’s a GASB recommendation to move to a level-dollar amortization, which is like going from a variable-rate mortgage that goes up over time to a fixed payment. And that creates some upfront, higher costs and additional cash requirements now that some legislators believe is just too expensive to do.

Here’s how we got around it in Utah. By having a hybrid option-and while most of the investment risk is shifted to new employees for their own retirement and the state agreeing to pay 10 percent but no more-but because it was technically a defined-benefit plan-the defined-benefit-portion of the hybrid-it did not count as the closing of the defined-benefit plan altogether, so therefore the GASB recommendations were not triggered and we didn’t have that issue.

So we got around that transition cost issue by being creative with this hybrid plan and essentially getting to a defined-contribution system while technically keeping the defined-benefit plan open, even though the risk to the state was defined and set.

One of the important things to note about Senate Bill 63 is that we ran clean up legislation the following year, before the plan went live, that basically enshrined that 10 percent in statute by saying that should the actuarially required contribution rates through that hybrid defined-benefit program go above that 10 percent, then the employees will make up the difference, automatically coming out of their paychecks. But we also put in the legislation that if the hybrid pension plan becomes critically unstable down the road-meaning that if required contribution rates continue to rise above 12 percent-then the legislature could go back and change benefits for existing employees and retirees in that new two-tier pension plan.

We even listed some options. We could lower the service credit, could increase final average salary, could reduce cost-of-living adjustments-we could do a variety of different things for anyone that was enrolled. The intent of that was to create a precedent to give future legislatures flexibility on how to deal with future investment crises without having the state be on the hook for poor performance in the markets.

That particular piece of legislation passed the following year unanimously and was really what solidified the Utah reforms as a defined-contribution style system, with the investment risks borne by new employees, with professional management to help mitigate those risks to make sure that the employees have adequate retirement when they finally do retire.

Gilroy: A 2012 analysis performed by two Brigham Young University economists estimated that the state’s pension fund had a 50 percent chance of becoming insolvent by 2028 in the absence of the 2010 pension reforms, but that with the reforms there’s now just a 10 percent chance of insolvency over the next decade or so. That seems to provide at least some academic validation of your reforms. How would you assess the financial risks that Utah taxpayers face today, post-reform, with regard to the state’s pension system?

Liljenquist: I’m not surprised by the findings of the report you mentioned. Here’s what we were trying to do. We understood that if we have another year like 2008 right now, it’s going to be really tough for us to recover. The purpose of this reform was that, as employees turn over and new ones come in, that over time we will reduce and eliminate the pension-related bankruptcy risk, person by person.

The new people will come in on a different deal where the state is not on the hook for the risk of the pension system long-term. We provide a generous 10 percent employer contribution toward retirement, which is generous by all accounts. But that is all we’re going to pay. And we provide professional management and some other tools around retirement that allow them to be protected from unsystematic market risk. But our intent was that as employees leave the public employee workforce, we will person-by-person reduce and eliminate the pension bankruptcy risk.

What the report’s numbers seem to be reflecting is that if we have a crash 10 years from now, we can probably absorb it, because half of our employees will have turned over, and we’ll only face the risk on half of the employees left. And 20 years from now, we can be completely out of this game altogether. That was the objective.

Gilroy: What are some of the lessons learned from Utah’s pension reforms that you would offer to peers in other states that may be contemplating similar efforts?

Liljenquist: There are a handful of things that probably offer the most important lessons. First, this is not a partisan issue, nor a left vs. right issue or an employer vs. employee issue. It’s a reality issue, and my recommendation to every policymaker is to keep it a reality issue.

Public employees did not cause this problem-they did not cause the market to collapse, they didn’t cause legislatures over the years to underfund pensions. They didn’t cause it, so it is not productive to blame them for it. I think it’s really important to make sure that these people know that the objective of pension reform is to make sure you can meet your commitments to them. I think that’s the moral and right thing to do.

From there, you’ve also got to make sure that you have data-data that show what risks there are to the plan. And it’s not just data on the risks of total insolvency, but also data that show what the opportunity costs are. If you have another year like 2008, people might be able to survive it, but at what cost? In Utah, the cost of the 2008 market crash was 8,000 schoolteachers. And had we come into that crash with a different system in place we would not have had to keep those 8,000 teachers from our classrooms. So I think that opportunity costs are what matters.

On the other side of that is that for employees-who are really going to bear the costs of these increases, just in terms of foregone wages and the continued shifting of healthcare costs from employer to employee-these reforms over time can help rebalance the equation between benefits and wages for public sector workers. It’s hard to find people in Utah who want to come out of college and work for the state, because starting wages are too low. Total compensation is competitive-and in some ways it’s higher in the public sector-but wages are lower, and that’s what most people look at when they start a job. And wages are lower because benefit costs are so high. So these are reforms that can ultimately help address that down the road.

I would also say that people should be sticking to the data. Be objective, and work with the unions as closely as possible. Work for solutions that work for all parties.

One of the things I’m most proud of in the Utah reform is that it’s a reform that nobody else had done in the country. And by the way, it’s something that no one else has replicated in the country, because it’s customized to work for us. There are dozens of ways to organize pension reform and get to your principles of predictable employer costs while leaving benefits for current employees and retirees. So my advice would be don’t be too rigid. Understand the underlying principles you’re after, and look for different opportunities and models to get your state to the model that makes the most sense for it. Not every state is the same; every state is different, and every dynamic place to place is different.

But there are real solutions that can mitigate the risk of bankruptcy in pensions and make sure that down the road-when all of the legislators currently serving are long gone-make sure that each state is in a better position should something like this happen again.

Dan Liljenquist is a former Utah State Senator nationally renowned for his work on major entitlement reform. In his first term as a state senator, Liljenquist championed Utah’s groundbreaking pension reforms, moving Utah from a defined benefit system to a defined contribution-style system. He also successfully sponsored a companion bill that ended the practice of “double-dipping.” Liljenquist has gained national prominence on this issue and has been highlighted by the New York Times, The Wall Street Journal, the National Conference of State Legislatures, ALEC, the Mercatus Center and others.

After pension reform, Liljenquist turned his sights to Medicaid reform. Watching a dramatic increase in Medicaid costs, from 9% of the state budget in 2001 to almost 20% in 2011, he spent a year working to bring all parties to the table. He carefully crafted a bill that fundamentally restructured the Medicaid program in Utah and saw it pass both the House and Senate without a single dissenting vote. Under his guidance, Utah became the first state in the nation to cap Medicaid growth as it relates to the state budget.

Liljenquist has a Juris Doctorate from the University of Chicago law school. After graduation, he joined Bain Consulting where he worked as a strategy consultant. He has continued his business career with Affiliated Computer Services where he served as Director of Operational Strategy. He also served as the president and Chief Operating Officer of FOCUS Services and has consulted with the Laura and John Arnold Foundation on fiscal reforms. He ran for the U.S. Senate in 2012 on a platform of fiscal reform and forced long-term incumbent Orrin Hatch into his first primary in 36 years. Currently, Liljenquist is the founder and president of Liljenquist Strategies, LLC, a business strategy consulting company based in Bountiful, Utah.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

The post Closing the Gap: Designing and Implementing Pension Reform in Utah appeared first on Reason Foundation.

One relatively new-and increasingly popular-type of performance-based PPP is the “social impact bond,” a construct that brings together government, which decides on a problem to be tackled, an intermediary, which finds investors to provide funds and hires service providers to deliver a targeted intervention, and an evaluator, who determines how successful that intervention has been.

Put simply, the private and third sectors finance and implement new social service delivery models on behalf of government under a pay-for-success model. If the interventions improve outcomes and save public funds, investors receive success payments from government that generate a return on their investment. If outcomes do not improve, government pays nothing and investors lose money.

In the U.S., social impact bonds are already moving forward in Massachusetts, New York City and Fresno, California, and are on the horizon in several other states, counties and municipalities. More information can be found in Reason Foundation’s Annual Privatization Report 2013.

The nonprofit organization Social Finance UK pioneered the social impact bond concept in the United Kingdom. In 2010 it raised $7.8 million from 17 investors to fund the first social impact bond pilot project, which aimed to reduce recidivism amongst prisoners in one British prison: HMP Peterborough. In June 2013, Reason Foundation Managing Editor Tom Clougherty sat down with Jane Newman, International Director at Social Finance UK, to learn more.

Tom Clougherty, Reason Foundation: Can you describe for our readers what a social impact bond is? What is the role of private capital in financing social interventions? And why the private and third sectors, not just government?

Jane Newman, International Director, Social Finance UK: We think of social impact bonds as a partnership between (a) government, which is the principal purchaser of services to address social issues, (b) service providers, who are the normal contracting party, and (c) a new set of interests, which are investors and private sector individuals who are interested in driving change in the way government contracts and also addressing social issues. From our perspective, I would say a social impact bond is really a partnership between social providers, the government and investors-brought together by an intermediary that focuses very specifically on a social issue. Very often, the social issue is a disconnect or gap in an existing service provision, or it’s an opportunity to invest in prevention and show that can generate savings down the line.

