Hybrid retirement plans are becoming a viable option to the traditional defined benefit and defined contribution plans, but what are they? And who are they right for? Dan Doonan, the Executive Director of the National Institute on Retirement Security, and Elizabeth Wiley, a Cheiron consulting actuary, co-authored The Hybrid Handbook, where they outline various public hybrid retirement plan structures. Dan and Elizabeth demystify these plans and explain why some struggling multiemployer plans should consider a hybrid option.
Some highlights from Hybrid Retirement Plans 101 include:
03:37 – The Hybrid Handbook
05:55 – The Spectrum: Defined Benefit & Defined Contribution
10:16 – Types of Hybrid Plan Structures
17:27 – Is Risk Sharing a Negative?
22:30 – Communication is Key
This is The World of Multiemployer Benefit Funds Podcast with Traci Dority-Shanklin. If you’re interested in labor and union benefit funds, well, you’ve landed in the right place. We are a go-to source for all things union benefit fund-related, and we are going to bring you interviews with key decision-makers and fund professionals that guide these plans. They’ll share their insights, experience, unique perspectives, all of the latest developments, and tips to unlock the mysteries of multiemployer benefit funds. Time is short, so let’s get started.
Traci Shanklin 0:35
We’ve had several guests on The World of Multiemployer Benefit Funds Podcast to discuss multiemployer pension reform and a potential pension crisis in America. These conversations increasingly include a hybrid plan discussion. Hybrid plans are an option to a traditional defined benefit or defined contribution plan, but the term hybrid really is an umbrella term that includes various retirement plans structures. I invited Dan Doonan and Elizabeth Wiley to this show because they co-authored, The Hybrid Handbook. In this Handbook, they outline the several different hybrid retirement structures. My first guest is Dan Doonan, the Executive Director of the National Institute on Retirement Security. My second guest is Elizabeth Wiley. She is a consulting actuary at Cheiron Inc. Hi, Dan and Elizabeth, thanks for joining us today.
Elizabeth Wiley 1:32
Dan Doonan 1:33
Hello, thanks for having us.
Traci Shanklin 1:34
I like to start our conversations by you telling our listeners a little bit about yourself and what led you to the work with retirement funds. How about we start with Elizabeth? Welcome, Elizabeth, can you please introduce yourself to our listeners and tell us about Cheiron and its role in worker retirement funds?
Elizabeth Wiley 1:55
Okay, thanks, Traci. So, I’ve been working with retirement funds as an actuary for the last 16 years with the last eight and a half being at Cheiron. And Cheiron is a consulting firm that we work exclusively in employee benefits. And we provide services to both retirement and health plans. And one thing that’s relatively unique about us is that over 90% of our work is with multiemployer and public sector plans. And in addition to serving as a consulting actuary, I’m also our public pension coordinator, so I do work primarily with governmental plans, but I do also work with international multiemployer plans.
Traci Shanklin 2:35
Dan, would you please introduce yourself and tell us about National Institute on Retirement Security and its role in workers’ retirement funds?
Dan Doonan 2:44
I am the director of NIRS, the National Institute on Retirement Security. We are a nonprofit, nonpartisan, research organization. We often describe it as a think tank on retirement. Personally, I do have a labor background. I’ve worked for some labor groups before. And way back in the day. I did a bit of actuarial work so many, many years ago at this point, but NIRS publishes research on a variety of retirement topics. We’ve put out reports on the economic impact that pensions have on our economy. I think a lot of our discussion ends up being around costs on pension, pensions, but eventually, those dollars get paid out and they are spent in the community. We’ve looked at recently how inequality impacts our retirement outlook, the concentration of wealth. And thanks again for having us on today.
Traci Shanklin 3:37
While the Hybrid Handbook you two wrote focuses much of the data on the public employee benefit models, it highlights various options in designing a hybrid retirement plan. So, while public funds have initiated the move to hybrid retirement plan structures more multiemployer plans are gradually transitioning or considering hybrid retirement solutions. Are there any differences to note for our listeners who mostly work with multiemployer plans?
Elizabeth Wiley 4:06
One of the key things is that there are many more multiemployer plans where the benefits aren’t related to salary, there’ll be a certain dollar amount per hour work in kind of year. And so, having that structure of benefit has some different issues than where you have something that’s related to salary because in the multiemployers that aren’t salary base, you tend to have more similar benefits across your workers, which is going to impact some of what you consider when you go to a plan design. But, I think that the fundamental concepts really do apply the same. One of the thoughts that I had is that when Dan and I were writing the paper, came up with a framework of the steps you need to do about intentional plan design. With any changes and thinking about this podcast. I was like, well, that paper was really written with a public focus, I do think that that framework applies very well with a multiemployer type plan. So, the final answers might be different than a multiemployer than in a government. But, I think that the process that you’re going to go through and what you consider in looking at a hybrid is very similar. What do you think, Dan?
