Pensions: Good News/Bad News (1998)
State legislatures may address two types of bills affecting our members’ pension plans in 1998. They represent both good news and bad news.
The Good News: Management of Public Employee Retirement Systems Act
The National Conference of Commissioners on Uniform State Laws (NCCUSL), a group that was created to promote uniformity among state laws and includes delegations from each state, has been meeting for several years to draft a uniform law covering public employee retirement systems.
The NCCUSL recently voted overwhelmingly to adopt and promote the Management of Public Employees Retirement Systems Act (MPERS). In accordance with the NCCUSL Constitution, delegations from each state must introduce the uniform law into the state legislature no later than the first legislative session immediately following approval of the language by the American Bar Association. The ABA approved the language at its January/ February 1998 meeting.
AFSCME, as well as other unions representing public employees, supports passage of the uniform law. The uniform law will:
- establish the independence of public plans from the sponsoring government;
- impose fiduciary standards on trustees very similar to ERISA; and
- impose reporting and disclosure requirements that will open the administration and operation of the funds to public scrutiny.
Some states may currently provide — through law or the state constitution — better protections than those in MPERS. Most do not. Where MPERS provides greater protections, we encourage you to work to pass and, where possible, to strengthen this legislation in your own state.
With respect to fiduciary standards, trustees can be held personally liable for a breach of fiduciary duty. While that is a potential concern to current or future trustees, the retirement system can insure trustees for the liability and should be strongly encouraged to do so. Also, many employees currently serving on pension boards will not come under the fiduciary standards because they will not meet the uniform law definition of trustee. Only those with actual trustee powers will be considered a trustee. Employees serving on advisory committees, investment boards and in similar positions will not be trustees under the uniform law.
The uniform law does not address the composition of boards of trustees, although this can be included in state legislation. Currently, most public pension fund boards do not include meaningful employee or retiree participation. Only with meaningful participation can pension funds truly operate independently of the employer. Joint representation on pension boards, with participants and retirees selecting their own representatives, is a goal that has been achieved in a number of states and municipalities.
The Bad News: Public Employees’ Portable Retirement Option Act
The American Legislative Exchange Council (ALEC), a national group of conservative state legislators, adopted the model Public Employees’ Portable Retirement Option Act (PRO) on May 30, 1997. ALEC proposes a sweeping replacement of the public sector defined benefit pension system, which ALEC refers to as "old-fashioned," with a defined contribution system. There is a concerted effort underway to replace defined benefit plans with defined contribution plans in a number of states.
In December 1996, the Michigan legislature passed a bill converting the pensions of state and judicial employees from defined benefit to defined contribution. The original legislative proposal also included teachers and other public school employees. However, these employees were removed from the legislation until an unfunded liability of approximately $7 billion in their current plan is erased. So far, Michigan is the largest state — and the largest pension system — to make this conversion. Three other states have taken similar action. West Virginia began a defined contribution plan for teachers a few years ago. Colorado and Washington provided defined contribution plans as part of a mix of plans offered to teachers.
Much has been made of the growth of defined contribution (401(k) type) pension plans for U.S. workers. Despite claims to the contrary, defined benefit pension plans still provide the best benefit to retired workers and to workers planning their retirement. Defined benefit plans are not only better for employees, but are also better for employers, and are simply better public policy.
Defined Benefit Pension Plans are Better for Employees
- Defined benefit pension plans provide guaranteed income security to workers for their retirement; no matter what happens in the stock market, how long an employee lives after retirement, or whether he or she becomes disabled.
- Employees are not subject to investment risk. Pension funds invest assets with an optimum mix of growth potential and risk. Studies show that individuals responsible for their own retirement income typically invest too conservatively, and thus do not adequately protect their retirement benefits from inflation.
- Retirement benefits are not dependent on employees’ ability to save. Lower-income workers and workers facing declining incomes lose twice under defined contribution plans, where employer contributions are often tied to employee savings. While defined benefit plans often have mandatory employee contributions, their contributions provide workers with a secure retirement.
- Defined benefit plans provide cost-of-living adjustments and pension formulas that are tied to the highest-paid years, which protect employees from inflation while they save throughout their working lives.
- Death and disability insurance, which are typically provided under defined benefit plans, provide income security for participants. Defined contribution plans provide no insurance benefit in case of an employee’s death or disability; employees must purchase this coverage at additional cost.
- Defined benefit plans provisions can allow for portability with shorter vesting periods, reciprocity agreements, and buybacks for prior or related service. Defined benefit plans may also allow employee borrowing.
Defined Benefit Pension Plans are Better for Employers
- Defined benefit plans allow employers to set and to guarantee income-replacement goals for their workforce. Employees with inadequate retirement income may work longer at higher wage rates than their younger replacements, negotiate higher employer contributions to their 401(k) type pension plans, or even sue employers for not providing enough investment and retirement-planning education.
- Employers benefit from the favorable investment performance of pooled pension fund assets. The wide range of investment options open to large funds makes it possible for employers to provide adequate benefits to employees while limiting contributions. Studies of some pension funds show that investment earnings have exceeded both actuarial assumptions and the interest credited to employee accounts over the last two decades.
- Defined contribution plans are not a "magic pill" to solve employers’ budget constraints. Defined contribution plans are not more efficient at providing benefits equal to defined benefit plans. Comparable benefits often require comparable employer contributions. Plus, features such as employee loans, investment options, education and information obligations, and periodic statements can make defined contribution plans expensive to administer.
- Employers face high costs to switch to defined contribution plans. For example, Michigan offered early retirement to employees — at a cost of $270 million — to win support for a switch to a defined contribution plan. The high cost of defined benefit plans today is often the result of large, unfunded liabilities accumulated for years, that still have to be paid even if the employer switches to a defined contribution plan. This is why states like West Virginia, which moved certain employees to a defined contribution plan, now favor switching back.
- Defined benefit plans offer an incentive for government employees to stay in public service. Many valuable employees, who would earn a higher salary in the private sector, stay in public service because of the guarantee of income security when they retire.
- Defined benefit plans are not hard to budget. Actuarial projections are made each year and announced months in advance, allowing employers adequate time to budget the expense. Pension liability in mature, ongoing plans typically changes little from year to year.
Defined Benefit Pension Plans are Better Public Policy
- Defined contribution plans shift the cost of administration onto employees. Employees pay significant management fees to mutual funds and other plan services directly out of their retirement savings, whereas pension funds use their own managers.
- Defined contribution plans can create other social costs. Individuals who fare poorly investing their defined contribution plan account, or who outlive their retirement benefit, may use more social services and need financial assistance such as Medicaid and welfare benefits in their retirement years, offsetting any perceived "savings" to taxpayers.
- Defined benefit plans promote retirement savings among lower-income workers, by mandating a single, low level of employee contribution to participate.
- Many defined contribution advocates resent pension fund power and influence on corporate governance issues. Corporations and executives who don’t like pension fund activism hope to use defined contribution plans to erode investor power, by breaking up large pension plans into small pools of individuals’ savings.
If you would like more information on MPERS or PRO, or assistance in addressing pension issues generally, please contact the Department of Research and Collective Bargaining Services at (202) 429-1234. If you become aware of activities in these areas in your own state, please let us know.