Clougherty: So you’re doing things that government wouldn’t do, because these activities are more speculative or more innovative?

Newman: Government can find it difficult to invest in prevention. Let’s take criminal justice. Government has the responsibility to deal with offenders, put them in prison. And it has to bear the costs of that responsibility.

At the same time, there are programs where-if you tackle some of the issues associated with offenders-you might be able to improve the possibility of those offenders not re-offending in the future. But it’s quite difficult for government to both carry the cost of the consequences and at the same time invest in prevention.

So what we’re talking about is an opportunity to try untested interventions-exploring whether something is capable of working, or, where it does work well small scale, if it’s capable of being scaled up. It’s an opportunity for government to innovate and explore and share the risk inherent in doing so with the private sector.

Clougherty: In the kind of archetypal social impact bond you just described, what is Social Finance UK’s role? Are you the intermediary in that scenario?

Newman: Yes. So, the first social impact bond in the Peterborough prison is focused on reducing reoffending. That was the first one. And in a sense, because it was the first one, we had more roles than we necessarily need to have. What we did is bring it together. We approached the Ministry of Justice and asked them, “how much is it worth to reduce reoffending, say by 5%? How much is it worth to reduce it by 10 percent?” and then we looked at whether or not there are programs that have the capacity to do that. Then we brought in the investors and co-developed the concept.

Having launched the program, the entity that actually holds the social impact bond-which means it holds the contract from the government, then employs service providers and raises money from investors-it’s a special purpose vehicle, an independent entity. And we have an advisory relationship with that entity. Having raised the capital from investors, we were concerned that it’s not the capital structure that drives change, it’s the program management which drives change, so we felt it was important to put in a layer of performance management in the program, so we have that role as well. But this is because the market is at a very early stage. As it matures, we expect other organisations will become involved in some of the roles.

Clougherty: Was it Social Finance who really developed this concept of the social impact bond from the beginning or were there other influences involved there?

Newman: There were other influences. The history can be found in materials on our website. Part of the idea was if you were to invest in prevention in an area that is capable of generating savings in the future, could you use those future savings for the initial investment in the program and drive change? So that theoretical concept was around in discussions. Arthur Wood, a former investment banker, was exploring the area, as were others, such as Peter Wheeler and David Robinson (both now on our Board). The Young Foundation had also done some research. What we did at Social Finance is that we developed the theoretical concept and turned it into a transaction, and that makes, I think, all the difference.

Clougherty: Could we talk a little bit more about the pilot program in the Peterborough prison? Now, obviously this is focused on reducing recidivism rates among male offenders in Peterborough. What prompted this particular program, and are there specific aspects about the way it works that you would like to share with us-people involved, various responsibilities and so on?

Newman: So, what prompted it: we were set up as an organization to bring together experience from the financial sector and explore how they could address social issues. We were exploring a range of different social finance/social investment options, and this was one of the most interesting ways to finance projects around a social issue.

There were a number of social issues we were interested in exploring. We quite quickly came to concentrate on the recidivism area, probably for a number of reasons. Criminal justice experts recognized there was a gap in the system-and that’s short sentence prisoners, who are not clients of the probation service. [Editor’s note: In the UK, adult offenders given prison sentences of fewer than 12 months do not currently receive support from the probation service upon their release from prison.] They also recognized that there were particularly high rates of reoffending amongst this particular group of people. So there was, on the government side, an interest and open-mindedness to explore innovative solutions that might be able to address that problem.

From an investor perspective, the investors in the Peterborough social impact bond are foundations and high net worth individuals. But the lead investors were some foundations that had been grant-making in the area for a long time and well understood the challenges. I think they were really excited about the idea of doing something at scale, over time. Bringing these influences together was, I think, important to the design of the bond.

Clougherty: I know there’s no full assessment of the Peterborough social impact bond due until 2014, but there are some interim findings. Can you tell us about how it’s going and what signs of success or otherwise you’re seeing so far?

Newman: To start with-just to say why there are no findings until 2014-that’s associated with the design of the intervention: the program is designed to work with 3,000 prisoners in groups of 1,000, so it takes time. It takes about 18 months for 1,000 prisoners to leave Peterborough prison – that’s just the volume going through the prison. And then after the last of those have left, we measure reoffending rates for a year afterward. So it takes about two and a half years, plus a bit of time to go through the courts to actually have a group of people you can measure-that’s why it’s 2014.

What we have on the ground is a sort of total experience of the way the program has changed, the way the prison is engaged in change, and the way it’s embedded into the system. There are some recent interim results announced by the Ministry of Justice, but it’s important to differentiate those as they don’t measure the reoffending behavior over the same period, and they don’t measure it against the same thing as the social impact bond is measured. But with that caveat, the recent interim results are encouraging because they suggest that measured against a historic baseline there’s a reduction of offending when the national average is going up. So we’re pleased to see that, but we’re very conscious that it’s not comparing like with like.

Clougherty: You talked about the possibility of scaling up the kind of interventions that you’ve tried in social impact bonds. And as you say, it’s obviously early days in Peterborough at the moment. But it does seem that the Ministry of Justice is keen on this payment-by-results idea throughout criminal justice, sentencing, probation and so on. There has been talk about massively expanding private contracting in probation using the payment-by-results model. Do you see this as a natural way for the sort of thing you’re doing in Peterborough to be scaled up? And do you think that there are dangers in adopting a more universal approach rather than specific targeted interventions?

Newman: I think it’s a very interesting question. It’s one we debate a lot internally because scaling up produces challenges. In principle scaling should be possible, but we’re also conscious that many of the organizations we might want to use as service providers are relatively small, under-capitalized or thinly capitalized voluntary sector organizations. To scale up, you would have to have the national/regional coverage that many of these organizations don’t really have.

Peterborough doesn’t provide probation services but works in partnership with all statutory providers in the area. It is true, though, that the government is trying to make the probation service more results-based, and also extend the probation service so that it deals with the group of people we work with-short sentence prisoners and people who fall through the system. What’s important about this is that the government is recognizing the social value which can be realized – not just cost saving. They want to wrap that all up together, package it into 21 units across the country, and invite private and voluntary sector organizations to bid for contracts to run each unit. I think the private sector will be the largest contractor for those, but the opportunity will hopefully be there for some social investment solutions as well.

It offers, I think, interesting opportunities, but challenges as well. One of the important things about the Peterborough model that we’re using at the moment is that it’s not compulsory-prisoners opt to participate in the program. In fact, we have very high levels of engagement. The interesting thing will be if you get the same levels of engagement if it becomes a compulsory system.

Clougherty: You’ve mentioned the investors and you’ve mentioned the service providers. I just wanted to get a little bit more detail on them. We’ll start with the investors. Now, you talked about the Peterborough social impact bond, and the money mostly coming from high net worth individuals and foundations. Are they doing it as a philanthropic venture or are they more concerned about the bottom line? Because it’s interesting that where this is being tried in the U.S., Goldman Sachs has been among the investors putting up money. You’d assume that the specifics of the contract and the profit margin at the end of it may figure more heavily in their calculations than it did for your investors. Is my characterization correct? And how do you see the investor space developing?

Newman: Yes, I think it’s very interesting. We would have been very interested to have more financial investors in the first round had there been that interest, but we recognize that the risk profile of Peterborough means that your maximum return is that 13 percent and there is the possibility that you would lose all your money. It’s a model program and the first of its kind, and that, to some extent, shapes the investors. Also, among the investors that we had-the lead investors-some were foundations that had been grant-making in this area. So their perception of risk would’ve been different because they had an understanding of the kind of things that work.. That shaped the first investment.

I think as we’ve moved on in the UK, we have a broader investor base. It’s still predominantly foundations and high net worth individuals, but there are also funds there. There’s Big Society Capital, which is there to make an investment, and there’s Bridges Ventures, which is also a social investment fund managing money. Internationally, the sector is broadening. The challenge is that to broaden the investor base, you need a track record-you need to have results and show that these things can work. There’s also the question of what the risk/reward balance is.

So we expect the investor base to broaden and we’re already seeing that. Certainly, if you look at the recent bond that’s been issued in Australia for the Newpin intervention, that has a different risk profile and will probably attract a different kind of investor.

Clougherty: Let’s talk about the service providers. You said they were undercapitalized and in some cases small non-profit service providers. Do you see that changing? Do you see bigger, more established social enterprises emerging, which are not charities on the traditional model, but are operating on a non-profit, philanthropic kind of ideal? Moreover, do you see the big for-profit players getting increasingly involved as well?

Newman: If you take the rehabilitation transformation in the UK and the large-scale contracts that will be bid there, I think it’s undoubtedly the case that the big, for-profit contracting organizations will be interested in those and are likely to be large participants in them. But we very much hope to see stronger social enterprises-not just charities, social enterprises-coming into the arena. Part of our philosophy is that this is an opportunity for the organizations that we work with, who are actually running these sorts of programs already, to participate in a program over 7-8 years, so that they have certainty of income, and know that if they continue to perform, they will have the opportunity to innovate and to grow. You use that stable funding base and grow around it. That’s very much a part of our core philosophy, to help that.

