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1 Question Recent news reports from a variety of sources predict that the public sector will be facing an uphill financial battle for the next few years some predict until This article first appeared in February 2011 on On the Dec. 19, 2010, 60 Minutes program, Meredith Whitney, an equity analyst who gained notoriety by forecasting stress in the U. S. banking sector before anyone would listen, recently turned her attention to state and local government finance, predicting that several states would face possible bond defaults in the next 12 months. Others have suggested that states will be feeling pressure not only because many of them are facing serious shortfalls in their budget this year, but also because federal stimulus money that propped up their budgets last year will likely be less this year, or not at all. This means that there will be less local government aid for cities, counties, schools, colleges and universities than in the past. In 2009 and 2010, local governments responded by cutting many of the discretionary costs. First, they spent down their rainy-day funds. Then, in a survey that we conducted with IPMA-HR in 2010, we found that many local governments cut their training budgets (66 percent), travel and conference budgets (55 percent), froze hiring (56 percent), restricted overtime (56 percent), froze pay (59 percent), reduced hours (15 percent), renegotiated union contracts (15 percent), or reduced or suspended their 457 or 401(k) match (5.5 percent). In that survey, we also found that this pattern continued throughout We found that public organizations expected to maintain the pace of renegotiated union contracts, and that many of the organizations that froze pay or restricted hours or budgets expected to continue that practice. The projected pay increases were the lowest that we have seen in our 30 years of experience in public sector pay consulting, coming in at a range of 0.35 percent to 0.69 percent for If you are a public sector employee, these are dismal numbers, especially, when you look at health care costs for large employers that are averaging about an eight to nine percent increase for This amounts to an effective decrease in overall net pay to employees, even when factoring in the two percent Social Security break that was granted by the 111th Congress late in So, how does all this stack up? We need to recognize that the private sector always seems to be about one to two years ahead of the public sector when it comes to the effects of recessions or good times. Thus, if the recession started in 2008, and hit the private sector full force in 2009 and started pulling itself out (slowly, we might add) in 2010, the government sector can expect to be in the PAGE GALLAGHER BENEFIT SERVICES, INC. ARTHUR J. GALLAGHER & CO. AJG.COM SEPTEMBER 2014.

2 doldrums until late 2012 or, as they have predicted, about Right on target! Not a happy thought. When we look to the private sector, here is what we see. In 2009, salary budgets were up by 2.2 percent, and in 2010, they grew to 2.5 percent. Still low by historic standards, (they have generally been about 3.8 percent) but a growth nonetheless. But hiring never picked up and unemployment at the end of 2010 stayed just short of 10 percent. Companies that had frozen 401(k) matches in 2009 restored those in For those private sector companies that reduced salaries in 2009 (we found no evidence that public sector employers reduced salaries, unless there was a reduction in hours worked), many restored those salaries in 2010 and, in some cases, increased them. What can a proactive human resources director do to respond to this situation? After all, 2013 is a long way away, and if Meredith Whitney is correct, a couple of bond defaults will put many government budgets back in the freezer for a longer period of time than we may want to think about. Is there any solution? How can we keep employees engaged if there is less money, perhaps fewer employees in our organizations, and a reconsideration of the work that governments do? What are the options? Should we just wait it out and hope that the economy will turn around by 2013 so we can go back to business as usual, or has the new economy so substantially changed the structure of government that we need to rethink the way that we do our basic business? What advice can we give to elected officials? Here are a few thoughts that we think deserve careful consideration. First, we believe that the structure of financing of government has structurally changed the way governments will continue to do business. While we are not finance experts, we point to a few facts that seem to be shaping this new landscape: 1. The new health care law will force a change in the way we look at how health care will be funded and the cost of basic health care. Governments have traditionally paid for about 85 percent or more of the cost of employee health care. How will this affect the cost of employment? For example, recently a CFO asked the question, Wouldn t it be cheaper for us to simply drop health care coverage for our employees, pay the fine, and let our employees buy their insurance from the health care exchange? The simple math would suggest that we could increase pay and still save money. Well, the simple math is really not so simple, and likely will result in some serious unintended consequences. 2. Greater reliance on local property taxes to fund local government. This will place greater accountability on local government officials to respond to its citizenry for results. When dollars have been easier to come by, or have come from other, less local sources, accountability is more diffuse. But when property taxes are raised to cover lost state or federal funding, the focus will shift. 3. Pension cost awakening. As citizens in New Jersey and New York are finding out, the cost of union pensions are surprising many in the private sector who have no such benefit. Reform will be demanded in some form or another, or the costs of funding these current and future costs may outstrip our ability to pay for the delivery of current services. Second, we believe that these conditions will cause elected officials to rethink the role of government. In short, to what extent is it the role of government to deliver the services that the citizens require (demand) and what services can be provided either by other forms of government (consolidated operations) or by organizations outside of the government? For example, for most governments, we have funded disability time off by allowing PAGE GALLAGHER BENEFIT SERVICES, INC. ARTHUR J. GALLAGHER & CO. AJG.COM SEPTEMBER 2014.

