Are There Transition Costs to Closing a Public-Employee Retirement Plan?

Closing a defined-benefit pension plan to new participants has two effects with regard to the plan’s financing.

  • Over time, the duration of the defined-benefit plan’s liabilities shortens as participants grow older and younger employees are shifted to other plans. As a result, the plan’s investment portfolio grows more conservative, and the portfolio’s expected return declines.
  • The value of the defined-benefit plan’s overall liabilities also shrinks because newly hired employees participate in a defined-contribution plan where employer liabilities are not accumulated.

The second result dominates the first: The reduction in liabilities from shifting newly hired employees to a defined-contribution plan more than offsets the higher contributions required to 2 fund the remaining defined-benefit plan liabilities as the participant population ages and the investment portfolio grows more conservative. Recently, the volatility of required government pension contributions has caused many state and local governments to fail to make full contributions, worsening the problem of underfunded public-employee plans.

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