Clougherty: Social impact bonds have certainly captured the attention of policy makers, certainly in the UK, the US and Australia as you’ve mentioned. I’m curious to know-beyond recidivism reduction, what other areas are social impact bonds going to work in? Are there other areas which are already in play or already ongoing? And are there new areas that aren’t tested yet where you think social impact bonds may have a role to play?

Newman: I think there’s a lot of exploration going on at the moment. In the UK, there are now four or five different issue areas. We are managing a project with Essex County Council which is targeted at young people on the verge of being taken into care by social services. That’s an intensive therapeutic intervention with the objective of keeping the family together, and avoiding the children going into care with all the consequences that come with having the state as your parent. There’s a very strong economic case for that as well.

There’s also some work around homelessness projects here, and programs which are focused on keeping young people in pathways to employment, improving their employability skills, stopping them from dropping out of school and things like that. Along with adoption-where another program was recently announced-these are areas that are already in operation in the UK.

Two of the Australian models are focused on different ways of tackling care issues. There’s also quite a lot of interest in early childhood development, focusing on the early years and seeing if a model could be built around that. A pilot, I think-not a social impact bond, but a demonstration project-was announced recently in the U.S., and we’re doing some work on that as well here in the UK.

There are a lot of areas being explored. The important thing though is that you need to have something which is quite focused. You need to have a target group that you’re going to work with, so you know who it is and who you’re going to measure. To get investors you need to have a defined cohort.

The other thing that’s important is that you really need to have a problem that is expensive for the state and have some well-structured programs that have an evidence base showing they they can tackle those problems. You need the cost of actually of providing the intervention to be modest compared to the actual cost to the state, so you can see that there’s that economic balance in your favor. This is why something like children in care is quite interesting, because the cost of care is very expensive. Any type of residential care is usually expensive. If it’s being spot-purchased or purchased on an incremental basis, and if by reducing the need for it you’re creating a saving, then there are quite strong economics around social impact bonds. Obviously, in this case not going into residential care also has to be the right thing for the individuals concerned.

Clougherty: One thing I see as a potential challenge in social impact bonds-and in fact, in performance-based contracting in general-is that governments often struggle with performance assessment. It’s not something that the public sector has traditionally tended to do. Given how central performance assessment is to the social impact bond concept, does this pose a challenge to their implementation? If so, how are you dealing with that? How are you making sure that governments, when they enter into these programs, assess performance correctly and do it in a way that is going to encourage future investment and participation?

Newman: Performance is fundamental to the structure. It’s fundamental because a social impact bond would be designed to measure improvement. So you need to have good data, and you need to have the data constructed and accessible in a way which is aligned with your objective.

I think the difference with social impact bonds compared to direct contracting with government is that in normal contracting it may well be that a lot of data is generated, but what happens to it? Could it be used better to drive performance? The interesting thing about a social impact bond is that it brings in a third party who is remunerated by reference to the results measured and captured by the data. That means there’s a third party with a stake in that performance assessment, so you have to design the social impact bond with it in mind. And this creates a robustness to that thinking because if you can’t actually get the robust data and a proper basis of measurement in the program design, then it’s not an investable prospect.

We actually get quite excited about this because we see it as a way of introducing third party interest and motivation to get government to think about data and performance in a really dynamic way. Some governments who have looked at this idea, one of the reasons they’re engaged with it is that they see it as an opportunity to look at performance in a new and refreshing way.

And when you have the data accessible, people can see better what works. That’s what we find in Peterborough. In the beginning you design a project in a certain way, and then you discover that some services aren’t being used, and you ask yourself why they’re not being used. Is it because they’re not needed or because we’re not engaging with the people in the right way? And we have changed the program to respond to what we’re seeing. The investors in that bond and in other ones get that information, and they’re really excited by it because they’re seeing feedback and reporting which is more granular than we’d normally see. And we’re getting a real sense of what’s effective on the ground.

Clougherty: And it’s fairly immediate as well, based on what you’re saying?

Newman: Yes. I think it’s quarterly in Peterborough, and some of our other programs have monthly board meetings.

Clougherty: Many of our readers are policymakers and officials around the United States who are thinking of launching these kinds of programs, maybe their first social impact bond program. If you had to give them some advice on the things they absolutely must do, and the things they absolutely must not do in order to have a successful first program, what would you say?

Newman: One of the most important things is to keep it simple. There’s a temptation to design things with multiple metrics and multiple measurements, but that creates a level of complexity that is difficult to talk to investors about, and it creates a cost as well because you have to have the measurement structure and the data coming in for each of those.

Another important thing that we have found is that the debate and the interest in social impact bonds centers around programs which generate cost-savings, and are therefore self-funding. But one of the problems, very often, is that the part of government commissioning the bond and paying for the outcomes is not necessarily the recipient of all the cost-savings. It’s important to find an area where costs and savings are relatively well aligned, because if you try to group all the beneficiary public departments together you end up having an impossible conversation-who’s going to pay for what-that makes the whole program excessively complicated.

The other thing I think is that it’s important for the program to have economic value, but it’s also important to consider the wider benefit-the un-cashable savings-when you think through the value that you are generating. So for example, if we’re reducing reoffending, there’s obviously a benefit to the population in Peterborough-not having unsafe streets and low-level crime. We can’t cash that saving, but it has a value, so that’s important.

Finally-and we see this everywhere-you need to realize that when you’re starting out, it takes longer than you think to design social impact bonds. But it’s really important to go through a meticulous and thorough process because that’s what will make it investable. And that development process has value because you’ll learn more about the issue, and so you will move the dial in that process. But I think Peterborough shows the power of an exemplary transaction in getting something done. You learn a lot from doing it and it creates momentum for new opportunities. So get on and do it!

Clougherty: If I could just ask a couple of final questions about other aspects of Social Finance’s work. The first one is related. You established a social impact venture capital trust. Tell us a little bit about that.

Newman: Yes. The capital we were raising for the social impact bonds is targeted at non-retail investors, and that is a function of our regulatory environment in the UK. We were interested in expanding the capital available for investing in social issues and broadening it to a retail investor base so there was an opportunity for people to invest in their own communities. The way we chose to do that was through the venture capital trust. The venture capital trust is a fund, so it can be marketed to retail investors-they get a tax credit, so it’s attractive for them to invest-and then the money going to the fund would be invested in a range of different social or charitable organizations. For the moment though, we have closed the VCT early and before we reached the minimum subscription level-the government has started a consultation process for a social investment tax relief, which may in the end result in a more suitable retail investment vehicle for the sector.

Clougherty: One last question, which may be a slight diversion from our previous conversation. I saw on your website that you have some activity related to mutualization, a process in which groups of public sector workers “spin out” to form independent, employee-owned mutual organizations, which could then bid for contracts to deliver privatized services. Is that something you see happening a lot? Is it just getting started? What attracted Social Finance UK to working in that particular field?

Newman: I think one of the issues associated with the criminal justice reform around probation-and the whole rehabilitation revolution-is that it’s likely that some of the existing probation service organizations will spin out of the public sector as mutuals. So some of the interesting potential social enterprises for that area are likely to be mutuals, which means it’s part of our world now. It’s a small part of what we do, and I think there was probably an expectation or a desire from government for the mutual agenda to grow more quickly than it has done actually. But I think that if you take something quite as large as the rehabilitation work, then there’s a possibility for that to take a bit of a step change.

Jane Newman joined Social Finance in 2012 as International Director. She leads work on developing an international network of impact investment intermediaries to develop Social Impact Bonds. She joined from The Social Investment Business, the UK’s largest social investor, where she was Director of Governance and Company Secretary; prior to which she was a senior corporate partner at a leading international law firm, Simmons & Simmons, where she advised a wide range of clients across the commercial and financial sectors. She has broad international experience, leading transactions in a range of jurisdictions, and also held positions as managing partner of Simmons & Simmons’ German operations and as head of its Mainland China office.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

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In this second part of our focus on Centennial, we turn to the topic of its forward-thinking approach to driving innovation in government. Centennial is one of a growing number of cities that have created a formal senior administrative position-the chief innovation officer-within the city government with the primary responsibility of driving public sector innovation. This role typically sits apart from the traditional departments and divisions so that it can have an enterprise-wide scope and think outside the traditional organizational silos. The deployment of cutting-edge technologies and partnerships with external service providers and community organizations are often key focus areas.

Centennial’s Chief Innovation Officer David Zelenok has a unique perspective on both innovation and partnerships, and the intersections between them. As the city’s former public works director, he served as the city’s lead player in developing its award-winning public works contract-so successfully that he eliminated the need for his own position, which was abolished-before ultimately transitioning into his current role as the city’s innovation change agent.

In July 2013, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Zelenok on the role of the chief innovation officer in government, the importance of sharing both risks and rewards in PPPs, emerging future opportunities in PPPs that mid-size cities can explore, and much more.

