State-funded teachers pensions are in peril around the nation from a combination of State governments over-promising, union demands and refusals to recognize economic realities, and those economic realities. Kentucky provides an example of that, without going into the relative impacts of those three factors to the overall outcome, and of a critical misapprehension.
Kentucky has more than 175,000 active and inactive or retired teachers in the State’s teacher retirement program, and it has a $14.5 billion funding deficit—more than $85,000 per teacher. The State was able to cover 88% of its agreed contribution to its program in 2007 and now can only cover 56%. In response, Governor Matt Bevin (R) has proposed
switch[ing] many longtime teachers into a riskier defined-contribution plan and put an additional 3% of current teachers’ salaries toward retiree health care.
That’s the misapprehension. Defined contribution plans are not riskier than State-run defined benefit plans, whether or not a State government mandates a per centage of a paycheck go into the defined contribution plan.
The vast degree of risk from a defined benefit plan is demonstrated by the failure of them in the private economy: the failure of corporations to adequately fund their defined benefit plans is well publicized and underlies their move to defined contribution, 401(k)-like plans. That State-run defined benefit plans are even riskier than private enterprises’ is empirically demonstrated by the failure of States like Kentucky, which is otherwise a fiscally responsible one (see Illinois for an even riskier example).
Defined contribution plans put the responsibility for the plan’s performance where it belongs: on the individual owning the plan. That person, with his own skin in that game, will take—or can be expected to take—much greater care with his own money and his own future than can a nameless bureaucrat managing a large collection of nameless (to him) people’s money. Even a dedicated, honest financial manager bureaucrat (stipulate the vast majority of them are) has his hands tied by fiduciary duty rules: because he’s handling OPM, he’s forced to be more conservative with his investment moves, excessively so, than the individual who is responsible only for his own money.
Finally, the economic risks are the same for both State-run defined benefit and individually run defined contribution plans. The Panic of 2008 hammered both types of plans. The critical difference here, though, is the economic blow hit all 175,000+ members of Kentucky’s defined benefit plan the same. Had those 175,000 been in their individual defined contribution plans instead, each of them would have managed their plan individually and differently from the others. Each of them would have been hit by the Panic in different ways and to differing degrees. The only individual hurt by the Panic’s impact on the defined contribution plan would have been that plan’s owner, not all 175,000 of his fellows.