Things have changed.
Public defined contribution and deferred compensation plans - decidedly unsexy and fairly invisible only a few years ago - are edging into the spotlight.
More states are adding defined contribution plans, typically 401(a) plans, as an alternative to their established defined benefit plans. At the same time, 457 deferred compensation plans are attracting more assets and increased participation as plan sponsors add investment options and 401(k)-like features. Between 1991 and 1999, the most recent data available, assets in 457 plans more than tripled to $49 billion from $15 billion, according to surveys conducted by the National Association of Government Deferred Compensation Administrators, Lexington, Ky.
Public entities are adding employer matches to their 457 plans directly or by adopting 401(a) plans for employer contributions. Since the first match plan was started in Tennessee in 1996, a growing number of states and local governments have added them. In a study this year of match plans, NAGDCA found the number of states offering match plans grew to 11, from six in 1999.
This year, bills to add or at least study adding a defined contribution plan were entertained by at least 10 state legislatures
"More states are considering legislation in a more serious way this year than last year," said Randy Taylor, senior vice president of governmental markets with CitiStreet LLC, Quincy, Mass., a joint venture of State Street Global Advisors and Citibank
In most cases, the states enacted optional programs, which gave employees a choice between the defined benefit and the defined contribution plans. But at least one state, Michigan, closed its defined benefit plan to new hires, Mr. Taylor said.
Much of the political drive to add defined contribution plans for state employees comes as a growing number of defined benefit plans have become fully funded, thanks in part to the bull market of the 1990s. A frequently cited example is Florida's 401(a) plan, which is scheduled to be unveiled in 2002. Florida's plan is expected to be the largest state defined contribution plan in the nation.
"I think one of the reasons Florida can give a supplemental defined contribution plan to existing employees is because its defined benefit plan is fully funded," said Steve McElhaney, principal, William M. Mercer Co. Inc., New York. In situations where there's an unfunded liability "and employees are taking money out (to move it into a defined contribution plan), they could be taking money that might not be there."
Typically, states are setting up defined contribution plans for new employees. Many are starting off by offering the defined contribution plan to a smaller set of state employees and then expanding it to all public employees in the state. For example, the Ohio Legislature last year formed a defined contribution plan for teachers. In Illinois, the Legislature established a task force to study whether to add a statewide 401(a) plan for police officers. Currently, police officers have defined benefit and 457 plans offered by the cities. The task force's report will be presented to the Legislature in the fall.
However, some observers predict legislative activity may slow.
"There has not been the acceleration of activity we had expected," said Guy Patton, president of Fidelity Institutional Retirement Services Co., Boston. "When markets are down sharply, there is some concern with positively publicizing how you are giving people control over their investments and no safety net."
So far, there is no typical plan structure or investment strategy. This year, the Ohio Legislature passed a law giving new state employees a choice between Ohio's defined benefit plan, a new defined contribution plan and a combination plan. Under the combination plan, the employees' money goes into a defined contribution plan and the employers' money goes into a defined benefit plan that does not offer the same level of benefits as the existing defined benefit plan.
"The rationale there is some employees want to be able to participate in individual accounts but do not want to go away completely from something with a guarantee," Mr. McElhaney said. "It allows some sort of floor (the defined benefit portion) as a guarantee."
Another plan design that some states, including Colorado and Oregon, have adopted provides public employees a defined contribution account within the defined benefit plan, he said. Participants end up with the greater of the two benefits between the money in the defined contribution account and the annuity from the defined benefit plan.
"One of the problems with the choice between a defined benefit and a defined contribution plan is that some employees will do better under the defined benefit plan and others under the defined contribution plan," he said. "It is not always clear to employees which would be better."
Other states, like Florida, South Carolina and Ohio, are giving participants more than one opportunity to switch between the defined benefit and the defined contribution plans.
"It makes defined contribution programs more acceptable to a wider range of legislatures," CitiStreet's Mr. Taylor said.
The downside of giving participants the best of both worlds - or at least another opportunity to choose - is cost. Mr. McElhaney said that giving participants several opportunities to move their money makes it difficult to calculate the value of what is being moved between the defined benefit and defined contribution plans.
"If you allow a second or third or fourth choice, there's a potential that costs would always increase to funding in the long term. From an actuarial point of view, it is best to have employees make one choice now and wherever the chips fall, they fall," he said. "Politically, I don't think that is a viable solution."
States also are struggling with how to provide investments in these new plans.
Florida's defined contribution plan will have a third-party administrator that will not offer investment options. It also will have education, communication and advice providers; separate money managers; and, if they add value, one or more so-called "bundled" providers, which would manage money and offer some services.
While all eyes have been on Florida, observers are not sure the investment-only and bundled providers model will take hold in other states.
The Florida model "adds administrative complexity and ... an element of confusion for the employees by having a state plan and essentially a separate plan offered by bundled providers," Mr. Taylor said.
Matching plan growth
In the 457 plan world, by far the biggest development is the increase of matching plans, according to Fidelity's Mr. Patton.
"It has a tremendously positive impact on participation," he said. "That's consistent with broader defined contribution trends. The public sector is becoming more like corporate defined contribution plans."
After Missouri created a 401(a) with a fairly small employer match, participation grew to 80% from 20%.
"The development and expansion of matching contributions in 457 plans has been one of the most significant developments for state deferred compensation plans in the last decade," John K. Barry, Maryland's assistant attorney general, wrote in the introduction to NAGDCA's 2001 match plan survey. (Maryland added a 401(a) plan in 1999 and the participation rate increased 50%, to an estimated 85% of state employees.)
Match plans are cheap, costing between 1% and 3% of payroll, he wrote. And the employer has a great deal of discretion in how to construct the match.