“History, Issues and Trends of Defined Benefit and Defined Contribution Plans and
How to Combat the Effort to Change From DB to DC”. 10/2009- Hole
History of pension plans-
The first US government pension plan was started by the militia. The first private
defined benefit corporate pension plan in the U.S. was started by American Express in
1875. In 1911 Massachusetts formed the first state pension plan. In 1948, unions won
the legal right to include pensions on the collective bargaining agenda and tried to force
company’s to set aside money to fund future obligations. The number of DB plans grew.
At that time, pension funds were invested mostly in bonds. In 1950, US Steel was one of
the first plan sponsors to utilize equities to fund pension promises. In the late 1960’s and
early 1970’s, trust banks lost control of conservative investing to pension funds and
money managers who now had the academic theories of the Markowitz and Sharpe
Modern Portfolio Theory and federal legislation. A portion of the 1970’s was a time of
low or negative returns due to high inflations. People began to move from job to job.
In 1974 the Employee Retirement Income Security Act (ERISA) was passed, largely in
part because of the collapse of Studebaker. This act set standards to protect members of
private DB plans. This first comprehensive pension reform law passed during a large-
capitalization bear market, thus further helping money managers. ERISA required
companies to fund ongoing pension costs and close unfunded liabilities; established a
tough fiduciary standard; directed plans to diversify their portfolios, and allowed pension
trustees to delegate fiduciary responsibility to money managers that registered with the
Securities and Exchange Commission (SEC). Laws were passed which reduced or
eliminated incentives and made it more expensive for the private sector to offer DB
In the 1980’s, corporate profits were down and the high interest rates reduced the present
value of pension obligations, creating surpluses that companies could use for
restructuring or acquisitions simply by shutting down the pension plans and paying out
the benefits. Corporate raiders used over funded plan surpluses to pay off debt associated
with their leveraged buyouts. In 1990 Congress ended this practice by imposing a 50
percent excise tax on reclaimed surpluses.
DB plans took another hit in the 1980’s, the recognizing of the defined contribution or
401(k) plan by the Internal Revenue Service. Union membership numbers were
decreasing, and workers were moving in mass from job to job. The DC plan filled the
needs. Companies had to think about costs as health insurance was becoming more
costly, and global competition was cutting into profits. The new DC concept seemed
cheaper to administer, but the bulk of the financing and the liability of investment risk
now fell on the uneducated worker.
In addition, the bull market began to rage in the 1980’s, and mutual funds became more
attractive. From 1985-2000, the number of corporate defined benefit plans fell from
170,000 to 49,000. In that same time period, the number of 401(k) plans jumped from
30,000 to 348,000. The bull market continued until 1996. DC folks were happy.
High assumed rates of returns were assigned. Many times, employers were not
contributing as they should have (contribution holidays). Corporations usually made the
minimum contributions. Multi-employers usually funded higher amounts due to contract
obligations. This not only stabilized funding and minimized volatility of employer
contributions, plans were able to increase benefits. Corporations on the other hand would
make benefit adjustments annually.
In 2000-2002 the US stock market tanked. Not only did the stock prices plunge, the
Federal Reserve Board deeply cut interest rates. As a result, pension liabilities soared
and many corporations had to pump in large amounts of cash to fund their pension plans.
In 2002 and 2003 the amounts went as high as three times the annual average contributed
over the previous 20-year average.
Plans went from being well funded to being under funded. Companies went from not
needing to make a contribution for many years to having to make a balloon payment, as
they had not continuously contributed. Employers saw a way to cut costs and liabilities
or obligations. Many small corporations and some governments changed from DB to DC
plans. Some corporations closed or froze their pension plans because it seemed like
everyone else was doing it.
In 2006, good market returns and a rise in interest rates improved the financial health of
many corporate DB plans. Plans were again fully funded, but plan freezing continued.
20-25% of the nations 2.3 trillion dollars in corporate DB plans had been frozen by the
end of 2006. In years past this was only done in troubled businesses, but now it came
from financially stable companies.
Part of the cause was due to the reform of the Pension Protection Act of 2006, a law that
was intended to strengthen DB plans. Tighter funding rules required sponsors to value
their pension assets and liability more frequently, beginning in 2008. Full funding had to
be phased in over the next seven years.
