Defined Benefit vs. Defined Contribution—the Continuing Challenge of State Pensions

ANCHORAGE, ALASKA—While public pension plans still face problems, the situation isn’t as bleak as the headlines report, according to Dana Bilyeu, executive director of the National Association of State Retirement Administrators.
In fact, public pension plans across the country are 80 percent funded, on aggregate; that’s down from 101 percent funded in 2001, Bilyeu said. She spoke at The Council of State Governments policy academy, “Accounting for the State of Public Pensions,” Aug. 9.
In addition, she said, about 87 percent of the public pension plans—covering state and local governments, as well as teachers, police and firefighters—make their annual required contribution, or ARC. Popular media, she said, focus on the plans in distress.
“There are jurisdictions that are absolutely struggling in making their annual required contribution,” she said.
Bilyeu and other pension experts discussed what put plans on the path to the pension crisis and how states are addressing those issues. Forty-nine states have modified their pension systems during the past four or five years, with changes such as cost of living adjustments, modifications of contribution rate mechanisms and development of hybrid plans, moving from defined benefit to defined contribution retirement systems.
No state has totally duplicated the changes made in another state.
While Alaska has moved new employees to a defined contribution plan, several speakers said states easily could make changes to the traditional defined benefit plans to make them as viable as defined contribution plans.
Hank Kim, executive director and counsel for the National Conference on Public Employee Retirement Systems, said defined benefit plans are definitely sustainable if:
  • Sponsors make contributions consistently and fully;
  • Employees make their contributions;
  • Investments are well managed and have low fees; and
  • Benefits are appropriate and funded.
“When you have those four tires of the pension automobile and they’re inflated to the right level, you will have a sustainable plan,” he said.
Roderick Crane, managing director for the government market for TIAA-CREF, which manages much of higher education’s retirement portfolio, said the varied solutions states develop should include defined benefit plans.
“Defined benefit pension systems, while they have problems, … they have worked really, really well over the course of the decades they have existed,” Crane said. “It is our view that they should continue to be part of the solution going forward. They have done yeoman’s work. … Don’t throw the baby out with the bathwater.”
He said defined contribution plans have had similar problems as defined benefit plans. “You shouldn’t throw those out with bathwater, either,” he said.
Adrian Moore, vice president of policy at the Reason Foundation, said the defined benefit vs. defined contribution retirement systems boils down to an issue of fairness to taxpayers.
Most people earn a living and save for retirement. While doing so, he said, they’re also paying for retirement benefits for government workers. The defined benefit system, he said, is the idea “that government workers should get a guaranteed government security paid for by people who don’t have a guaranteed retirement security.”
And, he said, problems with defined benefit plans have cost taxpayers a lot of money.
“The biggest reason for considering moving to a defined contribution plan is to take that risk to future taxpayers off the table,” Moore said.
Paul Angelo, senior vice president and actuary for Segal Consulting, reminded state policymakers at the session that moving to a defined contribution plan would ensure a lower benefit for government employees.
“The fact is every time you do the taxpayers a favor by going to a defined contribution plan, you are either going to have to increase contributions or you are increasing the probability that more people will die poor,” Angelo said.
“You don’t try to reform something by making it go away,” he said.
Angelo said there are risks in retirement investments, but minimizing risk does not mean eliminating risk.
“I personally think that while on an intellectual level the big either-or debate is interesting when it comes to figuring out how to legislate on this stuff, it’s about how can we get to a system that meets those principles which provide the sustainability and the retirement benefit,” Moore said.
Angelo argued the issue between defined benefit and defined contribution is at the core of what legislators are considering across the country.
The changes in retirement systems have been relatively new. Robert D. Klausner, a partner with a law firm that handles retirement system lawsuits, said it would be good if states could take a break to see if the changes they have put in place are effective.
“It’s almost as if you plant a tree and you’re so impatient for the shade that you think the only solution is to rip it up and plant another one that might grow faster,” he said of the continual desire of states to address the pension issue. “I think a cooling off period is needed in order to see whether the changes that have been made are working.”