Moving new employees to 401(k)s would endanger existing pensions, increase cost to taxpayers

pension fundDuring this year’s State of the State address, Gov. Mary Fallin expressed strong support for doing away with traditional  defined benefit pension plans for new hires within the Oklahoma Public Employees Retirement System (OPERS) in favor of 401k-style defined contribution retirement plans. The Governor touted the switch as beneficial both to public employees, whose retirement benefits would be more  portable if they wish to leave state employment early in their careers, and to the state’s fiscal stability. Moving to a defined contribution model, she said:

… stabilizes the system for current public employees and retirees. Oklahoma pension systems currently have $11 billion in unfunded liabilities. The system as it stands today is not financially sound or sustainable.
It’s important we shore up our pension systems so we can pay out the benefits we have promised to our retirees.
This proposal is now speeding through the legislative process in SB 2120 and HB 2630. Leaving aside the question of whether state workers would truly be better off with a 401(k) retirement plan, the claim that switching to a defined contribution model for future public employees would put the state on better financial footing simply does not withstand scrutiny. Instead, is likely to weaken a pension system that is now in strong financial shape and increase the state’s cost for meeting its pension obligations.
In recent years, Oklahoma has adopted a variety of strong and effective reforms to bolster its pension systems, including increasing employer and employee contributions, prohibiting any unfunded benefits, including cost-of-living adjustments, and raising the retirement age for new employees.  While these reforms have reduced the unfunded liabilities of all the state’s pensions systems, they have helped put the Oklahoma Public Employees Retirement System on especially strong footing: 
  • Source: State of Oklahoma Public Employees Retirement System, Actuarial Valuation Report as of July 1, 2013 (Cavanugh Macdonald Consulting, LLC)
    Source: State of Oklahoma Public Employees Retirement System, Actuarial Valuation Report as of July 1, 2013 (Cavanugh Macdonald Consulting, LLC)

    As of 2013, OPERS has an 81.6 percent funded ratio on an actuarial basis and an 87.6 percent market value funded ratio (see Graph). This is above the standard 80 percent benchmark for a well-funded plan;

  • OPERS’ unfunded liability of $1.6 billion represents less than 15 percent of the state’s total unfunded pension liability referred to by the Governor;

  • For each of the last three years, OPERS has exceeded its Actuarial Required Contribution (ARC), which means that contributions to the system are greater than what is needed to fully pay benefits for current and future retirees. In 2013, OPERS’ ARC was 19.38 percent and its combined contribution from employers and employees was 20.61 percent, creating a surplus of 1.23 percent.
In short, thanks to responsible measures adopted by the legislature over the past decade, OPERS is financially sound and sustainable. Yet the proposal to close off the system for new employees and shift these workers to defined contribution plans risks weakening OPERS and increasing the system’s unfunded liabilities. The reason is that pension plans depend heavily on investment earnings to grow their assets so as to be able to meet their obligations. As long as plans remain open to new employees, investment managers can invest for the longer-term because they have a mix of young, mid-career and retired workers. Closing off the plan to new employees does away with this critical balance, as explained in a recent report by Ross Eisenbrey and Steve Herzenberg:
If they are closed to new employees, an increasing share of remaining participants in the Oklahoma defined benefit pension plans will gradually age and retire. As this happens, remaining funds in the plans must be removed from illiquid assets, such as private equities, and invested in more liquid assets which are easy to convert into pension checks for retirees. This shift to more liquid assets will also lower the rate of return, increasing the taxpayer contributions needed to honor existing defined pension obligations.
Eisenbrey and Herzenberg note that, “Studies in 13 states that have considered a switch to defined contribution plans have reached an actuarial consensus that closing a defined benefit plan lowers investment returns and thus increases unfunded liabilities” (emphasis theirs).
There has been no comprehensive actuarial study conducted of the proposals now moving through the legislature, and no such study is anticipated. In a recent letter  “completed in a short timeframe”, OPERS’ auditors stated that if a significant share of new workers’ salaries are allocated to pay off the unfunded liabilities of the legacy plan, as is provided for in SB 2120 and HB 2630, it would pay off the liabilities over the remaining amortization period. However, the actuaries concede that as a growing share of OPERS participants reach retirement, the plan will likely need to adjust its investment allocation. “These allocation changes over time are likely to reduce the investment return generated by the fund, requiring still more additional funding,” they note. While they don’t estimate  the potential cost, when Pennsylvania considered a similar plan last year, three different actuaries concluded that closing the state’s defined benefit pensions to new employees would gradually erode investment returns, leading to a $40 billion increase in unfunded liabilities.
Approving a fundamental change in Oklahoma’s retirement benefits without the benefit of a thorough actuarial study on the impact the change would have on the system’s financial security – as well as on employees’ retirement security and the state’s ability to recruit and retain a high quality workforce – would constitute a serious failure of due diligence on the part of the Legislature. While there is much more that we need to know about the proposed pension switch, we know enough to doubt that moving new state workers into  a defined contribution plan will help the state meet its promises to its retirees.

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Former Executive Director David Blatt joined OK Policy in 2008 and served as its Executive Director from 2010 to 2019. He previously served as Director of Public Policy for Community Action Project of Tulsa County and as a budget analyst for the Oklahoma State Senate. He has a Ph.D. in political science from Cornell University and a B.A. from the University of Alberta. David has been selected as Political Scientist of the Year by the Oklahoma Political Science Association, Local Social Justice Champion by the Dan Allen Center for Social Justice, and Public Citizen of the Year by the National Association of Social Workers.

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