New Pension Reform Efforts Are Not a Solution

June 25, 2015

By Jack Ehnes

By creating the illusion of a catastrophic pension crisis, pension critics would have you believe that the only way to create a sound and sustainable retirement savings program is to move away from a defined benefit pension, preferably replaced with a defined contribution or perhaps none all. Many recent studies, media articles and now a new ballot initiative are based on the same flawed logic.

While a discussion on how to improve the financial condition of pension plans and reduce costs is a fair one to have, basing the discussion on the twin notions that public employee defined benefit pensions crowd out government services and that the only alternatives are to slash guaranteed retirement income and/or force public employees into 401(k)-type defined contribution plans is ultimately detrimental and costly to taxpayers and pensioners alike.

Case Studies on Pension Plan Swaps Speak Volumes

In fact, a study from the National Institute on Retirement Security found that converting from defined benefit to defined contribution plans actually increased costs and increased pension underfunding. Case Studies of State Pension Plans that Switched to Defined Contribution Plans summarizes the impact of switching from a defined benefit pension to a defined contribution in three states – Alaska, Michigan, and West Virginia.

One state, West Virginia, who moved to a defined contribution plan in 1991 actually switched back to a defined benefit plan 14 years later. After studying the costs of going back to a defined benefit plan in 2003, the state found that the normal cost (the cost of benefits accrued in a single year) for its defined benefit retirement system was nearly half of the required employer contribution to the defined contribution plan. This is why the state decided in 2005 to put all new hires into a defined benefit plan.

Moreover, 78.6 percent employees who opted to participate in the defined contribution plan in 1991 switched back to the defined benefit plan including 76 percent of teachers under 40 years old. The study also highlights the dismal average member account balance of the state’s defined contribution plan, which as of April 30, 2005, was just $41,478. Only 105 of the 1,767 teachers over age 60 had balances of more than $100,000.

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, as well as the plan design, making any appropriate adjustments – as stated in the report. Additionally, any existing unfunded liability must be addressed unless already accrued benefits are cut, which in California cannot occur due to legal constraints, nor is this idea being proposed by pension critics. Thus, switching from a defined benefit to a defined contribution does not offer a viable solution to shore up any unfunded liabilities, and can actually make them worse.

Pension Reform in California Has Already Occurred

Pension reform in California took place with enactment of the Public Employees Pension Reform Act of 2013. While PEPRA provided much needed safeguards around troublesome issues such as pension spiking and double dipping, it did not address the CalSTRS unfunded liability. A funding solution came with enactment of theCalSTRS 2014 funding plan in AB 1469. Through gradual contribution increases by all the plan’s contributors, the state, employers and members, the program is on course to be fully funded by 2046. For CalSTRS, contributions are projected to be sufficient to maintain the normal cost of the Defined Benefit Program and amortize the existing unfunded liability. In other words, the system is on solid ground.

Defined Benefit Pensions Are Responsible and Efficient

The economic downturn of 2009 still has many strapped governmental entities struggling to recover from tremendous financial burden. But defined benefit pensions are not the cause of the financial turmoil, nor is cutting those pensions the solution. Breaking promises to existing workers and eliminating a secure retirement for future generations only replaces one problem for another.

As these issues play out in the media and legislative process, keep in mind some very important facts. CalSTRS members earn a reasonable benefit for the service they provide to California’s students, on average retiring at age 62, receiving about 53 percent of their final salary after almost 26 years of service.

  • CalSTRS members receive no Social Security benefits for their CalSTRS-covered employment. For many, their CalSTRS pension is their only retirement income.
  • Generally, CalSTRS retired members do not receive employer-paid health care benefits after age 65.
  • CalSTRS has not taken any “pension holidays” which means contributions have been made continuously, thus reinforcing the sustainability of the fund.

With appropriate funding, a defined benefit plan such as the CalSTRS Defined Benefit Program is a responsible, efficient way to provide secure retirement income. Generations of California’s educators have come to rely upon this modest retirement income for more than 100 years as testament to the system’s sound design. Successful discussions that lead to solutions take place when undistracted parties focus on unbiased facts and practical recommendations.

CalSTRS will be closely following the pension reform issue, which has been rekindled with the June, 2015 introduction of the Voter Empowerment Act of 2016, as it plays out in the media and legislative process.