There are many ways to design a successful retirement plan in the 21st century, so what is the right design for government-sponsored plans?
Think back about 100 years when state and municipal retirement systems were being established. Did the founders of these plans start out by saying, “What contribution rate can we afford to apply to our defined benefit plan, and don’t forget we need paved roads as well?”
It is very unlikely that this was their approach. It is more probable that they started by compiling a list of objectives for their plan, which would’ve included employee outcomes, workplace recruiting and retention needs, budgetary realities, and competitive forces.
Objectives receive a lot of attention at the inception of a pension plan, but the focus on these objectives seems to dissipate as time passes. Policymakers can lose sight of a pension plan’s original objectives for several reasons.
First, today’s public pension plan sponsors may not be fully aware of what objectives were established by the founders, and; second, the world is a far different place now, with challenges and opportunities that could not have been considered 100 years ago when some of these plans were created.
A negative result of the increasingly high-profile pension dialogue taking place today is the loss of focus on plan success. Pension-related debates and discussions tend to focus on funding details, like unfunded liabilities, which may not encapsulate plan effectiveness in its entirety for its stakeholders. While unquestionably important, these public debates are not always answering the critical question of, “Is the plan effectively meeting its objectives?”
This question cannot be answered without rearticulating the pension plans’ objectives in a comprehensive way. To properly frame or reframe objectives, representatives of all impacted groups should participate in the discussion. Today, this would include representatives of the plan’s sponsors (employers and governing boards), employees in the pension plan (both new hires and long-tenured), lawmakers, treasurers, taxpayers responsible for funding much of the plan, and possibly others. Pension plan objectives that impact each represented group should be determined and agreed upon. Finally, the group should define and agree on the measures of success going forward.
While this may seem like an unnecessary and cumbersome task, it is the only way comprehensive success can be determined and buy-in from all parties achieved. Every day you can read about a public pension plan that is succeeding in meeting investment return goals, a plan whose unfunded liabilities are growing more quickly than Gross Domestic Product (GDP), or a plan that is creating a new tier for new hires—but are those public pension plans successfully meeting their objectives? Are they becoming more or less successful based on important measures?
Another reality to consider is that certain plan types (e.g. defined benefit or defined contribution) are often demonized by groups that, for whatever reason, are wedded to another design. For example, many public pension plan directors and employees, as well as union leaders, oppose defined contribution plans for state and local public employees. Likewise, some parties that are solely focused on pension debt and unfunded liabilities do not consider defined benefit plans as a viable option. These positions can detract from stakeholders coming together to determine the best plan design or designs for a public retirement system.
Focusing on objectives will take preconceptions out of the equation and enable decisions to be made based upon what pension plan design best meets the agreed-upon objectives.
All parties participating in public pension debates should take a step back and work together to define or restate the objectives for the plans in question. All plans maintain an investment policy statement that lays out the type of investments, asset allocation ranges, decision criteria, and other investment-related specifics. Maintaining an investment policy statement is an accepted best practice for all retirement plans.
The question must be asked, however, what investment policy would best fit a plan’s objectives? What, for example, is the objective for the income replacement ratio after a career of employment?
Objectives must be set first. This can be done using a retirement plan policy statement or a broader statement on benefit policies. Once a public pension plan has a clear set of objectives it will be much easier, and less controversial, to set and adjust policy.
Stakeholders should also understand that there are many different public pension plan designs available, and it is possible to use a mixture of designs if that is what best achieves the priorities set in a plan’s objectives. There is a good chance there are different designs that are better for current and new employees, as well as the employer.
Whatever the best pension plan structure is, policymakers cannot determine the right answer until they understand these questions and objectives. In the end, the right pension plan design—or designs—can only become clear once the plan’s objectives are clear.