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When Given A Choice, Why Do People Choose DC Plans Over DB Plans?

In many states, newly hired public employees are faced with a choice: enrollment in a traditional defined-benefit plan, or a 401(k)-style defined-contribution plan.

What drives the decision-making of those who choose DC plans? Scott J. Weisbenner and Jeffrey R. Brown examined the topic in a recent paper in the Journal of Public Economics.

They studied employees in the State Universities Retirement System (SURS) of Illinois, a system that gives every employee a one-time, permanent choice between enrolling in a DB or a DC plan. Here’s what they found about why people might choose DC plans:

First, we find sensible patterns with regard to economic and demographic factors: the probability of choosing the DC plan decreases with the relative financial generosity of the DB plans versus the DC plans and rises with education and income. However, while the relative generosity of the plans does have a nontrivial effect on pension plan choice, it certainly is not a “sufficient statistic” in explaining that choice nor is it the most important determinant in terms of its economic magnitude.

Second, we find that the ability to control for beliefs, preferences, financial skills, and plan knowledge – variables that are not available in standard administrative data sets – increases the amount of variation in plan choice that we are able to explain by approximately seven-fold, relative to using standard economic and demographic variables alone. Specifically, as measured by adjusted R-squared, economic and demographic characteristics such as gender, marital status, presence of children, education, income, net worth, occupation, and (self-reported) health can explain only 6.2% of the overall variation in the DB versus DC plan choice (adjusted R-squared = 0.062). When we expand our regression to include information about beliefs, preferences, financial skills, and plan knowledge, the adjusted R-squared rises to 0.471. Among the important factors in the DB/DC plan choice are respondent attitudes about risk/return trade-offs, financial literacy, beliefs about plan parameters, and attitudes about the importance of various plan attributes.

Third, we note that beliefs about plan parameters are important even when these beliefs are incorrect. In general, people seem to make sensible choices based on what they believe to be true about the plans, but they do not always have accurate beliefs (and thus may not be making optimal decisions). Finally, we provide evidence that preferences over the attributes of the retirement system (e.g., the degree of control provided) are also significant determinants of the DB/DC plan decision.

The paper is titled “Why do individuals choose defined contribution plans? Evidence from participants in a large public plan” and can be read in full here.

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New York Comptroller Candidates Square Off on Pensions

The New York State Comptroller serves as the sole trustee of New York’s $176.8 billion retirement system. So it’s not surprising that pensions were among the first issues broached during Wednesday night’s televised debate between the two candidates for Comptroller, incumbent Thomas DiNapoli (D) and newcomer Robert Antonacci (R).

Antonacci voiced several of his gripes with the state’s pension system; he claimed the assumed rate of return was too high and that the system should take on more characteristics of a 401(k)-style plan. From the Democrat and Chronicle:

Antonacci, who since 2007 has served as Onondaga County comptroller, took several opportunities to criticize DiNapoli’s oversight of the system. The pension fund’s assumed rate of return of 7.5 percent, Antonacci said, was too high.

A certified public accountant, Antonacci also said he believes the state should move toward offering defined-contribution retirement plans — what many would think of as a 401k-style plan. State and local-government employees currently receive defined-benefit plans, in which the payout at the time of retirement is determined by a formula and not subject to the whims of the stock market.

“We have to make some fundamental changes to the pension fund, including talking about a defined-contribution plan,” Antonacci said.

DiNapoli disagreed, saying a move to a 401k-style system would hurt working New Yorkers. He touted the performance of the pension fund — which is consistently ranked as one of the best-funded public plans in the country — while acknowledging his office may decide to lower the assumed rate of return in the future.

“Moving to defined contribution would put more and more New Yorkers at risk of not having adequate income in their golden years,” DiNapoli said. “That would be a bad choice for New Yorkers.”

DiNapoli is leading in the polls by 28 percent.

Photo by Awhill34 via Wikimedia Commons

Former Illinois Attorney General Pushes For “Plan B” On Pension Reform

In all likelihood, a judgment on the constitutionality of Illinois’ 2013 pension reform law will in the next six months.

Former Illinois attorney general Ty Fahner doesn’t want the state to be blindsided by the result. If the law is overturned, he says, there needs to be another plan in place.

