New National Institute on Retirement Security Report Examines Impacts of Switching Away from Defined Benefit Pension Plans

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National Institute on Retirement Security

Dec 04, 2023, 10:20 ET

The Five States Studied Faced Multiple Challenges After the Switch

WASHINGTON, Dec. 4, 2023 /PRNewswire/ -- A new report tracks the experience of five states that shifted new employees away from defined benefit (DB) pensions to defined contribution (DC) or cash balance plans. Among states that switched to a DC plan, costs rose, negative cash flow grew, and employee turnover increased. Additionally, the retirement security of plan participants in DC plans was negatively impacted because of a high degree of "leakage" of retirement assets from the DC accounts that replaced pension plans.

These findings are detailed in a new report from the National Institute on Retirement Security (NIRS), No Quick Fix: Closing a Public Pension Plan Leads to Unexpected Challenges. This report examines the experience in five states: Alaska, Kentucky, Michigan, Oklahoma, and West Virginia. The report is authored by Dan Doonan, NIRS executive director, Tyler Bond, NIRS research director, and Celia Ringland, NIRS research associate.

Read the report.

"These five states are a cautionary tale for policymakers considering changes to employee retirement plans in their states," said Dan Doonan, NIRS executive director and report co-author. "The analysis shows clear patterns across the states studied: retention of workers is poor and closing a pension plan to new employees fails to address any funding shortfalls."

Doonan added, "There often are claims that closing an existing pension to new hires will improve matters in a variety of ways, but it's hard to find proof among the public pension plans that have closed in the past 27 years. Instead, switching away from a pension starves the plan of employee contributions while the liabilities remain, creates higher negative cash flow, and leaves taxpayers supporting the costs of two plans for many decades. Moreover, moving away from pensions undermines employees' retirement security and causes workforce challenges for states that already are struggling to attract and keep workers who deliver essential public services. In contrast, funding discipline produces results."

The report's key findings are as follows:

Among the states studied, employer costs increased significantly after closing a pension plan. In some states, poor funding practices preceded the plan closure, with improved funding discipline only after closing the plan. Even 26 years after one of these plans was closed, employer costs remain high. In contrast, the ongoing contributions of new active members combined with sound funding practices show strong results.
In the closed plans, cash flows have become more negative over time as demographics shift and the plan begins to spend down its assets. The Michigan State Employees' Retirement System plan is furthest along in this regard, as the plan pays a growing share of its assets as benefit payments. Despite higher costs and larger contributions, the plan's high negative cash flow throughout the Great Recession forced more plan assets to be sold at a discount while markets took time to rebound.
Despite claims that younger workers will be attracted to savings-based plans, including cash balance and DC plans, the available retention data shows poor retention in the new plans or tiers. Workforce management has become a challenge in many of these states with closed plans.
Many workers are cashing out their DC plan account balances when leaving a public sector job, and the evidence indicates those dollars are unlikely to be used for producing retirement income. The available data suggests that DC plans are failing to help many workers accumulate sufficient retirement savings.
The West Virginia Teachers Retirement System, which was closed and then reopened, shows that reopening a closed pension plan is a viable option that can reverse many of the harmful trends documented in this report if reopening is combined with contribution discipline. In West Virginia, pension plan costs have stabilized and the funded status continues to climb.

The National Institute on Retirement Security is a non-profit, non-partisan organization established to contribute to informed policymaking by fostering a deep understanding of the value of retirement security to employees, employers, and the economy as a whole. Located in Washington, D.C., NIRS membership includes financial services firms, employee benefit plans, trade associations, and other retirement service providers. More information is available at www.nirsonline.org.

SOURCE National Institute on Retirement Security