Since it began its pension project in 2007, the Pew Charitable Trust has shed considerable light, and focused needed attention, on the funding challenges of public employee retirement systems.
In the past year it has extended that project, offering assistance to policymakers in states and municipalities seeking to reform their retirement system. For the outreach, it has teamed with the Laura and John Arnold Foundation, which also has its own area of interest and research in public-sector plan reform, with experts from both organizations consulting with policymakers.
Their involvement, as with any outside intervention, could provide valuable assistance so long as the assistance includes a framework for analyzing the issues in a comprehensive, evenhanded manner and presents choices that meet the resources of the entities as well as the needs of participants for a secure retirement income.
A framework for pension reform must have a balanced approach to be sustainable. It must be fair and involve all constituents in the makeover, including representatives of employees, employers and taxpayers. It must also provide transparency to assumptions, funding, benefits and conflicts of interest.
Pension legislation and regulation must address the stakes of all key constituencies, according to Keith Ambachtsheer, president of KPA Advisory Services Ltd., in his September report to clients. Otherwise, as he states, they should “not be permitted to come into force.”
One type of plan that legislators and public employee plan executives should examine is the cash balance plan, a variation on the defined benefit plan that shares the investment risk and rewards between sponsor and beneficiary, and thus addresses the stakes of key constituencies.
State and local retirement systems are grappling with a combined $1 trillion in unfunded obligations by their own measure and an estimated $3 trillion using assumptions used by academics, according to a July paper by Natalya Shnitser, associate research scholar in law and John R. Raben/Sullivan & Cromwell executive director of the Yale Law School Center for the Study of Corporate Law.
While some public plans are well funded, such as the State of Wisconsin Investment Board, New York State Common Retirement Fund and the Florida Retirement System, many are deeply underfunded in large part because of a failure to contribute the actuarially required amount each year to fund pension obligations.
Local government pension plans were funded an aggregate 69% in fiscal year 2012, down 11 percentage points from the previous year, according to a September report by Wilshire Associates Inc. of 106 county and city defined benefit plans.
Many plans are on a course that jeopardizes their sustainability. The crisis can either serve as a wake-up call for policymakers to embrace a well-rounded reform, or panic them to take sudden action that provides only a temporary fix or even worsens the situation, kicking the can of reform down the road, causing unfunded obligations to grow and making the pension promise of retirement income security more uncertain for participants.
The goal of any intervention should be to engineer pension reform that balances the needs of employees for retirement income with other demands on public-sector budgets for public services as well as the resources of the tax base.
But a reform that tilts to one constituency or set of constituencies — by shortchanging other public services, or putting in danger the state or local economy because of unaffordable tax demands, or placing unanticipated assistance burdens on public budgets due to a reform that generates insufficient retirement income — will eventually unravel, forcing a call to undo the reform and return to the drawing board to fix the damage.
Pew doesn't prescribe solutions but seeks to frame issues, present choices and provide resources to assist policymakers to make decisions to best fit their situation, including risks, means and politics. Policymakers considering reform should also considering mining objective resources such as the Employee Benefit Research Institute.
Reform should begin with the recognition there is no single answer or plan, whether DB or DC.
The nature of defined benefit plans, while they provide in the ideal retirement security promised by employers, are complex to fund and understand, while they are vulnerable to manipulation on both the benefit and funding sides.
The impulse of legislators to boost benefits without balancing that generosity with actuarially sound funding is at the root of much of the cause of the mounting unfunded obligations.
Replacing defined benefit plans with defined contribution plans, while it might serve some sponsors of public pension plans, can seem an uneven trade-off by reducing costs in favor of taxpayers and public budgets, while exposing participants to all the investment risk and the uncertainty of building an adequate retirement income.
One solution corporations and some public funds have adopted in recent years is a cash balance plan — a defined benefit plan that contains features of a defined contribution plan.
Some 36% of private-sector defined benefit participants were in cash balance plans as of 2010, according to the Department of Labor's Bureau of Labor Statistics. That's up from 25% in 2005.
The plans provide a shared risk for employer and employee. The plans are funded by an accumulation of benefits, based on employer contributions. They provide a minimum benefit often based on years of service and not dependent on market returns, as well as sharing a part of the return generated by the investment of the pension fund assets.
Their funding requirement is more certain, eliminating much of the actuarial complications that lead legislators to put off full funding of pension contributions. Employers rather than participants oversee investments, enabling economies of scale and more diverse professional management. Depending on the generosity of the pension formula, the minimum benefit often is generally less than that promised by a traditional defined benefit plan, favoring interests of taxpayers. But participants have the opportunity to earn more, depending on the investment return generated by the assets. In addition, like a traditional defined benefit plan, the Pension Benefit Guaranty Corp. protects benefits of a cash balance plan.
On the other hand, research in June by Jack VanDerhei, EBRI's research director, found voluntary enrollment 401(k) plans provide a stronger outcome advantage over traditional defined benefit or cash balance plans.
Reform depends in large part on the willingness of legislators to properly fund public-sector pension benefits, which are outside federal funding requirements imposed on private-sector plan sponsors. The less the discipline, the more reform might have to tilt to defined contribution-type plans. A more responsible commitment could lead to keeping and strengthening traditional defined plans, demonstrating they can thrive in a dynamic economy. n
This article originally appeared in the September 30, 2013 print issue as, "Promoting pension reform".