Fahner is asking lawmakers from around the state to start developing alternate reform ideas. From the News-Gazette:

“I still hope and expect, I truly do, that the court may find Senate Bill 1 constitutional. Whether that’s a false hope or not, I need to make the point that even if they do, after all of that, we’re still in terrible shape as a state,” Fahner said. “If they overturn it, there will be incredible hardship, which is what we are trying to get people to focus on now, not because it will change their decision, but I think there has to be a debate, a discussion, right now, because if you wait until the spring when the court finally rules, it’s going to be a little bit too late.

“They’re going to be in the middle of the budget at the end of the session. Whether it’s Quinn or Rauner, they’re going to have a difficult time. I think they need to talk now.”

He’s encouraging candidates for governor and the Legislature to address the question, and wants voters to ask them about it.

“That’s all we’re trying to do with this,” said Fahner, whose group is pushing what it calls a “What If?” initiative. “It’s so profound and the damages could be so terrible that people have to think about it now and not just give a political reaction later that, ‘We’ll have to sort it out.'”

State Rep. Adam Brown, R-Champaign, said he was “more than happy to be a part of the conversation” about an alternative pension plan.

“But at this point, there are just too many unknowns,” he said.

[…]

[Senate President John] Cullerton’s spokesman John Patterson advised patience.

“It has been a long struggle to get a law through the General Assembly and now a case to the courts,” he said. “Given the complexity of the issue and the difficulty in gettting to this point, we should now see what the courts have to say. There are a lot of people with a lot of opinions, but they aren’t on the Illinois Supreme Court, and it is the justices who will ultimately tell us what can and cannot be done.

“At this point the case is still before the trial court, so it seems a bit premature to already be predicting its demise. Let’s let the judiciary do its job.”

As for Republican gubernatorial candidate Bruce Rauner’s proposal that state employees be moved into 401(k)-style, Fahner said, “The idea of a 401(k) is great, but I’m not sure it would work in the current situation.”

Fauher also questions whether the reform law goes far enough. From the News-Gazette:

“[The law] only scratches the surface of the state’s problems. We also have to look at what drives jobs from the state. We’ve got to do a lot to make this a more jobs-friendly state.”

This year, he said, 26 percent of the state budget is devoted to pension payments. By 2024, pension payments would eat up a third of the budget.

He said that would lead to higher property taxes, fewer teachers and less money for social services.

“A lot of people say this isn’t a problem, all you do is just raise more taxes. This goes back to the jobs issue. We could raise taxes again, but we already know what the job losses have been,” Fahner said. “We’re losing jobs because it’s a very hostile work environment with regulations and everything else. If you have less jobs, you have less people to pay the taxes which fund all of these needs, and that’s what is happening to us.”

Governor Pat Quinn has said he doesn’t have a “plan B” in place if the law is deemed unconstitutional.

Corbett: “Entrenched Interests” Preventing Pension Reform in Pennsylvania

Pennsylvania Gov. Tom Corbett (R) is trailing by double-digits in many polls to opponent Tom Wolf (D) – but his campaign strategy of pushing the need for pension reform appears to be unchanged.

Corbett has been the most vocal critic of his state’s pension system, but most of his fellow lawmakers – and voters, for that matter – have not reciprocated that enthusiasm for major reform.

On Monday Corbett said that “entrenched interests” are preventing pension reform. And those interests, according to the governor, have seeds in both parties.

Reported by the Intelligencer:

“There are entrenched interests out there,” the governor said. “The public sector unions are all against change … There are Republicans that don’t like me. I’m pushing change. It’s very hard to get change in Pennsylvania.”

[…]

Corbett traces the current pension problem to 2001.

That’s when the state Legislature boosted the retirement package for state lawmakers and judges by 50 percent and increased pensions by 25 percent for 300,000 active state workers and school employees. Corbett wants to roll back those increases to pre-2001 levels for current employees — an annual multiplier of 2.0 rather than 2.5 for employees and from 3.0 to 2.0 for lawmakers and judges — and place new employees in a 401(k) style retirement plan.

But the Legislature, backed by the might of public section unions, has stood in his way.

“We said to present-day employees, going forward, that we need to ratchet it back to two,” Corbett said of the annual multiplier. “Did you earn that (2.5)? I don’t think so. You did nothing new.”

Corbett said he favors the state rolling back the benefits and letting the courts decide when the unions sue. The real problem for taxpayers, he said, would occur once the issue landed in court because the judges who benefited from the enhanced pensions would be asked to rule on the matter.

