By Ed Mendel
Monday, December 26, 2011

Gov. Brown’s proposal to give new state and local government employees a hybrid retirement plan is part of a national trend, joined by Rhode Island last month and Utah last year.

A typical hybrid combines a smaller monthly pension, guaranteed for life, with a more risky and unpredictable 401(k)-style investment plan, whose value can rise and fall with the market.

For government employers a hybrid reduces the annual costs of pensions and their long-term debt — a national burden said by Pew and other researchers to have soared to $1 trillion or more after massive pension fund losses.

A brief issued by the National Association of State Retirement Administrators last month said hybrids are “receiving increased attention” as some states look beyond the standard cost-cutting methods: increasing employee contributions and giving new hires lower pensions.

The NASRA brief lists nine states (Rhode Island acted after publication) that have some version of a hybrid retirement plan: Nebraska, Texas, Georgia, Indiana, Michigan, Ohio, Oregon, Washington and Utah.

Before Brown issued his plan, the nonpartisan Legislative Analyst’s Office had recommended a hybrid as a way to reduce the risk of “future unfunded pension liabilities” or long-term debt.

The analyst said in a review of Brown’s plan that a hybrid also would address “a key policy concern” about public pensions: a “growing disparity” with the private sector where pensions are increasingly rare, largely replaced by 401(k) plans.

The bipartisan Little Hoover Commission recommended in February that California move to a hybrid model to “restore the financial health and security” of public pensions.

The commission pointed to a “breakthrough” hybrid for new federal employees begun in 1985. The hybrid was 100 percent funded in 2009, while the traditional pension fund for federal employees hired before 1987 was only 39 percent funded.

The employee contribution to the pension part of the federal hybrid is low enough (0.8 percent of pay compared to 8 percent for most California state pensions) that in September a 5 percent hike was proposed to help finance President Obama’s jobs plan.

The federal hybrid is generous enough that some supporters fear Congress, as it struggles to reduce the deficit next year, may give new federal employees lower retirement benefits.

“We may end up with a two-tier situation where they grandfather existing employees under the existing rules but change them for new employees,” John Palguta of the Partnership for Public Service told the Washington Post last week.

One of the problems in persuading politically powerful public employee unions to back a hybrid plan is the potential for poor performance or big losses in the 401(k)-style investment part.

“The 401(k)-style component must be risk-managed to provide retirement security and minimize investment volatility,” said the Little Hoover hybrid recommendation.

The California State Teachers Retirement System, which recently called itself a hybrid, has a supplemental investment plan that guarantees a minimum return based on the 30-year federal bond, sometimes yielding more in good economic times.

For a decade ending last January, a quarter of the teacher contribution (2 percent of pay from a total of 8 percent) to the now seriously underfunded CalSTRS pension plan was diverted into a Defined Benefit Supplement created by AB 1509 in 2000.

An unusually brief legislative analysis of the last-minute bill, which did not go through the usual committees, said diverting part of the teacher contribution would have “no (state) general fund effect and no effect to the solvency of STRS.”

Now the contribution to the little-known supplement to CalSTRS pensions is mainly from pay earned outside the regular school year, such as summer school and overtime.

In his hybrid proposal, Brown said the 401(k)-style part “will be managed professionally to reduce the risk of employee investment loss.” The goal is to replace 75 percent of salary based on a full 35-year career, 30 years for police and firefighters.

The retirement income would come from a smaller pension, a 401(k)-style plan and Social Security, each providing about a third. For workers not in Social Security, the pension would be two-thirds of retirement income.

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