The 2006 the Pension Protection Act called for the valuing of assets and liabilities more
frequently, and said they must be funded. Corporate benefits were discounted using
corporate bond interest, which therefore increased corporate liability. Soothing was
tightened and therefore more conservative investing took place producing lower
returns. On the other hand, multi-employer benefits were discounted using interest
assumption on expected returns, and they had to go to a 15-year amortization period
instead of 30 years. Funding status zones were created.
As a result of the passage of the PPA of 2006 and FASB guidelines, many companies
shut down their plans rather than face new funding requirements, additional costs and
risks. Within a year of passage of the PPA, the Pension Benefit Guarantee Corporation,
which is the government entity established by ERISA to take over pension plans from
troubled companies, had 5,000 pension plan terminations. As a result, the PPA required
companies to pay a higher premium to the PBGC to assist with the bailouts.
The Financial Accounting Standards Board (FASB), has passed new rules that added
pressure such as no longer allowing the net funded status on their balance-sheet
footnotes, and no longer allowing smoothing values and liabilities over a variable period
of 10-15 years, but rather 24 months. Now current market values of assets and liabilities
had to be used and must be posted on the balance sheet. This could reduce the
company’s net worth considerably. In the following three years, FASB (if they are still
around due to lack of funding) was expected to extend the mark-to-market pension
accounting to the income statement, resulting in even more volatile earnings. This “FAS
Phase Two” initiative spiked the number of plans being frozen in the UK.
These and other measures, both accounting and political, forced more conversions from
DB plans to DC plans.
The real estate market bubble burst in 2007 and the financial world unraveled in 2008.
The trouble is that…
States and local governments have 14 million employees, 10% of the US workforce.
In 2000, 90% of those folks had a DB plan. One forth of those folks are not in Social
The number of government and private DB plans is falling rapidly. 437,000 individual
401 plans account for 65 million participants and 3 trillion dollars.
If you take away the DB benefits, some still have Social Security benefits to supplement
their retirement (Nebraska, District of Columbia, Michigan, and West Virginia
teachers), but how about those not under Social Security like Alaska? Other
states that are not under Social Security are: Louisiana, Colorado, Maine,
Massachusetts, Nevada and Ohio.
Some states like Florida, South Carolina, Colorado, North Dakota, Vermont, Washington,
and some plans in Ohio and Montana, a DC plan is optional.
Some states went from DB to DC and back to DB (West Virginia, and plans in
Some states went to hybrids (Indiana, Washington, Nebraska, Oregon, and some plans in
Texas and Ohio).
Retirees are living longer, therefore the need for retirement funds is increasing. In 80
years, a three year “down market” has only occurred once. Are employers using the
economic downturn just to strip benefits from plans that may not have been funded
properly during the “good years”?
DC participant issues and concerns: What they should be asking themselves.
1) Have members had to buy disability insurance or life insurance (side accounts)
because of lack of disability and survivor benefits that a DB plan has? (Disability
risk, survivor risk and mortality risk). If the DC plan does offer these benefits, they
are usually based on the account employee must pay for coverage.
2) Have members had to change their future plans such as buying long term care
insurance, because they can’t afford it now?
3) Shared longevity risk pooling of a large DB group lowers overall risk and cost due to
investment returns and mortality. (Demographic risk transfer/insurance principal).
This is not the case with individual DC plans. Do the members who switched from
a DB to a DC plan realize that they therefore must contribute a higher amount to
compensate for additional risks? DB plans which pay over the average life
expectance, not the maximum life expectancy; having a non-aging diversified
professionally managed balanced portfolio, produces higher returns at lower fees.