“What judge in this state can hear that case?” he asked. “It’s an economic conflict of interest. … People should be upset with that. I say, let’s try it.”

Corbett re-iterated that, if re-elected, he would call a special legislative session to push through pension reform measures.

Kolivakis: Time To Face The “Brutal Truth” About Defined-Contribution Plans

Leo Kolivakis, the man behind the Pension Pulse blog, has long been a critic of replacing defined-benefit plans with 401(k)-style plans as a means of reforming public pension systems.

The Canadian Public Pension Leadership Council released a report last week arguing that converting large public DB pension plans to DC plans would be costly and ineffective. In light of that report, Kolivakis took to his blog to re-explain his aversion to the oft-considered reform tactic. From Pension Pulse:

I’m glad Canada’s large public pension funds got together to fund this new initiative to properly inform the public on why converting public sector defined-benefit plans to private sector defined-contribution plans is a more costly option.

Skeptics will claim that this new association is biased and the findings of this paper support the continuing activities of their organizations. But if you ask me, it’s high time we put a nail in the coffin of defined-contribution plans once and for all. The overwhelming evidence on the benefits of defined-benefit plans is irrefutable, which is why I keep harping on enhancing the CPP for all Canadians regardless of whether they work in the public or private sector.

And while shifting to defined-contribution plans might make perfect rational sense for a private company, the state ends up paying the higher social costs of such a shift. As I recently discussed, trouble is brewing at Canada’s private DB plans, and with the U.S. 10-year Treasury yield sinking to a 16-month low today, I expect public and private pension deficits to swell (if the market crashes, it will be a disaster for all pensions!).

Folks, the next ten years will be very rough. Historic low rates, record inflows into hedge funds, the real possibility of global deflation emanating from Europe, will all impact the returns of public and private assets. In this environment, I can’t underscore how important it will be to be properly diversified and to manage assets and liabilities much more closely.

And if you think defined-contribution plans are the solution, think again. Why? Apart from the fact that they’re more costly because they don’t pool resources and lower fees — or pool investment risk and longevity risk — they are also subject to the vagaries of public markets, which will be very volatile in the decade(s) ahead and won’t offer anything close to the returns of the last 30 years. That much I can guarantee you (just look at the starting point with 10-year U.S. treasury yield at 2.3%, pensions will be lucky to achieve 5 or 6% rate of return objective).

Public pension funds are far from perfect, especially in the United States where the governance is awful and constrains states from properly compensating their public pension fund managers. But if countries are going to get serious about tackling pension poverty once and for all, they will bolster public pensions for all their citizens and introduce proper reforms to ensure the long-term sustainability of these plans.

Finally, if you think shifting public sector DB plans into DC plans will help lower public debt, think again. The social welfare costs of such a shift will completely swamp the short-term reduction in public debt. Only economic imbeciles at right-wing “think tanks” will argue against this but they’re completely and utterly clueless on what we need to improve pension policy for all our citizens.

The brutal truth on defined-contribution plans is they’re more costly and not properly diversified across public and private assets. More importantly, they will exacerbate pension poverty which is why we have to enhance the Canada Pension Plan (CPP) for all Canadians allowing more people to retire in dignity and security. These people will have a guaranteed income during their golden years and thus contribute more to sales taxes, reducing public debt.

Read his entire post on the subject here.

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Illinois Governor Candidates Talk Pensions in First Debate

One of the hottest issues in the race for Illinois governor is also one where the candidates differ starkly: how to fix the state’s retirement system.

So it’s no surprise that pensions came up during the race’s first debate.

There were no revelations here; Pat Quinn and Bruce Rauner both used the time to double-down on their stances. From the Associated Press:

Quinn signed legislation last year that would fully fund the retirement systems by 2045, in part by cutting benefits. Public-employee unions have sued, saying the overhaul violates a provision of the constitution that says benefits can’t be reduced.

Rauner supports letting retirees keep the benefits they’ve been promised but freezing the systems and moving employees to a 401(k)-style plan in which workers are not guaranteed a certain level of benefits. He said that plan — similar to what most private-sector workers have — wouldn’t save much money to start but would save billions in the long term.

“I don’t believe it’s right to change the payments to a retiree after they are already retired, and that’s what Gov. Quinn did,” Rauner said.

