Several factors favored the growth of defined benefit plans in the 1950s, 1960s and 1970s. The American workforce was relatively young, the medical advancements that are now allowing longer lives were still in development, and global competition for U.S. economic expansion was still a distant challenge. In the past 30-plus years, much has changed.
Because of these changes retirement planning has shifted away from Defined Benefit to Defined Contribution. Defined Contribution plans held $6.6 trillion dollars of employee savings in June 2014: $2.7 trillion was in Defined Benefit plans; $941 billion was in government or nonprofit sponsored 403(b) plans; $255 billion in 457 plans; and $401 billion in the Federal Employees Retirement System’s Thrift Savings Plan. Though the private sector was the early adopter of this form of retirement planning, it is now projected that public sector adoption will grow faster than the private sector as public sector plans play catch up.
The impetus for Define Contribution was the emergence of 401k plans, which coincided with a changing relationship between employer and employee and employees’ desire for the flexibility to switch employment opportunities when that change represented a professional improvement. Implicit was the employees’ willingness to assume more individual control over saving for retirement. On the employer side, economic changes leading to restructurings, mergers and bankruptcies made clear the need to control and manage employee benefit expenses and Defied Contribution accomplished this far better than Defined Benefit.
Defined Contribution allows employees greater control of their own retirement planning. Employers offer professional assistance with this planning. Retirement savings are invested in a limited menu of low cost investment vehicles that focus on generating adequate retirement income. Employees can, within limits, determine the level of contribution each chooses to make. Employers often match or contribute to the employees’ contribution and the federal government exempts these contributions and the investment return from tax liability until withdrawn from the savings plan. Defined Contribution accounts have no claim on the savings of fellow employees nor necessarily represent a post retirement obligation to the employer. The employer is able to keep cost in check by defining its long-term liability and short-term cost.
State and local government have recently implemented hybrid plans. These allow combining a mix of Defined Benefit and Defined Contribution to the benefit of the employee and employer. Hybrid plans offer a lower level of Defined Benefit coupled with an employee directed Defined Contribution plan. Employees can transfer benefits accrued under one employer to self-directed retirement plans when employment changes. In 1983, the federal government introduced this form of retirement planning for its employees.
Cash Balance plans combine aspects of Defined Benefit and Defined Contribution in a single retirement product. Employee contributions are pooled and professionally managed. The employer guarantees the employee a base level return on contributions invested and on retirement the cash balance within the individual’s account can be converted to an annuity with payouts for the remainder of the individual’s life, while often maintaining the employer guarantee of investment return.
Restructuring GERS requires careful thought. Existing commitments need to be safeguarded. Future promises made to new entrants or that add financial obligations can be aligned with what is truly affordable. Decisive action allows freezing the downward spiral of liabilities, identifying approaches for addressing obligations to retired and active workers, and defining retirement benefits that better align with the needs of employees and the financial well being of the community.
Concerning not addressing the retirement plan crisis head on
Failing to deal with the GERS crisis draws comparisons to managing retirement planning in a manner akin to a ponzi-like scheme. Ponzis exist when the financial contributions of late joiners satisfy the financial expectations of earlier joiners and there is no workable plan, short of enticing new joiners, to meet the financial expectations of the preceding level of joiners.
GERS’s actuary has estimated that absent an infusion of $600 million to stabilize the system, it will run out of funds in eight years. The Finance commissioner explains that the government does not have the financial ability to make such a major cash infusion. The system’s present obligations are, therefore, in no small part being paid by contributions from active employees. There is no assurance that those funding the current cost of the system can or will receive the benefits associated with their contributions to GERS.
It is easy to disregard the significance of this problem and to compare it to the Social Security problem. However, federal government resources, and the growth of the number of elderly voters ensure that Congress will continue to meet its Social Security obligation. The Social Security discussion cannot be viewed proportionately with government’s failure to address the GERS situation. GERS is a problem for a community of 100,000 people, with limited resources, a narrow based economy, and whose youth can easily relocate to pursue greater economic opportunity and avoid shouldering the financial burdens of earlier generations. The Virgin Islands faces considerable external debt, a systemic budget deficit, and stagnation of economic growth. If this assessment of the situation seems unduly pessimistic, stop and consider the employee retroactive payments negotiated in the 1980s that remain unfunded and unpaid.
Task force reports and measures proposed to address liabilities and increase contributions are not prescriptions for addressing the magnitude of the GERS problem. Yes, GERS requires funding, but as important and possibly more so, requires a redesign to make it affordable consistent with a shrinking and aging workforce.
There are examples of ways to address this challenge, which are more affordable and responsive to changing demographics and workforce needs. The solution is neither increasing the employer and employee contributions to the retirement plan nor expanding the plan to include a nominal number of additional workers in an effort to make the existing Defined Benefit plan financially stable. Finding a way forward that is affordable to government and the taxpayer requires rethinking how to save the Defined Benefit plan, which is increasingly anachronistic. GERS must design a new retirement benefit plan that learns from the experiences of others and adapts these to the Virgin Island reality. That plan must be affordable to both the community and the employee. It must also be responsive to the changing demographics of the government workforce. The political will on the part of the community and the government is then needed to implement the required changes.
Justin Moorhead is managing director of Virgin Islands Capital Resources Inc., a 501 (c) 3 nonprofit with a community economic development mandate. Moorhead is also president of Seslia & Company and Seslia Securities.