Pension commission hears testimony on plan design,
contribution rates and teacher fund consolidation
The Legislative Commission on Pensions and Retirement heard testimony over two days on topics ranging from alternative plan design, contribution rate increases for certain PERA and MSRS plans, minimum salary threshold for PERA membership, and the teacher fund consolidation study.
On Tuesday, the panel heard from three national experts on pension issues: Luke Martel of the National Conference on State Legislatures, Josh McGee of the Laura and John Arnold Foundation, and Diane Oakley of the National Institute on Retirement Security.
Martel provided an update on states that have made changes to their defined-benefit plans since the “great recession.” Six states have converted to alternative plan designs, such as cash-balance plans or hybrid retirement plans. Michigan and Alaska moved to a pure defined-contribution plan.
Several states – including Montana, New Mexico, Nebraska and Texas – made smaller changes, such as increasing employee contribution rates. Martel also noted that many states are enacting changes to their normal retirement age, with most moving from age 62 to age 65. Two states, Missouri and Illinois, have increased their normal retirement age to 67 for those hired after 2011. Martel said that six states have reduced retiree COLAs; in four states the cuts affect current retirees.
“COLAs are expensive benefits. Some states have postponed them, others have tied them to funding levels,” he said, adding that these changes have been the subject of lawsuits in a number of states, including Minnesota.
LCPR chair Sen. Sandy Pappas, D-St. Paul, asked how states handled transition costs when closing their defined-benefit pension plans.
“(Moving to an alternative plan) doesn’t fully fund the existing plan or pay transition costs,” Martel said. “You stop making the hole bigger by putting new employees in the new system. Just creating a new system doesn’t solve the problem.”
Josh McGee, vice president of public accountability at the Laura and John Arnold Foundation, commended the commission for good governance and noted that many states don’t have a separate commission to address public pension issues. He went on to say that discussion of plan design in the public sphere generally has been “unproductive” and driven by ideology.
McGee said that there’s a mistaken belief that defined benefit is the most efficient model and that myths have grown up around this belief. He said defined-benefit pensions do not impact recruitment and retention of public employees, that changing to an alternative plan design does not incur transition costs, and that reforms that “close loopholes” don’t solve structural problems that exist with pensions.
“Retirement income is an important part of the employee compensation package,” he said, and it’s important to provide all employees with a retirement plan that works for them. However, a 401(k) might not be the answer, he added. “The 401(k) has been implemented poorly in the private sector. It’s done poorly. There’s a lack of saving, people just don’t save enough for retirement. There are high fees. Folks had a choice of high-fee mutual funds, but over time those high fees really eat away at your retirement. There’s poor asset allocation and poor options for annuitization.”
But McGee said that DBs aren’t entirely the answer, either. Alternative plans can be designed that offer employees a path to retirement security that differ significantly from final-salary defined-benefit plans, he said, and these alternatives can protect employees from poor decisions and from outliving their savings.
“Retirement plan design does not run on a smooth continuum from final salary defined-benefit to a defined-contribution where the former offers the most security and the latter offers the least,” he said. There are many variations that can offer both sustainability and retirement security through a “well-defined annuity.”
“Simplicity and transparency should be the watchwords of plan design and public policy,” McGee said, adding that the more complex the plan design, the higher the likelihood that bad decisions will be made. He said ideally he wants to improve on final-salary defined benefit pensions, not necessarily do away with them altogether.
“Until you fix the funding policy and simplify the benefit structure, you face more ad hoc changes to benefit structure,” he said. “I don’t think it’s about cost reduction, I don’t think it’s about risk sharing. You want to provide benefits more securely and transparently under a better structure that is easier to understand, easier to manage and benefits the workforce.”
A new funding policy should “isolate the promises that are core that you want to provide to workers” and “isolate the annuity promise to workers.” He urged the panel to develop clear rules to deal with cost and benefits and establish equity between generations of workers. “We’ve seen inequitable distribution of benefits through time. Benefits for current workers are quite meager compared to those who entered the workforce in the ‘90s.”
He said cash balance plans are a very good option if you like having control over investment practice and you like having control over what people have at the end.
“All of the things we like about DB, the adequate savings rate, good benefit accrual rate, investment management, annuities – can all be incorporated in these other plan designs,” McGee said. “We should provide a path for retirement security for all people. Ultimately the DB model fails to do that.”
