New Menu for Public Pension Funds
Darby, Rose, Government Finance Review
A public pension system orders a competitiveness study? More than one public employer competes to offer retirement benefits to the same group of workers? Unheard of? Not really.
In 1994, the trustees of Colorado's Public Employee Retirement Association (PERA) found themselves ordering a study of why more and more of the state's municipal and university faculty members were opting out of the system. Like many other public fund systems, PERA was concerned that it was not providing a retirement package that does enough to help the state to retain good employees and attract new ones. Local governments, school systems, and other lower-level entities are seceding from big public plans in the hope of setting up their own, often more limited benefits packages. The timing is bad for large statewide systems, which are being urged by groups such as the National Conference of State Legislators to bring more local systems under their umbrella so as to lower their own actuarial costs. Offering a competitive, cost-effective set of benefits is essential if they are to preserve their long-term financial standing.
With $14.4 billion in total assets and 145,000 active participants, PERA is a composite of four separate retiree plans--state, schools and universities, judicial, and municipal. The latter include 85 cities towns, and local government entities such as water and library districts. In 1988, municipal systems gained the right to choose between remaining within PERA or setting up their own alternative plan. Since then, eight entities have opted to leave and replace the PERA defined benefit plan with their own defined contribution programs.
Universities, too, began to talk about the need for more portable retirement benefits to serve an increasingly mobile work force of young professors and administrators. In 1992, they asked for and won passage of legislation enabling them to leave PERA and create their own optional defined contribution plans. Shortly thereafter, nine universities set up these optional plans. When school and college employees were allowed to change over to the new defined contribution plan, one-half chose to do so. PERA has continued to grow despite the defections--in fact, enough smaller entities, lacking the resources to set up their own systems, have joined since 1988 to result in a net gain. But the handwriting was on the wall: PERA officials interpreted the departing members' choice as voting with their feet, a perception that what PERA was providing in terms of pension benefits or a pension plan did not meet their needs.
The competitiveness study that PERA trustees commissioned strongly echoes concerns at other public pension systems around the country. Issues raised in Colorado include lack of portability options under the present defined benefit plan; a formula for crediting employees' benefit accruals, tied to the year-end 90-day Treasury bill, which has resulted in very low accumulations over the past few years; and lack of choice between a lump-sum payout at retirement and an annuity arrangement.
To address the issues, PERA proposed creation of a new hybrid structure, one which alters the current defined benefit plan to make it more flexible and better able to meet the needs of both shorter-term employees and those planning to stay until retirement. The proposal was enacted by the Colorado legislature and signed into law in May 1995. The result is a plan that offers participants a retirement benefit formula based on either a defined benefit or a defined contribution formula, whichever is larger. What it lacks is the risk on the individual that typically goes along with many defined contribution plans.
The PERA approach is not new. The Wisconsin Retirement System converted to a hybrid plan in 1965 and has operated under this structure since then. Colorado PERA used Wisconsin and some other hybrid plans as models in devising its new plan. It is expected that other public pension fund systems will follow PERA's lead and break with the old ways of providing services. …