April 19, 2017
Mounting evidence that altering the price cap is not the answer
We believe the last thing the U.S. Postal Service needs to fix its current predicament is price increases above inflation brought on by removal of the current CPI price cap system. The price cap is the closest thing USPS has to the discipline that all private sector organizations face every day.
We are not saying that everything is hunky dory at the Postal Service. We are saying that it is facing a sea change that threatens its relevance and sustainability. Its biggest problem is the loss of customers and volume. Raising rates faster than inflation will only hasten those trends and lead to a crisis.
Instead, we and others have recommended a multi-pronged strategic approach to a long-tern structural problem. Our recommendations are:
There is no immediate liquidity crisis. Above-inflation rice increases seem like a quick, easy way out to some. They will only exacerbate the largest threat to USPS sustainability—loss of customers and volume. And price increases will remove the main incentive USPS has to make and implement the tough decisions that are needed.
Below we provide excerpts from expert testimony provided in the current rate review process.
USPS should not be analyzed as a private sector business
The Financial Condition of the Postal Service Should Not Be Undersold: The PRC’s Financial Ratio Analysis is Misplaced
As discussed above, the Commission’s review occurs against a backdrop of a Postal Service that is, by many objective measures, improving its performance. As it conducts its review, the PRC should ensure that it is properly considering the state of the Postal Service as it evolves. The PRC should also realize the limits of some metrics that might otherwise appear useful: The Postal Service is not a business, does not have a profit motive, and should be evaluated through a lens that recognizes it is ultimately an instrumentality of the U.S. Government.
The PRC, in part, uses standard financial ratio analysis to analyze the financial wellbeing of the Postal Service:
“The Commission’s Financial Analysis report uses “ratio analysis” to measure the profitability, solvency, and financial stability of the Postal Service. As detailed in the Commission’s Financial Analysis reports, ratio analysis is used to conduct a quantitative analysis of information in a financial statement. Ratios are calculated from current fiscal year numbers and are then compared with previous years and historic averages to determine the Postal Service’s financial performance. The ratios explain the Postal Service’s financial health and provide valuable insight into its past performance. The financial data used in the ratio analysis is derived from accounting information not adjusted for inflation, changing demographics, industry dynamics, or government regulations.”
Based in part on these analyses, the PRC often finds the Postal Service to be in difficult financial conditions.
We caution against the use of ratio analysis to analyze the financial well-being of the Postal Service, for the very same reasons that Chairman Taub, himself, recognizes: financial analysis used in the private sector may not be directly relevant to government agencies because revenue streams, equity structures, and management incentives differ.
Postal Service revenue streams, for example, are in fact different from those in the private sector, since revenues for products paid for through meters and stamps are often received well in advance of when the costs for the products are expended. Equity structures may be very different. Consider this:
Finally, unlike any private sector entity, the Postal Service is backed by the U.S. Government. As a result, while there may be political consequences, there is no immediate penalty associated with the failure to fund some of the Postal Service’s larger obligations. This is something the Postal Service understands:
“Disruption of the mail would cause undue hardship to businesses and consumers, and in the event of a cash shortfall, the U.S. government would likely prevent the Postal Service from significantly curtailing or ceasing operations.”
Enjoying the comfort of knowing their operations will continue no matter what makes the Postal Service decidedly different than the private sector. Thus, traditional financial metrics comparing the Postal Service with private entities are not the most appropriate.
USPS does not make decisions like a business
Declaration of Halstein Stralberg:
The purpose of this declaration is to demonstrate that the Postal Service’s decision to pursue its failed Flats Sequencing System (FSS) program despite questions and concerns raised by the flats mailing industry, rather than fully embracing comailing, has caused USPS costs of Periodicals and Standard Mail flats to be inefficiently high. Even now the Postal Service could substantially reduce the combined costs of Periodicals processing by phasing out the failed FSS program and properly encouraging mailer worksharing…
Based upon the above, the Commission should (1) retain the price cap in its current form to ensure that mailers of flats are not unfairly punished for the Postal Service’s FSS mistake; and (2) encourage the Postal Service to abandon the disastrous FSS deployment (not just tinker around the edges) and begin passing through 100 percent of workshare cost avoidances to spur increases in comailing.