Diane Oakley, executive director of the National Institute on Retirement Security, said the purpose of providing a retirement plan is to achieve the objectives of stakeholders: employers, taxpayers and employees. She said that retirement security benefits everyone, helping to stabilize the economy and manage the public workforce.
Oakley discussed the core elements of pensions: mandatory participation, employee-employer cost-sharing, benefit adequacy, pooled assets invested by professionals, and lifetime benefits. Defined-benefit pensions, she said, deliver the same benefit at half the cost of 401(k)-type plans.
Oakley discussed lessons learned from well-funded pension plans elsewhere: New York, Delaware, Idaho, Illinois Municipal, North Carolina and Texas. The Texas teachers fund looked at various options and found that the DC was the most expensive option and the DB the least expensive, she said. Other lessons learned: “COLAs have to be done responsibly. You need anti-spiking measures. Making sure economic and actuarial assumptions can be reasonably expected to be achieved over the long term,” she said.
And closing a DB can create other issues, Oakley said. In Utah, for example, employees contribute to pay down the unfunded liability of the closed DB even if they are enrolled in the DC. Closing or freezing a DB plan and switching to an individual account does not address funding, and incurs transition costs, she said.
West Virginia learned this the hard way. After closing its historically underfunded teacher retirement system in 1991 and moving everyone to a DC plan, the state found that teachers coming up to retirement had only about $25,000 in their accounts on average.
“They ended up reopening the TRS system in 2005 and eventually let those in the DC plan move over to the DB plan,” Oakley said. “That plan today is 58 percent funded, which is almost a 200 percent improvement over what it had been,” thanks to higher contributions going into the system from both employees and employers.
NIRS analyzed all public retirement systems that offer employees a choice of retirement plan, and when given the choice, the majority overwhelmingly chose the DB system. Oakley gave the commission data on the retirement crisis, highlighting the NIRS finding that the typical working-age household has only $3,000 in retirement assets and the average near-retirement household has only $12,000.
Rep. Alice Johnson, D-Spring Lake Park, asked Oakley what she thinks will happen if more and more people are left with inadequate savings in retirement.
“We do have individuals running out of money,” Oakley said. “Because of pensions there’s $8 billion dollars in the economy that are saved in public assistance costs. … In reality, we’ve got a bigger crisis in the private sector and nobody measures it. In the public sector we have ways of measuring it.”
Rep. O’Driscoll wondered why DB pensions are singled out as an economic stimulus in the state when anybody who retires is spending money, whether they have a pension or a 401(k).
“The individuals who have 401(k) plans who saw the value of their accounts at the end of 2008, 2009 drop by 30, 40 percent, the first thing those retirees did was stop spending,” Oakley said. “A DB is an economic stabilizer, where a DC plan is an economic destabilizer.”
At the Wednesday meeting, the pension commission heard testimony from Mary Vanek of PERA about minimum salary level for inclusion in the plan. Vanek said that after surveying employers and employees, most preferred moving very low-pay employees to an annualized earnings threshold.
Vanek and MSRS executive director Dave Bergstrom also testified regarding their systems’ request to increase employee and employer contribution rates. MSRS is seeking a .5 percent increase for its general and correctional plans from 5 percent to 5.5 percent; PERA is requesting a .25 percent increase for employees and employers in its general plan – from 6.25 percent to 6.50 percent for employees, and from 7.25 percent to 7.5 percent for employers.
The meeting ended Wednesday with testimony from Laurie Hacking and Jay Stoffel of TRA and Paul Doane of St. Paul Teachers Retirement Fund Association regarding the Minnesota Teacher Fund Consolidation Study. The legislatively-mandated study was due to the commission on Jan. 6; the three fund directors summarized its findings for the panel on Wednesday.
Doane said that after studying the options, the board of the St. Paul fund voted to remain a separate fund but to transfer its assets to the State Board of Investment to be pooled and invested along with the assets of the other funds.
Stoffel, who directed the Duluth fund until recently, described the demographic challenges – declining student and teacher population relative to retirees – that have caused the current funding problems in that city. The Duluth Teachers Retirement Fund Association’s board voted to merge with TRA.
Hacking described the process used to develop the report and the feasibility and requirements to bring Duluth into TRA. The TRA board recommends bringing any merging fund in fully funded to mitigate risk to TRA and protect TRA’s assets.
The teacher fund consolidation report is available at www.minnesotatra.org. Information about the PERA legislative agenda is available at www.mnpera.org. The next LCPR meetings will be held in February; dates to be announced.