Converting Pension Plans from Defined Benefit (DB) to Defined Contribution (DC): The Myths and the Messaging Part 3
The information monopoly possessed by Defined Benefit (DB) plan actuaries creates an enormous information imbalance in the discussion over how to transition from a DB to a Defined Contribution (DC) plan. Demanding the right data in order to separate reality from accounting anomalies enables policymakers to take back control of the narrative.
As we noted in Part 2 of this series, actuaries already have a reasonable estimate of the yearly cash outflows required to pay existing liabilities should new employees enroll in a DC plan rather than the current DB plan. Yes, actuaries already use this known expenditure stream to help calculate the plan liabilities.
Lawmakers should request this data in a format that shows the estimate by year for all current members—including non-vested members—of those groups within the DB plan. This should be the first piece of information requested. Creating a consensus for conversion of the DB plan to a DC type hinges on obtaining and properly analyzing this vital information.
Actuaries will generally refuse to voluntarily release this data, often claiming the data are “proprietary.” Such a claim is groundless since the data form the basis for the actuaries’ calculation of the plan liabilities financed by your constituents. The DB pension system purchased the single software program designed to conduct these calculations. Policymakers should not accept this “proprietary system” excuse.
The next roadblock erected by the actuaries is the claim that the Governmental Accounting Standards Board (GASB) requires a substantial increase in the amount of Annually Required Contribution (ARC) to the DB plan in the event of a transition to DC for new employees. As a CPA and former state comptroller and state budget director, I can attest to the misleading nature of this claim.
GASB generates this increase in ARC based largely on three assumptions:
1) The pension plan must begin selling off assets to stay operational as the system stops accepting new members
2) This ‘sell-off’ of assets will diminish the system’s rate of return as earnings are no longer reinvested into the plan
3) The DB plan no longer collects retirement contributions from the large number of employees who leave the system before vesting, as discussed in Part 1. Such an employee may contribute tens of thousands of dollars into a DB retirement plan without attaining a single dollar of future benefits. If you have not read Part 1, please do so. Messaging is key to offsetting this often used talking point.
Of course, in preparation of a state Comprehensive Annual Financial Report (CAFR) as state comptroller, I adhered to GASB and showed the liabilities on the balance sheet that reflect this ‘compaction’ of the cash outflow for the DB plan. The net effect of this artificial amount on the balance sheet is not generally significant and has almost zero effect on a state’s bond rating. The rating agencies care about one thing: the state’s ability to meet future bond payments. The rating agencies will welcome a well-designed plan to transition from a DB to a DC system for this reason: The costs of DC plans are predictable while market and political forces make DB plans notoriously volatile. This transition-related cash outflow compaction is almost completely irrelevant. Nothing in GASB requirements results in a negative change of net cash outflow by a single penny in a conversion to a DC plan. If properly designed and implemented, a conversion will generate instant cash flow savings rather than perpetuating this current intergenerational transfer of debt. A DC plan conversion significantly lowers the future tax burden on our children and grandchildren while providing a secure retirement for public sector employees.
In Part 4, we will lay out a plan design successfully implemented in my home state of Oklahoma which reinforces Part 3’s claims regarding bond ratings and cash flows related to DB to DC plan conversions.