Pension Reform

Converting Pension Plans from Defined Benefit to Defined Contribution: The Myths and the Messaging Part 1

The Notion of Transition Costs is a Myth

Welcome to part one in a series on how to successfully explain the conversion of public pension plans from defined benefit (DB) to defined contribution (DC) to legislators and the public. This insight is based largely off my experience in navigating the long-anticipated adoption of the plan developed a decade earlier to convert the Oklahoma Public Employees Retirement System (OPERS) by providing only a DC option for new members.

Unfortunately, the actuarial “experts” controlling the discussion in most committee conference rooms are not “unbiased subject matter experts.” Bias is unavoidable thanks to the substantial fees earned by actuaries consulting for DB plans; these fees would be nearly nonexistent under DC plans for the simple reason that these actuarial services would no longer be needed. In addition, many of these actuaries relied upon as “expert” witnesses have little to no experience with the actual DB to DC conversion process. Regardless, actuarial “cost” warnings are disseminated through the media and accepted as common truth by the general public. Plan participants likewise become extremely distressed by these “costs” to their retirement system. These two important facts regarding actuarial experts must be brought to light at the beginning of the messaging process.

So what exactly is the “transition cost?” DB plans routinely take advantage of employees who cease employment prior to pension benefits vesting. Their employer contribution was included as part of their total compensation package and was on every W-2 they received while working for the DB plan sponsor. Their hard-earned dollars remain in the pension fund for the benefit of others. The vast majority of the transition costs estimated by actuaries stems from no longer being able to count on this massive forfeiture of wealth. Actuaries will readily admit that an increase in employer contributions would be required if vesting requirements in DB plans were to be curtailed. Attempting to escape these “costs” is simply an attempt to continue diverting money from the future retirements of those non-vesting members.

Regardless of legalities, think about the impact each year of confiscating these funds from a new parent who decides to stay home with his child, a person who becomes seriously ill but is not considered permanently disabled, or a person choosing to care for an aging parent. Do we really want government entities to utilize DB plans designed to siphon off a portion of one individual’s compensation under the guise of retirement security only to deny him those benefits and divert these funds to another individual?

Without vesting requirements and/or spending reduction in essential government services such as education or transportation infrastructure, DB plans will become insolvent. DC plans avoid the moral quandary of vesting requirements and fiscal crises by ensuring an individual’s retirement account funds belong to him from day one—both the employer’s and the employee’s contributions. This is equitable to both taxpayers and public sector employees.

Transition costs merely acknowledge the existence of the accumulated damage from past government fiscal negligence. Current-year contributions should be invested on behalf of current employees in order to ensure promises made to these employees are readily kept. But not a single state has fully funded their major public pension plans. It’s for this reason that payouts to current beneficiaries rely upon contributions from current employees and from the forfeiture of contributions from participants who failed to vest. Commencing the transition—acknowledging the costs—ensures that these unfunded liabilities no longer continue on their dangerous upward trajectory.


In Depth: Pension Reform

Modern, 401(k)-style plans are now commonplace in the private sector. For state workers, however, traditional pensions are still the norm. As former Utah State Senator Dan Liljenquist wrote in Keeping the Promise: State Solutions for Government Pension Reform, this is not a partisan issue, but a math problem. State Budget …

+ Pension Reform In Depth