4) Are members lobbying to reduce the high investment costs that come out of their
assets? DB, 31 basis points (31 cents/$100 assets) as opposed to DC, 96-175 basis
points). These fees should be transparent. Administrative, investment, sales and
other fees and expenses may be on top of mutual fund retail fees. Compound this
fee difference over a 35 year career and it could be 25% a differential. Employers
make money even if the worker does not. Rebates and even revenue sharing gives
providers get a cut of the expense ratio on 401 funds to cover day to day
administrative costs. Even though costs stay the same, the fees are a percentage of
your assets and therefore, their fee dollars increase. Administrative fees are
expenses which include accounting, legal fees. These are charged to DC members
either by pro rata (proportionately based on individual account balance), or per
capita (flat fee). Investment fees may include a percentage for transaction costs
such as sales loads, sales charges, sales commissions, deferred sales charges,
redemption fees, surrender charges, exchange fees, account fees, purchase fees,
mortality and expense fees, and management fees such as advisory fees, or account
maintenance fees. The referenced pertains to actively manages funds, annuities,
collective investment funds, and mutual funds. In addition, there may be individual
service fees to cover any optional features. When do your monies go to work for
you? Is it the earliest date of contribution or deduction, or 1.5 months later? Are
the amounts being properly allocated to you? DB plans offer clout in negotiating
fees because of economy of scale. Commingled, bundled and pooled investments
offer negotiated group pricing and therefore lower expenses than DC plans.
5) Should more products or investment vehicles be offered to enhance diversification?
This includes manager selection, style (growth and income), and alternatives. The
more choices, the more risk. What is the default investment choice? What if the
sponsor changes their mind? (Freeze, conversion, buy-back, irrevocable)
6) Have target date/life cycle funds been improved? People need to consider how much
income they will need, not how much the final amount will be. The standard 401
model began to fail when, in the last thirty years, it shifted from an adequate and
secure retirement to wealth accumulation and maximum returns. Individuals have
shorter time horizons than do DB plans and therefore those plans can be more
7) Have retirees out lived the unpredictable DC benefit? (Annuitization rate
risk/savings shortfall risk/income stability risk). Retirees with big lump sum checks
sometimes spend big amounts of money.
8) Have active members dipped into their accounts for emergencies or living expenses?
(Life event risk/leakage risk). Pension leakage could be caused by termination,
unemployment, part time or temporary work, disability, pre-retirement death, or
long term care. Once borrowed, it is seldom returned. There is no chance for
compound interest on those investments cashes.
9) Have members gone from job to job and cashed out their balances? (80-90%)
10) Why is vesting still from 6 months to 3 years in a DC plan? (PPA).
11) Is there an age requirement to join? Best practice implication is that there is not.
12) Why does it take up to five years to be 100% eligible? Is your time cliff or graded?
13) Have members found they have to work longer because of declining account
balances Early retirement risk), or figured that they may out live their benefit,
especially as people are living longer? (Longevity risk). Members have seen a
recent decline in net worth due to a decline in real estate equity and the capital
14) How many members don’t contribute to their DC plan? (Savings risk).
It is not mandatory forced savings like a DB plan. Are DC members lobbying to
make it automatic enrollment? (Pension Protection Act).
15) How many members don’t contribute the max. to their DC plan? What if they do not
contribute enough? (Contribution risk). Are members lobbying to increase the
maximum amounts or have escalating contributions? From 1950-1986 we saved
8% of income per year. Until recently that has dwindled down to 2% of income,
and then it was for a vacation, not retirement. Until recently, the average 401 had a
balance of $35,000, the average balance for a 55-64 year old was $60,000. How
many years could you live on that? What if that balance went down 40% this year?
Guidelines suggest that total annual contribution should be 12%-14% of pay if you
are under Social Security, and 18%-20% of pay if you are not under Social
16) Usually people want to lower their investment risk in later years by shifting from
stocks to bonds, which usually lowers their returns. Will they be able to afford to
do that? (Investment risk). Do they know the value of diversification?
17) Do participants know they have to contribute more because they won’t get the
COLA that a DB plan may have given? (Inflation risk). Will inflation erode your
18) If a participant had a DB plan and now has a DC plan, have they figured out that their
returns will probably be lower (due to higher fees and non-expert management),
and therefore they need to invest more? A retiree may need to under consume or
change their standard of living out of fear or necessity. (Replacement ratio). Will
the retiree be too thrifty for fear of running out of money? Will there be a over
savings dilemma as the employee must plan and save for maximum life expectancy
and therefore have to self insure by over saving about 25% more than a DB plan
costs for the same benefit?
19) Are participants concerned that if they have Social Security, there may be pension
offsets or windfall provisions that may effect their benefits? What if Social
Security or other government programs are reduced?
20) How many participants vote proxies in hopes of getting better boardroom governance
and therefore higher stock prices?
21) How many participants file anti trust/SEC litigation claim forms in hopes of getting a
22) One of the arguments as to why a DC was needed was to protect health insurance.
