Pennsylvania's hybrid plan seen as falling short

After many fits and false starts to pension reform, Pennsylvania's governor has a signed a measure that establishes a hybrid defined benefit/defined contribution plan for new state employees.

Although some industry observers believe the new law is a step in the right direction, several others said the switch to a hybrid DB/DC plan does little — if anything — to solve the state's core underfunding problem.

"What's notable about this plan design change in Pennsylvania is that it does very little to address the underfunding," said Alex Brown, research manager for the National Association of State Retirement Administrators, Washington. "Most of what this change does is address the composition of risk between the participating employers and the members."

Mr. Brown added that most of the cost savings won't accrue for years because the change only affects new hires at the $51.3 billion Pennsylvania Public School Employees' Retirement System and $26 billion Pennsylvania State Employees' Retirement System, both based in Harrisburg. The two plans had more than $56 billion in unfunded liabilities as of June 2016.

The bill, signed June 12 by Gov. Tom Wolf, will change retirement benefits for most state employees and all school employees hired after Jan. 1, 2019.

Most new employees will be put into the hybrid retirement system, receiving half of their benefits from the current taxpayer-funded DB plan and half from a 401(a) plan. Workers in high-risk jobs, such as state police​ and corrections officers won't be affected by the changes.

Pennsylvania isn't alone in recently offering a DB/DC plan for state employees.

Illinois' budget package approved on July 6 included such state-level pension changes as a hybrid plan for certain new state employees. Michigan Gov. Rick Snyder signed into law on July 13 pension reforms requiring the establishment of a new hybrid pension plan and new DC plan for the state's public school employees hired after Jan. 31, 2018.

Pennsylvania's move to a hybrid plan is one that some organizations and industry observers are championing.

Greg Mennis, director, public sector retirement systems, Pew Charitable Trusts, Washington, said that while hybrid plans are not new, they've evolved to the point where "they're more sophisticated and better for both workers and employers."

"The hybrid plan provides a higher level of savings," he added.

In a letter providing support for the Pennsylvania legislation while it was still in the state Senate on behalf of Pew, Mr. Mennis wrote the law would "achieve full funding of the state's pension system, lower costs and significantly reduce risk for taxpayers, and preserve a path to retirement for skilled public workers."

"Our research indicates that this would be one of the most — if not the most — comprehensive and impactful reforms any state has implemented," he added in the June 5 letter.

Not everyone is convinced a hybrid plan is the right way to go for Pennsylvania — or other states looking to switch to DC.

"While it's important to note that Pennsylvania preserved a good portion of its defined benefit plan, I think this (new) plan is not saving all that much money and is just forcing employees to take a benefit cut," said Bailey Childers, executive director of the National Public Pension Coalition in Washington.Ms. Childers said Pennsylvania is an outlier in that, while most states' pension plans are well-funded, politicians in the Keystone State didn't make full payments to the state pension plans for years, so Mr. Wolf "was stuck fixing a big problem."

"The employees didn't do anything wrong; they've been making their contributions through every paycheck, so states like Pennsylvania should take a step back and push for changes," she added.

Ms. Childers cited New Jersey as a state that approached its underfunding problem in a different — and in her view, better — way.

New Jersey Gov. Chris Christie signed into law on July 4 a fiscal 2018 budget that includes a $2.5 billion state contribution to the $73.6 billion New Jersey Pension Fund, Trenton, of which an estimated $1 billion will come from the proceeds of the state lottery.

Diane Oakley, executive director of the National Institute on Retirement Security, Washington, shared Ms. Childers' sentiment.

"The changes (Michigan and Pennsylvania) made don't improve the underfunding," Ms. Oakley said. "They cost more initially and don't change any of the commitments to the funding."

She added that state employees will "pay more and get less."

DB plans are especially important in the public sector, because it's important to retain police officers, firefighters and teachers, Ms. Oakley said.

"And that's where the DB does a particularly good job," she said.

Even Mr. Mennis acknowledged that while the hybrid plan reduces risks for taxpayers going forward, it "doesn't fix the problem of underfunding that many of these states are struggling with today."

Both Ms. Childers and Ms. Oakley cited West Virginia and Alaska as two states that decided to switch to a DC plan from a DB plan for state employees — and it didn't go well for either.

In 1991, West Virginia closed its teacher retirement system to new employees to address its underfunding issue, according to a 2016 NIRS survey shared by Ms. Oakley. After 10 years, the replacement DC plan was costing the state twice as much, so it went back to a pension.

"Switching to the DC plan did not help with the funding or legacy costs. When (West Virginia) realized most teachers couldn't retire, they switched back to a DB plan," said Ms. Oakley.

In 2005, Alaska moved all employees hired after July 1, 2006, into a DC plan from its two DB plans. At the time, the state faced a combined unfunded liability of $5.7 billion for its two plans and retiree health-care trust, Ms. Childers said.

Although the switch to DC was made to slow the increasing unfunded liability, the total unfunded liability more than doubled, ballooning to $12.4 billion by 2014. Legislation has been introduced to move back to a DB pension plan, according to an NIRS case study.

An investment consultant with whom P&I spoke said hybrid plans are something that public pension systems have been looking at for five to 10 years, if not longer.

"Managing a public pension plan is big business," said Kristen Doyle, a partner and head of public funds at Aon Hewitt in Chicago. "It means looking for ways to make the costs and risks inherent to the plan most efficient between the employers and employees. That must be done in the context of benefits that are fair and reasonable for the participants."

One reason this hybrid approach is becoming more common, according to Ms. Doyle, is because some states are recognizing that there needs to be some form of defined benefit and some professional management of the assets. With a hybrid approach, states can preserve the benefits of the DB plan and the costs and risk-sharing plan of a DC plan.

Ms. Doyle added she hasn't necessarily seen a direct correlation between a state's funding status and it establishing a hybrid plan. "All states are looking at this regardless of their funding status," she said.