Leonard Gilroy, Reason Foundation: The position of chief innovation officer is a relatively new position in the world of public administration. Can you describe your role, both in terms of its position in the enterprise and how you approach it in terms of the scope and breadth of responsibilities?

David Zelenok, Chief Innovation Officer, City of Centennial, Colorado: In terms of the organization, I report to the city government’s chief executive, which here is our City Manager John Danielson. That was done deliberately, in part because my role is intentionally not a part of any of the city’s other departments, so I’m not a part of planning, public works, the court system or the clerk’s office, for example.

My role is really the chief advocate for innovation within the organization, but beyond that it’s instilling a culture of “thinking outside the box” in the organization, as well as seeking new opportunities not just for cost savings or cost avoidance, but also revenues, and that often leads us into partnerships and unique ways of structuring or restructuring the basic functions of our government.

And very often we find that the conventional approaches that have been used both here and in other cities might be outdated technologically or may have been surpassed by legislation at a variety of levels.

Gilroy: Some public administration experts have lauded the development of the chief innovation officer role, but have questioned whether cities have empowered it with sufficient authority, both in terms of direct budget controls and decision-making authority. How would you respond to this concern? How can cities maximize the value of their chief innovation officers?

Zelenok: Looking across the country, many cities that think of themselves as “leaning forward” have appointed these chief innovation officers. A lot of major cities are now doing this, and media outlets like CNNMoney and Government Technology are starting to cover it.

First and foremost, the emphasis of the job is to advocate for new, innovative and creative ways to avoid costs and to enhance revenues. At the most basic level-just in terms of covering my own costs as an employee-our city manager has given me a challenge to come back with what some places call a “benefit-cost” or “value-for-money” ratio of 20 to one, meaning benefits at least twenty times the cost. So he’s asking that I at least recapture the expenses of the job many times over. And I was pleased to report back by the end of the first month that I had already positioned the city to bring in a combination of revenues and infrastructure improvements exceeding 20 times my salary for the year.

Part of maximizing the value of the CIO role really hinges on the level of the position. If the position is buried deep within the organization, then their influence will only go as far as their peers or counterparts inside that department. So I think that organizational placement is a major part of it, having a single point of contact for innovation, both in terms of moving projects forward and then instilling that culture of innovation in the organization. These creative, innovative ideas really need an advocate in the government at a high level that can push them forward and restructure or look outside of the conventional ways of delivering services.

It’s also important to focus on efforts where the benefits outweigh the costs. In some cases, there may be an opportunity to create a partnership with another government or quasi-governmental authorities. Right now we’re in the process of structuring a partnership with a metropolitan district-a quasi-governmental authority-to have them perform $8 million of improvements on our city streets with their money. Ultimately the money will benefit the district, but for us, if they’re committing $8 million into widening our streets and adding in new roundabouts to improve traffic flow, reduce congestion, and improve safety, then we win, the district wins, and the businesses that support that district with their own funding win because they see improvements in congestion.

The bottom line is that we think that everything that government does in this arena needs to have a quantifiable objective or subjective benefit that outweighs the cost of doing it. That’s the first rule of business that we look at-it has to be worth doing financially and economically, and it has to benefit the community.

Gilroy: You were the public works director for Centennial when it launched its widely recognized, large-scale public-private partnership to deliver the full scope of public works services. As the public sector lead on that project, can you describe the rationale for that PPP and how you approached its development in terms of ensuring that the city retained flexibility and received good value for money?

Zelenok: The city entered into an agreement with CH2M HILL in 2008, and we just renewed that contract for another five years, increasing their scope of services while not increasing the cost of the five-year agreement. We believe that the arrangement is working well, and beyond that, we also have a contract with another firm-Merrick-that has been providing quality assurance/quality control services since 2007 to verify that it’s working. Overall, we think we’ve got a great combination with the two firms performing our public works services and ensuring we’re getting our money’s worth.

We believe that Centennial is the largest city in nation to have completely outsourced all of our public works to the private sector, and we’re proud to be the largest one doing this successfully. We do know that we’re the largest city that has snow removal built-in to the contract; there are some cities that do snow removal and others that do not. But as far as street maintenance goes, there are many cities that organize their public works service activities around snow removal, so cities in the north, for example, will organize their summertime operations around their wintertime needs, and vice versa.

“Managed competition”-or public/private competition-is a term that’s been used a lot in recent years. Five years ago, “managed competition” and “value for money” were not really in vogue yet, and as it turns out what we were doing was really managed competition with an emphasis on value for money. And the essence of it was that we received three private sector bids, and we also prepared our own internal public sector bid. In other words, we fully burdened the increase in costs across all governmental departments-whether that was in human resources that has to do recruiting for hiring employees, or taking on additional risk in safety training for the employees, or for new copiers and other equipment, or for the budget person that needed to put together the department’s budget, and so on.

So we fully burdened those hidden costs into the public sector model and ran them through a net present value financial analysis. We also fully burdened our own government bid assuming that we would, like the private sector, only be doing the work for a set number of years-in our case, it was a five-year bid. So the assumption that we made and the net present value financial calculation that we did had the same five-year assumption in order to fully burden all of the costs. When we evaluated that, our internal bid to create a traditional public works department on an annual basis was about $9.9 million.

We received a total of three private sector bids, with one at $9.8 million and another at precisely $9.9 million, with another bid that was somewhat higher. The larger point there is that those bids confirmed to us that we had removed some of the risk for the private sector contractors, because when you get not just one, but rather a number of bids from private contractors that confirm our own number, then they can’t do it any cheaper than we can, but they’ve also got to make a profit, they’ve got to depreciate equipment, they’ve got to pay taxes, and cover risks in an entirely different way than we did with a traditional governmental organization. And despite that, they were able to prevail with virtually identical numbers.

When we took the issue to our city council, they recognized that even though the bids were almost identical, there was another factor that we weren’t considering, which was that with the private bids there would be a known, predictable budget into the future. The budget for the private sector would be contractually held at that $9.9 million cost with some planned escalators, and those would be guaranteed fixed points where the council knew exactly what they would get in terms of value and level of service for that amount of money.

By contrast, the public sector would see future changes that were not as predictable. So the council looked at the private sector bid as being more predictable and even less risky than the public bid, because for the long-term, they knew precisely what they’d be getting for exactly how much money. Our public sector bid was thought to be something less than that because it would always be subject to the political whims of the future, as well as the market swings in the price of materials and things that none of us could really control. We were assuming all of the risk in our bid, but the private sector was not only assuming risk in their bids but also locking in guaranteed costs for the next five years.

And with that our city council-and I think rightfully so-decided to look to the private sector to operate the entire organization. In fact, one of the bittersweet ending points was that we have such a high-performing partner in CH2M HILL that I was able to completely transition my job to the private sector; I was serving as the public works director at the time. Right now the city does not have the standalone position of director of public works, which is how I came to become the city’s chief innovation officer.

So we think we’ve figured this out, and we’ve negotiated another five-year contract for the same set of services, so we think it’s working very well and we’re proud of the results to date.

Gilroy: One important aspect of well-constructed public-private partnerships is in “risk sharing,” via the ability to better allocate important project or service delivery risks to the party best suited for handling them. And you’ve described PPPs as also involving “reward sharing.” Can you explain what you mean by that? Can you point to some examples in your public works contract, or perhaps in your snowplowing innovations?

Zelenok: There are a wide variety of contracting mechanisms between public and private sector entities. Oftentimes, many of these terms-such as “outsourcing” and “privatization”-are used loosely and synonymously, when in, fact, they refer to very specific and different arrangements. Many agencies believe they are engaging in a partnership to, for example, privatize their services, when in reality they aren’t “conveying” any assets to the private sector; rather, they are simply sourcing the work from a different provider, often in the private sector.

Likewise, many agencies claim they’ve executed a partnership agreement, when in fact they’ve simply executed a traditional contract for services with a set schedule of fees and expectations. In such an example, there’s definitely not pure privatization going on, and there’s probably not much partnering there, either.

There are two crucial elements to a public-private partnership. To be considered a true partnership, I believe there needs to be sharing of risks on both sides, or else you don’t have a partnership. For example, both parties need to have a common purpose, which, among other things, is to help ensure the success of the other partner and to promote an enduring relationship. In fact, sharing risks is one commonly-held tenet of nearly all PPP advocates.

But I would offer that equally important is sharing both risks and rewards. Rewards are often easy to define by the private sector and are usually related to short-term or long-term revenues. In the public sector, rewards can be defined in many ways, including cost savings, revenues generated, cost avoidance, reductions in future cost increases, or perhaps even more subjective but important concerns like the stability of the government or public support for actions and programs. Clearly, some of the most effective, long-term relationships are built on these two, and arguably equally important, pillars, and a well-defined and transparent system for sharing in both directions-risks and rewards.

In the case of Centennial’s first contract for public works services, these tenets were outlined in a base contract document of only 39 pages. Throughout the document are the themes elaborating on the details of how both parties would share-and limit-risks and rewards. The result has been nothing short of stunning. The contract has been a resounding success, and the city council has just authorized an additional five years, with expanded services and costs contained well into the foreseeable future.

