When you’re deep in a hole you want to get out of, at a minimum it’s best to stop adding more shovels to dig the hole deeper. The Florida legislature recently took a powerful step towards reducing the shovels in its underfunded defined benefit (DB) pension plan.
The Florida Retirement System (FRS) currently has $24.9 billion in unfunded pension liabilities (debt) that will be borne by taxpayers over the coming decades, and absent major reform, the state’s pension debt is likely to continue growing. While the legislature chose not to overhaul the retirement benefit design or deal with the pension debt problem head on this session, it did the next best thing by enacting a policy that will default all new state employees (except those in the “special risk” category) into Florida’s optional defined contribution (DC) retirement plan, called the FRS Investment Plan (FRS-IP).
Under previous law, each new hire into a job covered by FRS was defaulted into the FRS Pension Plan—a DB plan—and had to voluntarily choose the FRS-IP if they wanted a DC retirement plan instead As of June 2016, about 18% of the system’s total active membership had voluntarily selected the FRS-IP option over the pension plan. Under the new law, new hires will be defaulted into the FRS-IP, but could still choose to opt out and into the DB pension plan.
The importance of this policy shift boils down to risk. Public sector DB pension plans are exposed to major volatility in employer contribution rates when experience differs from expectations across a range of economic assumptions, such as the assumed rate of return on investments, mortality rates, payroll growth and more.
By extension, every single new hire the state brings into the workforce that stays in the pension system brings long-term liabilities with them that will be exposed to those same underperformance risks.
By contrast, there are no new long-term liabilities to consider with DC plans for new hires. When the employer makes their DC contribution, their obligation to the employee is fulfilled. Of course, switching to a DC plan won’t eliminate the debt accrued in the legacy DB plan—which needs to be paid off no matter what plan new hires are defaulted into—but it will at least prevent any more debt from accruing as far as new hires go.
Thus, the new DC default policy—assuming that it prompts a spike in FRS-IP participation, as expected—would reduce the financial risk to the state and taxpayers gradually and automatically over time as more new workers enter the DC plan, which by definition has no possibility of accruing unfunded liabilities and is not exposed to the same assumption problems as traditional pensions.
At the same time, the policy preserved the ability of new employees to elect to take a traditional pension benefit if they choose. From the taxpayer perspective—those that will be paying off FRS’s current $24.9 billion in pension debt over the coming decadesvit is not unreasonable to ask that new employees be automatically enrolled in the less risky of the state’s two retirement options.
And to the extent that the new DC default policy helps stem the growth of new unfunded liabilities, it will be also a positive step for the financial health of FRS and its ability to continue paying out promised pension benefits over the long term.