Cash balance plans gain favor as option among public pension funds

Public pension fund boards and state legislators are showing increased interest in cash balance and other hybrid plans as the unfunded liabilities of traditional defined benefit plans continue to grow.

More than 15 cities, counties and states have cash balance and other types of hybrid plans, the majority approved or implemented in the last two years, according to Pensions & Investments data and reports from the National Conference of State Legislatures. Meanwhile, pension board and state officials in Texas, California and Mississippi have made proposals or commissioned studies on adding a hybrid plan option.

The Kansas Legislature on May 17 passed a bill creating a cash balance tier for new employees hired after Jan. 1, 2015, within the $13 billion Kansas Public Employees Retirement System, Topeka. Gov. Sam Brownback is expected to sign the bill.

Louisiana could be next, as the Legislature there continues to debate a bill to create a cash balance plan for new state employees in the $13.7 billion Teachers' Retirement System, $9.3 billion State Employees' Retirement System and $1.4 billion School Employees' Retirement System to help lower the state's $18.5 billion in unfunded liabilities.

Kansas elected to take the cash balance route as both a cheaper alternative and more efficient way of reducing unfunded liabilities, said state Sen. Laura Kelly, who was a member of a committee that reconciled the state House and Senate bills.

Only four public funds in P&I's database of the largest 1,000 retirement plans reported having hybrid plans.

The $19.5 billion Texas Municipal Retirement System, Austin, and the $17.5 billion Texas County & District Retirement System, Austin, are the largest cash balance plans. The $152.9 billion California State Teachers' Retirement System, West Sacramento, has $7.3 billion in cash balance plan assets.

In Nebraska, the $702 million State Employees' Retirement System and $221 million County Employees' Retirement System — part of the $9.6 billion Nebraska Public Employees Retirement Systems — moved to cash balance plans from a defined contribution plan in 2003 as a more cost-efficient way to provide benefits more equal with employees in defined benefit plans under the Nebraska PERS umbrella, said David Slishinsky, Denver-based principal and consulting actuary for Buck Consultants LLC. Mr. Slishinsky is an actuary for Nebraska PERS, based in Lincoln.

Kansas fund executives contacted Nebraska plan officials when designing its cash balance plan, said Phyllis Chambers, director of NPERS. Ms. Chambers said the cash balance plan is less expensive than a traditional DB plan and is more advantageous for employees than DC plans, which costs participants more through investment fees.

“The least expensive (option) is probably going to be the cash balance,” she said.

But if one goal is to reduce liabilities, “cash balance plans still have a very real possibility of additional unfunded liabilities,” said Rich Hiller, senior managing director, government markets, at TIAA-CREF in Denver.

To Mr. Hiller, hybrid plans are the way to go. Under Mr. Hiller's definition of a hybrid plan, a public retirement system has both its legacy defined benefit plan and a new defined contribution plan. Although the plans are separate, they work together — along with Social Security — to typically replace 75% of a participant's income.

The key, Mr. Hiller said, is to design a proper defined contribution plan that does not resemble a 401(k) plan. The plan should include limited high-quality, low-cost options, target-date funds and guaranteed annuity options.

Several states have implemented or approved creating hybrid plans:

• The $53.6 billion Virginia Retirement Systems, Richmond, will launch a hybrid DB/DC plan for new employees hired after Jan. 1, 2014.


• Last year, the $21.9 billion Utah State Retirement Systems, Salt Lake City, created a hybrid DB/DC plan that allows new employees a one-time option to join the hybrid plan or a standalone DC plan.


• The $10.7 billion Hawaii Employees' Retirement System, Honolulu, created a hybrid plan for general employees hired after July 1, 2006.
  


• The $9.4 billion Orange County Employees Retirement System, Santa Ana, Calif., gave employees hired after May 7, 2010, a choice to join the DB plan or a newly created DB/DC hybrid.
  


• Last fall, the Rhode Island General Assembly approved creating a DB/DC hybrid plan that will take effect July 1 for new employees as well as the future service of current employees of the $7.2 billion Rhode Island Employees' Retirement System, Providence.
  


• The $2.5 billion University of Missouri, Columbia, will switch to a DB/DC hybrid for employees hired after Oct. 1.
  


• Also last year, the Atlanta City Council approved a hybrid plan for all new employees for the $954 million General Employees' Pension Fund and $562 million Police Officers' Pension Fund.
  


• New Castle (Del.) Retirement Pension Plan, with $350 million in assets, closed its two DB plans to new employees hired after Nov. 1, 2011, and created a hybrid plan.
  

Cash balance plans are a viable option for state employees, but member groups like unions prefer traditional defined benefit plans, Mr. Slishinsky said.

“I think the issue is compromise,” he said. If employees and state officials are willing to compromise, it is more likely that more public defined benefit plans will move to cash balance, he said.

Nebraska cash balance plan participants receive a 5% guaranteed interest credit and a dividend determined by excess returns and funded status, Ms Chambers said. Since the cash balance plan began in 2003, county and state participants have received an annualized credit of 8.6% and 8.3%, respectively, higher than the implied 8% return of the state's traditional DB plans, Mr. Slishinsky said. Both are more than 90% funded.

“During that entire period, the state hasn't had to contribute ... more than the statutory rate,” Mr. Slishinsky said.

Mr. Slishinsky believes more public funds will move toward cash balance plans. And Mr. Hiller expects many public fund executives to monitor the success of Rhode Island's new plan. He also said “there's a lot of interest in Illinois” as Rhode Island Treasurer Gina Raimondo recently spoke at a Chicago event about her state's hybrid plan.

KPERS' cash balance plan shares many similarities to Nebraska's. The assets will be managed alongside the three DB plans in the KPERS trust, which includes the $1.7 billion Kansas Police & Fire Retirement System and $132 million Kansas Retirement System for Judges, which are not part of the new cash balance tier. Employees receive a 5.25% guaranteed interest credit as well as a guaranteed dividend when investment returns exceed 10% for the year and the funded status is at least 80%. The current funded status is 62%.

The Kansas House in March passed a bill that would have allowed new employees to choose to enter either the cash balance or a new defined contribution plan. The Senate killed that proposal. Ms. Kelly, the state senator, said the defined contribution option was too costly, left retirees to the “whim of the markets” and did nothing to pay down KPERS' unfunded liabilities.

Andrew Biggs, resident scholar at the American Enterprise Institute, Washington, sees the advantages of a cash balance plan, but believes defined contribution is the best route for pension reform. “The idea that it is more expensive because of transition costs (is) really just a BS excuse to not reform your pension.”

Mr. Biggs said a big issue is that DC plans can't match “the generosity in contributions to DB plans. ... DB plans are scary generous.”

“The irony is that states most likely to pass DC plans are the ones that run their system the best,” he added.