This is a co-authored post by Anita Yadavalli, program director for city fiscal policy in NLC’s Center for City Solutions, and Jean-Pierre Aubry, associate director of state and local research at the Center for Retirement Research at Boston College.
It is the third piece in a three-part series about pensions and healthcare. Each piece includes insights gained at different state municipal league meetings across the country. Find the first installment here and the second installment here.
The National League of Cities (NLC) recently completed its last road trip of the year to Manchester, New Hampshire, for the annual conference of the New Hampshire Municipal Association. Amidst the glowing Southern New Hampshire University campus was a city eager to tackle the future of retirement. Top of mind was how to use retirement benefits to recruit and retain talent.
To start, stop thinking about employer contributions alone and start thinking about the total compensation package (i.e., wages, retirement benefits, etc.) offered to public sector employees, suggested Jean-Pierre Aubry, Assistant Director of State and Local Research at the Center for Retirement Research at Boston College. In terms of retirement benefits, think carefully about the level of retirement benefits that you want to provide your employees, and then back into the total contributions — employer and employee combined — required in order to meet those goals (assuming some reasonable investment return on those contributions).
For classic defined benefit (DB) pension plans, the total normal cost reflects the total contribution required to provide benefits if assumed investment returns are realized and is a useful measure for comparing benefit generosity among plans. For example, the New Hampshire Retirement System (NHRS) provides lower-than-average retirement benefits compared to the nation because its total normal cost is 10.4 percent of payroll compared to the national average of about 12.6 percent. Much of NHRS’ lower normal cost is because the System does not provide cost-of-living adjustment (COLA) increases on retirement benefits.
In a time when benefit reforms are becoming more common, states and cities must carefully consider the available plan design options for providing a desired level of benefits. For NHRS, the employee is currently asked to pay for a large share of the expected total normal cost – the employee and employer contributions towards the NHRS total normal cost are 2.7 and 7.7 percent of payroll, respectively.
However, because NHRS is a DB plan, the employer is responsible for any additional contributions that must be made if, for example, investment returns are lower than expected. Alternatives to the classic DB plan – such as defined contribution plans, cash balance, and the less-common shared-risk plans – distribute these costs differently between employee and employer.
So, how do you make an informed decision among the possible options? Aubry suggests NOT comparing total benefit level or contributions. Instead, he suggests comparing plan designs by how they distribute the costs and risks between employee and employer, as well as an employer’s human resource needs and governance structures. The table below walks through these points using the classic DB plan as an example.
|Ways to Compare Plan Designs||Example: Classic DB|
|Who bears the cost?||Employer bears all the cost; the employee bears no cost|
|Who bears the risks?||Since the employer bears all the cost, the employer also bears all the risk|
|Human resource needs||Shifting away from the classic DB can benefit short-term workers and reduce predictability of public employee exits|
|Governance and political realities||Need strong governance, with legislation promotion adequate funding and reasonable pension benefits|
Ultimately, retirement benefits are an important tool in recruiting and retaining talented employees. A well-designed pension system should aim to provide adequate retirement income for members while striving to distribute the costs equitably between employers, employees and retirees.
About the Authors: Anita Yadavalli is program director for city fiscal policy in NLC’s Center for City Solutions.
Jean-Pierre Aubry is the associate director of state and local research at the Center for Retirement Research at Boston College. He oversees and conducts research and data collection, develops new analytic techniques for evaluating retirement benefits, and secures funding support.