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South Carolina has become the latest state looking to close its defined benefit pension plan and move all new state workers into a defined contribution plan.
According to a report in Chief Investment Officer, in an effort to control the state's unfunded liabilities, Henry McMaster, the governor, sees a DC plan as a means of shutting off the flow of state funds to what he describes as an "open system"—as he termed it in this comment in his state of the state address: "Putting money into an open system like that is like trying to fill a bathtub with the drain open. We must close enrollment first."
A look at the governor's budget reveals his aim of closing enrollment in the South Carolina Retirement System to new employees after December 31, 2020, the report says. New hires would instead join the State Optional Retirement Program. Participants in the defined benefit ORP, it points out, "are solely responsible for their retirement account and they choose how to invest and manage their money."
As of July 1, 2019, the South Carolina Retirement System had unfunded liabilities of just under $23 billion. At the same time in 2018, the total stood at $22.1 billion. McMaster sees the switch as a way of protecting taxpayers. But based on the experiences of other states and municipalities who went that route or proposed to, it doesn't always save money.
Kentucky proposed going that route in 2017, with a proposal to shut its DB plan to new participants and instead putting them into a DC plan. But, the report says, "An analysis of that proposal released in late 2019 said … that the move would have saved the state money in the short term, but would have been more expensive over the longer term."
Kentucky, which has the worst-funded pension plan in the country, has fallen prey to high fees and risky hedge fund investments. According to a report in The Intercept, despite the fact that those alternative investments failed to provide the returns state pension officials were promised, Kentucky Retirement Systems continued to invest in alternatives that not only did not reward the effort but imposed "fees roughly 10 times what a pension fund would pay to invest in a plain vanilla stock fund."
Kentucky plan participants saw their plan fork over "$13.6 million in annual management fees. Five years later, that figure had ballooned to $126 million" but still did not account for "all the millions of dollars in those 20 percent 'performance fees' that hedge funds and private equity collect." Switching to a DC plan wouldn't solve the problem of trustees who perhaps could have done more due diligence on the plan's investments.
And a report from the Teachers Retirement System of the State of Illinois reviewed the pros and cons of switching from a DB plan to a DC plan, and found that not only are DC plans not popular among employees, they provide smaller benefits, cost more than DB plans, and provide weaker investment results than DB plans. They also raise government contributions.
In fact, it points out, West Virginia actually switched from a DB plan to a DC plan and then went back again, and Nebraska switched from a DB plan to a DC plan which it subsequently closed, switching all members to a cash balance plan that, like a DB plan, provides a guaranteed annuity in retirement.
The city of Palm Beach, Florida, likewise ended up reinstating a DB plan after the switch resulted not just in lower benefits but also a "mass exodus of public safety officers" in neighboring towns who departed after DB benefits were reduced. It too saw a 20 percent resignation of the town's workforce, as well as losing 100 first responders—and the resignations resulted in higher costs in other areas, such as overtime to fill the gaps caused by the resignations and millions in expenses for training courses for new replacement personnel.
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Marlene Satter
Marlene Y. Satter has worked in and written about the financial industry for decades.
