Why Employers Hate Defined Benefits for Pension Plans

So even with the dancing girls, you're not interested enough to read a whole story on public pension plans. We understand. You just want to know if these things are really the ticking time bomb (or your clichéd-alarming-metaphor of choice) they are made out to be. The answer is ... it's hard to say!

How much a Defined Benefits pension costs an employer from year to year depends on a whole bunch of variables, including but not limited to: A.) what kind of returns the pension fund gets from its investments; B.) how many people actually retire as soon they're eligible; and C.) how long those people live. If employees keep working for five or 10 years after they reach full retirement benefits, the employer's long-term liability drops. And if they fall over dead the day after they retire, that saves the employer money, too. (One of the daily duties at the city Pension Board is scrolling through the obituaries for names of retirees. Families sometimes forget to tell the city to stop sending checks. And just so you know, if and when the city discovers this, it will ask for its money back.)

Actuaries have to mince and chop all those things and feed them through a bunch of formulas to figure out how much money to set aside each year. But here's the catch: When something unexpected happens—like, say, a global economic meltdown—all of that figuring comes up short. If the stock market falls off a cliff, suddenly the pension fund has less money in it than it was supposed to, and the employer has to put more in. Inconveniently, this tends to happen at times when revenues like sales and property taxes also take a dive. Which means that a city or county with Defined Benefits plans suddenly has to put a whole lot more money into its pensions at the same time it's actually getting less money coming in.

This is the kind of thing that gives actuaries the heebie-jeebies. And it is exactly what has happened with the city of Knoxville's plans over the last few years. For example, for its police and fire plan, the city this fiscal year is having to contribute the equivalent of 22 percent of those employees' salaries. ("Historically, that's just off the charts," says Mike Cherry, executive director of the city's Pension Board.)

So all of these estimates of the city and county's obligations over the next decade or two are just that, estimates, and in fact you could do new calculations every day because the pension funds go up and down with the market. If we ever get fully recovered from the disaster of the past several years and find some new bubble to inflate, the year-to-year numbers could look a lot better. But you can see why an employer would prefer a nice, flat Defined Contributions plan where they merely match 6 percent of salary, no matter what insane thing is happening on Wall Street.