The FSS program was a mistake from the start. Ending it can reduce flats costs significantly
The Postal Service, when deploying the FSS machines and designating some 5-digit zones for FSS processing, generally picked the zones with highest density and the highest degree of carrier route presortation. The Postal Service took, in other words, the most efficient portion of the flats mailstream and turned it into something much less efficient.
Far from reducing flats costs as the Postal Service had hoped, the FSS program has increased those costs significantly, and there is no evidence that the Postal Service knows a way forward to make the program produce real cost reductions. In fact, FSS productivity has been falling almost every year since the machines were deployed.
When the Postal Service initially promoted the FSS program and claimed it would lead to significant cost reductions, its cost reduction projections appear to have been based on several assumptions, that I and others in the flats industry questioned at the time, and which later events have shown to be invalid:
Because none of the above assumptions have turned out to be true, it appears extremely unlikely that the high expectations at the start of the FSS program will ever be realized.
Major labor cost pressures persist, as USPS pursues removal of price cap incentive to control costs
Within the Postal Service operating budget, as a labor-intensive enterprise, the primary cost driver is employee compensation.
In turn, USPS compensation costs include a substantial premium above the standard for comparable levels of work in the private sector of the economy. Long-documented in past analyses, my current evaluation of occupational wage data, benefit structures, and quit rates again demonstrates that USPS career Tier 1 employees continue to be compensated at levels well above market.
My review of occupational wage data also indicates that the lower levels of pay for USPS noncareer Tier 2 employees are much more closely aligned with comparable private sector wages, and would be competitive in the market as the rates for permanent positions. This conclusion is further supported by the Postal Service’s ability to fill approximately 130,000 positions at these Tier 2 wage rates, despite no job security, minimal benefits, and unfavorable schedules and working conditions for this cohort.
Going forward, the USPS could achieve multibillion dollar savings through strategies including: replacement of retiring Tier 1 workers with future career service hires on a pay schedule similar to the current Tier 2; restructuring compensation for incumbent Tier 1 employees (or, at a minimum, restraining future compensation growth); redesigning employee benefits and/or taking the high cost of USPS benefits into account when negotiating wages under a total compensation framework; and, expanding the use of noncareer service employees.
The scale of these potential savings from reducing the USPS compensation premium could fund substantial capital investment, postal rate relief, and/or balance sheet improvements, if any, determined to be warranted after a more complete valuation of existing real estate assets and Postal Service-specific retiree liabilities.
During the 2010-2013 round of collective bargaining, facing fiscal constraints and pressures, the Postal Service took partial steps in pursuing many of the strategies outlined above. In the NRLCA settlement that initiated the more recent round of bargaining, however, as well as subsequent arbitration awards in line with this pattern, the USPS has slowed – and in some cases reversed – its progress toward reducing its compensation premium.
In collective bargaining and interest arbitration, economic context matters. Past USPS negotiation history and arbitration award language demonstrates this reality, consistent with my experience over 25 years of involvement with public sector bargaining and arbitration nationally. Reasonable constraints on Postal Service revenues will provide a counterbalance against pressures to continue and increase the USPS compensation premium. Without such a counterweight, the incentives to negotiate toward the statutory goal of private sector comparability will be greatly diminished.
Well-funded retiree benefits at $338. 4 billion, and undervalued assets, mean USPS has decades to work on perfecting its balance sheet
USPS pension liabilities are comparatively very well-funded. The Postal Service funded ratio of pension assets to liabilities – 92.5% for FY2014 and 93.1% for FY2016 – is stronger than the equivalent ratios for the federal government, the great majority of state and local governments, and those private employers that still offer defined benefit plans. The USPS reported funded ratio is also well above the private sector standard for being considered at risk, and would be designated as “strong” for a state government according to the standards used by Standard & Poor’s.
