States and municipalities are adding defined contribution plans to their retirement programs largely because of the fund and insurance industries' intense lobbying and despite the fact that there is virtually no demand for the option from state employees, said pension plan and public sector executives.

"Most defined-benefit plans are well funded and there hasn't been an outcry from public employees for defined contribution plans," said Cathie Eitelberg, national director of public sector markets for the Segal Company, a benefits consulting firm based in New York. "Typically, vendors bring about the change (in policy). If you talk to participants, generally they prefer to stay in the defined benefit camp."

Despite participant preferences, states are moving away from defined benefit plans and are offering defined contribution plans to their employees, she said.

Florida is one of those states. It recently passed legislation that will offer all state employees a defined contribution option. The plan is the result of heavy lobbying efforts on the part of Fidelity Investments of Boston, TIAA-CREF of New York, Prudential Insurance Company of Newark, N.J. and Variable Annuity Life Insurance Company (VALIC) of Houston, Texas.

Florida's plan is unique because it will allow new and existing employees to choose between its defined benefit or defined contribution plans while most states only offer defined contribution plans to new employees, Eitelberg said. Also, Florida's defined contribution plan covers all public sector employees while most state plans only cover a certain sector of public employees, she said.

Fidelity has been working with Florida legislators for the past three years to try to "educate" them on the differences between defined contribution and defined benefit plans, said Tom Hughes, the senior vice president of Fidelity's Tax-Exempt Service Co.

State and local governments are interested in adding defined contribution plans because they are required by law to make regular payments into the plans and cannot postpone payments like they can in a defined benefit scheme. That prevents them from winding up with under-funded pension liabilities, he said. Defined contribution plans also provide state participants greater choice and portability, making it easier for state and local governments to compete in today's tight labor market, he said.

Florida governor Jeb Bush has endorsed the legislation on several occasions and is expected to sign it, Herndon said. The state will begin offering its defined contribution plan in July 2002 and will issue requests for proposals sometime this year, said Thomas Herndon, executive director of Florida's board of administration. The state will probably work with more than one vendor and will evaluate proposals on the basis of performance of funds and annuities, experience working in public sector retirement plans, price and the advice and education offered, he said.

While the plan will give state workers greater choice in their retirement planning, its eventual success will depend on the investment climate in 2002, Eitelberg said.

"A great concern is that there is a whole generation of investors that have never seen a down market and there is not sufficient knowledge of market risk," she said.

By adding a defined contribution plan, the economies of scale of a single plan are eliminated, resulting in increased fees that are passed on to the participants, she said.

Public sector employees have not always embraced statewide defined contribution plans. In 1997, Michigan stopped offering a defined benefit plan to new employees and switched to a defined contribution plan, said Penny Griffin, a spokesperson for Michigan's department of management. While state employees covered by the defined benefit plan had the option of converting, only 4,000 employees chose to do so, she said.

"We didn't have a lot of turnover (in the plan) because we didn't offer a lot of incentive to switch," she said.

Public employees usually favor defined benefit plans because they are more risk adverse, she said.

"When you move to a defined contribution plan, you take on a lot of responsibility yourself and there is some element of risk," she said.

Regardless of employee sentiment, fund and insurance industries are eager to gain access to the $3 trillion public sector market which represents 14 million state workers, said Eitelberg of Segal.

Vendors prefer defined contribution plans because the fees they receive for them are higher than for defined benefit plans, she said.

Several states, including North and South Dakota, Michigan, Vermont, West Virginia and Utah have added a defined contribution option to their pension plans, Eitelberg said. Public school educators are often the first sector to be offered the option, she said.

Kansas recently introduced legislation that would have added defined contribution plans as a retirement option for some state workers, but the measure was voted down, said Gene Kneely, president of the Kansas National Educators Association of Topeka, Kan., a union for public school teachers. Under the proposed legislation, new public school teachers would have been required to invest in the defined contribution plan while existing teachers would have had a choice between either plan, Kneely said.

Subscribe Now

Access to premium content including in-depth coverage of mutual funds, hedge funds, 401(K)s, 529 plans, and more.

3-Week Free Trial

Insight and analysis into the management, marketing, operations and technology of the asset management industry.