Does Higher Education Need Retirement Plan Overhaul?
Today’s college and university chief financial officers have a central role to play in human resources strategy and implementation. That wasn’t always the case. From 1950 to 1975, U.S. demographics, laws, and regulations allowed employers to primarily think about benefit program design as opposed to financing.
That began to change in 1975 as the Employee Retirement Income Security Act (ERISA) set new standards that made investment and funding issues more central. State legislatures likewise put new laws in place to mimic aspects of ERISA for public plans to discourage Congress from enacting a public ERISA. And both the Financial Accounting Standards Board and the Government Accounting Standards Board adopted standards that require calculation and disclosure of the liabilities attributable to pensions, retiree health, and other post-employment benefits.
Since then, Congress, the states, FASB, and GASB have continued a juggernaut of legislation and regulation, with standards going into effect, or expected to go into effect, during the next two years that promise to have a major effect on financial statements. Chief financial officers have seen their involvement in these various issues grow during this period, and the legal and accounting changes now in play will create many new challenges ahead. At the same time, CEOs and boards have become more involved.
The Evolving Emphasis of Benefit Plans
Higher education institutions have generally had an objective of providing longtime service workers the opportunity to retire with adequate retirement income. For decades, this entailed payment of life income annuities, regardless of whether the institution sponsored a defined benefit (DB) or a defined contribution (DC) plan. And for decades, the private sector’s largest employers followed a similar approach.
Things began to change in the private sector in the late 1970s with the arrival of DB plan options for single-sum distributions. Higher education programs also changed in the 1980s as TIAA-CREF began to allow withdrawals and transfers to other providers in a non-annuity form. In the early 1980s, more private employers adopted “hybrid” DB plans that accumulated benefits using a career average instead of a final-pay approach. These new plans distributed more of the contributed dollars to shorter-term employees and less to longtime service employees. Employers also added or expanded supplemental DC plans to which workers could contribute on a tax-advantaged basis. Many small and midsize employers terminated DB plans and moved to low-cost DC designs that would provide less retirement income to longtime service workers unless they saved a great deal themselves.
By the 1990s, large private employers began to exclude new hires from DB plans and freeze accruals for current workers in DB plans. The new century has seen even large profitable organizations making these changes and knowingly and purposely moving to DC plans that will provide much lower levels of retirement income and lower employer costs. Increasingly these employers are using savings plans to attract workers and reduce turnover at the same time they are increasing dependence on performance management and cash payments to sever or retire workers whom they want to leave.
Government employers in general and colleges and universities in particular are now taking or considering similar actions. Because the evolving emphasis of benefit plans has human resource and financial implications, both functions must become involved in strategic reviews and policy making.
Will Colleges Follow Course?
The fact that higher education institutions have tenure as a consideration makes managing workforce exit an even greater challenge. Adequate retirement income and retiree health care will be central factors in whether older and longtime service workers choose to retire “on time” or will want or need to continue working into their 70s and 80s. For CFOs who seek the lowest long-term cost to their institutions for any given benefit objective, advance funding and a DB design will generally be the least expensive approach, but it can also be more volatile.
Advocates of DC plans point out that a DC approach provides greater individual choice and control. From the point of hire until tenure is achieved, workers may prefer the DC approach even if the contribution level is insufficient to match the DB benefit. Were the DC contribution sufficient to match the DB benefit, the DC approach might still be preferred by the worker but it would be much more expensive over time for the employer to achieve equal benefits for longtime service workers as more funds would leave the plan with workers who opted for shorter-term employment.
One central question is this: Are higher education institutions (public and private) willing to follow the private sector trend of knowingly sponsoring DC plans to which 50 percent of workers make no contributions and fewer than 20 percent contribute enough to produce an adequate retirement income, given normal job turnover? Dealing with dynamic change requires effective strategy if an organization wants to avoid getting trapped with program approaches that offer a temporary advantage but may bring long-term disaster. Traditional benefit structures with a clear adequacy objective may be most appropriate for the future of higher education from a financial and human resources perspective—or not.
The bottom line on benefit plans is that institution leaders must take particular care in clearly setting forth the goals and philosophies behind their programs. Whereas many private employers may not survive to worry about the consequences to employees of today’s benefit trends, most public and private institutions of higher education are likely to endure decades into the future and will have to deal with the outcomes of plan design decisions. Following a strategic process that begins with clear articulation of objectives is essential, and an institution’s human resource and finance executives must both play central roles in this process.
Dallas Salisbury is president and chief executive officer, Employee Benefit Research Institute, Washington, D.C.; e-mail: email@example.com.
Consider This: Matching Strategy to Benefit Plan
Does your institution want a program that provides longtime service workers with 60 percent income replacement at age 65 at minimum cost to the employer? You may want a defined benefit (DB) plan that pays only annuities. Another option: If your institution seeks to budget between 4 percent and 6 percent of pay on a stable basis that allows workers to build assets but without a goal related to adequate income in retirement, then a defined contribution (DC) plan may be the better choice. If managing workforce exit is a goal, a DB plan is far more effective than a DC plan. Financially, the employer gets far more retirement income bang for each dollar spent on a DB plan than is possible to achieve with a DC plan of the same contribution cost.
Health insurance for active workers and retirees raises other issues of strategy for the chief financial executive and for forward-thinking institutions that recognize the need to integrate health care strategy with retirement plan strategy. For instance, a DB plan allows the employer to use higher health plan co-payments by workers without competing with retirement savings. A DC plan that depends on substantial employee contributions to achieve adequacy could be hurt by every dollar of required employee spending on health care. Finding ways to pre-fund retiree health benefits will help an organization protect itself from extraordinary future costs while making it possible for workers to retire and helping with FASB and GASB balance.
How does your institution match benefit plan design to long-term strategic and financial goals?