Article published on Aug 8, 2006
By Raquel Pichardo
debate over replacing or supplementing public defined
benefit pension plans with defined contribution options
appears to be dying down. Some states still face the
possibility of change, but there appears to be little
enthusiasm in the wake of the unraveling of two high-profile
attempts in California and Colorado.
On the corporate pension side, companies continue to shut down or freeze traditional defined benefit plans. But the public arena is a different story.
Last year, the nation’s largest plan, the $210 billion California Public Employees Retirement System, staved off a push from Gov. Arnold Schwarzenegger to convert the state plans to defined contribution. Among the changes discussed between last year and this were a retirement structure that offered a voluntary defined contribution plan to supplement a reduced defined benefit plan and a mandatory hybrid plan for new employees. Both initiatives failed.
Meanwhile, the $34 billion Colorado Public Employees’ Retirement Association launched 2006 by implementing a DC plan as an alternative to the DB plan to state employees hired after January 1, 2006. The move passed legislature at the end of 2004 and was backed by Gov. Bill Owens, a Republican.
But a proposal by a Libertarian-backed group, FIX PERA, which called for all state employees to enroll in a DC plan was being looked at by legislators this year. In May, the group pulled its initiative after lawmakers approved a bill to close the system’s $11 billion unfunded liability.
“The experience in California may have resonated with other states,” says Keith Brainard, research director at the National Association of State Retirement Administrators. There are lessons to be learned from that failure. Namely, it is more difficult to generate savings by closing DB plans than one might expect, says Brainard. Second, it demonstrated the political strength of employees trying to save their plans.
During the peak of the California debate, the pension community was taking a serious look at converting plans, says Bill Atwood, executive director at the Illinois State Board of Investments. However, as that unraveled, systems around the country realized the threat to DB plans wasn’t as immediate as they might have expected.
Illinois Senator Bill Brady, a Republican, last year introduced a bill that would allow employees to opt in to a defined contribution plan. “It never went anywhere,” says Atwood.
Public defined benefit plans are often targeted for conversion because of low funding levels and Illinois is one of the worst in the country at 60%. But it was this very fact that made conversion even harder. Theoretically, if ISB converted entirely to defined contribution plans, the unfunded liability will come due, strapping the state, says Atwood. If the conversion is done gradually, cash flow into the plan will taper off, worsening the funding problem, he adds.
Most plans calculate liabilities and earnings by using a smoothing technique that averages the past three to five years of returns. Moving into 2006, the year 2000 drops off the calculations, thereby improving funding levels and relieving the pressure to abandon defined benefit plans. An improved equity market is one reason the push to switch plans has waned, says Hank Kim, executive director at the National Conference for Public Employees Retirement Systems.
But there will always be those who see DC plans as “a panacea for all the ills of the world,” he says. NCPERS supports DB plans. People shouldn’t feel like the threat of converting has disappeared, he says.
As part of his property tax and relief platform late last month, New Jersey Senator Jon Corzine discussed a “two-tiered system for pensions that respects prior commitments, but introduces changes like defined contribution plans for new employees and a change in the retirement age. If the idea takes root, a contentious debate could evolve, says Kim. Multiple calls to the Senator, a former Goldman Sachs executive, went unreturned.
In New York, John Faso, the Republican candidate for Governor running against incumbent Eliot Spitzer, has also shown interest in introducing a bill that would see new government workers signing up for a DC plan. The discussion is part of Faso’s property tax proposal. A DC plan would add predictability for municipalities having to funnel money into current systems and would be attractive to today’s mobile workforce, says a spokeswoman for Faso.
The $140 billion New York State Common Fund is 100% funded. There has never been an attempt that’s gained momentum to replace the fund, says a fund spokesman.
In Michigan, Representative Brian Palmer continues to support converting the Michigan Public School Employees Retirement System into a DC plan, though his chief of staff, Phil Browne admits “it’s a crap shoot.” In 2005, Palmer introduced a bill offering DC plans to new hires. It never made it to the Senate. If there is no action taken by the end of the year, Palmer will have to reintroduce the bill, says Browne.
Alaska was one of the only states in 2005 to eventually consent to a defined contribution plan, effective for employees hired after July 1, 2006, though the proposal was originally met with resistance. And the West Virginia State Teachers’ Retirement System went against the grain in the pension plan space as the once-closed defined benefit system reopened to new hires this year.
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