A Look At Defined Benefit Pension Costs

The Economist:

FRESH from a duel with Free Exchange, I now find myself compelled to add some context to a Democracy in America post on the Wisconsin situation.
The problem with public sector/private sector pay comparisons is that pay comes in two forms; current and deferred (ie pensions). A pension promise from the government is a very valuable thing indeed; some states have made it constitutionally protected. So, unlike the typical private sector employee who is now in a DC scheme, the public sector employee has certainty about his or her pension entitlement. If the equity market falters, the DC plan member will suffer; the employer of the DB member will make up the shortfall. In effect, the employer has written the employee a put option on the market.
How valuable is this option? We can make a judgment by looking at the Bank of England scheme. It avoids all equity risk by buying index-linked bonds to cover its pension liability. This costs it 55% of payroll in the current year (the ratio varies with the level of real yields). The average contribution into a DC scheme (employer and employee) is 10%, in both Britain and America. In a room full of actuaries last week, I asked whether this was a fair basis of pay comparsion and the answer was yes.

One thought on “A Look At Defined Benefit Pension Costs”

  1. somewhat broader discussion, but what I still don’t see if comparison of types of jobs with this scheme. how does an engineer working for the State of WI compare to an engineer working in the private sector.

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