Just to illustrate one of those areas where we share the risks, we know for a fact that no one in the public sector nor the private sector knows how much it will snow next year, yet cities tend to insist on having a fixed budget to rely on for snow removal. Here in Centennial, we’ve included in the contract that we will share the risks with the private provider, and since they do not know how much it will snow next year, we agreed that the city would purchase all of the very expensive de-icing chemical materials. And so when a dump truck leaves the barn, if it’s a 10-ton dump truck at $100 per ton, that’s $1,000 worth of material going out on that snowplow. The most expensive aspect is really in the materials.

What we found in our research is that governments that have outsourced snow removal who don’t have risk sharing in their contracts tend to get very high private bids back that make them seem uncompetitive. But the reality is that all they’ve done is shift 100 percent of the risk from the public sector to the private sector, and the private sector builds that risk into their bid, and it often makes them uncompetitive. Here, with a true partnership we share that risk.

We also do the same thing in fuel prices. Since the contractor has no control over fuel prices-or asphalt prices or a lot of other materials prices-in all of those cases we buy 100 percent of those materials. But since we do that, it’s also incumbent upon us to ensure that the contractor is not abusing it, that they calibrate their equipment and put down precisely and only the actual amount of material they need to have. So we watch them, and they have to then watch themselves.

Gilroy: Centennial’s public works PPP is large-scale and comprehensive, covering the breadth and variety of public works services. However, in a recent conference sponsored by the National Council of Public-Private Partnerships, you discussed some potential mid-size PPP opportunities that cities like Centennial could explore. One of these involved streetlights. What emerging PPP opportunities do you see in streetlight operations and maintenance?

Zelenok: There are many millions of streetlights across the nation. What we’ve learned is that every situation is unique in terms of who owns them, how cities pay for them, and how they are maintained. In some cases, for example, cities don’t pay for them, but rather a homeowners association or a private sector entity pays for them.

We have roughly 3,000 streetlights owned by Xcel Energy and roughly another 1,200 owned by the Intermountain Rural Electric Association (IREA). The city and its predecessors originally purchased and installed many of those streetlights and turned them over to Xcel and IREA as required by existing agreements or the public utility commission (PUC) arrangements in place at the time. We also pay for major replacements, upgrades and knock-downs, like those caused by errant or drunk drivers.

For the hundreds of thousands of streetlights that are operated for the public, by the public, in Colorado, there’s PUC rate, for example, for a 100-watt streetlight in terms of dollars per streetlight per month-approximately $18 is the current monthly fee per streetlight that we pay to the local power companies. Only about $2 of the $18 monthly rate is for power, and the other $16 goes to the power company for a variety of things, so under Colorado’s PUC ruling roughly 90 percent of the monthly cost to operate a streetlight goes to things other than power. So if you have a 40 year old streetlight that cost $200 decades ago, that streetlight has been paid off many times over, and a high-pressure sodium light-which is a 50-year old technology bulb-costs about $10 per bulb and will last a couple of years, so you’re doing perhaps $50 worth of maintenance on that streetlight every couple of years. But you’re paying roughly 5-10 times that in recurring monthly charges to operate that streetlight.

So what we’re trying to do is look at possibly recapitalizing or restructuring the ownership of those streetlights to where we would be able to pay what’s called an “energy-only” rate, and we’re hoping to capture perhaps not a 90 percent cost savings, but at least a significant cost savings in the millions of dollars by assuming ownership and maintenance, and then changing the rate structure. And in addition to that, we certainly hope that we can divert from the 50-year old technology of high-pressure sodium lights towards more of the efficient technologies such as LEDs or induction lighting.

In addition to recapitalizing the system, where we can save about $16 of the $18 per month to bring us a $2 monthly power bill per streetlight, we can cut that $2 power bill in half again by using new technology lighting as well as looking at creative ways for renewable energy and buying that power through the grid-sometimes called “retail wheeling.” We haven’t figured out all the details there, but certainly by changing the technology of the bulb and recapitalizing the system, there are significant savings to be gained, at least 50 percent if not more. We’re pretty confident that we can do that right now.

So technically this would not be a pure partnership, where you’re sharing risks and rewards. If we purchase the streetlight system, then we are assuming all of the risk of the system, and then we would probably look to the private sector to provide all of the operations and maintenance on the entire streetlight system. So we’re more likely looking at a traditional contract arrangement for the system’s operations and maintenance. I suppose that we could buy our own bucket truck and we could hire a government employee to work the night shift and then do the re-lamping ourselves, but we would probably find that it’s more to our benefit not to buy the equipment and not to have a full-time employee, but rather to contract with the private sector on either a performance-based contract-which is more of a traditional contract with no risk sharing-or look again to explore a PPP. We are just now exploring our options.

But every city is unique. Some cities in Colorado have done a re-lamping, but the rate structures are totally different. The $18 per streetlight per month is unique to the largest power companies in the Denver area. What people don’t realize is that in terms of the efficiencies to be gained from a conversion to LED lights or other new technologies, you really have to consider the benefit-to-cost ratio or return on investment (ROI). If you’re paying 10 cents per kilowatt-hour, you’re going to spend about $2 per month on power for each light. Perhaps a conversion to LED can reduce that bill in half, dropping from $2 per month to $1 per month, but if it’s costing you $500 to do the change-out and you’re only saving $1 per month, that’s a 500-month ROI, which is essentially decades. In fact, the LED fixture will probably have to be changed out again before you ever hit the ROI on the initial installation. In other cities where you’re paying a very high amount for power-such as in Honolulu or in the Northeast, where you’re paying 20 cents or 30 cents per kilowatt-hour in some places-there the ROI comes much faster, maybe in seven to ten years.

Each situation will be different, but what each city definitely needs to do is to take the total streetlight bill, divide by the total number of streetlights, and then see what that monthly bill is per streetlight and how that bill is structured. It makes sense to look at recapitalization and to look at possibly purchasing energy from alternate sources, as well as re-lamping and moving to the newer technologies. All of these apply to virtually every city.

Gilroy: Another midsize municipal PPP opportunity you mentioned was in traffic signals. What PPP opportunities do you see there?

Zelenok: With traffic signals, we’re looking at a blend of PPPs as well as looking at the benefits and costs of embracing new technologies. On the technological side, traffic engineers call these lights indications-these are the incandescent light bulbs 12-inches in diameter that give you the red, yellow and green lights. Typically a yellow light will burn at about 70 watts, while red and green lights burn up to about 130 watts of incandescent power.

We found that by re-lamping and changing those out, we can change the power consumption down to between 6 and 12 watts, and the return on investment on just the change-out from incandescent to LED is about two years to pay back the entire conversion cost. And we’d reduce the power consumption in those traffic signals by about 90 percent.

We think the PPP part of the traffic signals may lie in improving the communications to every single one of our traffic signals. Five years ago when the city started looking at its traffic signal system, we used a very solid and reliable 1980s technology that coordinated some of the 84 intersections throughout town that were signal-controlled, and their thousands of indications. Of the 84 signal-controlled intersections in town, only about one-third of them were coordinated in the area and very few of those had any communication links at all. We’ve done public-public partnerships and PPPs for extending communication lines, primarily via conduits for fiber optics to either every single signal or to node points where we can communicate to groups of signals wirelessly.

In some cases, we’re extending through public-public partnerships with the Colorado Department of Transportation, because we can piggyback on them and use state highway conduit and our own fiber optics within them to reach out to our signals at the other end of state highways-in other words using state highways as a backbone for that. In fact, what we found is that much of the state’s fiber optic conduit-which is 2-inch conduit-only had 24-fiber bundles in the conduit. We made an offer to the state to pull out the 24-fiber bundles and then we installed two 96-fiber bundles back into the same 2-inch conduit. And so the state upgraded from 24 fibers up to 96 fibers, getting four times the amount of throughput that they had before, and we were able to work in a second 96-fiber bundle for city use in the same conduit.

In other cases, by installing fiber optic conduit at the same time the private sector is installing fiber optic conduit, it turns out that the cost for the private sector to pull through, say, 1,000 feet of conduit is about $15 per foot for the first conduit, but then $1 per foot for the second conduit. And so we fully expect to pay 100 percent of the upcharge for a second conduit, but in exchange we have a conduit that we can then use to communicate with our traffic signals for a very small fraction of the true cost of installation.

So over time, we’re looking to phase in an entire fiber optic network throughout the community at a fraction of the full price and by doing so, be able to communicate with every single traffic signal in town. Once we can do that, we can have real-time coordination of our signals and have what some have called “demand-responsive signal control.” For example, if there’s a large event or a traffic incident on the freeway, we’re able to re-coordinate the traffic signals and accommodate these constantly changing volumes in traffic in real time, and thus reduce congestion, reduce delays and improve safety for our citizens-all because we’re using either a public-public or a public-private partnership.

Gilroy: You’ve described some potential midsize PPP opportunities in fiber optics and telecom. What opportunities do you see there?

