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Richmond Times-Dispatch
Sunday August 27, 1995 Section F Page 2
'Defined contribution' is a plan with benefits
by Jeff E. Shapiro
Ed Burton -- like his Albemarle County neighbor -- George Allen -- enjoys toppling totems. Maybe it's the independent streak that comes from being the son of a Texas wildcatter. Perhaps it's because as a teacher -- Burton is on the business faculty at UVA - he's inclined to question.
For whatever reason, Burton is the who says "why not?" when others ask "why?" And these days, he's wondering aloud about the very foundation of the entity that Gov. Allen appointed him to help run: the Virginia Retirement System.
Burton, a Ph.D. who's been in and out of the investment industry for years, recently arranged a presentation to his fellow pension fund trustees, by a colleague at the University of Virginia, economist Jonathan Skinner, on the possible advantages of a defined contribution plan over a defined benefits program, such as VRS.
Bored already? Don't be. This could be one of the most politically volatile state employee issues ever.
Right now, state retirees collect a pension that is established by law -- literally, a "defined benefit." It's a pricey proposition for Virginia, which is liable not only for what it pays out, but for the billions of dollars managed by the retirement system to cover those monthly checks.
To appreciate the cost of preserving the status quo, consider what VRS estimates is necessary next year to start fully financing automatic cost-of-living mcreases for retirees: $765 million, nearly $200 million of which would be additional money.
Workers could style their own accounts
With a defined contribution plan, workers would style their own accounts rather than defer to VRS. This presumes some familiarity with the financial markets because employees would have to choose investment options: stocks, bonds, mutual and money market funds, or some combination thereof.
For the employer, the financial advantages of a defined contribution program are considerable. That's because the employer is virtually free of all responsibility for paying for retirement, other than matching dollars for workers.
Just think what Virginia could do with the millions and millions of dollars that it now sets aside for pensions? Allen might build more prisons. His successor might erect schools. The point is that ever-increasing pressure on the general fund -- that portion of the budget over which the politicians enjoy some discretion -- could diminish.
For future retirees, the bottom line is performance. Put another way, which program -- defined benefit or defined contribution -- will make for a more comfortable retirement? This is where the experts are divided.
As a defined benefit program, VRS isn't doing badly these days. Returns are up more than 17 percent from a year ago, when the fund actually shrunk. That means for the past two years, growth has been only
about 9 percent -- just barely above the return rate the actuaries say is necessary for the retirement system to meet its obligations.
With a defined contribution plan, an employee who made wise investment choices could be in clover. Someone who committed to the stock market over the past 20 years or so would have seen an annual average return of 11.5 percent. Historically, stocks have outperformed all other investments.
Education an important factor
But the key is education. If VRS converted to a defined contribution plan -- it already has a small supplemental income program with about 6,000 participants -- how would it go about informing employees about their options, and how to craft their retirement accounts?
Skinner suggests that if Virginia went about promoting a defined contribution program the way it sells the lottery, employees would participate in droves. But the biggest beneficiaries of VRS -- among them, school teachers, many of whom are reliable Demorats -- aren't convinced, and worry that a switch would put their retirement at risk.
This, of course, translates to political risk for legislators who might have to decide the future direction of VRS.
Burton, who, incidently, is bullishly conservative on VRS investment decisions, concedes as much. As a result, it would take considerable time -- measured largely by election cycles -- to determine whether defined contributions pay off big time.
Jeff E. Schapiro covers state government and state employee issues for The Times-Dispatch.