Similarly, while most public employers have minimal or no prefunding for retiree healthcare, the Postal Service has already reserved approximately 50% of its projected long-term liability.
The Postal Service has achieved these strong prefunding levels despite the use of conservative actuarial assumptions, reflective of extraordinary constraints placed on its investment practices. It is remarkable that the USPS has achieved its current funding levels despite these limitations. If the Postal Service retiree benefit liabilities were calculated using a 7.0% discount rate (which is consistent with private sector practice, and at the low end of the range for public pension plans), aggregate USPS retiree benefit assets would already exceed projected liabilities.
The Postal Service also has reasonable opportunities to further reduce its retiree benefit liabilities, subject to legislative approval. Full integration with Medicare alone would substantially eliminate the USPS retiree healthcare unfunded liability, and additional savings may be achievable by using Postal Service-specific demographics for developing actuarial assumptions.
There is no near-term – or even intermediate-term – budget risk associated with USPS retiree benefit obligations. As of September 30, 2016, the Postal Service held an aggregate $338.4 billion in assets dedicated for these benefits. Even with no reforms, no legislative change, and no new employer contributions into these funds, the USPS assets already on hand are projected to be sufficient to pay for all retiree benefit costs for the next ten years – and to still leave an estimated $243.3 billion available as of September 30, 2027.
Because of this comparatively strong position, major funding increases are not required to address these balance sheet concerns. To the contrary, the Postal Service is already experiencing savings of approximately $4 billion annually in reduced contribution requirements for retiree healthcare in FY2017 based on the end of a frontloaded payment schedule that was not actuarially based. Going forward, additional reforms proposed by the Postal Service (such as Medicare integration) hold the potential to reduce these annual payments by approximately $5 billion more per year. Given that current projections anticipate sufficient benefit funding for decades ahead, these opportunities to reduce the liability should be given time to be fully pursued prior to increasing the USPS revenue requirement to address costs that may never materialize.
Beyond retiree benefit liabilities, the USPS balance sheet also understates the value of Postal Service real estate, now presented on a net book value basis rather than on a fair market value basis. OIG estimates and subsequent market trends strongly indicate that this accounting presentation understates the true economic value of these assets by over $70 billion, and potentially by as much as $100 billion. These assets provide an important and underrecognized long-term safety net relative to the Postal Service’s liabilities.
Any actions to address Postal Service balance sheet concerns should be grounded in an accurate understanding of the value of USPS assets and liabilities. Currently, however, the best available estimates of USPS real estate fair market value are based on 2012, broad market indicators, and Postal Service retiree benefit liabilities are not being calculated based on USPS-specific data and demographics.
Postage increases above inflation would have an immediate, negative impact on nonprofits and the people they serve
Use of direct mail — primarily nonprofit outgoing and first class return mail – is vital to our organization’s ability to disseminate important information, raise funds, and fulfill its charitable purpose. Direct mail generates more than 85 percent of DAV’s annual donations and more than 90 percent of its membership dues. In 2016, DAV spent nearly $12 million on standard postage, over $1 million on periodical postage, and nearly $8 million on first class postage stamps for return mail. It also spent approximately $200,000 on business reply envelope postage for return mail and generated more than $500,000 in additional first class return postage.
The need for DAV’s services, and the central role that direct mail plays in effectuating those services, is greater than ever. Our nation’s military continues to engage in conflicts globally, while our servicemen and women are increasingly surviving catastrophic injuries due to medical advances. DAV has therefore created new programs to help these veterans, such as transition services, career fairs and employment opportunities, winter/summer rehabilitation events, programs for children of ill, injured, and fallen veterans, and mobile service units that enable us to reach veterans in rural locations. These newer programs supplement DAV services that have existed for nearly a century, such as outreach and care for veterans with brain injuries.
Unfortunately, while the need for DAV’s services has grown, rising postal rates and challenging economic conditions have limited our reach and resources. Since 2013, the number of DAV donors has declined by approximately ten percent. Our net income is decreasing by an even greater rate, and rising nonprofit postal rates is a strong contributing factor to that decline. In short, DAV has been unable to maintain the mailing volume necessary to maintain its former levels of public support.
