Rethinking Public Employee Retirement Plans

There have been two prominent retirement plan designs in the United States since employer-provided retirement benefits became ubiquitous. The first, the traditional pension plan, was the preeminent design in the private and public sectors for many years. These pension plans, also termed defined benefit plans, rewarded employment longevity and were economically efficient in a nation with a relatively young workforce that tended to stay close to home and work for a single employer long-term.

Around the latter part of the 20th century, the private sector began to move toward a defined contribution retirement plan design. With an aging workforce that was growing more mobile, the traditional defined benefit pension became difficult for employers to support financially and fewer employees were achieving a benefit in retirement that enabled them to sustain their desired standard of living.

In the public sector, however, the defined benefit plan has held on longer as the standard.

At first, this made sense, as there was less mobility among public sector workers, and lower salaries were able to be offset by richer benefits in retirement. Public employers generally saw the higher retirement income provided by pension plans as an acceptable tradeoff for lower salaries. Today, however, salaries are generally seen as essentially equal between the public and private sectors or, even higher in the public sector, and the mobility of the public workforce is similar to the private workforce.

Throughout this evolutionary process, many public sector-defined benefit plans have suffered financially due to poor design and ineffective political oversight.

Crippling unfunded actuarial liabilities, which are commonly referred to as pension debt, have grown to unsustainable levels. This causing the need for major pension reforms in states and municipalities across the nation. These reforms have included increasing the contributions made by public employers and employees into the pension plan; lowering the benefit tiers for new and future hires along with higher contributions from them; freezing cost-of-living increases; lowering the expected rate of investment return assumptions to more accurately account for the obligations promised to public workers; and many other types of changes to either slow the growth of runaway costs and pension debt or to increase the amount going into these funds each year.

Notably, because the modern employee rarely stays in a job long enough to fully, or even partially, vest in a public pension benefit, some of the reforms to debt-riddled pension plans are making them less and less desirable for public workers.

In many jurisdictions, the increasing costs and volatility of the traditional defined benefit plan have led policymakers to call for their state and local governments to switch to a defined contribution (DC) plans going forward.

Those arguing for a switch to DC plans argue about the increasingly harmful and unsustainable unfunded liabilities caused by defined benefit plans. They point out how high contribution requirements are cutting into spending on other critical governmental services, like education and infrastructure. They also highlight the inability of traditional defined benefit pension plans to meet the needs of a mobile, modern workforce.

Those in favor of keeping defined benefit pension plans say the lack of income guarantees in defined contribution plans, as well as the shift in investment risk from the employer/taxpayer to the employee, is harmful to workers. The defenders of defined benefit plans often portray the typical government employee as an unsophisticated investor, incapable of making the defined contribution plan work for themselves.

While a number of the arguments for and against defined benefit and defined contribution plans have merit, they fail to get to the root of the problems. Politicians and government officials frequently do a bad job of managing public pensions. And if poorly designed defined contribution plans are implemented in their place, some of the designs may threaten employees ability to support themselves in retirement

In state capitols across the country, the political battles over pension reform can be fierce. They often pit employee unions against legislators and taxpayer groups. In many cases, efforts at reform fall short in completely addressing the core issues that threaten the long-term success of a retirement plan. Decision-makers are left nibbling around the edges, adjusting earnings assumptions, and making difficult decisions about what other public services to cut in order to find the money for to make their legally-mandated pension contributions. These changes at the edges rarely represent a comprehensive fix to a pension plan’s structural problems. What’s worse, they often serve to kick the can a little further down the road.

It is time for public retirement plan stakeholders to get creative. Combining aspects of traditional defined benefit and typical defined contribution retirement plans to better meet the needs of all stakeholders is absolutely possible, despite being an option often overlooked by policymakers.

The priority of public retirement reform efforts should be finding effective solutions. Yes, out-of-control public pension debt is a significant problem. But it’s also a problem if states replace them with poorly designed defined contribution retirement plans that don’t offer employees the retirement security or income they think they’ll have. Neither issue should be ignored.

The long-term answer to government-sponsored retirement problems probably lies in taking certain aspects from defined benefit and defined contribution plans, combining them into unique structures that address employees’ long-term retirement needs while recognizing the very real funding concerns for employers and taxpayers. Such an approach could better balance the goals of taxpayers and retirees, providing at least some guaranteed income to employees, but avoiding out-of-control costs that plague many traditional defined benefit plans today.

Making the retirement reform process revolve around data and common goals improves the chances of implementing retirement benefits that work for both public workers and taxpayers.