Question

As a consultant to a state’s underfunded pension fund, you have been asked to search for solutions to prevent underfunding in the future.

1. One explanation for the underfunding of a defined-benefit plan is that the economy was weak recently, so financial markets were weak, and this caused the underfunding. If so, the underfunding may not be a problem in the future. Do you think this explanation is sufficient and there is no need to search for an alternative explanation and solution? Explain.
2. One possible solution is for the state’s defined-benefit plan to be converted into a defined-contribution plan. Explain why this may or may not be a viable solution to the problem.
3. Some state workers prefer a defined-benefit plan because they are afraid that they will make poor investments if they are forced to manage their own funds (as they would if they had a defined-contribution plan). Is that a sufficient reason to force a state to remain on a defined-benefit plan?
4. (Extra credit). Some defined benefit pension have been subject to abuse and some managers have gone to prison for their illegal activities. Can you cite and any particular case where this happened and explain why it did?

Answer 1

As it is mentioned that, there was an underfunding in the pension plan, and one explanation to this was given that the economy was not doing well at that time due to which this occurred and since economy is improving this will not be an issue in coming future.

But saying this is not sufficient as there could be any other reason also possible regarding this underfunding. Or this may be possible that in future some other circumstances occur. So it is always better to be ready with a backup so that situations do not get worse. Some other sources of funding should be kept for times of crisis.

So it is not right to predict something with no full evidence and making ni back up plans. It is very important to have an alternative solution to this.

Coming on the second part of the question, it is a viable plan to convert this defined benefit plan to defined contribution plan. A defined contribution plan can be said as a plan regarding retirement where employee or may be the employer make contributions in an individual account. It will reduce the problem of scarcity of fund as employer or employee or both will contribute to the funding.

And later when it's time to pay pension, fund scarcity would not be faced. This way it will not be a burden for employer also to pay pension, and the employrr would also enjoy his pension. So it is good decision.

No, just because employees think that they could not make a good investment out of their money, remaining on defined benefit plan is not good. They are loosing their own opportunity to earn huge. If they having confusion regarding investments. They can consult people in office, regarding this, or the firm should take initiatives to make employee understand about defined contribution plan. This way employees will become more proficient in investing and can earn huge profits. Also there could be risk of getting pension in defined benefits plan, so employees should go for defined contribution plan.