Examining the Cost-Effectiveness of DC plans vs. DB plans

Commentary

Examining the Cost-Effectiveness of DC plans vs. DB plans

Critics of pension reform aiming at replacing defined benefit (DB) plans with defined contribution (DC) plans often argue that DB plans are more cost-effective thanks to their superior investment returns and annuity feature. A recent paper by pension expert Josh B. McGee at the Manhattan Institute examines the validity of those claims. Below are the key findings of the paper:

– Previous reports that found higher investment returns for DB plans overestimated those returns by conflating the effects of plan size and plan design (bigger plans tend to earn higher returns than smaller plans). Correcting for this bias considerably reduces the performance gap between DB plans and DC plans. The paper finds that the gap is generally not statistically significant.

– Accounting for plan size also shows negligible differences in money-management fees between DB plans DC plans

– A proper cost comparison between DB plans and DC plans must include the cost of carrying pension debt, which is a significant cost driver for DB plans. For example, carrying a 10 percent pension debt would increase annual cost as a percentage of payroll by about 70 percent, and carrying a 20 percent penson debt would increase the cost by 140 percent.

– Limited annuitization in private DC plans is largely the result of federal regulation. Yet, many private DC plans do offer annuities. Moreover, public DC plans not subject to such regulation can and have provided annuities that are priced similarly to those provided by public DB plans.

To read the full paper, go here.

Truong Bui is a policy analyst at Reason Foundation, where he works on the Pension Integrity Project.