To fix their persistent pension problems, some U.S. states are looking to reshape their retirement plans to resemble those in the private sector, but they may find may employees resistant and the savings elusive.
Over the last few decades, the private sector has ditched traditional pension plans with their defined benefits. They have been replaced with defined contribution accounts, such as 401(k)s, in which employees allocate a set amount each month to invest — often partly matched by employers — and then cash out at retirement.
This has left the public sector as the main provider of defined benefit plans, which pay employees a fixed amount each month after retiring.
But pension funds have been stung by the recent financial crisis and recession, leaving taxpayers and political leaders agonizing over the possibility they will be unable to afford those defined payments. Estimates of a total shortfall range from around $700 billion to $3 trillion, due to differing forecasts of investment returns.
"If the idea is that tax revenues are down and state budgets are crunched, and they surely are ... I think it's worthwhile to take a step back and look at the actual costs," said Ilana Boivie, director of programs for the National Institute on Retirement Security, or NIRS
"Most states that have done those feasibility studies have found that you're not going to save any money" by switching to a defined contribution plan.
According to the National Conference of Public Employee Retirement Systems, the next two years will see "modest growth" in hybrid plans that combine elements of the defined benefit and defined contribution schemes. Around 5 percent of public entities already offer hybrids.
About 20 percent provide defined contribution plans, and around 5 percent will add a defined contribution option in the next two years.
Some states want to keep current employees in pensions and put new hires into defined contribution plans.
Alaska, the District of Columbia, Michigan and Minnesota all use defined contribution plans as their primary retirement offerings. In July, Utah began requiring employees to choose between a defined contribution plan and a hybrid.
The NIRS, in a study released Thursday, found that moving into a system similar to 401(k) accounts can push up costs, especially at the start.
"That unfunded liability represents a debt that is a benefit promised and owed," said Boivie. "That unfunded liability will not go away."
When the defined benefit plan is closed to new members, employees and employer contributions to the plan could spike because the time span for wiping out funding gaps will be shorter and new employees will be putting money into their own retirement accounts instead of the pension plan.
Meanwhile, employers must bear the administrative costs for both plans as they phase out the pension program.
Defined benefit plans pool risks to achieve greater investment returns, the NIRS report found. They are able to "provide the same retirement income at about half the cost of a defined contribution plan."
The study also looked at retirement systems that offer employees a choice and found almost all workers prefer pensions.
The group examined the West Virginia's Teachers Retirement System's decision to provide new employees with defined contribution retirement plans in 1991. It found that the loss of new members made it more difficult to finance the unfunded obligations of the defined benefit plan.
Stock market problems prevented retirements from 2000 through 2002 and those in the new plan "achieved much lower investment returns" than the closed pension fund. In 2005, West Virginia returned to a defined benefit plan.
Nebraska opted for a defined contribution plan in 1967, which it closed in 2002 for a plan that does not let employees control investments made with their accounts. Instead, it guarantees an annual return and then pays out like a defined contribution plan, according to the National Conference of State Legislatures.
ALL GOVERNMENTS RETHINKING RETIREMENT
During the 1990s stock market boom, said Timothy Rouse, vice president of business development and public markets at ING U.S. Retirement, interest in public sector defined contribution plans surged. But, he said, it came from employees hungry for higher returns and not from states seeking savings.
The ING retirement group does not advocate how governments structure their retirement systems. Instead, it helps them manage the redesigns they choose.
Rouse said state and other public authorities can struggle with shifting to defined contribution plans because "in the short-term you're trading an 'IOU' for a hard dollar expense."
During recent budget crises, some states shrank their pension contributions or skipped them entirely.
Rouse said each state and local government has a unique set of issues to address in pensions. He added, though, that the recent recession is forcing all governments, including the federal government, to look at reforms.
"It's pretty much across the board. No one is safe from these discussions," he said.
© 2015 Thomson/Reuters. All rights reserved.