Economic Issues Confront State-Sponsored Retirement Plans for the Private Sector

At last count, 17 states have considered legislation to establish retirement plans for private sector employees that would be operated by state governments. Four states (California, Illinois, Oregon and Massachusetts) have actually enacted legislation creating such plans, subject to a variety of organizational and implementation steps.

There remain a number of regulatory and legal concerns, not the least of which is obtaining an exemption from ERISA (Employee Retirement Security Act of 1974) that otherwise applies to retirement programs established for private sector employers. Without this exemption, operating such plans could create potentially onerous obligations for governments and the taxpayers in the affected states.

While the ERISA exemption has been the primary focus of most public debate on this creation of such plans, there is another looming issue that could be just as significant.

Who Takes the Financial Risk of Operating These Plans?

Thus far, the legislation in the affected states requires that these plans be self-sufficient, and not require any taxpayer subsidy to create and operate plans. While this sounds like a reasonable requirement, the economic facts of creating a new plan are formidable:

  • Record keeping costs are relatively fixed. It costs about the same to maintain a million dollar 401(k) account as it does one with just a few thousand dollars in it. Since most of these plans would be created with no existing assets, the upfront costs of establishing the record keeping and administrative functions could not be borne by the participants unless a significant portion of these costs were deferred or subsidized in the early years. So, the first question is who pays to establish the infrastructure of these plans until they can be “self-supporting”?
  • Since these plans would be created (primarily) to serve very small employers, the operational expenses will be far grater than plans established for medium-sized to larger plan sponsors. Small employers tend to have very manual operations and it could prove difficult to rely on automated systems for contributions, benefit payments and other routine functions of daily plan governance.
  • Small employers do not have the Human Relations (HR) or Benefits Department apparatus that exists in most other companies of even relatively modest size. With no HR or Benefits department in these small employer operations, the state-run system is going to have to assume virtually all the functions of enrollment, monitoring and communication that would otherwise be handled by or shared with the employer.
  • Participant service functions (call centers, etc.) are much more costly for small plans where the employer may have a work force that is not used to self-service benefit arrangements handled on-line. As any retirement vendor will tell you, servicing small and micro-plans is very costly, not only with respect to routine administrative functions, but for participant service functions as well.

It remains to be seen how all of these upfront costs will be paid for if these plans are to be “self-sufficient” when there are no assets to begin with. New plans, without any rollover assets, can take years to accumulate enough in assets to fund operational and communication expenses through a reasonable asset fee.

What About Competition?

No service provider, state-run or otherwise, is immune from the impact of competition. Just because the micro-market is not well served today does not mean it will forever be a “market orphan”.   As other entities (private and public) find creative ways to serve the micro-market, state-run plans will have to determine how they protect plan participants and plan sponsors from the impact of diminished assets that could result from competing plans in the future. In the private sector, this risk is mitigated by the capital a company is prepared to devote to supporting the business. In state-run plans that are “self-supporting”, what happens when costs rise or assets are depleted, or both, due to competition? How can participants be protected from having their fees increase due to a shrinking pool of assets with fixed administrative and operational costs?

Prudent Study and Modeling 

Most legislation appears to require a series of prudent steps in order to implement these plans. The economic issues noted above, and ways to mitigate expense risk to participants will likely be a larger issue than the ERISA exemption. With careful planning and modeling, such solutions may be possible, but they won’t be easy. Not unless someone, like the taxpayer, is ultimately on the hook for the risk.