Top pension plan may change to 401(k)-style plan

The top-rated and tightly managed Dutch retirement systems, sometimes cited as an example of how struggling U.S. public pensions should be run, may go over to the other side — switch to a 401(k)-style plan advocated by pension critics.

The Dutch government, after several years of discussion, issued a reform proposal this month that would switch current employees from pensions based on salary and years on the job to plans based on the earnings of individual investment accounts.

The change is scheduled for 2020 if employers and employees can negotiate an agreement that would be approved by the Dutch parliament. Tax money could be provided to ease the transition.

“The Netherlands is widely regarded as having one of the world’s strongest and most sophisticated occupational pension systems, so the proposed reforms will be closely scrutinized by many governments that face challenges in paying retirement incomes,” the Financial Times reported on Oct. 13.

In the United States, most corporations have switched from pensions to 401(k) retirement plans that only require an annual payment into the employee’s tax-deferred investment account, avoiding the long-term debt of providing lifetime monthly pension payments.

Public pension systems fear being swept into the private-sector trend toward 401(k) plans, which critics say often are inadequate, shift investment risk from the employer to the employee, and were originally intended to be just a retirement supplement.

Many public pension systems for state and local government employees, facing questions about long-term sustainability, have not recovered from huge investment losses a decade ago and are doubling employer rates, taking money from government services.

Dutch pension systems were rated “A” by the Melbourne Mercer global pension index last year with the best benefit adequacy and an overall score of 80.1, trailing only Denmark at 80.5. For U.S. pensions the grade was “C” with a score of 56.4.

The Dutch pension systems are usually based on private-sector and government occupations, something like medieval guilds. The largest, ABP for civil servants and teachers, narrowly avoided cutting retiree pensions this year to maintain high funding levels.

Regulators require Dutch systems to maintain a funding level of 105 percent. The California Public Employees Retirement System currently is about 70 percent funded, similar to the 72 percent aggregate funding for 170 public pension systems in a nationwide study last year.

One of the reasons the Dutch systems are tightly managed is that they are mainly cooperatives, owned by the members. U.S. public pension funds rely on taxpayers to fill the funding gap if the systems are badly managed.

An in-depth New York Times look at the Dutch retirement systems three years ago said they could “provide an example for America’s troubled cities, or for states like Illinois and New Jersey that have promised more in pension benefits than they can deliver.”

The Dutch systems use a low-interest safe bond rate, with little risk of major loss, to offset or “discount” their future pension obligations. California pensions use the earnings forecast for risky stock-laden investment portfolios to discount pension costs.

Predicting strong investment returns allows governments to put less money into the pension fund. CalPERS recently lowered its investment forecast from 7.5 to 7 percent. Now cities face seven years of growing CalPERS rates, painfully squeezing their budgets.

“For years, economists have been calling on American cities and states to measure pensions the Dutch way,” the Times story said.

Employer payments into the Dutch systems are capped. Annual contributions into the fund are usually split 50-50 between employers and employees or, less often, a third from employees and two-thirds from employers.

A CalPERS and county systems reform requires employees hired after Jan. 1, 2013, to pay half of the “normal cost,” the amount owed for pensions earned during the year. Rates for employees hired before 2013 are bargained by unions and set by statute.

As a result, only the government employer, not the employee, pays the large and growing debt or “unfunded liability” from below-target investment earnings, lower discount rates, longer life spans, and the now-banned retroactive pension increases.

This year, for example, the employee rate for “miscellaneous” state workers is 6 to 11 percent of pay, many at 8 percent. The state rate is 28.4 percent of pay and was projected to increase to 38.4 percent of pay in 2023.

State miscellaneous workers receive federal Social Security in addition to their pensions. As in the private sector, the annual Social Security contribution is a 50-50 split, 6.2 percent of pay each for employees and employers.

The employee rate for the California Highway Patrol, which does not receive Social Security, is 11.5 percent of pay. The state rate this year is 54.1 percent of pay and was projected to be 69 percent in 2023.

Highway Patrol rates are similar to many local police and firefighter rates, where they are a larger part of government budgets. A trendsetting Highway Patrol pension increase, part of SB 400 in 1999, is often mentioned in debates about whether public pensions are sustainable.

An extra $6 billion state payment to CalPERS this year, doubling the required amount, is expected to lower the projected rate increases for state workers by paying down debt more quickly, saving the state $11 billion over two decades if all goes as planned.

“After the financial collapse of 2008, workers and retirees in the Netherlands took the bitter medicine needed to rebuild their collective nest eggs quickly, with higher contributions from workers and benefit cuts for pensioners,” said the New York Times story.

CalPERS has not recovered from a huge loss during the financial collapse, some say partly due to delaying rate increases. With investments valued at $260 billion in 2007, CalPERS had 101 percent of the projected assets needed to pay future pension costs.

Then losses plunged the CalPERS investment fund to a low of $160 billion in early 2009, dropping the funding level to 61 percent. By last week investments had grown to $340 billion. But liabilities have grown faster, leaving current CalPERS funding at roughly 70 percent.

The first of four CalPERS rate hikes spread out over five years was not adopted until 2012. An actuarial reform a year later took a step toward faster payment of debt, ending a 15-year rate-smoothing period and “rolling amortization” that refinanced debt annually.

But pension debt is still being paid off over 30 years. A criticism of U.S. pension management is that paying off debt over decades pushes part of the cost of current worker pensions to future generations, who did not receive the services of the current workers.

So, if the Dutch systems are fully funded using rigorous accounting, have low rates said to be typically 15 percent of pay for employers and employees, and top-rated benefits amounting to 70 percent of lifetime average pay, why propose a switch to a 401(k)-style plan?

A seven-member group of pension experts prepared a report for the International Centre for Pension Management this month based on 14 informal interviews of Dutch pension experts and key stakeholders.

The report said in part low interest rates have prevented full indexing of pensions. More workers are moving between jobs or self-employment. Young and old workers get the same credit per dollar of contribution, even though the young worker’s invested dollar has more time to earn.

“In the new system, pension funds will be responsible for setting the rules — but they will no longer be held accountable for the actual (pension) outcome,” the report concluded. “In this sense, the reform is a massive transfer of risk from the cooperative to the individual.

“This is at odds with many values upon which the Dutch society is built. Are the Dutch prepared for that?”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 23 Oct 17

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


%d bloggers like this: