Gov. Arnold Schwarzenegger's charisma might induce California voters to adopt his proposal to move new public employees to a defined contribution plan and end, through attrition, public defined benefit plans in the state.
But no decision on such a dramatic move should be made without thorough study and discussion. The taxpayers and legislators need to examine the ramifications of his proposal from all perspectives.
Yes, defined contribution plans may appear to be less expensive than defined benefit plans, but if they provide equivalent benefits, are they?
Yes, defined contributions plans reduce the volatility of the contribution stream, but do they not, in effect, pass it on to the employees?
There is nothing charismatic about pension issues, except maybe when the "governator" is talking about action on them. Will his proposal really improve public employee benefit security and control taxpayer cost? Is his move revenge for corporate governance activism by the California Public Employees' Retirement System?
In the short run, the move would cost the state more money to operate two systems, defined contribution and defined benefit plans, until the DB plan dies out. In the long run, it's not certain the change will save contribution costs.
Mr. Schwarzenegger complains the state's contributions have soared in four years to $2.6 billion from $160 million. That rise is cause for concern, but it was caused in part by stock and bond market developments, and possibly by past funding decisions. Nearly all pension systems, public and corporate, have faced huge run-ups in contributions in recent years because of unfavorable markets.
Because defined benefit plan sponsors bear the risk, contributions increase as funding declines. With defined contribution plans, participants bear the risk and would see their relative account positions fall, too, but without anyone to increase funding.
Public systems across the country are facing pressure over their DB plans. When more and more companies, especially in California's economic engine of Silicon Valley, have only DC plans, the cost of DB plans for public employees becomes harder to defend.
CalPERS, however, is one of the best-funded state systems. Another California fund, the California State Teachers' Retirement System, is also relatively well funded, according to a 2003 study of state systems by Wilshire Associates Inc., Santa Monica, Calif. A 2004 study, by Cost Effectiveness Measurement Inc., Toronto, found CalPERS added more value to its investment portfolio at less risk and at a lower cost than other large public pension funds.
The governor's proposal would affect all public defined benefit plans in the state, many of which may not be well funded. For some of those cities and counties, switching to DC plans might make sense. California is a powerful trendsetter; its move from defined benefit plans could cause other states to drop their DB coverage. In some states, where the politicians haven't adequately funded the program, ending DB plans would be a salve.
But maybe moving to a cash balance plan rather than a DC plan would better serve California. For example, it would greatly reduce the contribution volatility problem.
As for the suggestion that the proposal is a swipe at pension fund shareholder activism, there should be more public debate about corporate governance activities. Any move to a DC plan should quantify the impact of the loss of the so-called CalPERS effect on corporate performance. A Wilshire study shows CalPERS' involvement in corporate governance significantly improved the shareholder return of companies on its focus list.
CalPERS' activism has gone over the top on occasion, such as its ill-considered campaign against Coca-Cola Co. directors last year, but such errant actions should not condemn the entire system.
If corporations are provoking the governor to kill the activist CalPERS they could regret it in the long run. The Securities and Exchange Commission has said investment managers have to become more active in corporate governance.
California public officials should resolve the DB vs. DC issue this year, after promoting serious study and debate. Mr. Schwarzenegger still has to provide his details and make his case; the public employee DB plans and their legislative allies, in turn, have to defend their status quo.