Have participants seen their health insurance change, i.e. co pays, caps, or
23) Have women complained that the DC plan is discriminatory? Women usually take
time off from work to have babies and maybe even raise the family. A DB plan
may have allowed this. Perhaps even credits could be purchased. In a DC plan, if
she does not work, she does not contribute. The sad part is that women need more
money then men because they usually live longer. If the partner dies, one may
still need 80% of the marriages financial needs. In addition, women are paid less
than men, therefore able to invest less.
24) What if the government “takes over” or negatively changes the 401 rules?
25) If the employee leaves the employer, how much will they be charged to keep their
money in the old plan?
26) If the employee cashes out their 401, does that mean creditors can lay claim for child
support or alimony?
27) Is there an early 10% withdrawal penalty if the employee is younger than 59 ½? (IRS
28) Is there an option to purchase an annuity with joint and survivor benefits (life
income) to manage longevity risk? Few DC plans offer annuities, fewer
participants opt for them.
29) Can the employee manage inflation risk with a variable or inflation protection
30) Does the employee have the knowledge to make the proper asset allocation, do the
proper research, select the best investment options, monitor the performance and
make periodic changes including rebalancing? Is the employee able to handle the
record keeping and education needed?
31) Does the employer offer enough investment advice in the accumulation stage and
through retirement? Is it personalized one-on-one or web based? Is there a
single point of contact and a single record keeper?
32) If the company closes, how much will the Pension Benefit Guaranty Corporation
(PBGC), if applicable, pay for the DB benefit, that is if they are still around?
DC plans have no requirement to insure benefits. (Company solvency risk).
33) Has the employer given the time and resources to plan and run my retirement
program as promised? Were the employees given a choice between a DB or DC
plan? Did the employees understand the differences? What was the default
34) Sometimes employees invest not as planned. (Financial planning risk). How can
they manage money to meet their objectives, especially when an individual can
not do anything about changes in: demographics, legal or political issues, or
economical issues such as Social Security, economic growth and stability,
Medicare, healthcare, the financial markets and inflation?
35) Will their job be effected if the employer expands pension plan eligibility to part
time employees? Would a temporary or part-time employee have a 401?
36) If the employee is a low income worker, and could get a DB benefit, they would be
less likely to need government assistance.
Employer pension issues and concerns: What they should be asking themselves.
1) Are employers concerned that with DC plans, there will be a lower demand for
goods and services as participants and retirees can’t afford to buy? State and local
economies will be effected. (Multiplier effect). DB assets promote national
savings, economic efficiency, and create markets. They promote corporate
governance thereby making more efficient markets. They promote investment in
hard to value, less liquid assets such as real estate. DC investments conflict with
these ideals. Without the stable long term DB additions to our economy, interest
rates could be higher, the cost of capital could be higher, and investment returns
could be lower.
2) Are governments concerned that if people outlive their DC benefit, the governments
will be burdened, as the governments and social services will be the payers of last
resort? Low income workers will be hit the hardest. DB plans reduce the poverty
level for the elderly, as joint and survivor benefits give a level income for life.
3) Are employers concerned that if a DC member has to work longer because of the low
account balance, he/she may have low productivity “retire in place”? Many retire
when markets do well, and few retire when markets do poorly. Do employers really
want old men doing the young mans job of police officer or fire fighter?
4) Did employers loose effective workforce management that the DB plan offered i.e.
ability to facilitate an orderly and timely movement of employees out of the
workforce? DB’s offer flexibility in plan design in such things as investments,
contributions, and retirement windows, which can target groups of workers.
(Demographic risk). How important is the freedom to be able to allow early or late
retirement benefits that a DB plan allows? DB benefits can be increased in a tight
labor market. Ad hoc COLA’s can be given in times of high inflation or good
investment return. In private DB plans, employer contributions are flexible, they
can contribute more in good years and less in bad years. This has no direct impact
on employee benefits. In a DC plan, the employer may be required to match a
portion of the employees contribution. If the employer plans to reduce the amount
of match contribution, it must be announced prior to the benefit year. This has a
direct impact on the employees benefits. A DB plan has no such restriction.
5) Are employers having trouble attracting and retaining qualified employees because
the DB benefit is not there?