Dan Doonan 5:22
Yeah, I think that’s right. The public plans are not ERISA. You know, as you noted, a lot of these issues are the same. A lot of the public plans are multiemployer systems with local governments paying into a state system, so there’s a lot of similarities there. But, others function more as a single employer plan, so there’s a variety of types of systems and all those things can play into decisions and sort of optimizing your plan. But there’s a lot of similarities. And I think it’s safe to say the math behind pensions basically remains the same.
Traci Shanklin 5:55
To get us started, I think it would be helpful to our listeners to give a short definition of a defined benefit fund, a defined contribution fund, and a loose definition of hybrid plan.
Elizabeth Wiley 6:06
Understanding what’s meant by defined benefit and defined contribution is really critical to understanding and evaluating hybrid plan models. I’ll start with defined benefit. And I would say a defined benefit fund is one where the provisions of the plan define what the benefit received in retirement will be. For example, it gives $1 amount per year of service earned or a percentage of salary that will be received in retirement. And then these benefits are paid over the member’s lifetime as an annuity. So, such the two key characteristics that I would highlight about a defined benefit plan are that the amount of the benefit payments received in retirement are what is defined and that the retirement benefits are typically received over a member’s lifetime in retirement.
Elizabeth Wiley 6:55
And then at the other end of what I’m going to call a spectrum, you’ve got defined contribution plan. In a defined contribution plan, that’s one where the provisions of the plan define the contributions or the amount of money that are going to be played – paid into an individual’s account while they’re working. And this is similar to a 401k style plan that many people are familiar with. So, in these plans, typically the funds are kept in individual accounts that the members managed the investment of, and then they receive that individual account that retirement is a lump sum. So, I would say the key characteristics of defined contribution are there’s individual accounts, individual management of investment, and you receive your retirement benefits as a lump sum, instead of spread over your lifetime.
Elizabeth Wiley 7:42
Now, with these two goalposts, we can now discuss what a hybrid is. As the simplest definition that I’m gonna offer is, it is any plan that is neither a traditional defined benefit nor a traditional defined contribution plan. And the initial hybrids were actually called hybrids because that’s what they were. They were a hybrid of defined benefit and defined contribution plans. They were plans featured elements of both of these two more traditional goalposts. So, for example, as a real simple hybrid would be a DC plan, you know, we’ve got those individual accounts, but where you can annuitize that balance in retirement. So, instead of receiving a lump sum, you get a monthly payment, as long as you’re alive.
Dan Doonan 8:25
And the only thing I offers may be a little background, I think the amount of customization that you’ve seen on benefit design in the public sector has been pretty overwhelming since the Great Recession. We had a lot of plans that were pretty easily defined 20 years ago. And you might be able to summarize the benefits of the public retirement systems in maybe 50 pages back then. And today, the complexity and the customization, there’s just been a lot of changes coming out of the cost increases. And the concern around that in the public sector. You do see different ways of combining DB DC, as well as just a range of plan provisions that are being adopted across different public systems. So, we felt like there was a good reason to do this report is to sort of go through and look at the types of changes that are out there so people and sort of have an understanding or see a summary of that.
Elizabeth Wiley 9:24
One of the things that I thought was important to kind of gave up in the paper is really understanding how different plan provisions affect the efficiency of the system at achieving the objectives, whether that’s retirement security or workforce management, or the costs. Some of the reforms that happen particularly after the Great Recession, we’re really focused on decreasing the cost and the bit of — just the benefits themselves, and that’s where a lot of the conversation was, but in terms of increasing retirement security in this country, some of the more important work has been at increasing the efficiency and coming up with designs that work better for all the stakeholders, which is the members, the employers in the case of governmental plan the taxpayers, and really increasing that efficiency.
Traci Shanklin 10:16
And that was one of the big takeaways for me coming out of the Handbook is that I really felt like you did a very nice job of laying out all the stakeholders and thinking about what was the goal of the plan. It was the first time that I really had wrapped my head around all of those various components that go into building these customized plans. It was well done. You highlighted four retirement hybrid structures. Could you please list some of the names we might hear that are hybrid structures, and give us a high-level understanding of each? Maybe even highlight any specific differences hybrids have with a DB or a DC plan since those are the most well-known, or well-understood plans?
