COUNTERPOINT: MISTAKEN RUSH TO CHANGE PUBLIC PLANS TO DC
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June 09, 1997 01:00 AM

COUNTERPOINT: MISTAKEN RUSH TO CHANGE PUBLIC PLANS TO DC

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    Douglas B. Roberts, Michigan state treasurer, and Matthew J. Hanley, treasury legislative specialist, present a very one-sided and myopic view of the merits of defined contribution plans vs. defined benefit plans in the public sector.

    Certainly defined contribution plans have many advantages, but they also have some serious disadvantages that Mr. Roberts and Mr. Hanley, in their March 31 Others' View commentary, "Defined contribution 'right' for public plans," failed to include in their endorsement of defined contribution plans for public employees.

    We would dispute their implication that defined contribution plans will satisfy the needs of every public jurisdiction.

    Lost focus

    Cookie-cutter approaches to retirement plan design just don't work - the variety of circumstances, problems and needs of each jurisdiction require a diversity of benefit solutions.

    To suggest imposing one type of plan universally is counter to the fiduciary duties of those responsible for the plan. All fiduciaries are required to act solely in the best interests of the participants and beneficiaries of the plan. Legally, the concern of all fiduciaries should be for plan members and beneficiaries when making plan decisions. Practically, plan design will have a collateral impact on taxpayers - cutting costs in the short term through adoption of a defined contribution plan might result in personnel fallout, which works to the disadvantage of the taxpayers from a customer service perspective.

    In response to tough questions from attendees of the National Conference on Public Employee Retirement Systems' legislative meeting, Mr. Roberts stated that the move to a defined contribution plan only happened because it was accomplished during the midnight session of a lame duck legislature. Such statements cause us to wonder whether appropriate planning was done prior to embarking upon such a serious change that will affect the lives and the retirement security of Michigan public employees.

    The cornerstone for assessing the merits of various types of pension plans should be the human resources objectives of the sponsoring jurisdiction as expressed in its retirement policy. These objectives generally deal with the recruitment and retention of staff.

    Perhaps, the jurisdiction values younger workers who will stay for short periods of time and therefore wants a retirement plan that emphasizes portability and a savings component. High training costs might cause a jurisdiction to make retention of staff a high priority that could be facilitated through a retirement plan that rewards career service. The retirement plan might be seen as a way to allow career employees to leave the employer's service without financial hardship.

    Of course, current plan demographics must also be considered when evaluating new plan designs.

    Erroneous assumptions

    The commentary made several assumptions that are contradictory to sound retirement policy. While the balance of this response rebutes these errors, this is done in the name of clarity, accuracy and fairness, not in defense of defined benefit plans for all public employees. As stated above, plan design is a decision that should be made by each jurisdiction in terms of the objectives of their personnel policy.

    Investment decisions

    The commentary criticizes the investment decision process by the boards of public sector defined benefit plans, implying the boards operate in a very closed environment. Nothing could be further from the truth. Many members of public pension plan boards are elected by the participants and retirees of the plan itself. Unlike the situation at the state level in Michigan, most public pension fund boards answer to popularly elected bodies such as the state legislature or city council, and ultimately, to the taxpayers.

    These plans receive additional and vigorous scrutiny from local media and from interested taxpayers. Further, the potential for government control of private companies is minimal.

    Public pension funds own about 6% of all stock in U.S. companies, about one-third as much as private pension funds and half as much as mutual funds. Shifting to defined contribution plans would increase the power of mutual fund managers to control corporate America.

    Finally, decentralizing investment decisions was portrayed as beneficial in order to more closely reflect the social opinions of the participants. The purpose of a pension fund is to provide retirement income - not to provide a mechanism for demonstrating the social opinions of the members to corporate America. Many pension participants have other individual investments with which they can reflect their social opinions.

    An advantage of defined benefit plans is pooling investments to achieve superior returns and efficient fee structures through professional managers. The prudent person standard for investing that requires fiduciaries to work for the most efficient combination of risk and return automatically limits consideration of social objectives.

