Choice a Detriment to Public Worker Retirement Savings

Researchers explored employee behavior when the state of Utah moved away from its traditional defined benefit pension plan and offered new hires a choice between a defined contribution (DC) plan and a hybrid plan.

Robert L. Clark, from the Poole College of Management at North Carolina State University; Olivia S. Mitchell from the University of Pennsylvania’s The Wharton School; and Emma Hanson, from the North Carolina Department of State Treasurer Retirement Systems Division conclude that their analysis provides evidence suggesting it is important not to neglect the effects of retirement plan restructuring on public employee behavior.

According to a research published by the National Bureau of Economic Research (NBER), legislation authorizing pension reform in Utah passed in March 2010 and went into effect in July 2011, officially closing the state’s defined benefit (DB) plans to new employees and establishing the two-option replacement plan. The two new pension options were expected to be less generous than the former DB plans. Post-reform, new hires could choose one of two new options: a defined contribution (DC) plan, or a hybrid pension plan that incorporated both DB and DC elements. New hires who failed to make an active choice between plans were automatically enrolled in the hybrid plan after one year of employment. 

The researchers say one may have anticipated that having a less generous retirement plan would have encouraged new hires to also save for retirement in one of the state’s supplemental plans, such as Utah’s 457 plan, but that didn’t occur. However, the researchers found that those who did actively elect their primary plan were also likely to participate in supplemental plans.

After the reform took place, nearly 60% of Utah’s new hires failed to make an active choice between the two plan options and were therefore defaulted into the hybrid plan. The researchers say this level of default is consistent with findings from other states that have offered workers a choice of primary retirement plans.

One explanation for why so many people may have defaulted is behavioral inertia. Another explanation might be that employees actually preferred the hybrid plan over the DC option and avoided making an active choice because doing nothing would result in the same option. Of the approximately 40% of Utah Retirement System (URS) new hires who actively elected a retirement plan, slightly more than half selected the hybrid plan, and slightly fewer (48%) chose the DC plan.

Nearly 35% of pre-reform new hires made voluntary contributions to one of the supplemental retirement plans offered by URS during the plan choice year, but only 18% of the post-reform sample contributed to these plans. The researchers found employees who defaulted into the hybrid plan post-reform were far less likely to contribute to supplemental accounts, compared to new hires making an active plan choice. “This analysis suggests that people who are defaulters in one dimension – failing to make a choice of their primary plan – also fail to make an active choice in other areas,” the researchers wrote.

Defaulters who did make voluntary contributions, saved less on average than did active choosers. Participation rates for those making an active election were actually higher than pre-reform (33% compared to about 25%) while those who defaulted into the hybrid plan were much less likely to save additional amounts (7%). And, even though those who elected the hybrid plan were somewhat more likely to enroll in one of the supplemental saving plans, compared to those choosing the DC, they contributed less as a percentage of pay, on average, than participants who chose the DC.

NEXT: Pension reform affects turnover?

One other thing the researchers note is that more than 87% of those hired prior to the reform were still employed two years later, while fewer than 83% of those hired after the reform remained at the two-year mark. In addition, new hires not making an active choice of a pension plan post-reform had considerably higher separation rates, compared to the new hires who elected either the DC or the hybrid plan.

The researchers concede that while it is difficult to prove that the URS reform drove the increase in separation rates, the findings are suggestive that reduced expected benefits could have encouraged employees to leave or,  if public employment became less desirable due to the reform, new hires may have been less productive workers, and employer-initiated terminations may have risen. “Yet separations could also have risen due to the recovering economy,” the report says.

The researchers say their findings that many workers fail to make active retirement plan choices could spur plan administrators to provide financial education programs and opportunities to learn about the retirement benefits offered. “As yet, we cannot determine precisely how these reforms will influence public employees’ retirement patterns, nor do we estimate cost savings to the state or taxpayers associated with the reform in this paper. But we do believe that defaults in pension reforms shape public workers’ employment, saving, and turnover behaviors,” the researchers conclude.

The research report may be accessed or purchased here.