Dan Doonan 11:05
We sort of broke these into a couple groups. Hybrid plans, we start with cash balance, and this looks like a savings account. But, like a savings plan, like a 401k, you have an account balance every year it grows. But at retirement, it’s annuitized. And instead of getting just what the market provides and investment returns, there’s actually more of a formula, you might get a certain guaranteed investment return. And then a percentage of returns over another amount, depending on the design, but it really looks like more of a 401k. But, you get the life income you get some of those features. And back to your comment before this question, Traci, the focus on features is something that we really do want to encourage more than what is the name of this or how we refer to it. But what features and what are you accomplishing with the plan.
Dan Doonan 11:58
We also had defined contribution plans with annuitization; this would be like a 401k. But at retirement, you can get an annuity with the money, so you have that life income. You still are able to risk pool at retirement for longevity risks because an individual may retire and may live six years and they may live 36. So that’s really difficult for individuals without risk pooling to manage.
Dan Doonan 12:24
And then we talked about three different ways of combining defined benefit and defined contribution. There’s horizontal hybrid, that all of your pay is in both the DC and the DB. And typically, this looks like a DB that’s sort of watered down and the benefits are reduced. But you get a DC in addition or 401k type plan in addition. We also have a few examples of vertical hybrids out there, where you’re in the DB up to a certain amount of pay. And then anything over that is in the DC system. And this does a better job protecting lower-paid workers because they tend to be all in the DB. And then finally, there are choice systems too where when you’re hired, you’re forced to choose either I want this pension with this amount of contributions, or defined contribution, and those choices of different in different places. And then finally, we have really more traditional pension systems that share risks in some way. It’s very common in the public sector, for employees to pay a portion of their salary for their pension. So, we have cost-sharing in some plans. As well as benefits that are contingent on certain triggers that might impact accruals or the cost of living increase.
Elizabeth Wiley 13:43
While we’ve kind of defined these categories, they’ll talk about it, it’s important to realize that you can take elements of these and combine them. So, for example, those risk-sharing provisions that you’re talking about, those can be added on to a traditional DB plan, or they can be used with a plan that’s also a hybrid in that you’ve got a defined benefit and defined contribution, whether it’s vertical, horizontal or choice. So, there is some blurring of these lines. But, I think thinking about them this way can be really helpful for working through the process and that intentionality that was spoke to.
Traci Shanklin 14:20
Is there one structure that tends to have more acceptance? I mean, since most of our listeners focus on multiemployer pension plans, I guess, to target the question, what type of hybrid should our listeners working on multiemployer funds understand?
Dan Doonan 14:38
I think it depends on where you’re coming from and what your goals are. I think advocates of workers’ retirement security try to continue to get most of the features that pensions offer when they’re thinking about hybrid designs. So, they want that life income. They want some inflation protection once you retire. The accrual pattern rewards long career service continues to be important in things like education where there’s a teacher shortage. I think some of this is where are you coming from. People, you know, more concerned about costs or taxes may have a different take on that. I think a lot of times too these different proposals are received differently based on the conditions in this state. You know, we’ve seen states where there’s a high degree of trust, and people are able to work together. And that certainly impacts how things are received as well.
Elizabeth Wiley 15:31
Dan was talking about the risk-sharing provisions. There are a lot of public systems that are risk-sharing provisions that adjust benefits in retirement, based on, you know, experiencing factors, but there’s really only one significant plan that it all does adjustment of benefits while they’re being accrued in the public sector. But, on the multiemployer side, there has been more adoption, it’s still pretty limited. But, it’s more than one of what we call either an adjustable pension plan or an app, or a variable pension plan. So, that the actual benefits that are accrued can vary some with the funded status of the plan and just reiterate because I think it’s very important, what Dan is saying, and that is, there is no one right answer, unfortunately. I haven’t gone through these and come up with this is the perfect plan, and everyone should be doing it. Because it’s going to vary with a lot of factors. And that’s the characteristics of the workforce. What are the provisions of the plan that you already have in place? Who are the employers? What are their objectives? And then also kind of the greater community in which the plan is operating, and, you know what other workforce blitzes are there, and, you know, competition that comes into play. You really got to think through your circumstance, the objectives of all of the stakeholders, and then consider this kind of menu of options.
Traci Shanklin 17:02
The key thing is the customization of it. So, there’s a framework that is presented with these various plans that you’ve outlined in terms of what they look like but really taking into account the shareholders and the goals. Going back to the risk-sharing what are the key considerations and trade-offs for workers’ retirement security, when talking about pensions that have risk-sharing?