    Investment risk

    In a defined contribution plan, market volatility means workers who retire when the market is up will have a higher pension than those who retire when it is down. The authors chose to place the financial burdens of poor investment performance and increased longevity on the participants they claim to represent, rather than potentially increasing the unfunded liability of a defined benefit plan. These financial burdens would increase the possibility that defined contribution plan participants would outlive their benefits and force them onto government welfare rolls in their old age -resulting in a detrimental effect on taxpayers.

    The commentary did not address what steps Michigan is taking to educate its participants so they have a reasonable opportunity to replicate the final benefit provided in a defined benefit plan.

    Transferring investment risk is more palatable during an up market as we have experienced over the past few years. These participants will be greatly challenged in any forthcoming down market. From a policy standpoint, what is the long-term effect of totally transferring investment risk to the average public employee who is not trained or educated to handle such an awesome responsibility? The result likely will be future demands for additional benefit programs to supplement inadequate retirement income.

    More than just investment risk during employment, participants will now be exposed to increased risk when they separate from employment. Michigan participants will need to be educated on the use of lump-sum distributions that they will begin to receive upon separation from service.

    Studies have shown more than 50% of lump-sum distributions are used for immediate purchases rather than remaining in long-term savings. Such dilution of long-term savings could result in a depletion of their retirement savings after only a short time in retirement. Taxpayers ultimately might bear a larger cost for these individuals in retirement than had the defined benefit plan remained in place.

    Benefit increases

    In both a defined benefit plan and a defined contribution plan, benefit increases must be accounted for in current contributions to the plan. Each year, defined benefit plans must evaluate their financial status and set contributions to match the determined funding policy. It is the responsibility of the plan actuaries to determine contribution levels that will ensure a benefit increase today could not, as the commentary asserts, remain as a wholly unfunded liability for years.

    Personnel policies

    Increased turnover rates form the basis for much of the remaining arguments. No study or empirical evidence is used to support this assumption except that employee turnover is expected to increase in the future. In fact, several public retirement systems are experiencing a significant drop in turnover rates. Carrying the authors' argument to the logical conclusion, employees should job-hop to create a more efficient economy. Being in a constant state of training, however, does not increase work force efficiency. Jurisdictions, as employers, need to determine the level of turnover they can sustain while maintaining a trained work force at a competitive cost, including the costs of training, pension and other benefits.

    In addition, we wonder whether consideration was given to other types of plan design changes that could accommodate a more mobile population. Most jurisdictions offer their employees a defined benefit plan and a defined contribution supplement, allowing employees the opportunity to individually save and invest. Several plans have combined various features of both defined benefit and defined contribution plans to create hybrid plans. Other plans have increased portability by increasing distribution options and by allowing additional purchases of service credits.

    The validity of Michigan's decision to convert to a defined contribution plan will be judged in the future - after taxpayers and employees have had a chance to review and experience the impacts, an opportunity they were denied prior to its passage. Each jurisdiction will need to evaluate the merits of defined benefit and defined contribution plans in view of their own personnel policies, demographics, finances and retirement policy. Public servants along with other taxpayers deserve a more comprehensive evaluation than that provided by Messrs. Roberts and Hanley.

    Marsha Richter

    Chief executive officer

    Los Angeles County

    Employees Retirement Association

    Los Angeles

    This counterpoint also represents the collective response of the following systems' administrators and does not necessarily represent the official policy position of these systems' boards:

    Retirement Systems of Alabama, Arkansas Local Police and Fire Retirement System, Colorado Public Employees' Retirement Association, Contra Costa County Employees' Retirement Association, Employees' Retirement System of Georgia, Houston Firemen's Relief and Retirement Fund, Illinois Municipal Retirement Fund, State Retirement Systems of Illinois, Louisiana State Employees' Retirement System, Missouri State Employees' Retirement System, Public Employees' Retirement System of Nevada, New Hampshire Retirement System, New Mexico Public Employees Retirement Association, School Employees Retirement System of Ohio, State Teachers Retirement System of Ohio, Pennsylvania Public School Employee Retirement Systems, Texas Municipal Retirement System, Texas County and District Retirement System, and Utah Retirement Systems.

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