The Hybrid Pension Scheme and Four Important Issues

Hybrids are pension schemes where the state and the employee both contribute simultaneously to a defined-benefit pension plan and to a defined-contribution savings plan or 401 (k) plan. State employers would have to match the employees’ contributions, though there would be a contributory limitation.  

In effect, the defined-benefit pension plan has always acted as the “Social Security” alternative for Illinois teachers. Teachers do not pay into the Social Security system because the State of Illinois opted out of that arrangement years ago to save money. The defined-contribution savings scheme, as part of a hybrid plan, would offer an opportunity for savings beyond the existing capped defined-benefit for teachers who began their career in January 2011 (SB 1946, April 2010).

The recently proposed HB 5754 in February 2012—a bill regarding defined-contribution or “self-managed” plans (401 k)—applies to all public pension systems and their “current” members. HB 5754 is not a bill for a hybrid plan. It’s a bill for opting out of a guaranteed defined-benefit pension plan.

Undeniably, though hybrid plans would include a partial guaranteed annuity because of their component part—the defined-benefit pension plan—and would be a much better choice than having only a 401 (k) plan, hybrid plans would induce legal and regulatory questions, some of which might include whether these defined-contribution savings plans would be covered by the Pension Benefit Guaranty Corporation, whether there would be a pay credit formula in place for these plans based upon the employee’s age and service, and whether there would be a minimum interest credit rate tied to long-term bonds (30-year Treasury yield) without risk to principal.

What would be essential for state employees before choosing a hybrid pension plan is relevant and clear information (full disclosure) regarding its cost and consequences.  As stated, there is an incomplete guarantee with a hybrid plan. What must also be considered is the precarious part of the hybrid-plan equation, in other words, the defined-contribution’s investment of assets, its expenditures and its legality.

Hybrid pension plans are as effective as the competence of their trustees and the regulation and complex structure of such schemes. It would entail proficient knowledge of their funding standards.  Note that hybrid pension plans would not take into account the longevity risks for retiring teachers, unlike a defined-benefit pension plan. It is important to perceive that hybrid plans (and defined-contribution savings plans by themselves) are not definitive solutions for the apparent state’s budget problems.

What remains a critical issue is that redistributing the funding burden to the state’s school districts and to their teachers and property taxpayers is unreasonable and unwarranted, and that legislators bear in mind that offering a fair and sustainable pension plan for teachers is a priority, not only for teachers but for the public school districts in Illinois. What is also at stake here is whether “the best and brightest” possible teaching candidates become one of the state’s exigencies. The state will not attract or retain the “best” teaching aspirants without offering an equitable and solvent defined-benefit pension plan for them. Finally, what continues to be most crucial for all of us is that policymakers in Illinois guarantee a minimum level of payment to the public pension systems and pay the unfunded liability, thus, upholding the state’s constitutional obligation while maintaining their legal and moral responsibility.

See "Pension Hybrid Plans, Constitutional Challenges, and the Ethical Path to Take"
See also "Defined-Benefit Pension Plan v. Defined-Contribution Savings Plan"