Case Study Warns of Effect of Move From Public DB to Public DC

Since 2009, nearly every state modified its retirement systems to ensure long-term sustainability, most often by increasing employee contributions, reducing benefits or both, according to the National Institute on Retirement Security (NIRS).

During these deliberations, some retirement systems faced pressure to move from defined benefit (DB) pension plans to defined contribution (DC) 401(k)-type individual accounts, in part or whole. Advocates of switching from DB to DC plans position the change as reducing employer costs for unfunded liabilities, but the move to DC accounts does nothing to reduce plan liabilities on its own. At the same time, significantly reduced retirement benefits under the DC savings plan create other workforce challenges, such as difficulty in recruiting and retaining public employees, NIRS says.

The NIRS studied the case of Palm Beach, Florida, which it says offers “an important cautionary tale on the detrimental impacts of switching public employees from DB pensions to DC accounts.” In 2012, the Palm Beach Town Council closed its existing DB pension systems for all employees, including police and fire. Going forward “combined” retirement systems offered police officers and firefighters dramatically lower DB pensions and new individual DC retirement accounts. The move was made because financial markets experienced severe investment losses during 2001 to 2002 and 2008 to 2009. For the DB pensions of Palm Beach, this caused a dramatic increase in the town’s costs for its employee pension funds, which increased by over 600%, from $1.1 million in FY02 to $7.5 million in FY10, the NIRS explains.

According to the NIRS’ report, from the town’s budget perspective, the changes to the pension plan cut costs about 45%. According to a report by the Palm Beach Civic Association, which supported the changes, the pension reforms were anticipated to save taxpayers $6.6 million in 2012, and the annual savings would grow to $10.2 million in 2020. While the Civic Association’s study concluded that employees still would have a meaningful retirement plan, many public safety employees felt differently.

The police union calculated based on the pension reform proposal that the amount of pension income paid to future police officers would be $20,094 compared to the average benefit provided under the existing plan of $56,263.

The NIRS reports that the reaction of existing protective service officers to seeing their pension benefits frozen was swift. Retirements accelerated dramatically. Because the only way younger public safety officers could obtain a better pension was to leave the town’s police and fire departments, those existing employees who did not retire looked for opportunities in nearby local jurisdictions. The town’s two public safety pensions had covered 120 employees at the end of 2011. In addition to the 20% of the town’s workforce that retired after the change, 109 other protective officers left before retirement in the next four years. Mid-career public safety officers departed the forces in unprecedented numbers, with 53 vested police officers and firefighters departing Palm Beach’s forces from 2012 to 2015, compared to just two such experienced employees in the four years from 2008 to 2011.

The town did not anticipate the financial impact of the high attrition. For example, the NIRS firefighters had to work extremely high levels of overtime to fill staffing gaps. Also, the unprecedented loss of new and experienced public safety officers caused the town’s training cost to soar likely reaching upwards of $20 million, based on an “all in” cost estimate of $240,000 per officer to bring a new police officer through the rookie period in Florida.

The Town Council voted in 2016 to abandon the DC plans and improve the DB pensions for police officers and firefighters by raising benefits substantially and lowering the retirement age. The Council offset the cost of the police and fire DB pension improvements by increasing employee contributions and eliminating the DC plan with its employer match.

A previous report from the NIRS showed how three states’ switch from a defined benefit pension to a defined contribution plan exacerbated pension underfunding.