Gerald Miller in Governing Magazine again provides terrifically valuable explanations of pension and retiree health care costs. His latest includes this:



There is nothing whatsoever inherent about a defined benefit plan that produces higher returns than a defined contribution plan. The superior investment performance reported in the studies results instead from collective vs. individual investments, which is not a function of defining benefits vs. defining contributions….

In fact, many defined benefit plans have suffered a fatal inherent investment inefficiency: They have granted a perpetual straddle option to employees that is a wickedly costly investment for taxpayers (“heads, I win; tails, you lose”). This straddle option is priced at zero by DB plans ? yet its actual cost is immense. Certainly these perpetual options cost far more than any fees paid to mutual funds vs. pension money managers. In fact, they carry a cost far greater than all the investment inefficiencies of DC plans cited in the pension advocacy research.

What’s the intrinsic value of the employees’ perpetual straddle option? Ask yourself this: How much would you pay to an insurance company to guarantee that your IRA would always return 8 percent (the average pension discount rate), yet still give you all the upside if the markets do better than that? Your answer will depend on your risk tolerance, but I am confident that it’s far more than the fractional difference in fees between mutual funds and institutional money management!