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More State Governments Embrace Defined Contribution Plans

The defined-contribution-plan revolution that swept through corporate America over the past few decades is finally gaining a foothold in the public sector. With this new wave of popularity comes an opportunity to introduce stable value products to another segment of the investing public.

As with most attempts to break new ground, this one won't be easy, warns Phil Suess, a principal with Mercer Investment Consulting.

"The stable value industry has a challenge as it pursues these state retirement plans," Suess said in an address to the SVIA Forum. "To date, the emphasis of the people administering these plans has mostly been on market value products, not book value products. Their understanding of stable value is much more theoretical than practical." By way of example, Suess noted that in Florida, plan administrators preparing the launch of that state's defined contribution plan this year chose not to include stable value funds among its investment options. One trustee described stable value products as "esoteric."

All that said, the opportunity in public funds can hardly be dismissed.

From 1991 to 1999—the most recent data available—assets in so-called "457" government retirement plans more than tripled to $49 billion, according to the National Association of Government Deferred Compensation Administrators. What's more, 11 states now offer so-called "match plans" to their 457 plans, often in the form of 401(a) plans. Match plans allow government employers to match employee contributions to their 457 plans. Employers provide the match in 401(a) plans because contributions made to them do not count against federal limits on 457 plan contributions.

Suess cited several reasons for the increasing popularity of public defined contribution plans, including term limits on legislators. Within many state legislatures, these limits have effectively erased the institutional memory of defined benefit plans, including their history and their features. Term limits also have reduced legislators' political concerns about the long-term consequences of their actions, which makes it easier for them to embrace changes that workers might oppose. In the executive branch, meanwhile, political leaders have become increasingly interested in saving money, just like their counterparts in the corporate sector. Defined contribution plans typically cost less to fund than defined benefit plans.

Other factors driving the popularity of defined contribution plans in the public sector include lobbying by the financial services industry, which sees public funds as a relatively untapped but potentially lucrative market, and the rousing performance of the stock market during the 1990s. As stocks soared and private sector employees recorded big gains in their 401(k) plans, public sector workers began looking for opportunities to do the same. They were also attracted to the portability of defined contribution plans; upon leaving a job, assets in those plans can usually be rolled over into an Individual Retirement Account.

Stable value vendors seeking to break into the public sector retirement plan market should bear in mind that their customers will be contending with different issues than administrators of corporate plans. Many public administrators will be unfamiliar with defined contribution plans in general. They will be more accustomed than their private sector counterparts to managing money internally, and less accustomed to contracting the job to vendors, such as stable value managers. Because their defined contribution plans will be relatively new, the plans will also draw more scrutiny from participants than they might in the corporate sector. Finally, because public sector employees and plan administrators are more accustomed to defined benefit plans, they may react more strongly to market fluctuations in their account values. This could benefit stable value vendors, since their products feature a book-value guarantee.

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