Other states might follow Oregon’s DC trail

State governments with fiscal problems are looking at public defined contribution plans as a possible alternative to costly and underfunded defined benefit plans.

The state of Oregon recently passed a sweeping reform of its public employees pension plan, with a defined contribution plan as the centerpiece of its new system.

Cost was the reason behind the formation Jan. 1 of the Oregon Public Service Retirement Plan, a hybrid defined benefit-defined contribution plan for employees hired after Aug. 29, 2003. The new plan has a DB component much smaller than the $33 billion Oregon Public Employees Retirement System, Salem. The DC component is the main element of the new plan, with all employees, not just new hires, participating in it. The $606 million 457 plan of Oregon PERS is frozen to new employees.

Oregon PERS had a $16.43 billion funding shortfall as of April 2003 (Pensions & Investments, April 14, 2003). There were also structural problems with the pension fund, according to Mary Ellen Glynn, spokeswoman for Oregon Gov. Ted Kulongoski. "It was a real mess," she said.

Ms. Glynn said the guaranteed benefit from Oregon PERS' defined benefit formula, which was very large, "worked well in the 1990s when the markets were doing well, but did not work well during the markets' downturn." That is what led to the huge funding shortfall. The new pension plan has a lower formula for the defined benefit portion - 1.8 % times the final average salary and years of service for police and firefighters and 1.5% times the average final salary and years of service for other public employees, according to the fund's website.

Ms. Glynn also said that several lawsuits have been filed against the new plan. The suits claim the law creating the new fund is illegal because the old law established a contract with state employees that can't be changed. "Obviously, we disagree with that," said Ms. Glynn.

"It will be interesting to see if other states adopt (the new Oregon plan)," said Randy Taylor, senior vice president of CitiStreet, North Quincy, Mass., which was selected as the provider for the defined contribution part of the new plan. "Oregon had budget issues," he added.

Earlier this year, legislators in Virginia introduced a bill to create a new defined contribution plan for public employees, but abandoned it after the expected cost savings proved elusive.

A bill creating a plan was introduced on Jan. 14 in the House of Representatives. But according to Jeannie Chenault, director of public relations for the Virginia Retirement System, Richmond, a fiscal impact statement indicated that besides high setup costs, the existing retirement system would need higher contributions to cover workers remaining in its defined benefit plan. The bill was tabled Feb. 9 and no further action is expected.

Overall, government 457 plans in this year's P&I survey accounted for more than half of the nearly $100 billion in total assets of the nation's 50 largest public defined contribution and deferred compensation plans.

Click here for table of top 50 public defined contribution plans or click here for profiles of the top 50 public defined contribution plans

Coming in a distant second to the 457 plans' $53 billion were 401(k) plans, with about $13.4 billion in assets. In third place were 403(b) plans with about $11.2 billion in assets, but most of that was from the $9.8 billion New York City Teachers' Retirement System, according to statistics compiled by P&I.

The 401(a) plan, which is increasing in popularity, accounts for $10.3 billion in assets among the top 50.

The three largest funds held the same rankings as last year. The Texas Municipal Retirement System, Austin, is the largest, a money purchase plan with $10.25 billion; the New York City Teachers' plan is second, with $9.84 billion; and the New York State Deferred Compensation Plan Albany, is third, with $5.66 billion.

The New York City Deferred Compensation Plan, New York, climbed to fourth place from sixth last year, with $4.88 billion in assets, while the Washington State Investment Board, Olympia, rose to fifth from seventh last year, with $4.68 billion in assets.

Dropping out of the top five were the California State Savings Plus Program, Sacramento, ranking sixth with $4.65 billion versus fourth place a year earlier, and the Ohio Public Employees' Deferred Compensation Program, Columbus, in seventh place this year with $4.55 billion versus fifth place in last year's survey.

The top five plans in this year's survey grew more than 16.5%, to a combined $35.3 billion in assets. The same five plans last year had $30.3 billion. Assets of the top 50 overall hit $99.7 billion, a 31% increase from the $75.8 billion a year earlier.

Several large public defined contribution plans were not included in the list last year, which accounts for some of the growth. They include the $2.7 billion 401(a) plan of the Indiana State Teachers' Retirement Fund, Indianapolis; the $2.3 billion 401(k) plan of the North Carolina Supplemental Retirement Income Plan, Raleigh; the $1.69 billion South Carolina Deferred Compensation Commission, Columbia; and the $1.58 billion City of Los Angeles Deferred Compensation Plan.