6) Are employers finding out that turnover and training costs are higher because the DC
benefit is offered? In a DC plan, there is no loyalty or tenure equity, no reward for
career employees or “get ahead” employees. This is because when salary increases
in a DB plan, it effects future benefits, but in a DC plan, in only effects
7) Are employers finding out that their DC administrative costs are higher than a DB
plan? How can I address the big cost of service fees on low balance accounts,
especially in times of lay offs, when terminated employees keep their money in my
8) Why are open market fixed annuities so expensive? Is it fair they have liquidity
restrains and little fee transparency?
9) Do employers realize that they still have accrued DB costs, even if the new employee
has a DC plan? Current employee and retiree benefits must still be paid for. If
assets are less than the accrued liability, unfunded liabilities remain. The employer
contribution rate may go up because fewer active members are putting in less
money. In addition, assets may have to be sold to pay benefits, and this may result
in investing in short term securities with less return. This too would increase the
employer contribution rate. The perceived advantages of changing to a DC plan are
not there. Even though this is a way to cut my costs and liabilities, savings may not
be realized for many years. Employers find they may have a misconception of what
unfunded liability really is and its cost.
10) Will employers be sued because of failure to educate the worker on asset allocation,
and the financial liabilities of investment/market risk, or fee structure, or even
failure to give information to all members, even inactive members, especially in
these times of poor performance? (2008 LaRue).
11) Do employers realize that with a DB plan, employees will retire with regularity, thus
enabling promotion of younger workers.
12) Will employers reach a point where my employer contributions will stop, either
because they need the money or tax provisions are no longer favorable?
13) Knowing the shortcomings of a DC plan, should employers, increase their
14) Is it fair to pass too much risk and responsibility for funding and managing retirement
and health care costs to my employees? (Medical cost risk). Is this degree of
decision making something that too many employees will be ill-equipped to take?
15) As a corporate/municipal leader, are employers concerned that it may be poor public
policy to shirk the responsibility of insuring that my retirees have sufficient pension
16) Do employers want to retire older workers with dignity by giving them a stable and
secure income, not one effected by a drop in market value, jumps in inflation, poor
returns, leakage etc?
17) Are employers concerned about all the rules they must comply with if thinking about
eliminating their DB plan, as the government is concerned about the company going
“belly-up” and being a drain on the Pension Benefit Guaranty Corporation?
18) Do employers realize that they may see increased productivity by employees in a DB
plan as their moral is higher and they have reduced fears about retirement, as
compared to a DC plan.
There are DBDC issues the Federal government should be concerned about:
In 2027 Social Security expenses will exceed revenue and interest. In 2041 the SS
coffers will be depleted. Eligibility age increases and benefits are reduced. As many as
eight states are not covered by Social Security. Many government workers do not
contribute to SS or face pension offsets and windfall provisions. If you take away the DB
plan of those workers, who will bare their financial burden? Government and social
services will become payor’s of last resort.
People are not saving for their future. The median balance for 401(k)’s is $35,000. For
ages 55-64 the average is $60,000. How long can one live on $60,000? One could easily
outlive their DC pension monies. The DC final benefit is determined by the market when
cashed out. What if one retires in a down market and loose 40% of their retirement
monies just before they are to collect?
Contributing to a 401(k) is not mandatory, they are discretionary plans. Yes, it is
portable, but a large part of the participants do not take them to the 8-10 jobs they hold
over their careers. Many have cashed them out or have borrowed against them.
Most government DB plans are well funded, as they are forced savings, managed by
trained trustees and professional money managers. Employers should be forced to make
necessary contributions and not be allowed to borrow from the pension plans.
Governments/sponsors should not restrict investments because of genocide, terrorists or
the likes. (ESG- environment, societies, and governance). Governments should not
require social or geographic investing. (ETI- economically targeted investing).