But Quinn called Rauner’s plan “risky” because workers’ retirements would depend largely on market performance. He said he deserves credit for making Illinois’ full pension payment each year he’s been governor — something his predecessors didn’t do. That contributed to Illinois having the worst-funded pension systems of any state in the U.S.

Illinois’ pension reform law has spent the last 6 months being fast-tracked through lower courts. A ruling on the constitutionality of the law could come before the end of the year.

Fact Check: Has Tom Corbett Been Shorting The Pension System?

Tom Corbett has used the campaign trail to paint himself as a pension reformer – Corbett, the incumbent governor of Pennsylvania, says the pension system needs to be overhauled and supports a plan to shift public workers into a 401(k)-style plan.

His opponent, Tom Wolf, disagrees. Wolf says the problem isn’t the current system—it’s the current governor. He says the system’s current funding problem stems from Corbett’s failure to make required payments into the system.

The issue was brought up during a debate Wednesday night. WESA reports:

Wolf argued that the pension system itself is not flawed, but that the state needs to put more money into fully funding its pension obligations.

“Governors have not adequately paid into that fund,” Wolf said. “We need to figure out a way to do that, pay that debt, because that balance keeps coming up. I plan to do something about that. I will not keep delaying payment, I will do something.”

Corbett took issue with Wolf’s assertion that his and previous administrations have not adequately paid into the system, and instead said it’s the system itself that needs to be overhauled.

“We do have to, though, bite the bullet and start reforming how we’re paying into that system, rather than continuing to say we’re just going to continue to pay at $610 million new dollars each year for the next, I think it’s 25 years,” Corbett said.

Corbett seemed to dodge the issue of failing to pay the state’s actuarially required contributions (ARC). But Wolf has a point.

Since 2008, Pennsylvania has consistently shorted its largest pension funds.

The state has gone above and beyond when it comes to making payments to the Municipal Retirement System (MRS); but that system is also much smaller than the others.

Both candidates have points here. Wolf is right that Corbett has shorted the pension system. But while making full payments would be a step in the right direction, it wouldn’t solve the system’s funding crisis on its own.

Think Tank Director: Corbett’s Pension Proposal Would Increase Pension Debt and Reduce Benefits

Stephen Herzenberg, the executive director of the Keystone Research Center, took to the newspaper on Monday to counter Pennsylvania Gov. Tom Corbett’s argument that the best bet for saving the state’s pensions would be to switch new hires into a 401(k)-type plan.

Herzenberg claims in an op-ed that such a plan would provide no savings for the state, reduce benefits for retirees and actually increase the state’s pension debt.

Herzenberg starts by talking about the fees and other costs associated with 401(k) plans. From the op-ed, published in the Patriot-News:

For two years, Governor Corbett has advocated a shift from pooled, professionally managed, defined-benefit pensions to a system where each employee manages an individual account, similar to a private sector 401(k) plan.

[…]

How does the efficiency of today’s defined benefit pensions system translate, in bottom-line terms, measured by the level of contributions required to fund retirement? According to the National Institute on Retirement Security, individual 401(k)-style accounts cost 45% to 85% more than traditional pooled pensions to achieve the same retirement benefit. That’s a big efficiency gap.

A lot of this efficiency gap results from the fees that financial firms charge holders of individual accounts – for administration, for financial management and trading stocks, and for converting savings at retirement into a monthly pension check guaranteed until the end of life – an “annuity.” In essence, these fees are transfer from Main Street retirees to Wall Street. In an economy with stagnant middle-class incomes and all the gains for recent growth already going to the top, such a transfer seems like the last thing we need.

Given the high fees and low returns of 401(k)-style accounts, it is hardly a surprise that actuaries who have studied the Governor’s proposal for an immediate switch to them – or a more gradual switch under a new “hybrid” proposal that the Governor now supports – don’t find any savings.

Far from providing savings, in fact, this switch could result in a large upfront transition costs – because the investment returns on the existing pension plans would fall as the plans wind down. The Governor’s plan was projected to have a $42 billion transition cost.

He goes on to write that Corbett’s plan would be “highly inefficient” and would actually reduce retirement benefits. From the op-ed:

The switch would also reduce retirement benefits. This is not only bad for teachers, nurses, public safety personnel, and other public servants. It could also require a future wage increase to enable the state and school districts to attract and retain high-quality staff – another cost to taxpayers.

