Pension Solvency and Closing Defined Benefit

Commentary

Pension Solvency and Closing Defined Benefit

Can closing a defined benefit pension plan to new hires and replacing it with a defined contribution plan help improve the solvency and sustainability of a state’s retirement system finances?

In a new policy study, we consider this question in the context of Michigan and Alaska’s pension reform efforts that closed defined benefit plans and replaced them with defined contribution plans. As we write in the study, supporters of the shift from defined benefit to defined contribution plans in Michigan and Alaska make two overarching claims:

First, closing the defined benefit plan has prevented problems within the plans-whether due to overly optimistic actuarial assumptions, underperforming investment returns, underfunded employer contributions, and/or mismanaged assets-from getting worse… Second, there is growing evidence that 401(k)-style personal retirement accounts (as offered by defined contribution plans) are preferred by 21st century employees, as they are portable, allow employees to tailor their retirement planning to their personal goals, and allow individuals to bequeath the full value of their retirement benefits.

However, we also note that these pension reform efforts are not without their detractors:

…critics of the Michigan and Alaska pension reforms argue that closing the defined benefit plans has increased costs, destabilized recruitment, and made pension plans less sustainable. Critics of the shift to defined contribution plans also point to the fact that both Michigan and Alaska have higher unfunded liabilities today than when the plans were closed as evidence that pension reform has failed.

This critical position highlights a correlation between a closed pension plan and a growth in pension debt, but it does not prove that unfunded liabilities have grown because of the pension reform efforts.

To test whether pension reform has improved the sustainability of retirement systems or been the cause of increasing unfunded liabilities, we developed a model that allows us to test what would have happened if pension reform never passed. Specifically, we forecast what the level of unfunded liabilities would be today if there had been no reform. We also test what unfunded liabilities would be if Michigan and Alaska had managed the closure of their defined benefit plans differently.

For a complete summary of the methodology of our study and our findings, see:

Did Pension Reform Improve the Sustainability of Pension Plans?

or Download the full Policy Study 450 [PDF]

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.

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