Governments should allow pension plans to invest in non-traditional asset classes, both
alternative and international up to 40% including hedge funds, real estate, private equity,
Trends in the pension world
Pension plan trends: (DB unless otherwise stated)
Change in investment policy/allocation
Increase in fixed income, international and hedge funds, hi-yield, infrastructure, and
indexing, and other alternatives
Decrease in US equities and real estate
Lower returns due to less aggressive investments
Change in consultant and/or manager
More DC loans and withdrawals
Reviewing risk tolerance
More due diligence
Better administration, cut down on expenses
More manager flexibility, not static and hold
Faster to react to issues
Rebalancing (consider risk, cost and volatility), and increase ranges
Reduce manager fee structure
More governance policies include errors and omissions insurance
More interaction with press and public
Reduction of COLA’s
More disability applications
More asset and liability studies
Change to Liability Driven Investing
Longer amortization period
More in-house education
Capital and liquidity issues due to lock-ups (hedge and index funds) and funds with
capital needs (real estate and hedge), redemption gating or side pockets
Voting proxies in hopes of corporate governance
Becoming more involved legislatively
Cash flow concerns (for DROP, early retirements or incentives)
Employer trends: (public and corporate)
Reduced/eliminated health care benefits to active and retirees
Increased health care premiums/out of pocket, active and retired
Salary cuts including executive compensation packages
Layoffs, or accept lower paying job
Phased retirement: reduced work schedule, or rehiring retirees on part time or temporary
Reduction/elimination of “er” contributions to DC plans
Change DC offerings to value, money market or treasury
Elimination of DB plans to new or all “ee”s, 2nd tier
Reduce DB benefits to new or all “ee”s, include caps
Increase “ee” contributions to DB plans
Lowering of DB multiplier percentage
Increasing of minimum retirement age
More communication to “ee”s reference economy and pensions
More governance policies (proactive not reactionary risk management, oversight and
enforcement, enhanced accounting standards, executive compensation tied to
shareholder interest, more disclosure and transparency)
More due diligence
Less leverage investing
Extending minimum benefit eligibility
More negative press comments: rich pension gifts will bankrupt employers. Employers
must realize that pensions are compensation traded for work.
To freeze or terminate-
Some companies have chosen to freeze their plans and wait until interest rates rise further
and the value of their liabilities declines before terminating and annuitizing benefits.
Freezes come in two varieties, “soft” or “hard”. A soft freeze is less of an impact on
employees and their morale. Benefit accruals are ended for a segment of the workforce,
typically new hires and those with little seniority. A hard freeze stops the benefit
accruals for all employees. Liabilities are reduced but not stopped, as future obligations
are based on actuarial assumptions, which are subject to change.
Fidelity has recently decided to terminate their plans. This is an expensive option as
accrued benefits must be paid out to employees, so plans must be fully funded or have the
cash on hand to pay the difference between assets and liabilities. Typically benefits are
distributed in the form of a single- annuity for vested employees. Insurers can charge
high fees, sometimes up to 10-25% of the plan’s fully funded value.
Corporate greed allows for the freezing or closing of pension plans. The effort should
first be made to fund the pension every year, and reduce or eliminate a COLA, increase
the minimum retirement age, reduce early retirement incentives, and increase the
Decreased job security
Reduced contributions to DC plans
Suggested mandatory DC pension contribution
Funding level requirements (Fed. Pension Protection Act, and State of Mass and Penn.)
Sudan Accountability and Divestment Act of 2007 (spread to state and local level)
IRS surveys of governmental DB plans
Increase of trustee terms
Federal reform (regulatory and judicial overhaul including SEC, hedge funds, rating
agencies, banking, Fannie Mae and Freddie Mac, and naked short selling)
SEC and Congress making proposals to give shareholders more boardroom clout
(executive pay and board elections). Recently limited brokers proxy voting if
shareholders are not voting (Broker vote rule helpful as 75% of all US company shares
are held in street name and managed by brokers). Introduced shareholders say on pay
Budget cuts due to GASB 45, taxpayers, credit rating agencies and plan participants my
demand prefunding. Do you continue to pay-as-you-go, issue obligation bonds,
increase “ee” and/or “er” contributions, or contain costs?
Revival of proposed legislation to repeal the WEP (Windfall Elimination Provision) and
GPO (Government Pension Offset of the Social Security Act)
More SEC and anti-trust litigation (less SEC settlements but larger dollar amounts, and
more subprime lawsuits)
Court rulings: Citigroup and AIG in Delaware Chancery Ct. made it harder for investors
to hold directors liable for fiduciary breaches related to their oversight duties. Half of
the publicly traded US companies are incorporated in the state of Delaware
TARP (Troubled Asset Relief Program) said no unreasonable or excessive executive
Some managers taking more risk. Larger tracking errors between portfolio and index.
