DB Plans Still Dominate for Municipalities

An issue brief, “Defined Contribution Plans in the Public Sector: An Update,” released by the Center for State and Local Government Excellence notes since the onset of the financial crisis in 2008, there has been much discussion by state and local governments about shifting from a defined benefit (DB) to defined contribution (DC) plan. However, the Center’s analysis shows few municipalities have actually taken action to adopt DC arrangements.

Only about 11% of public sector workers currently have access to a DC plan, and the researchers predict by 2042, as the percentage of new employees grows, still only about 19% of the public sector work force will rely on DC plans as their primary retirement savings vehicle.

The authors of the issue brief find whether public employees have Social Security coverage did not have a significant effect on the adoption of DC plans either before or after the financial crisis.

Before the financial crisis, a number of states had introduced a DC plan to their retirement programs, according to the brief. Most of these plans took the form of an optional DC plan. That is, the sponsor retained its DB plan and simply offered employees the alternative of participating in a DC plan instead.

Now public-sector retirement plan sponsors are once again showing interest in DC plans. However, they are handling the consideration differently this time around. First, most or all of the newer state and local government DC plans are mandatory, as opposed to the mainly voluntary offerings observed in the pre-crisis period, the Center says. Secondly, being mandatory, they apply only to new employees. Thirdly, none of the sponsors has followed the model of forcing employees to rely solely on a DC plan, where the employee bears all the risks. Instead, these post-crisis plans consist of either a hybrid plan or a cash balance plan, a DB-like arrangement that maintains notional individual accounts but provides some guaranteed base return.

The brief examines specific hybrid plans established in Georgia, Michigan, Rhode Island, Utah, Tennessee and Virginia, as well as cash balance plans in Kansas and Kentucky.

Other key findings by the authors of the brief include:

• Post-2008 action by state and local governments on retirement plan offerings has typically been to establish either hybrid plans or cash balance plans, rather than stand-alone DC plans;
• Changes appear to have been driven by the desire to avoid future unfunded liabilities, reduce investment and mortality risk, and to help short-tenure workers; and
• When changes are made that transfer risk to participants, it is important for sponsors to find ways to enhance the likelihood of responsible funding to increase employee retirement readiness.

The brief also voices potential concerns by participants about shifting from a DB to DC plan, which include that participants may face the risk of poor investment returns, the risk that they might outlive their assets, and the risk that inflation will erode the value of their income in retirement.

Retirement research done by the center can be found here. A copy of the issue brief can be downloaded here.

The Center for State and Local Government Excellence helps state and local governments identify best practices on competitive employment practices, work force development, pensions, retiree health security and financial planning.