Transition Cost Should Not Bar Pension Reform

January 10, 2014

Defined benefit plans have an estimated $1 trillion to $4 trillion unfunded liabilities, say Andrew G. Biggs, Josh McGee and Michael Podgursky in Pensions & Investments.

Detroit's bankruptcy was in large part a result of pension funding pressures. Similarly, Stockton, San Bernardino and Vallejo, California, all filed bankruptcy due largely to public employee benefits.

Capping these liabilities would seem to be the most logical step, but the plans and actuaries are claiming that shifting to more manageable alternatives would actually increase costs, and reforms in several states have slowed due to this claim. That claim, the authors write, is bogus:

  • One of the arguments against transitioning to more manageable plans claims that the Governmental Accounting Standards Board (GASB) requires that unfunded liabilities be repaid more quickly. If that were true, accelerating payment would actually produce larger long-term savings. Moreover, the GASB standards have been updated and the provisions that would have supported this argument no longer exist.
  • The second argument against transitioning to a closed defined benefit plan is that the finite life would mean that the plan would need to hold less risky and more liquid assets, in order to ensure that it has the money required to make benefit payments. That, advocates say, would require higher contributions upfront. However, closed pension plans with less risk actually impose lower contingent liabilities on future generations; therefore the total cost of the plan would not increase.

If the full economic costs of defined benefit plans are accounted for, the costs of shifting to more sustainable models are eliminated.

Source: Andrew G. Biggs, Josh McGee and Michael Podgursky, "Transition Cost Not a Bar to Pension Reform," Pensions & Investments, January 6, 2014.

 

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