The investment-related costs of moving to defined contribution from defined benefit plans in the public sector are small, according to a new study from the Mercatus Center at George Mason University.
As some states contemplate closing their defined benefit plans, one issue raised is whether the investment portfolio should be more conservative, which would require more funding from sponsors and taxpayers.
“Some support exists for the claim of investment-based transition costs: a closed plan would hold a safer, lower-yielding portfolio than a plan that remained open. But these differences are small and unimportant relative to the diminution of liabilities that would gradually take place as a DB plan were closed to new entrants,” the study concluded.
“There are differences in appropriate investment policies for open and closed plans, but they're nowhere near as big as people think,” author Andrew Biggs said in an interview. Mr. Biggs, a resident scholar at the American Enterprise Institute, analyzed optimal investment portfolios for open and closed plans, and found the investment allocations differed slightly between the two and those differences appeared slowly over time.
A bigger factor is risk, Mr. Biggs said. Both open and closed public pension funds “should be taking a lot less investment risk than they are taking. You want to fund them with benefits that have less market risk. There's some case for holding (stocks); there's no case for holding 70%. If pension plans invest as they should, and if they decide to close, it's not going to make much difference,” Mr. Biggs said.
