Cost of switching to DC plans can be high

Switching from a defined benefit plan to a defined contribution plan can be a costly proposition for a retirement system, a study indicates.

The National Conference on Public Employee Retirement Systems stated last month that defined contribution pension plans are at least 20 percent less efficient in delivering benefits. In its research paper entitled, “What is the Cost of Transitioning from a DB Plan to a DC Plan,” NCPERS lists a myriad of factors that states and plan sponsors need to consider when considering such a change.

Some states have turned to mandatory defined contribution plans as a way to relieve themselves of future liabilities. When this subject comes up, the defined contribution plans are touted as a way to save money by controlling future expenses while providing the same level of benefits. But history has shown that’s not the case.

OPERS offers its members a choice of a traditional, defined benefit plan, or the option of either a defined contribution plan or a hybrid of the two. We believe that maintaining these options is the best way to ensure retirement security for all public employees.

The NCPERS paper notes that among the costs of switching plans are:

  • Establishing the structure to accept employer contributions
  • Creating employee communication materials to explain the new system
  • Changing the retirement system’s forms and other materials used for correspondence
  • Earlier-than-expected retirements from current members, even if the plan is not mandatory
  • Choosing the appropriate amortization period and investment return assumption for legacy unfunded actuarial accrued liabilities

The paper states that when scrutinizing any retirement plan, one should keep in mind the equation that benefits equal contributions plus investment income, minus expenses. If the cost of a plan equals the contributions made by employees and employers, then savings must come from reduced benefits, increased investment returns or lowered expenses.

In summary:

  • Defined contribution plans “increase the cost of delivering a comparable retirement benefit.”
  • Regarding mitigating risk by switching to mandates defined contribution plans, “other plan design options are available for reducing or transferring risk that do not require sacrificing the plan’s investment activity.”
  • Moving to mandatory DC plans does not help a retirement system address unfunded liabilities from previous years.

Michael Pramik

Michael Pramik is communication strategist for the Ohio Public Employees Retirement System and editor of the PERSpective blog. As an experienced business journalist, he clarifies complex pension policies and helps members make smart choices to secure their retirement.

Michael Pramik

Communication Strategist

  • I am a Opers retiree. Is someone suppose to contact us regarding our change in Health care. When does this change become effective

    • Marlene,

      Participants in the OPERS Medicare Connector will be contacted by the plan’s administrator, OneExchange, to set up an appointment for you to choose a health care plan. The appointments will take place from October through December, so that initial call will come sometime before October. The change is effective Jan. 1 of next year.

      –Ohio PERS

    • Marlene,

      If you are referring to health care for those 65 and older, you will be contacted by OneExchange to set up an appointment to choose your plan. The new plan will become effective Jan. 1.

      –Ohio PERS

  • Am I correct in that it will be necessary for my wife and I to file each and every month with One Exchange to receive my stipulated premium amount when this becomes effective? If yes, it seems to have not been well thought out to have this additional burden placed on retirees, Surely it could have and should have been automatic. What am I not understanding? Thank you

    • Tom,

      It will be possible to sign up for automatic reimbursement. That will take 6-8 weeks to become effective, so we encourage people to submit manual claims the first two months after filling out paperwork for auto reimbursement. If the Connector administrator has all of the appropriate documentation, they will process the manual claim within one week.

      –Ohio PERS

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