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.
The pension part of the hybrid would be capped by limiting the amount of pay counted toward the pension, which is usually based on years of service, final salary and age.
A hybrid is one point in Brown’s 12-point pension reform plan, only outlined in broad concepts so far. An administration spokesman said the plan will be put into bill form and introduced in the Legislature.
If a hybrid is approved, the state Department of Finance plans to obtain expert outside help and spend about six months working out model hybrid plans for the wide range of local governments in California.
“There are different situations for different workers and different levels of government, and that’s why we think the hybrid plan will deserve extra study,” Michael Cohen, finance chief deputy director, told a legislative hearing early this month.
Sen. Joe Simitian, D-Palo Alto, asked the California Public Employees Retirement System to make some assumptions about the governor’s plan and “run numbers” on several versions.
“I think that will help spark some thinking at the legislative level about how we might or might not want to modify or adjust what the governor proposed,” said Simitian.
CalPERS representatives agreed to provide estimates based on the governor’s plan. But they told the two-house legislative committee that 401(k)-style plans tend to earn less and cost more to administer than pension plans.
“It’s possible to achieve cost savings and reduce risks through adjustments to a defined benefit (pension) plan without compromising retirement security as can and usually does occur in a hybrid plan,” said Ann Boynton, CalPERS deputy executive.
The NASRA brief said the cost of closing a pension plan to new employees can exceed the savings, one reason along with retirement security that some states are looking at hybrids rather than switching to only a defined contribution 401(k)-style plan.
In Rhode Island, Treasurer Gina Raimondo’s website said switching to a 401(k)-style plan would cost an additional $882 million in contributions over the next five years. The website said a hybrid avoids those costs and is “fair to both employees and taxpayers.”
California Pension Reform led by Dan Pellissier filed two versions of a sweeping pension reform — one putting new hires in a hybrid, the other in a 401(k)-style plan. The Legislative Analyst is expected to make a cost analysis as part of the initiative process.
Brown said earlier this month he will vigorously push for pension reform that can be placed on the ballot, an apparent cost control to encourage voters to support his proposed tax increase to avoid deeper state budget cuts.
“I believe it’s imperative for the Legislature to pass a credible pension reform that will be right there alongside a tax measure in November,” the governor said at a budget news conference.
A Public Policy Institute of California poll early this month found that 83 percent of Californians think public pension costs are a problem. A switch to a 401(k)-style plan was supported by 68 percent of adults and 64 percent of public employees.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 26 Dec 11