Zelenok: In many parts of the country there may currently only be a single provider of high-speed internet, and that’s usually the cable TV company. They often have essentially a monopoly on high-speed internet to every home in town that they currently have wired for coaxial cable, which has a high bandwidth that’s suitable for most home applications.

In most parts of the country, the telephone companies realize that they would like to get into the same market as well, and they are now in the process of installing millions of miles of fiber optics nationally. If there’s someone pulling fiber optics through a community, then there may be a chance for cities to piggyback and have those companies bring through conduit for use by city governments, if they pay the upcharge.

We can use that not simply for communicating with our own traffic signals, as we discussed, but also for a variety of other public purposes. And so what we’re trying to do is look ahead and work in the future cooperatively as we see the next wave coming through our community. It will be a blend of the telephone companies bringing a competitive high-speed internet to each city, and we can look then at combining that with our street lighting. One technique is being called “adaptable streetlighting”, where streetlights dim themselves at, say, midnight and then brighten themselves back up again at an hour before dawn, which allows you to save energy. So if you have that fiber optic communication network, you can communicate with your traffic signals, streetlights, weather stations, and all sorts of other things to advance a public purpose through innovative technological applications.

Gilroy: What lessons have you learned along the way in terms of implementing PPPs that you could share with others who may be contemplating similar moves elsewhere? What can other cities learn from Centennial?

Zelenok: I’m convinced that Centennial is a model for almost any city in the country in terms of public-public and public-private partnerships. More than any other large city in the nation, we’ve really broken the code, so to speak, in terms of demonstrating that a city of 100,000 people can truly operate with less than 50 governmental employees. We are completely debt-free as a city; in fact, we have a growing fund balance. We have infrastructure that I think is second-to-none that’s being maintained to some of the highest standards possible. And beyond that, we really think that there are always opportunities for partnerships, and that holds for any city our size.

We definitely had the benefit of being a newly incorporated city. In some of the more traditional cities, union contracts, for example, can be limiting in so many ways, based on the local circumstances and the specific terms of the contract. In some cases it may be impossible to outsource public sector jobs to the private sector. Sometimes legislation can be very limiting when it comes to a city’s ability to outsource or privatize any of what are now thought to be “inherently governmental” functions. But what’s often thought of as “inherently governmental” are often not so inherently governmental, just what’s been “traditionally” governmental.

Every situation will be different. If there are no legal barriers to outsourcing either at the state legislative level or internal to city charters, then there’s a world of opportunity out there for creating these new and innovative partnerships.

Also, the leadership and governing body-like the city council and senior administrative staff-needs to embrace and understand the value and importance of thinking outside the box, being creative and innovative, and applying these new approaches to managing cities in combination with new technologies. If you can find these opportunities and technologies and you’re open to this innovative way of thinking, then I think that many cities can benefit in terms of saving money, enhancing revenues and avoiding costs in ways they’ve not even begun to think about.

David Zelenok is the Chief Innovation Officer for the City of Centennial, Colorado. Zelenok has thirty years of senior transportation-related management experience at the municipal, state department of transportation and federal levels as well as having managed the “full spectrum” of transportation and public works operations, including Aviation, Mass Transit, Traffic Engineering, Toll Highway, Street Maintenance, Engineering Design and Construction Services as a consulting engineer.

Prior to his position with Centennial, he was Director of Engineering for Merrick and Company, one of the largest consulting engineering firms in Colorado, overseeing civil infrastructure design and business development in their Colorado Springs office. He also served fourteen years as Director of Public Works and Director of Transportation for the City of Colorado Springs.

Earlier in his career, he held a number of senior engineering management positions with the Pennsylvania Department of Transportation and on active duty in the United States Air Force. In 2003, he took a leave of absence from his position to serve on active duty in a number of assignments supporting United States military’s efforts in the Middle East as an Air Force Reservist. As Deputy Director of Planning and more recently, as Deputy Director of Operations for Air Force Space Command (both authorized Brigadier General positions), he was heavily involved in planning and operating much of the nation’s $11 billion annual military space program.

He holds a Bachelor’s Degree in Civil Engineering from the United States Air Force Academy and a Masters Degree in Engineering from the University of Texas at Austin, and is registered as a Professional Engineer in the State of Colorado and the Commonwealth of Pennsylvania.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

The post Colorado appeared first on Reason Foundation.

In 2008, Centennial launched what has become its most recognized signature achievement: a large-scale public-private partnership with national engineering firm CH2M HILL to provide all of the city’s public works services. Centennial’s public works contract has gained national attention for its scope and innovation and garnered the city a series of awards, including the 2010 National Council for Public-Private Partnerships Service Award, the 2010 American Public Works Association Innovative Customer Service Call Center Award, and the 2012 Institute of Transportation Engineers Transportation Achievement Award for Operations.

In December 2012, Centennial’s city council opted to extend its public works partnership with CH2M HILL through 2018 in a five-year, $51 million contract extension that lowered the costs of service delivery by nearly $1 million and expanded the scope of services even further.

In June 2013, Reason Foundation Director of Government Reform Leonard Gilroy interviewed Centennial Mayor Cathy Noon and the City Manager John Danielson on the groundbreaking public works PPP, how the city drives performance and accountability from contractors, citizen satisfaction, lessons learned in contracting and more.

Leonard Gilroy, Reason Foundation: Can you give our readers some context on how Centennial was incorporated in 2001? What drove the incorporation, and what set of public services was the new city responsible for providing?

Cathy Noon, Mayor of Centennial, Colorado: The city of Centennial was incorporated from unincorporated land in Arapahoe County, a very established area that was mostly built out. The city was formed so citizens living in this area would have more representation-a “bigger voice.” This area didn’t have a “traditional” county look and feel; it was much more suburban-even urban in areas-but still receiving “traditional” county services. That being said, surrounding cities were annexing the commercial property in this area but not the residential developments, which was concerning for residents because the tax base that would help support the county services would diminish. So it was a bit of a self-determination to decide that we wanted to come together and create the tax base that would then support a “full service” community.

In the summer of 1998, the city’s five founding fathers-people from the chamber of commerce, the county assessor, our county commissioner at the time, and a community leader-led the charge of Centennial becoming a city by forming a volunteer organization known as the Arapahoe Citizens for Self-Determination, and an incorporation steering committee filed a petition in District Court in October 1998 requesting an election to determine whether Centennial should be formed as a city. The District Court conducted hearings and determined the petition invalid. The volunteers corrected the petition and on December 12, 1998, in six hours obtained more than 2,500 signatures on a second petition known as the “Centennial Petition.” An election was scheduled for September 2000, in which 77 percent of voters approved the formation of the city. Centennial was officially incorporated on February 7, 2001 with approximately 100,000 residents, the largest single incorporation in U.S. history. We’re pretty proud of being able to put that effort together.

In terms of the set of public services, this particular area received a lot of what you might call “city-type” services from special districts. In the state of Colorado, this is a way that we provide services in county areas where cities don’t exist and when counties don’t feel that they want to get into the provision of things like water, sanitation and fire. Once we became a city we had to provide for law enforcement and public works-the two main services Centennial was responsible for-as well as land development oversight, issuing permits and planning.

The city of Centennial does not provide water and sanitation-those are done by 13 different special districts. Three other special districts provide our fire services, and our schools are provided by two individual school districts. So the city itself does not have to provide for those services.

Gilroy: Centennial has been widely recognized for its large-scale public-private partnership with CH2M HILL to deliver the full scope of public works services, way beyond the scale of outsourcing seen in more traditional, older cities that may use piecemeal contracting for discrete services. Can you describe what led Centennial to tap a PPP for public works to begin with, and discuss the results in terms of cost savings and service quality?

Noon: For one year following the city’s incorporation the county continued to provide services to the city, which is typical in Colorado. For the next few years, the city decided the best way to manage these public works and law enforcement services was through a contract model. So we contracted back with our county to provide the same level of service they had always provided. We never contemplated implementing our own police force. The Arapahoe County Sheriff has always provided exceptional law enforcement even before the city was formed.

As far as public works, we spent a few years using the county’s services, but then they started looking at a significant cost increase. So the city decided to bid out these services. As it turned out, private companies came in with a lower cost providing the same or higher level of service. So we decided to pursue a partnership with CH2M HILL, and within roughly a six- to eight-month period we undertook one of the largest conversions from a public entity to private.

As far as results go, what we have seen has been a far better response to the needs of our city. If there’s a pothole, it’s repaired quickly because we have performance measures built into the contract that say “you will do this” within a certain amount of time. We have innovation in the way things are being done. Working with a partner, we have other people with great ideas that we can just tap into to make things better. We can tap the wealth and depth of the private employees and the innovation that they bring to the table.

John Danielson, City Manager, Centennial, Colorado: We look at all of the relationships with our service providers as an evolving environment. As we learn how we can go further and do things better, we challenge them to figure out new and better ways to do things. In just the past year we went through a re-working of our contract with our public works provider [CH2M HILL], and we found all kinds of ways to save money, to streamline the process, and to financially encourage them to do more innovative things.

