Editorial Board Memo: Potential Dangers of Cash Balance Pension Plans
Date: Friday, October 4, 2013
From: Stephen Herzenberg, Keystone Research Center
To: Pennsylvania Editorial Writers | CC: Capitol Reporters
Subject: The Potential Dangers of Cash Balance Pension Plans
This week, state Rep. Glen Grell (R-Cumberland) inserted a new three-pronged proposal into the debate on Pennsylvania’s public pension system. As explained at more length in a conference call with the media, the Keystone Research Center endorses one prong of Senator Grell’s package (the use of low-interest bonds to pay down the state’s pension debt) and recommends close examination of a second prong (two voluntary cost-saving changes to pensions for current school and state employees). Keystone, however, has deep reservations about the third prong, a so-far unvetted pension proposal called a “cash balance” plan.
As you research Rep. Grell’s cash balance proposal, we urge you to take a close look at our new report, New Pension Plan Could Increase Taxpayer Costs and Cut Benefits Deeply, the first accessible primer for Pennsylvanians on this unfamiliar type of cash balance plan.
The Grell cash balance approach recognizes that putting all new state and school employees in 401(k)-type individual retirement accounts is not the way to go because it would leave taxpayers with a $40 billion bill over 30 years. Keystone pointed out these transition costs in a February pension primer, and actuaries confirmed the point in May and June.
Cash balance plans themselves, however, could dig a deeper pension hole for taxpayers, while leading to an exodus from public service among experienced mid-career employees who play key leadership roles in our schools and state agencies.
Here’s how cash balance plans work: Rather than providing a defined pension benefit tied to final salaries and years of service, cash balance plans provide defined contributions into an employee’s individual (at least, on paper) accounts — 7% from employees under Rep. Grell’s proposal and 4% to 5% from employers. Under the Grell plan, the money in each employee account is also guaranteed a minimum 4% rate of interest and half of pension plan earnings above 4%. At retirement, the accumulated cash balance in an individual’s account converts to an annuity that pays a fixed pension benefit until death.
Stepping back from the technical details, what do cash balance plans means for taxpayers, for public servants, and for schools and state agencies seeking to attract and retain effective, committed workers? The KRC brief finds:
- Long-term, cash balance plans could erode the investment returns on state and public school pension plan assets, increasing the state’s unfunded liabilities and the cost to taxpayers. Here’s why: if pension fund managers are only required to meet a 4% guaranteed rate of interest, this may become their investment target rather than the current 7.5% investment target. If pension funds invest more conservatively and earn closer to 4% than 7.5%, taxpayers will have to pay more.
- The proposed cash balance plan would result in substantial reductions in the pension benefits of public employees. Building on actuarial studies of two similar cash balance proposals advanced in the 2011-12 legislative session, KRC estimates that Rep. Grell’s cash balance proposal would reduce benefits by roughly 20% on average across a range of public service careers.
- The proposed cash balance plan could make it more difficult for state agencies and schools to retain experienced mid-career employees because it would reduce pensions for those who stay on until retirement by much more than 20% -- an estimated 46% to 66%. This could lead to staff turnover that erodes the quality of public service and make it necessary for public employers to provide offsetting wage increases, another cost for taxpayers.
- Some cash balance plans, including Rep. Grell’s proposal, would result in employers paying little or nothing for the pensions of future public employees, allowing the state and school districts to divert equitable contributions for worker retirement to pay down the state’s unfunded liability. In effect, cash balance is a not very well disguised attempt to get new workers to pay off a pension debt that they had nothing to do with creating. This seems arbitrary and unfair.
In conclusion, cash balance plans are poorly understood and have not gotten the scrutiny that led the Legislature to wisely reject 401(k)-type individual accounts. Rather than rush to approve a radical pension overhaul, lawmakers should stick to the elements of Rep. Grell’s plan that build on the progress already made in a 2010 pension reform law.
If you have any questions, please feel free to call Communications Director Chris Lilienthal at 717-255-7156.