In his recent book on inequality, economist Thomas Piketty worries that high returns and low financial management costs are only accessible to massive pools of wealth. This means that the assets of the wealthiest individuals and families grow faster than the wealth of the rest of us. It reinforces the drfit back towards Gilded Age levels of wealth inequality.

But in the context of public sector retirement plans, defined-benefit pensions give taxpayers and the middle class the ability to grow their pooled retirement savings in the same manner as Warren Buffet and Bill Gates.

If define benefit pensions are poorly managed, as they have been in Pennsylvania, they do create some challenges. As with paying a credit card bill, if you don’t put in the required contributions you can run up a large expensive debt. But the way to fix that problem is to pay the required contributions, not to switch to a highly inefficient retirement savings vehicle.

Read the entire column here.

Think Tank: Pennsylvania Lawmakers Need To Reform Pensions – Now

Katrina Anderson, a senior policy analyst and director of government affairs for the Commonwealth Foundation, has published an op-ed in today’s Patriot-News urging Pennsylvania lawmakers to “reform the [pension] system now”.

Ms. Anderson explains her support for a solution similar to Gov. Corbett’s plan, which would move new hires into a 401(k)-style plan. An excerpt from the op-ed:

The first step lawmakers need to take is changing state-level retirement plans for themselves and new teachers and government workers. This would not erase our $50 billion pension debt, but it would prevent the problem from getting worse while protecting families from higher taxes and preserving the system.

Our current pension system has a huge flaw: It’s too easy to boost benefits when times are good and skip payments when they aren’t.

Moving new employees to a well-designed 401(k)-style plan would prevent deliberate underfunding and make “kicking the can down the road” impossible.

Reform would also benefit employees. As workers change jobs—an average of 10 times in a career—retirement portability and personal ownership of investments have never been more important. Such flexibility simply can’t be found in the current system.

But flexibility is the hallmark of 401(k)-style plans, which are also always fully funded—meaning they carry no debt—and offer predictable costs.

Not only has most of the private sector already left the old system behind—including the Wolf Organizaiton, founded by Democratic gubernatorial candidate Tom Wolf—but many states have as well. Since 1996, 18 states have converted to plans which build on the 401(k) model.

There are several bills in the General Assembly that would address this crisis for new employees, including plans that combine aspects of the current system and 401(k)s into what’s commonly called a hybrid plan, as well as reforms addressing the municipal pension crisis.

Conventional wisdom says lawmakers won’t do anything significant shortly before an election. But many statesmen in the legislature are fighting on behalf of retired teachers like Bill Frye to address this issue now.

They should understand—as property tax payers already do—that the stakes are too high to play politics and ignore real reform.

Anderson points out that pension costs have risen more than $600 per household since 2008—and are projected to rise another $550 per household in the next five years.

Read the entire column here.

Corbett Promises Special Pension Session If Re-Elected

Pennsylvania‘s incumbent candidate for governor, Tom Corbett, has made pension reform his campaign’s rallying cry.

But Gov. Corbett’s calls for reform haven’t been met with much enthusiasm. So Corbett announced this week that, if he is re-elected, he will call a special legislative session specifically to deal with pension reform on the state and municipal level.

From New Castle News:

Gov. Tom Corbett, if re-elected this year, plans to call for a special session of the Legislature specifically to deal with Pennsylvania’s pension issues.

He would like to see the meeting address state, municipal and school district concerns.

“I’ve been trying to fight the pension battle,” Corbett, a Republican, said during a meeting with The Tribune-Democrat Friday.

“I don’t know that we’re going to even get the little bit that we’re trying to get now. I’ve already announced, I’m going to call, in my second term, right away, a special session on pensions; not just the state pension, we might as well bring in the municipal pension, too, because I can tell you, all municipalities are coming to us, saying, ‘Take a look at this.’ Is that a big one to bite off? Yes. But, if we don’t do it, who’s going to do it? I know one thing, my opponent (Tom Wolf ) is not going to touch it.”

Pennsylvania has $47 billion in unfunded pension liabilities, according to the state’s budget office.

Standard & Poor’s and Fitch Ratings both cited pension concerns when they dropped the state’s general-obligation debt rating this week.

“The downgrade reflects our view of the state’s diminished financial flexibility and growing expenditure pressures due to inaction on pension reform and limited revenue growth,” S&P said in its report.

Corbett wants to pass a plan that would shift new hires into a hybrid-type plan that more resembles a 401(k) than a defined benefit plan.

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