For example, they won national awards with our snowplowing services by figuring out a way to more efficiently do the same routes at no additional cost. In fact, they added 93 additional miles of roadway to be plowed for the same cost.

So we think of it as an evolving relationship, and it should continue to get better and better. It helps their bottom line, and it improves our service quality. So I think that next year we’ll look for the next snowplowing route or the next better way to build a mousetrap.

Gilroy: How flexible is the contract in terms of making adjustments in priorities along the way, for example, in the event that city revenues come in less than expected at the beginning of the fiscal year or if priorities change over time?

Danielson: One of the things we did in the last contract negotiation was actually reduce the amount of money we’re paying on the contract, and we created something called a “flexible spending account,” which gives us a lot of ability to expand or contract as circumstances demand. Plus, all of our service providers understand that this is a partnership, and if we were to get into a fiscal situation where we no longer deemed something affordable or no longer a priority of the city council, then we could pretty easily modify the contract if need be.

Noon: A few years ago before the most recent renegotiation of the contracts with all of our contractors, there were some revenue downturns that we weren’t expecting during the recession. We worked with our private partners and were able to do a reduction in services. For instance, in the public works contract, instead of doing six street sweepings, we would do four for that year. We cut back on the amount of mowing we did. The contract was written so that we are able to expand and contract in order to match the revenues we have. Consequently, we can pay extra for something because we know what the costs would be. For example, if we decide we need another street sweeping, the cost is spelled out in the contract so that we know what it would cost to add another sweep. And we also have an “exchange” written into the contract, so to speak, such that one street sweeping equals two mowings, for example. So if we decide that we don’t see a need for a particular service in a given year-perhaps it’s a dry year and we don’t need as much mowing-we can exchange that for another service.

Danielson: That’s a really good point. One of the things that we spent an extraordinary amount of time and effort on up front was discussing all of the aspects of the contract, so that when it comes time to add some other feature or service, then we have a pretty good idea of what it’s going to cost, and we’re not starting from scratch. I think that’s a really good part and a significant part of the new contract.

Noon: I think we had a little bit of that in the public works contract the first time around, but when it was time to renegotiate, on both sides we saw a benefit to having that further spelled out in the contract.

Gilroy: Was the enhanced flexibility you built into your public works contract during renegotiation something that you learned from somewhere else, say another city, or did you innovate that yourselves based on experience?

Noon: A great deal of it was innovation from our own staff coming up with these ideas. But of course we wrote a request for proposals that asked for specific things, and when we selected the current provider CH2M HILL, who had municipal experience elsewhere, they recommended some ways that we could build more flexibility into the contract.

Danielson: I’ve been with quite a few contract cities that have been very similar to Centennial, and I think this is the most advanced contract I’ve seen. I think it can be credited to a three-part mix of CH2M HILL, some pretty creative city staff, and also Merrick Engineering, who worked with us on an assessment of a lot of the terms and conditions of the contract. This contract is pretty technically advanced.

Noon: We have similar things in our building services contract. We have a company that does all of our permitting and other development functions. When we re-bid that about two years ago and went through the entire process, we felt our current provider did an exceptional job of not only fulfilling the contract, but also exceeding the contract. They even offered to have the contract tightened up further and raise the bar even higher in terms of how they would perform. I think that we’ve learned from each contract we’ve done, and have been able to write an even better one the next time. It’s beneficial for both sides and good for everyone. It doesn’t do you any good to have your partner unhappy, on either side. The reason that this really works is that it’s a win-win.

Gilroy: In all forms of privatization, a key concern is that the government will “lose control” of public services. How do you hold the private sector accountable for living up to their end of the contract?

Danielson: I’ve heard that for a lot of years, and one of the things that I find interesting is that we in government tend to not hold ourselves to the same standards as we hold our contractors to. How many government agencies say that we’ll give ourselves X number of hours or days to respond to a particular request and hold ourselves to it or penalize ourselves if we don’t do it? But we do that consistently with all of our contract relationships. So I’m a little bit skeptical about the fear of losing control. If it gets away and there is a downturn in service, and your contract doesn’t provide specific stipulations about what the remedy is for that, then you don’t have a very good contract. We do have that written into our contracts, we do have responsiveness, and we do have penalties. I think that we’re actually more responsive as a contract city than the cities that are completely staffed by in-house personnel.

Noon: That’s very true. I think that because we have to look at the contract, it keeps us more in control. It’s much easier if it’s just your city staff, and everyone is just going on and doing what they’ve always done. But we have to make sure that someone else outside of our city payroll is really providing what we’re supposed to get. I really think that makes us more engaged, because it’s usually easier to hold someone else accountable than it is to hold yourself accountable.

If you hire your brother-in-law to redo your kitchen and things aren’t going right, do you want to complain to your brother-in-law? That can create a lot of problems. But if you hire someone off of a preferred contractor list, and he signs on to do something a certain way, it’s easier to tell him what he’s doing is right or wrong.

Danielson: That’s absolutely true. And further, you have so much more flexibility in staffing than you would if these were all city employees. If there’s a downturn in the number of building permits, well guess what? Those people won’t just be sitting around. If we don’t need engineering services this month, then we can just let the engineers stay home. I can’t do that with in-house staff. I can’t suspend their activities because I have no work to give them.

Noon: And the reverse is that if we have a bump in the need for a service, we can just bring those people in through the contract. And when the work for the city is done, the contractor can reallocate them accordingly.

Danielson: And the contractors are financially incentivized such that they hope that we do ask them to bring somebody else in, because the more employees they have working, the more it benefits their bottom line. So they’re delighted to bring people in. And I should also note that since we pay for work done-and not for someone’s time-then it does the contractor no good to have someone sitting here with no work coming in.

So it’s actually an ideal business relationship. We have shared risk in that sense. The contractors are hoping for a good year when they can bring people in, but it’s a liability for them to have folks sitting around that they can’t pay, so they’ll instead move them around to other locations where they’re needed.

Gilroy: How does that translate to ensuring the performance of contractors?

Danielson: On performance, we get almost instantaneous feedback. I know exactly what project is on time, and I know exactly what the outcome is. Believe me, we get spontaneous feedback on what works and what doesn’t work. I don’t know how many cities do this, but we’ve got a citizen response center where a real human being answers calls 24 hours a day, seven days a week on anything and everything that may be going on, from law enforcement to potholes to street sweeping. We get continuous feedback in terms of our turnaround time on building plans, building inspections and the like, and we respond to many of those the same day.

So we monitor our contractors much more closely-and it’s much easier to monitor them-than I think it would be if we had an entirely in-house staff because the complaints come back more circuitously in that environment.

Noon: I think that’s one of the things that helped lead the council toward implementing key performance measures both in-house and externally. We started performance measures with a lot of the contracted services like code compliance and building services, but now we’re looking at how we put that in place for other areas. We now have it in place for our planning department, which is in-house completely, and even with our municipal court. We literally track the time that it takes from when someone comes in for their arraignment or for a court case and when they leave. So we’re using performance measures for things people do not enjoy-no one likes having to come in to court-but what we hear is “you made it efficient and took care of us in a professional manner, and you treated us with respect.”

So we’re focused on looking at how we can guarantee good customer service not only by our contractors, but also by our in-house staff. We’re setting performance targets for our own internal operations, and we’re looking to do even more of that.

Danielson: That’s a key point. We’re not just monitoring our external contract operations; we monitor our own in-house operations just as closely, even though they’re much smaller. We really are interested in our efficiencies, both inside and out.

Noon: Also, when we’re doing requests for proposals for services, we do an in-house model as well and we ask our own staff to put a proposal in. When we did code compliance a few years ago, we prepared an in-house model that looked at how many people we’d need to hire, how many trucks we’d need to buy, what kind of space we’d need, and the like.

Gilroy: Being located where you are in Colorado, snow removal is a big deal. You were recognized recently for innovations in how you deliver snow removal services on your streets, and you also started a program to promote volunteer snow removal for sidewalks and parking lots. Can you describe both of those initiatives?

Danielson: There are several industries-like solid waste, FedEx and others-that are using computer-aided routing to lower fuel costs and improve efficiency. They’re asking, “What is a better way to drive a route?” Here in Centennial, our contractor CH2M HILL took it upon themselves to look at snow removal to figure out if there’s a better way to run their routes to save money or do it faster. So they went about doing that scientifically with computer-aided design, looking at better ways to run routes to avoid having to backtrack or double back on. And in the same period of time and for the same cost, they were able to add 93 miles more roads.

Noon: When we took over from the county, we took over their snow routes, which included main thoroughfares as Priority 1’s, major arterials as Priority 2’s, and neighborhood collector streets as Priority 3’s. And we’ve always plowed Priority 1’s, and then we completed the Priority 2’s, and occasionally we could get to Priority 3’s depending on how much snow there was. But it was not routine to go into the neighborhoods. Because we inherited the routes from the county, we inherited the way the routes were done as well. When CH2M HILL came to us with their idea, the first time we ran the numbers it showed us a 29 percent time savings to do the same amount of routes, and after doing that a second time, they increased that to a 40 percent time savings. CH2M HILL was then able to plow all of the Priority 1’s and Priority 2’s, and if there wasn’t a huge snowfall then we were able to also add Priority 3’s as routine.