3 employees to bank unused sick time until retirement. At retirement, if there is still unused time, it is paid out at the current rate of pay, up to a limited number of days. Thus, most government employees have a set number of vacation and sick days. Only about seven percent of governments have a PTO policy where these days off are rolled into a pool of days off, regardless of the reason. On the other hand, about 63 percent of private sector employers have a PTO policy where employees receive a set number of days off for the year and do not have to account for the reason for the time off. For short and long term disability, insurance picks up the salary cost. Private sector employees do not get to bank the unused days off until retirement. Many private sector employees would not return to a fixed number of vacation and sick days once they have moved to a PTO policy. The question we have to ask, is it cheaper to have a PTO policy than the current number of fixed days for sick and vacation? Should we just wait it out and hope that the economy will turn around by Third, is there a way that services provided can be delivered more effectively and cost efficiently? To this question, we think that current and possible conditions are such that the way human resources have done business in the past may no longer be sustainable. Instead, at least from a compensation and benefits perspective, we believe that the following things should be considered to make your systems more responsive to the structural changes: 1. Jobs need to be redefined. Tasks and duties need to give way to roles and levels of responsibility for results. This may seem like a fine difference, but in reality it is a major change. It means that we should no longer define five or six different descriptions of clerical work or five levels of maintenance work. Rather three or maybe four levels of work should be sufficient to define each level of responsibility within a specific job family. You have to ask, are there really that many different distinct levels of work, or have we created that many to reward long term employees or (for clerical work) distinguish between the clerical work done for a director versus clerical work done for a supervisor? Have we created more definitions of work and layers of supervision to become more efficient or to become more rewarded? In our experience, we think the latter is truer than we care to admit. Our experience with organizations that have simplified their classification structure is that their organization has operated much more smoothly because the employees have figured out that their job was to focus on their job and not on how to create another layer. When you have seven layers of supervision from the head of public works to the guy on the street filling potholes, you have an organization that has too many layers and therefore cannot be run efficiently. 2. Pay ranges should be broader than the typical 30 to 35 percent from minimum to maximum. To be honest, one of the reasons that we have so many levels of jobs (see number one above) is that employees have reached the top of their range and now we need to find a way to reward them with more pay, so we have created a new level with a new pay grade. If the ranges were broader we would not need to create these additional classifications. Many of the activities we engage in take up a lot of our time and energy. Is this what we were hired to do? Were we hired to write new job descriptions, act as a gatekeeper to those jobs and then throw up the red flag when someone crosses the line because they broke our rules? Or, were we hired to figure out a way to make sure that the employees were given the opportunity to PAGE GALLAGHER BENEFIT SERVICES, INC. ARTHUR J. GALLAGHER & CO. AJG.COM SEPTEMBER 2014.

