Taxpayer Costs Rise When States Move Out of DB Pensions

Research says changing benefits for new hires does not solve funding shortfalls.

US states that move new employees to defined contribution or cash balance plans from defined benefit pensions experienced increased costs for taxpayers, without major improvements in funding, according to research from The National Institute on Retirement Security (NIRS).

NIRS said the research, which encompasses a series of case studies, also indicates that the move away from pensions cuts employees’ retirement security and that employers may face increasing challenges hiring and retaining staff.

The case studies cover four states that closed their pension plans in favor of alternative plan designs: Michigan, Kentucky, West Virginia, and Alaska. According to NIRS, switching to a defined contribution or cash balance plan from a defined benefit pension plan did not help existing pension underfunding as promised. Instead, it said, costs for these states increased after the pension plan was closed.

“These case studies are cautionary tales for policymakers considering changes to employee retirement plans in their states,” Dan Doonan, NIRS’s executive director and co-author of the report, said in a statement. “What’s important to understand is that switching away from pensions starves the plan of employee contributions while the liabilities remain.”

Doonan said this can reduce the economic efficiencies of a pension system as the number of retirees grows compared to the number of employees paying in.

“Ultimately, taxpayers are left with the bill,” he added. “Moreover, such a switch undermines employees’ retirement security and triggers workforce challenges for employers.”

According to the research, the Michigan State Employees’ Retirement System (SERS) pension plan has been closed for more than 22 years with all new hires participating in a defined contribution plan. When the SERS pension plan closed in 1997, the plan was actually overfunded with 109% of assets, however, by the end of September 2017, the plan was only 66.5% funded and had an unfunded liability of $6 billion. And, the system now must be managed with six retirees for each worker.

In Kentucky, the legislature initiated a new tier of benefits for plans in the Kentucky Retirement Systems (KRS). Public employees hired since the beginning of 2014 were placed in a cash balance hybrid plan instead of the pension plan with the hope that this would improve KRS’ funding. However, one of the KRS plans—tthe KERS Non-Hazardous—was funded in fiscal year 2004 at 85.1%, and by fiscal year 2018, the funded status was down to 12.88%.

In West Virginia, the Teachers’ Retirement System (TRS) pension plan was closed in 1991, and new teachers were placed in a defined contribution plan. However, after teachers faced low retirement account balances, and after calculating that it could provide equivalent benefits at half the cost of the defined contribution plan, the state re-opened the defined benefit pension.

When West Virginia reopened the pension plan in 2005, the funded status of the plan was at 25%. However, since then the state has seen steady progress as the funded status improved with steady contributions to 50% funded by 2008, and 70% funded by 2018.

And for Alaska, the research found that closing the pension plans has not helped the state manage its existing unfunded liability. The combined unfunded liability for pension benefits was higher in 2017 than it was in 2005, despite a $3 billion infusion of the state’s financial resources. While the state has been able to moderately improve the funded status of both its plans after increasing its funding commitments, the unfunded actuarial accrued liability for pension benefits has increased in the pension plans since 2005. As a result, NIRS said that many workers there face a retirement with no Social Security or pension.

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