The deferred compensation plans account for so much of the assets because many of those plans have been around for decades. In contrast, most of the public defined contribution plans, especially 401(a) plans, were formed only during the past 10 years.

"Alternative defined contribution plans had come about because people wanted to invest their own money," said Wendy L. Young, principal with Mercer Investment Consulting, New York. "Now, the costs of defined benefit plans is motivating the formation of public defined contribution plans," she added, because state and local governments are looking for ways to save money.

The public defined contribution plans are not untouched by the recent mutual fund scandals. Many are taking a careful look at providers and fund families implicated in the scandal.

"The mutual fund scandals have raised people's awareness of market timing and the fact that some of their participants are doing it as well," said Ms. Young.

"The public (DC) plans, particularly the larger plans, have been very responsible with their analysis of the fund complexes that have been involved in the market-timing scandal," said Bob Francis, president of workplace distribution for ING US Financial Services, Washington.

"The fund committees have been very good with their due diligence and have acted decisively on some of these issues," he added.

"As a result of the mutual fund scandals you're seeing more funds scrutinize their investments; more are questioning the investments in their portfolios," said Rob McCallum, director of media relations for Great-West Retirement Plan Services, Greenwood Village, Colo.

Public defined contribution funds that have changed investment options in the last year include:

-- The Phoenix City Deferred Compensation Trust, which completely overhauled investments in its $506 million plan because a review hadn't been done in many years;

-- The $509 million Arizona Deferred Compensation Plan, Phoenix, which added the three new funds and dropped six funds from its investment lineup as part of its yearly investment review;

-- The $828 million Colorado Public Employees' Retirement Association, Denver, which added several new funds and terminated others because of the market-timing scandal; and

-- The $489 million Louisiana Public Employee Deferred Compensation Plan, Baton Rouge, which added several new funds and dropped several others because of the market-timing scandal.

There has also been an increase in searches for providers, with more RFPs issued, according to CitiStreet's Mr. Taylor, not only because of the mutual fund scandals but because "many plans have not been out in the market for many years. Plans that have been with a provider for many years are now in the marketplace looking at what is available for them. Some are coming out with RFPs."

Mr. Taylor mentioned the $1.6 billion South Carolina Deferred Defined Contribution Plans, which recent selected Citistreet as its provider, and the $1.7 billion City of Chicago Deferred Compensation Plan, which is in the midst of a search. He also said that the Missouri State Employees Deferred Compensation Commission, Jefferson City, is getting ready to search for a new administrator for its plan.

The Missouri commission, which manages more than $1 billion in assets for the state's three deferred compensation plans, is searching for a new consultant; after the consultant is hired, the commission expects to search for a third-party administrator, according to Alan Scott, employee benefits manager. The current administrator is PEBSCO, a subsidiary of Nationwide, the largest U.S. third-party administration of 457 plans, he said. The fund is looking because "we've had this one for a long time and the market has changed quite a bit. But we're not dissatisfied with PEBSCO," which will be allowed to rebid.

The North Carolina Supplemental Plan — "the largest public 401(k) plan in the country," according to Michael Williamson, benefits manager — selected Prudential Retirement Plan Services, Newark, N.J., to be its new provider last year. The previous provider was Branch Bank & Trust Co., a local North Carolina bank. It also changed all of its mutual fund offerings. The plan had the same providers and mutual fund offerings since its inception 18 years ago, and executives wanted more up-to-date investment and provider services, he said.

CitiStreet's Mr. Taylor also said there is more interest in investment advice for public DC funds. CitiStreet partners with Financial Engines, Palo Alto, Calif., to provide investment advice to plan participants.

"We're seeing RFPs that ask for how a firm provides investment advice to plan participants," Mr. Taylor said.

Public defined contribution plans are also "waiting to see what will happen with the SEC rules on a 4 p.m. close for mutual fund trading," said Regina Hilbert, president of the National Association of Government Defined Contribution Administrators, Washington.

She said defined contribution plans that deal with intermediaries and third-party administrators for their trading "want to see if the new rule will hurt us if they go to a hard close."

Ms. Hilbert said public defined contribution plans are also concerned about how federal proposals for new types of retirement savings accounts will affect their plans.

She noted that starting in 2004, public deferred compensation plans will be allowed to make loans to participants, just as corporate 401(k) plans have been able to do. The change was one of the provisions in the Economic Growth & Tax Recovery and Reconciliation Act of 2001.

The information for this survey was collected from questionnaires and phone calls to public plan executives. Most data are as of Sept. 30, 2003.