4 apply their skills and get paid a fair wage for a fair days work? Are the HR guidelines allowing them to do that? Fewer salary ranges along with fewer job descriptions will be simpler to manage and allow you to focus on developing employee skills. 3. Pay for performance will need to become a reality. We have all heard the cry and the whine: you cannot create a fair pay for performance system in the government; it will all be based on favoritism, etc, etc. But here is the retort that will be coming from the elected officials and the citizens: We can only afford the best employees who are performing at the top levels of effectiveness. We can no longer defend the practice of across the board pay increases because the cost of living has increased. The fact of the matter is that 85 percent of the people employed in the United States (those in the private sector) do not get cost of living increases, step increases or any other regular increase. When private companies increase their salaries by 2.5 percent, that means their payroll costs are going up by 2.5 percent. That includes all salary costs: cost of living, and performance. Finally, there is ample evidence that other governments have successfully applied pay for performance systems to their employees. 4. Peg total compensation costs to the market. This will include a comparison of salaries, the cost of benefits, the cost of retirement benefits, and any postretirement health care costs in comparison to both public and private benchmark jobs. We can no longer compare only public salaries to public salaries without a comparison of the total cost of carrying an employee on the payroll. While the comparisons for some government jobs cannot, and should not be made because there is no comparison (e.g., police and fire), there are plenty of good comparisons in the private sector for human resources, accounting, customer service, maintenance, clerical, paralegal, social work, information technology and others to provide a reasonable comparison with the market. Likely, what we will find is that the total compensation package for public sector employees will be quite favorable at the lower and middle levels of the organization with the private sector, where most of the public sector employees are situated. 5. Institute total compensation statements. If you have not involved your employees in understanding the value of the total compensation received, including their salary, the value of the employer contribution to health care, retirement, time off, workers compensation, unemployment and all other benefits, you have only invited them to demand more. While they may not appreciate the amount of their total compensation package that you are providing them at first, they will come to understand that they may not be able to replace it in any other organization. Many have talked about the new economy, and many have tried to ignore its implications. But ignoring it did not make it go away and it did not get better. We are not quite sure what the new normal in compensation and benefits management will look like, but we do know that ignoring the signs is probably not the best answer. When the cost of personnel consumes about 60 to 70 percent of most government budgets, human resource directors are responsible for managing a substantial public asset. This asset walks out the door every day. To make the most of managing that asset, we should figure out how to manage the systems that manage those assets in the most effective and simplest way possible, so that we can focus on how to assure that they are as effective at their jobs as they can be. In our opinion, that starts by making our HR systems simpler and easier to manage. Fewer job descriptions and fewer salary ranges is simpler and easier to manage. PAGE GALLAGHER BENEFIT SERVICES, INC. ARTHUR J. GALLAGHER & CO. AJG.COM SEPTEMBER 2014.

5 About the Authors The Comp Doctor is the team of Jim Fox and Bruce Lawson of the Compensation Consulting Practice for the Human Resources & Compensation Consulting team of Arthur J. Gallagher & Co. Their practice helps organizations strengthen the performance of their organization with sustainable solutions for compensation, program design, employee engagement, executive compensation, HR audits, surveys, training and development, recruiting solutions and more. James C. Fox, Ph. D. Managing Director, Compensation Consulting Human Resources & Compensation Consulting Bruce G. Lawson Managing Director, Compensation Consulting Human Resources & Compensation Consulting Consulting and insurance brokerage services to be provided by Gallagher Benefit Services, Inc. and/or its affiliate Gallagher Benefit Services (Canada) Group Inc. Gallagher Benefit Services, Inc. is a licensed insurance agency that does business in California as Gallagher Benefit Services of California Insurance Services and in Massachusetts as Gallagher Benefit Insurance Services. Neither Arthur J. Gallagher & Co., nor its affiliates provide accounting, legal, or tax advice. PAGE GALLAGHER BENEFIT SERVICES, INC. ARTHUR J. GALLAGHER & CO. AJG.COM SEPTEMBER 2014.