You are falling into a cost trap. I have focused on compensation, not costs. The DB plan in Colorado provides employees with a large amount of deferred compensation because the taxpayer is assuming all risks. Essentially, employees have a fixed return investment with a large amount of deferred compensation. Wage indexed securities do not exist.
The DC plan with the same employer contribution level is much less valuable to career employees because the employee must take the risk. The DC plan does not provide deferred compensation. Risk averse employees will need to choose low risk investments.
The problem with the cost trap is that actuarial assumptions cannot be insured. Politicians increase benefit levels as market returns increase forgetting about risk. The cost of the DC and DB plans are not the same. The DB cost must include a large risk component that taxpayers bear when actuarial assumptions are not achieved.
When one adjusts returns for risk, the advantage of the DB plan is clear. In my analysis, the DB plan provided a 4.5 to 6 times the risk adjusted return. With the state of the US economy, risk considerations are a vital part of the plan cost. Public pension agencies use outrageous assumptions to justify high benefits. Public employees should bear the risk of their retirement. DB plans when offered should be designed to provide returns comparable to a guaranteed investment. I believe that the FERS plan is designed in this manner.
No trap. I'm focusing on both.
The DB plan in Colorado provides employees with a large amount of deferred compensation because the taxpayer is assuming all risks. Essentially, employees have a fixed return investment with a large amount of deferred compensation. Wage indexed securities do not exist.
I don't agree with that characterization. Employers accept the responsibility of offering a pension to employees upon retirement entering into a contract of sorts. The employee agrees to work for a dollar now (salary) combined with a dollar later (pension). The employer sets aside money that will fulfill that obligation, assuming that the money will grow over time as it is invested. Those investments can include securities, real estate, bonds, or any variety of things. That set-aside fund may indeed incur some losses, but it will also experience gains. There is both risk and opportunity. Contribution amounts to fulfill the employers obligation will consider the long term rate of return considering both of those factors.
The DC plan with the same employer contribution level is much less valuable to career employees because the employee must take the risk. The DC plan does not provide deferred compensation. Risk averse employees will need to choose low risk investments.
I don't agree with that either. The compensation amount under a DC plan is computed based on the same variables and actuarial assumptions as a DB plan. Theoretically, an individual has the opportunity to earn the same long term rate of return as does the pension fund. In fact, the objective of both would be to make available a target amount of dollars to that employee upon retirement. Whether it is set aside by the company in a DB plan, or put aside in the name of the employee under a DC plan, the end game is intended to be the same.
The problem with the cost trap is that actuarial assumptions cannot be insured. Politicians increase benefit levels as market returns increase forgetting about risk.
Changing benefit levels is a change in the fundamental contract with the employee; it is not a change in actuarial assumptions (as would be return on investment, actual age at retirement, mortality, etc). Now, have politicians (and companies) used accumulated funds in a pension plan, originally set-aside for one purpose, as a piggy bank to fund new benefits beyond those originally prescribed? Absolutely. Those actions, IMO, are a violation of the trust initially established with employees and in the long run often cause an increase in contribution amounts for which taxpayers are left holding the bag. One solution would be to prevent politicians from taking such actions--that seems a whole lot more appropriate than proposing a wholesale change from a DB to a DC plan.
The cost of the DC and DB plans are not the same. The DB cost must include a large risk component that taxpayers bear when actuarial assumptions are not achieved. When one adjusts returns for risk, the advantage of the DB plan is clear.
Well, I've worked on several of these in real life, including studies of whether companies should change from a DB to a DC. The cost is basically the same. The compensation is also generally the same after adjusting for the time value of money. The only way employers have been able to offer such a change, and make it palatable to employees, is to demonstrate that the new plan is equal to, or even more generous, than their existing plan. The amount an employee receives under a DC plan is basically computed using the same variables as would be used under a DB plan.
In my analysis, the DB plan provided a 4.5 to 6 times the risk adjusted return. With the state of the US economy, risk considerations are a vital part of the plan cost.
How many years are you using in performing your analysis? If the economy were booming, would you say that opportunity considerations should also be part of the plan cost?
Public pension agencies use outrageous assumptions to justify high benefits.
I contend it is the politicians who are quick to dole out the benefits, not the pension agencies who act as managers of the funds more than pseudo-philanthropist. Politicians have used funds in various ways to cater to their favorite group to try to gain favor with their policies. When they do this, it is no different than any other misuse of public funds and it should not be tolerated. These situations should be exposed, rectified, and those responsible prosecuted to the greatest extent possible.
Public employees should bear the risk of their retirement. DB plans when offered should be designed to provide returns comparable to a guaranteed investment. I believe that the FERS plan is designed in this manner.
Why have a pension at all, then? If public employees should bear the risk, why not just give them a bigger salary and be done with it--no pension, at all? What seems to get lost in these discussions is the reason for pensions in the first place. It was to offer stability and future income in return for employment. It was a service, offered by an employer. For those who are not able to make intelligent investments (or not interested), the employers offered to do it for them. Under a DC plan, it is basically eliminating that service. It is also opening the door for hoards of not-so-ethical investment managers to sell their "services" to not-so-savvy retirees and deplete their retirement funds. (Have you seen the astronomical increases in elder fraud lately?) My guess is that would just put more pressure on already strained social service programs as more and more seniors join the "indigent" category.
IMO, public employees should be offered competitive a competitive wage and benefit plan, including pensions. A computer analyst with a given set of skills, and given similar job requirements, should be paid comparably by either a public or private employer. If a politician(s) or public employer pension fund is incompetent or crooked in how they manage that fund, I don't think changing the employee/employer relationship is the solution.