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Public DB plans get some love

October 26th, 2011 Leave a comment Go to comments

By Mark Olleman

Here’s some good news about defined benefit (DB) plans: Public employees, in overwhelming numbers, are showing that they understand and appreciate the value of their defined benefit pension plans.

We know this is true because we studied the data from seven statewide retirement systems that offer employees the choice between a DB and a defined contribution (DC) plan such as a 401(k). The systems included in the study were Colorado Public Employees’ Retirement Association, Florida Retirement System, Montana Public Employees Retirement Association, North Dakota Public Employees Retirement System, Ohio Public Employees Retirement System, State Teachers Retirement System of Ohio, and South Carolina Retirement Systems.

Full results can be seen in Decisions, Decisions: Retirement Plan Choices for Public Employees and Employers, which I co-authored with Ilana Boivie of the National Institute on Retirement Security.

The data show that employees’ preference for DB over DC amounts to a landslide. As we note in the paper, “Across the board, the experience of these seven systems indicates that public employees overwhelmingly choose the DB plan. In the most current year, North Dakota’s DB plan has the highest take up rate at 98%; the lowest DB take up rate is in Florida, which still saw a full 75% of employees opting for the DB pension.”

But what about the cost to state budgets of fulfilling this employee preference for DB plans? Readers of this blog will be aware that the pension-funding deficit for corporate plans is right now reaching record levels. And our own informal poll, the Retirement Town Hall DB Challenge, shows that readers are concerned with market volatility (38%), high sponsor costs (29%), and low bond yields (33%). In other words, they are worried about the cost of funding pension benefits.

That’s why Ilana and I devoted considerable attention in Decisions, Decisions to the actual experience of public funds that had maintained both DB and DC plans. This research showed that, in fact, the traditional DB-only option provided the same level of retirement adequacy for a lower cost.  DB fees tend to be 35 to 145 basis points lower and DB returns tend to be higher by 80 basis points or more. DB plans pool longevity risk; DC plans do not.

But the real deal breaker with a frozen DB plan is the fact that the plan sponsor must maintain it and keep it funded for the lifetime of all enrolled employees. So the cost and exposure to market risk doesn’t go away until decades in the future. In fact, the West Virginia Teachers Retirement System decided, after a 15-year experiment with a DC-only program, to switch back to a DB plan in 2005.

One of the chief reasons for the switch was the expectation of lower pension costs. West Virginia’s research showed that with an average return of 7.5%, the program could save $1.2 billion over a 30-year period whereas a 6.0% annual return would keep the cost of the program on par with that of a DC plan.

DB plans have advantages for both public employees and their employers. New public employees choose DB over DC by a landslide. DB plans provide the same benefit for a lower cost. From an employer’s perspective this means the DB plan provides a strong tool not only to retain public employees, but to attract them as well.

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