Removing the CPI cap and freeing the Postal Service to raise postal rates faster than inflation would devastate DAV’s ability to raise significant funding to support veterans and their families. Our operating budget depends almost exclusively on donations from the general public, and our ability to reach that public and ask for financial support depends predominantly on direct mail.
Price cap removal will kick out the anchor of the mailbox, Periodicals, reducing USPS relevance
Declaration of Jerry Faust, Time Inc.:
Prior to PAEA, the unit costs of Periodicals flats, as reported by the Postal Service’s costing system, increased almost every year by more than inflation despite greater worksharing by mailers and increased postal automation, both of which were expected to reduce costs. Under PRA’s cost-of-service pricing, the Postal Service was able to pass the ever-increasing costs on to mailers in the form of higher Periodicals rates. As a result, Periodicals rates had increased much more than inflation, while at the same time mailers were incurring higher non-postal costs in order to make flats easier for the Postal Service to transport, handle and deliver. Under PAEA, the above inflation rate increases have stopped, the Postal Service has more effectively controlled costs and, since 2009, Periodical cost increases have more or less stayed within the CPI-U limit. Nevertheless, Time Inc. believes there is more that the Postal Service can do to reduce costs for processing and delivering Periodical flats. For example, the Postal Service has the option to further incent carrier route presorted pieces to achieve more efficient and profitable mail in Periodicals.
As noted above, postage increases since 2006 have outstripped the cost increases for other inputs such as paper and print. In other words, Time Inc.’s suppliers of other inputs have been able to keep cost increases below the rate of inflation in response to financial pressures since that time. However, the one core cost that has increased annually during this period is postage. In 2006, postage represented 24% of Time Inc.’s total physical production cost. In 2011, postage was 29% of total production costs and in 2015 it was 38%.
Time Inc. has had to address a changing market and look for opportunities to reduce costs to stay competitive. Key revenue streams for Time Inc.’s print magazines – print advertising, newsstand copy sales, subscription circulation – have been declining since 2007. At the same time, Time Inc. has been negatively impacted by new postal rules and regulations. For instance, as a result of earlier Critical Entry Times (“CETs”) established by the Postal Service, all four of Time Inc.’s Weekly magazines moved up their editorial close schedule to ensure deliveries were made to the USPS processing facilities prior to the earlier CETs implemented in both FSS and non-FSS zones and minimize the increase in post-weekend in homes. Collapsing the editorial schedules has decreased the magazine’s ability to 5 cover news and events throughout the week in a print format, impacting the value of the product. Despite the editorial close schedule changes, the earlier CETs still pushed delivery of our Weekly magazines to later in the week; for example, approximately 22% of Sports Illustrated subscribers receive their magazines one day later now than their prior delivery day.
The requirement of the 250 lb. FSS Scheme pallet significantly increased pallet charges invoiced by the printers for our Weekly magazines as well as causing us to incur extra postage.
As a result of these financial pressures, since 2007, Time Inc. has closed eight magazine titles, sold twelve magazine titles, reduced issue frequency for seven magazine titles and cut circulation for five magazine titles to manage costs in a market of declining magazine print advertising and circulation revenues. Staff reductions have been a routine occurrence at Time Inc. to help offset declines in print related revenues. In fact, Time Inc. has lowered its cost base every year from 2011 – 2015 through staff reductions and lower print and paper costs.
Without the price cap, the Postal Service would likely return to the practice under the PRA of simply passing cost increases on to the mailers. If the USPS were allowed to increase its market-dominant rates substantially faster than inflation, Time Inc. would pursue additional magazine closures, circulation cuts, issue frequency reductions, conversions to digital only, and further headcount reductions. We estimate a postage rate increase of 5% above CPI would result in a 14% reduction in the number of periodical pieces mailed by Time Inc. (approximately 6 97MM pieces/yr.); CPI +10% would result in a 39% reduction in total mailed pieces is estimated (approximately 272MM pieces/yr).