The additional 93 miles of roadway is directly beneficial to residents because we were now in their neighborhoods. That doesn’t mean every street and every cul-de-sac, but now each and every citizen is within an eighth of a mile of a plowed street. Some citizens emailed us and told us they had seen the first snowplow ever in their neighborhoods-or even twice-so people were really happy. That was the direct result of innovative thinking by our contractor-our “certified smart guys,” as we like to call them-and a great award-winning product. In fact, I think we may be the only city to use this kind of technology in snowplow routes, and it’s really helped us be accountable to our citizens.

Danielson: Going back to your earlier question about ensuring that we’re getting the performance from our contractors, this snow plowing example is Exhibit A. I’m not certain that program would have been easy to achieve under an in-house model due to labor issues and other reasons. Because the snowplow routes are GPS-based, we know where the trucks are all of the time. Going back to the question about making sure the city doesn’t lose control working with a contractor, I can look at a screen and tell exactly where those trucks are. They log their location and mileage in real-time, but after every snow event we’re able to go in and assess the efficiencies and efficacy of the effort by seeing how many miles they drove and how long it took them.

With regard to the volunteer program, the city council really wanted to do something about sidewalk snow and ice removal. We in government tend to want to be punitive and use the stick more than the carrot, but what we wanted to do was encourage people to voluntarily remove snow and ice from sidewalks and recognize them for a job well done, as opposed to hiring more code enforcement officers to cite people for being bad neighbors.

So we started the Snow Hero program, which is not focused on being prescriptive or writing tickets. It focuses on thanking and recognizing people publicly for taking care of snow removal. People have the opportunity to nominate neighbors and local individuals that were taking care of way more sidewalk frontage than they really needed to do. So we recognized them on the Internet, and Mayor Noon handed out a certificate and yard sign to them.

We weren’t sure if this was going to work, and we’re doing an after-action assessment now. We think the total number of neighbor vs. neighbor complaints was significantly down this year compared to previous years, and in terms of the nominations, we literally received hundreds of nominations. So we’re pretty happy with the first year. Preliminarily it looks like it was quite successful, which means that instead of being prescriptive, maybe there’s a better way-by thanking people for being good neighbors-to get a better response. It will probably be a two-year program, and then we’ll go back and assess it to see how effective we’ve been.

Gilroy: Can you describe the citizens’ satisfaction with the public works contract in general? Have they been pleased with the services they’re getting?

Noon: A few years ago we did a scientific survey specific to public works, mailed to 3,000 households. Interestingly enough, more than 1,000 surveys were completed-a response rate of about 34 percent, which is high. The results showed that 94 percent ranked the overall quality of life as a good or excellent place to live. Sixty-seven percent felt that our public works were good, and another 12 percent felt that our public works were excellent-so roughly 80 percent were very satisfied with their public works.

This survey was completed before the snowplow innovations, and when you read the survey results, you see residents wanted improved snowplowing. I think if we did a survey next winter or the winter after that-once they see the payoff of the innovations full force-we would get those numbers even higher. The city wants to be accountable and responsive to our citizens, so we took survey results and found out what’s important to people, and we took steps to address where people felt we could do better.

As far as our citizen response center, when people call in to report a pothole, they will get a response back that says, “this pothole was fixed today.” People are not only happy that the work gets done, but they’re also happy that we got back to them. The citizen response call center had an 11 percent increase in usage in 2012 over 2011, so people are understanding that by calling things in, they get taken care of, so then they’re more likely to call back again.

Danielson: I think the interesting paradox of being a contract city is that we’re held to a much higher standard. The reason for that is that we teach people that we actually respond. Compared to other cities that I’ve worked in, our complaints are actually higher. But it’s not that people are unhappy with us. It’s that if a citizen calls and speaks to a human being, and then things get done, we teach people to be a little more demanding. You put yourself out there more as a contract-style city, as a responsive government, and you’re automatically set to a higher standard.

Gilroy: How many employees does Centennial have today, and how would that compare to the workforce of a similarly sized “traditional” city of 100,000 people elsewhere?

Danielson: We’re running at approximately 51 full-time equivalent employees. It’s a little bit skewed because we contract for law enforcement and have districts providing things like water and fire, but I would guess that a full-service city of our size would typically be about 1,000 to 1,100 employees. Indianapolis, for example, is running at about one employee for every 85 residents, and we’re running at one employee for every 2,000 residents.

Noon: If you just took the contractors that are providing services that the city would otherwise do, like law enforcement and public works, then we’d probably have between 400 and 600 employees.

Gilroy: Does Centennial have looming, unfunded pension and retiree healthcare obligations like so many other municipal governments?

Noon: We have no pensions for our employees here in Centennial. We have a defined contribution, 401-style system for the employees, so we have to consider vesting, but that’s not a long-term issue like defined-benefit pensions. People know exactly what that amount is at any given time. Each contractor is responsible for handling their own pension or 401-k plans. We do not have unfunded retiree healthcare obligations either.

Gilroy: What lessons have you learned along the way in terms of running a lean, entrepreneurial city that you could share with others who may be contemplating similar moves elsewhere? What can other traditional cities learn from Centennial?

Danielson: I think being a contract city is not necessarily easier; in fact, it’s often harder to operate because you have fewer resources, everyone has to wear a lot of hats, and that might scare some folks off from trying things in the first place, especially if they’re in an organized labor environment. The other thing that you have to be consciously aware of is that there’s this inexorable creep to find ways to hire more people in-house. And then one day you wake up and instead of having 50 employees you have 60, and then the next year you’ve got 70 employees, and so on. I think you have to resist that and stay true to the model. If you’re going to go down this route and really make it work, avoid employment creep wherever you can.

In fact, over the last year this city has actually shrunk its workforce by about 20 percent, and we’ve added more efficient contract labor to replace some of that. I would caution everyone that it’s a difficult place to get to, but once you get there, we’re providing better services at a lower cost with a higher sense of satisfaction and more responsiveness.

Noon: I think that the city at one point in the past did start to creep, and we would think, “well, let’s just hire someone.” But when development in the city came to a screeching halt, we realized that we didn’t need a huge planning and engineering staff. There was less for them to do.

So at one point we had wavered, but we realized that we needed to get back on track, and we did. In the current culture our employees do have to wear a lot of hats, because at any given time, one sector of your city could be booming and another could be dwindling. So you’re a greater benefit to the organization if you can do more than one thing, or at least be willing to learn.

Danielson: The reduction in staffing wasn’t done for financial reasons. It was really to get back to our core competencies. We are a great manager of contracts, and that’s what we should be doing. I tell everybody that the days of single-purpose employees is over; it just doesn’t work. Everyone that we have here today has multiple talents and skills.

Noon: And one of the biggest lessons we learned is that the contracts you write are the key to making this a success. We had a contract model for our planning department when we first started the city, and this was a contract that was not working well so we decided to bring it in-house. It may not have been as unsuccessful if we had written a different, better contract. I’d advise other places to go to cities that do contracts well and talk to them. There’s no sense learning the hard way when you can learn from our experiences and other people that have done it. We don’t want to give the impression that there hasn’t been a bump anywhere or that we’ve always known exactly what we’re doing. We’ve taken a few steps back and forth throughout this process, but what has come out of it is a better organization with a better process.

Danielson: I know this contract city system works. I see it every day, and I’ve been doing this for a lot of years. I’ve been in cities that don’t do this, and I’ve been in a few cities that do it spectacularly well, and it’s always better. Why other cities don’t do it comes down to political courage and it comes down to difficulty-it’s not an easier model but a tougher model in some ways. But it just works better.

Mayor Cathy Noon was elected as Centennial, Colorado’s second mayor in 2009. As mayor she serves on many state, regional and local committees and boards. Important to Centennial’s economic prosperity, Mayor Noon advances Centennial’s identity with worldwide businesses continuing to locate to the City. Also important is creating unique places in Centennial, which was proven with the opening of the award-winning Centennial Center Park. Under Cathy’s leadership the city’s finances and fund balances are strong. Mayor Noon is a strong proponent of public-private partnerships, providing taxpayers the best value for their tax dollars.

Mayor Noon deems the emphasis placed on protecting property values, improving transportation and roads, and the vibrant community of great parks, open space, schools, businesses and neighborhoods earned Centennial Money Magazine’s 47th best place to live.

John Danielson is the City Manager of Centennial, Colorado. He has helped to create a high functioning core management team that requires only approximately 50 employees to provide outstanding services to more than 100,000 residents. Spanning a 25-year career in municipal management, Danielson has served as city manager in a wide variety of cities and special districts. During that time he has had the opportunity to create two new cities from their inception, based on the public-private partnership model, played an instrumental role in developing the infrastructure and municipal management models of three other new cities, and consulted with municipalities affected by complex financial and structural issues in need of critical resolution.

Other articles in Reason Foundation’s Innovators in Action 2013 series are available online here.

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