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Pension risk-transfers to insurance companies are peanuts compared with another brand of transfer still awaiting its big break: the pivot of a major public pension from defined benefit (DB) to defined contribution (DC).
And if the GM/Verizon-Prudential deals are peanuts at this carnival-convenient and delicious to some, absurdly overpriced to others-then the public DB-plan-to-401(k) swap is Whac-A-Mole. Strong unions and mobilized members can beat down most any politician or pension overhaul bill. But as reformers pop their heads in more frequently, isn’t it inevitable that, eventually, they start making it through?
At least one already has: showing remarkable foresight into its economic future, Michigan broke ground in 1997 by closing its state employee DB plan to new members. Revised future liability assumptions immediately boosted funded status from 91.5% to 109%. But the state quit paying its actuarial required contributions in 2002, and funded status now resides at 65.5%. Still, researchers estimate the reform shaved about $2 to $4 billion off the system’s current $5.4 billion shortfall.
In fact, Michigan legislators passed another potent reform bill last summer-which is apparently no easier the second time around. “We took on a really tough, ugly issue,” said Governor Rick Snyder, speaking at a town hall meeting two weeks after signing the bill into law. “A lot of people got really mad at me.” The legislation included a $150,000 earmark for an independent study of transitioning the state teachers’ hybrid DB/DC plan to pure DC. The estimated price tag: $4.5 billion over the first decade-and that’s assuming state employers paid required contributions in full, every year. New teachers in Michigan can still choose between hybrid and DC, although they won’t retire with guaranteed income streams like educators elsewhere in America-for now.
Pennsylvania, Florida, Washington State, Arizona, Kentucky, and Texas: bills or serious proposals to shut and swap open pension plans for DC schemes have appeared in legislatures in all of these states recently. None of them have come to pass yet, although more will surely pop up in the near future.
“As we’ve seen on the corporate side and now the public side, the transition from DB to DC is happening,” says Fredrik Axsater, State Street’s global head of defined contribution. The public plan segment is also growing at a faster pace than the DC market overall, according to data from financial research firm Cerulli. From 2006 to 2011, the public DC sector had a compound annual growth rate of 3.4%. Firm analysts expect further growth acceleration, hitting 6.7% for the 2012 to 2017 period.
Axsater backs this prediction. “The cost of DB plans is just so high from a plan sponsor standpoint,” he says. “It’s not surprising that last year global DC assets under management topped DB for the first time. The next step in this transition is figuring out how to make DC plans as powerful as possible for participants.”
State Street’s DC team has a three-step approach for the structuring of new and overhauled plans. First comes assessment: “What are the client’s needs? How can we take advantage of in-house expertise?” For answers, the firm might survey participants to better understand their needs and financial literacy. Second, program design: It’s here that clients and their hired guns hammer out the plan’s communication and investment infrastructures. Finally, implementation: communicate the imminent changes, follow-up with participants, and make regular reviews systematic.
Public plan sponsors tend to top their corporate peers at one-on-one interaction with participants, which Axsater says is fundamental to this last stage-and often to positive DC outcomes as a whole. Still, sitting down for a fireside pension chat with a Detroit schoolteacher (or, any Michigan state employee circa 1997) might turn into another Whac-A-Mole situation. But as the earmarked teacher plan study points out, DC and hybridized plans do offer advantages over DB structures: portability is one, as well as the option to have both an income stream and lump sum liquidity at retirement.
Corporate America reached a general consensus over the last couple of decades that DB plans were not broadly feasible in the long term, and has been following the glide path from DB to DC ever since. Public and private employers may well end up with the same retirement benefit target-DC plans with annuity wrappers, say-but the public path includes a nasty set of obstacles.
For some governments, formidable political barriers to reform and weak funded-status requirements have made feeding the DB beast vastly easier than taming it. But festering problems require bigger fixes. And thus, we see the recent spate of bills proposing wholesale shifts of massive retirement systems from DB to DC. But as Michigan’s governor learned, impoverished pensions can price themselves out of that option. A number of courts have ruled that quitting a DB plan does not mean quitting the promises it already made. Sooner or later, obligations must be paid.
Michigan couldn’t do that, and its pure DC plan failed. The mole lost another round, but not because of a mallet blow to its head. It had simply dug its hole so deep it could no longer get out.