Researcher: High Transition Costs For States Switching From DB to DC Plans Are a “Myth”

Anthony Randazzo, director of economic research for the Reason Foundation, recently sat down with CapCon to talk about the concept of a state switching from a defined-benefit system to a defined-contribution system.

Disclosure: the Reason Foundation is a libertarian-leaning research organization.

Randazzo has published research in the past claiming that the “transition costs” of switching from a DB to a DC plan are largely a myth – and he expanded on that view in the interview.

From Michigan Capitol Confidential:

Michigan Capitol Confidential: You argue that these “transition costs” are a myth. What’s the basis for that myth?

Randazzo: The myth is based on two mistaken assumptions that certain steps need to be taken when switching from a defined-benefit system to a defined-contribution system. They are:

(1) That government must start making bigger debt payments to the defined-benefit system after it is closed.

(2) That a defined-benefit system needs new members in order to keep it solvent.

Neither of these assumptions are true. Regarding the first mistaken assumption; it might be recommended that a government increase the size of its debt payments after the system has been closed in order to pay off the debt sooner, but there is no legal requirement that it do so.

Regarding the second mistaken assumption, defined-benefit systems are supposed to be fully funded on a yearly basis by employer and employee contributions plus investment earnings. These systems are not based on new workers subsidizing older workers.

Michigan Capitol Confidential: So we have this disagreement between independent pension experts and individuals with an interest in the current systems. What’s at the core of this disagreement?

Randazzo: I think it is a disagreement between philosophies. It’s true that a defined-benefit system could be changed to a defined-contribution system that would be more expensive. But to prevent this, all you would have to do is put in a defined-contribution rate that ensures lower costs. Therefore, if the defined-contribution system – that’s put in place to try to solve a growing debt problem being created by a defined-benefit system – ends up costing too much, to me, that’s not a transition cost, it’s just the result of a bad policy decision.

[…]

Michigan Capitol Confidential: And you would argue that switching to a defined-contribution pension system would do away with most of the guesswork.

Randazzo: A defined-contribution system is 100 percent more transparent than a defined-benefit system because it requires zero actuarial assumptions about the future, and zero backroom negotiations with pension boards and union members. The costs of a defined-contribution system are clear every year: it is simply whatever the government body has chosen to be the contribution rate to each employee’s retirement account. The cost is known each year, and taxpayers don’t have to worry about whether investment returns will equal assumptions, or whether people will wind up living longer than expected and costing the system more money than it has projected pensions to cost.

Read the full interview here.

Photo by 401kcalculator.org