More counter party risk wherein broker fails to deliver or take delivery of security.
More organizational changes in financial companies
How a DB trustee/employee group can fight against going to a DC plan:
Educate yourself/trustee, plan members, tax payers, the media and the elected officials.
As a trustee understand the relationship of risk and asset allocation. Consider
aggressive transition management.
Go after those who violate anti trust or SEC regulations in hopes of recouping monies.
Direct how proxies are to be voted.
Don’t bow under pressure to chase trends. Review assumption rates. Check your
managers and consultant for conflicts of interest.
Separate the question of generosity from retirement system efficiency. Know your plan
benefits and how they are funded and measured.
Know the differences in the public DB and private DB plans such as: private DB liability
valuation risk is based on interest rates, whereas public DB plans use long term rate of
return assumptions. Private DB plans use “mark to market” rather than smoothing
gains and losses. Both issues result in greater volatility in private DB employer
contributions. The Pension Protection Act requires corporate DB plans to have higher
funding targets and use more conservative investment strategies. Public pension
funding levels exceed those in the private sector. Sources of public pension revenue:
12% employee contributions, 24% employer contributions, and 64% from investment
earnings. (In Florida, the constitution protects government pensions. Cities cannot go
bankrupt. The State would step in and run the plan, and the employer must still
contribute to the plan).
Don’t buy benefits because a plan is over funded.
Insure the employer makes the timely required contributions.
Don’t allow the employer to borrow from the plan assets.
The COLA may have to be eliminated. (Regressive bargaining).
May have to eliminate any early retirement incentive, or increase minimum retirement
May have to increase the employee contributions due to lower investment returns,
increased life expectancies, and increased benefits.
May have to create new employee benefit tiers, perhaps with lower multiplier percentage.
May have to look at a hybrid plan such as a cash balance plan, which combines length of
service and investment return. Another hybrid alternative uses two plans, one using a
lower DB multiplier, and the other is the DC portion.
Don’t let the employer/yourself be more concerned about foreign policy and social
behavior than returns. (Divesture) Includes ESG (Environment, societies, and
governance) and ETI (Economically targeted investments).
Push for higher limits of alternative/International investing.
Campaign if needed (New Hampshire Retirement Security Coalition). Beware of pension
envy. Challenges may come from the uneducated, or partisan political groups or from
ideological interest groups, not necessarily from public discontent wanting wholesale
Show the costs. Less benefits do cost less. The cost of a DB plan is almost half the cost
of a DC plan when one figures the cost of lower DC plan return, higher fees and need to
invest for the maximum life expectancy. A higher DB plan return equates to a savings
of 26%, DB plan non-aging diversification equates to a 5% savings, and longevity risk
pooling (over saving) equates to a 15% savings. In other words, more money has to be
invested in a DC plan and a DB plan, to achieve the same benefit level.
Again, do not forget about the liability costs of those who may have been in the DB plan.
Those who have been in a DB plan for years and now have a frozen plan will loose the
forthcoming years of “highest” salary, and will have only a few years of market
downturn or gain with their DC investments.
State that DB plans are a source of stable long term patient capital that plans invest into
publicly traded companies that benefit our US economy. If this DB money was not
infused into our economy there may be diminished economic growth.
The DC retiree savings pool is not stable. The IRA asset pool is larger than either the DC
or DB asset pools. This is because many older conservative workers rolled their 401’s
into IRA’s. Sadly, untimely deductions from IRA’s come with a penalty. In addition,
they usually have lower returns.
In closing, preach that pensions are not gifts, they are compensation traded for work.
401’s are not retirement plans but are optional savings plans that, unless changed, may
turn out to be only a supplement to Social Security.
DC plans intensify future problems rather than provide solutions.
A special note for police officers and fire fighters: Police officers and fire firefighters
should realize that if budgeted positions are cut to pay for their DB plans, they will face
increased job risks. Police officers and fire fighters do not judge personal risk, they put
their personal safety aside to protect the public. A DB disability does help take care of
the officer if needed. No affordable DC disability insurance could do the same. If
retired, and need to go back to work, who will hire a part-time police officer or fire
fighter? In what other jobs can they use their unique skills? If they wish to start a
second related career, there may not be that many positions available in the job market.