Report Shows State Shifts from DB to DC Are Costly
The National Institute on Retirement Security says three states’ switch from a defined benefit pension to a defined contribution plan exacerbated pension underfunding.
A
report from the National Institute on Retirement Security suggests that states
that shifted retirement plans from defined benefit (DB) pension plans to
defined contribution (DC) plans experienced higher costs.
“Case
Studies of State Pension Plans that Switched to Defined Contribution Plans”
presents summaries of changes in three states—Alaska, Michigan, and West
Virginia—that made the switch from a DB pension to DC accounts. The case
studies examine key issues that impact pension plans, including demographic
changes, the cost of providing benefits, actuarially required contributions
(ARC), plan funding levels and retirement security for employees.
The
case studies indicate that the best way for a state to address any pension
underfunding issue is to implement a responsible funding policy with full
annual required contributions—and for states to evaluate assumptions and
funding policies over time, making any appropriate adjustments, the Institute
says.
According
to the report, in Alaska, legislation was enacted in 2005 that moved all
employees hired after July 1, 2006, into DC accounts. At the time, the state
faced a combined unfunded liability of $5.7 billion for its two DB pension
plans and a retiree health care trust. The unfunded liability was the result of
the state’s failure to adequately fund pensions over time, stock market
declines and actuarial errors. Although the DC switch was sold as a way to slow
down the increasing unfunded liability, the total unfunded liability more than
doubled, ballooning to $12.4 billion by 2014. In 2014, the state made a $3
billion contribution to reduce the underfunding. Legislation has been
introduced to move back to a DB pension plan.
In
Michigan, the DB pension plan was overfunded at 109% in 1997. The state then
closed the pension plan to new state employees who were offered DC accounts.
The state thought it would save money with the switch, but the pension plan
amassed a significant unfunded liability following the closure of the pension
plan. By 2012, the funded status dropped to about 60% with $6.2 billion in
unfunded liabilities. In recent years, the state has been more disciplined
about funding the pension plan, making nearly 80% of the ARC from 2008 to 2013.
In
West Virginia, the state closed the teacher retirement system in 1991 to new
employees in the hopes it would address underfunding caused by the failure of
the state and school boards to make adequate contributions to the pension. As
the pension’s funded status continued to deteriorate, retirement insecurity
increased for teachers with the new DC accounts. Legislation was enacted to
move back to the DB plan after a study found that providing equivalent benefits
would be less expensive in the DB than in the DC plan. By 2008, new teachers were
again covered by the pension, and most teachers who were moved to the DC plan
opted to return to the pension. After reopening the DB pension, the state was
disciplined about catching up on past contributions, and the plan funding level
has increased by more than 100% since 2005. The teacher pension plan is
expected to achieve full funding by 2034.