Officials in nearly every state are considering implementing shared-risk public pension plan designs that help mitigate funded status volatility and investment and longevity risks.
Such a move is seen as an alternative to drastic benefit freezes or cuts legislatures have imposed on struggling public plans since the financial crisis, and as a way to defuse criticism of public defined benefit plans in general.
While public plan participants have long been required to contribute to their defined benefit plans, in most cases, employers have assumed all or most of the investment risk.
Sharing that risk “was sort of an abstract concept until the recession,” said David Kausch, chief actuary with actuarial firm Gabriel, Roeder, Smith & Co. in Southfield, Mich., which specializes in state and local government plans. Now, he says, “there's definitely a big movement to share more risk. Employers are not able or willing to pick up all the costs anymore.”
Shared-risk plan design allows sponsors to change employee contributions, benefits, or some combination of the two, when the plan's financial condition is affected by market downturns, longevity changes or inflation.
In the private sector, particularly with multiple employers, interest in the variable benefit, or adjustable pension plan, idea is growing among sponsors like Consumers Union and the $3.7 billion Sheet Metal Workers' National Pension Fund, Fairfax, Va., which in 2013 adopted an approach that ties benefits to the pension fund's returns. Other variations promoted by actuarial firms, particularly for struggling multiemployer plans, call for different accrual and benefit formulas, but in general allow for sharing of investment risk through benefit adjustments.
In the public arena, “sponsors are moving away from pure defined benefit to more employee risk for contributions or benefits,” said Keith Brainard, Georgetown, Texas-based research director for the National Association of State Retirement Administrators.
“It's being done or looked at in virtually every state,” said Dana Bilyeu, NASRA's Portland, Ore. -based executive director.
The poster child in the U.S. for a shared-risk approach is the $95.4 billion Wisconsin Retirement System, Madison, which was designed from the start in 1982 to adjust employee contribution rates and reduce or eliminate retirees' annuity increases as needed. The system, one of the best-funded in the country, is 99.9% funded as of Dec. 31, 2013, according to spokesman Mark Lamkins at a time when most large public plans are below the generally accepted level of 80%. The first annuity increases in five years came this spring, following $4 billion in cuts since 2008.
Moving to a shared-risk approach also takes politics out of the equation, with officials knowing beforehand what funding levels dictate which actions.
“You don't want to overreact in a politically sensitive environment,” said Mr. Kausch of Gabriel, Roeder. He said he thinks shared risk can go a long way to preserving DB plans, but he cautioned that such designs can't help plans with severe funding problems.
An upcoming issue brief from NASRA will examine both formal and de facto risk-sharing approaches taken by public pension systems.