Report Shows State Shifts from DB to DC Are Costly

The National Institute on Retirement Security says three states’ switch from a defined benefit pension to a defined contribution plan exacerbated pension underfunding.

A report from the National Institute on Retirement Security suggests that states that shifted retirement plans from defined benefit (DB) pension plans to defined contribution (DC) plans experienced higher costs.

“Case Studies of State Pension Plans that Switched to Defined Contribution Plans” presents summaries of changes in three states—Alaska, Michigan, and West Virginia—that made the switch from a DB pension to DC accounts. The case studies examine key issues that impact pension plans, including demographic changes, the cost of providing benefits, actuarially required contributions (ARC), plan funding levels and retirement security for employees.

The case studies indicate that the best way for a state to address any pension underfunding issue is to implement a responsible funding policy with full annual required contributions—and for states to evaluate assumptions and funding policies over time, making any appropriate adjustments, the Institute says.

According to the report, in Alaska, legislation was enacted in 2005 that moved all employees hired after July 1, 2006, into DC accounts. At the time, the state faced a combined unfunded liability of $5.7 billion for its two DB pension plans and a retiree health care trust. The unfunded liability was the result of the state’s failure to adequately fund pensions over time, stock market declines and actuarial errors. Although the DC switch was sold as a way to slow down the increasing unfunded liability, the total unfunded liability more than doubled, ballooning to $12.4 billion by 2014. In 2014, the state made a $3 billion contribution to reduce the underfunding. Legislation has been introduced to move back to a DB pension plan.

In Michigan, the DB pension plan was overfunded at 109% in 1997. The state then closed the pension plan to new state employees who were offered DC accounts. The state thought it would save money with the switch, but the pension plan amassed a significant unfunded liability following the closure of the pension plan. By 2012, the funded status dropped to about 60% with $6.2 billion in unfunded liabilities. In recent years, the state has been more disciplined about funding the pension plan, making nearly 80% of the ARC from 2008 to 2013.

In West Virginia, the state closed the teacher retirement system in 1991 to new employees in the hopes it would address underfunding caused by the failure of the state and school boards to make adequate contributions to the pension. As the pension’s funded status continued to deteriorate, retirement insecurity increased for teachers with the new DC accounts. Legislation was enacted to move back to the DB plan after a study found that providing equivalent benefits would be less expensive in the DB than in the DC plan. By 2008, new teachers were again covered by the pension, and most teachers who were moved to the DC plan opted to return to the pension. After reopening the DB pension, the state was disciplined about catching up on past contributions, and the plan funding level has increased by more than 100% since 2005. The teacher pension plan is expected to achieve full funding by 2034.

The full report is available here.