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

Abstract

Defined-benefit pension plans for state and local government employees have imposed rising costs and financial risk on government budgets. In response, some policymakers have proposed shifting newly hired public employees into alternate retirement plans, including 401(k)-style defined-contribution accounts. Some critics have argued that closing a pension plan to new entrants would impose transition costs on plan sponsors. When a pension has no new participants, the duration of the plan’s liabilities shortens. Shorter-term liabilities are generally funded with safer investments, and safer investments have lower expected returns. These lower returns, the argument goes, would force plan sponsors to increase contribution levels. In this study, I show that if a pension plan were closed to new hires, over time the duration of liabilities would shorten, and the portfolio used to fund those liabilities would become more conservative. However, the effects of these transition costs are so small as to be barely perceptible.