I happened across a P&I survey in a Tweet today. The survey was focused on state pension plan’s and future costs. Here is the question and the potential answers:
What is the best change states have made to reduce future pension costs?
- Raising age and tenure requirements
- Change to a DC plan
- Shrinking or stopping cost-of-living increases
- Increasing employee contributions
- Trimming salary calculation formulas
Most, if not all, state plans have enacted several changes during the last 6-7 years to try to reduce their plan’s liability, and many of those changes are part of the suggested answers above. However, we continue to believe that the best approach to improving funding (reducing costs) is to manage the plans with a focus on that fund’s liability and not the return on assets assumption (ROA), which has been the singular focus for decades.
Regrettably, the potential responses cited above are all directed at the beneficiary (plan participant). Is that fair? Remember, the benefits paid on a monthly basis provide excellent economic stimulus to the local economy. With the demise in the use of DB plans in the private sector and the transferring of the pension liability from the sponsor to the individuals (DC plans), we are jeopardizing future economic activity. Our economy is already struggling with <2.5% annual GDP growth. Any further reduction in the demand for goods and services could be severely damaging.
I think that P&I does a wonderful job of elevating and reporting on the critical issues for our industry. In fact, I just spent 90 minutes at their office early this week discussing many of the issues plaguing our retirement system. They get it! However, I think that the survey posted above should have included at least one item that focused on re-thinking the day-to-day management of DB plans, and not just the whittling of benefits or the escalation of employee contribution costs.
If you asked me how I would vote above, I would say definitely don’t move employees into a DC plan, as they were never intended to be anyone’s primary retirement vehicle, and they’ve proven to be ineffective as such. Many employees are already paying a significant chunk into the system, so that wouldn’t be my choice either, unless there exists a plan that doesn’t receive any contribution on the part of the employee. Raising age and tenure may be doable for some employees, but there are a number of occupations where one is just not physically able to perform the task well into their 60s.
I would support the shrinking of cost of living adjustments if the plan is below a certain funded ratio / status – perhaps 80% funded. Also, DB plans were once considered part of the overall retirement plan (along with personal savings, social security, home equity, etc.), and as such they were meant to replace a certain % of the employee’s compensation – not all of it! We should get back to basing the benefit on an employee’s salary or lifetime average earnings, and not include elements such as vacation and sick pay, and over-time, when that liability hasn’t been known and couldn’t have been managed by the fund’s actuary.
Lastly, and before doing any of those possible strategies above, I would try to get plans to gain greater knowledge of the liabilities, build an asset allocation and investment structure that reflects those liabilities, and make sure that my asset allocation decisions are dynamic and responsive to changes in the funded ratio. This approach sets the plan on a derisking path that should stabilize contribution costs and begin to move the plan toward, and then beyond, full funding.