Elizabeth Wiley 17:27
If you don’t mind one slight detour, there’s a point I really want to make before getting into this question. And that is that there’s sometimes this tendency to see risk sharing as a negative thing. From the perspective of workers just as across the board, it’s negative, but it really doesn’t have to be. Risk-sharing provisions can be adopted that will actually increase the retirement security for members. They also can allow members to participate positive upside experience. I think you really do want to think about it from all the perspectives and recognize that risk sharing isn’t by itself a negative thing. And this is almost a communication management that you need to take going into it.
Elizabeth Wiley 18:08
But, that said to the actual question, there definitely is no perfect structure that’s going to achieve all the objectives. And that’s why that intentional plan design is so important. Because if you haven’t defined what your objectives are, it’s impossible to balance them. And in general, from our discussion of work, what we frame in the paper is that there’s three big picture objectives that are being considered. And the first relates to workforce management or the three Rs. That’s recruitment, retention, and retirement. The second relates to cost considerations, which include both the level of the funding that’s needed and the variability and predictability of that funding level. And then the final is the retirement security for the members, and so you’re generally trying to balance these things.
Elizabeth Wiley 18:58
To give a specific example, if you’re adding a risk-sharing provision to a plan, where cost of living and adjustments in retirement are potentially going to be reduced based on the plans funding status, this will likely result in a reduction in the level and the variability of the funding requirements. But, it will also reduce the protection against inflation, and thus, the retirement security for the members. In this example, the point at which the COLAs, which are those adjustments to the benefits to counteract inflation are reduced, and how they are reduced, should be selected trying to balance between these effects and really optimize what you’re getting at. And that’s just kind of a specific example. But, I think that you really nailed the head on what you have to do in terms of balancing these objectives.
Dan Doonan 19:49
I think plan adequacy or generosity is one issue and structures another, and it’s very, very common for these things to be sort of thrown in the same bucket, because what we’ve seen, especially in the public sector, and I assume the multi-sector as well, you’ll see a proposal that both has risk-sharing and reduces benefits for future workers or future accruals. So, they get lumped in together. But, you could have a plan with COLA risk-sharing through the COLA mechanism. You can have another plan that has no COLA. It doesn’t necessarily mean it’s more or less generous. It’s really how these things going to work. And what core features do you achieve?
Dan Doonan 20:30
Now we think payouts that last year of retirement are really important pooled investing for mortality, the traditional features of a traditional pension. It’s an incredibly user-friendly experience. You go to work. The money is invested on your behalf and paid out later. Those are still core goals in my mind. But, to get to your other part of the question with the trade-offs, its sponsors, its sponsor health, it’s when you’re a multiemployer system, I think there’s a need to have employers comfortable with the system they’re in. You don’t want employers to leave. You’d like new employers to come in over time. And I think having a chance to show that this system won’t have costs that are as volatile is something that you can use to sort of keep the plan demographics healthy over time. We’ve seen there’s a real connection with some of the plans that are troubled, being more likely to have unhealthy demographics where there’s a lot of retirees and very few workers. So, in terms of the trade-off, workers get with some risk sharing, I think there’s an effort there, again, to attract employers and keep the plan healthy and ongoing?
Traci Shanklin 21:47
Agreed. And I think, and I may be really stepping out here by saying this, but I have had a couple conversations with some millennials or Gen Z. And I think there’s far more appetite in the up-and-coming leaders and workers for risk-sharing. And they understand it better than maybe the people who grew up in the more traditional systems, that said, I may be stepping out and saying that I may be incorrect, there may be very, a lot of willingness to talk about risk-sharing. But, it’s just those conversations specifically, I think that they’re used to volatile market, so risk is defined very differently. for them.
Elizabeth Wiley 22:30
Communication is definitely a very key part of this process, in a multiemployer context, if you’re looking at making a change in the structure that’s significant. It’s not just talking to the trustees from both management and labor, but also doing education of other employers who aren’t on the board and getting their understanding, as well as if it’s significant change, you know, outreach to the membership as a whole to get their understanding of what’s being done. In particularly in cases where you’re doing this not trying to reduce the level of benefits or the costs but to reduce the risk of the outcomes not being what you expected. And to make the benefits that you’re providing be more efficient in terms of value and appreciation by the membership. I think there is definitely a heavy component of communication.
Elizabeth Wiley 23:34
This is on the public side rather than multiemployer. But, I work with a system that is a statewide plan, but it is for the different local governments throughout the state. And they did a pretty systematic change to their plan both to adjust some provisions to be more efficient and add in to risk-sharing provisions. And as part of it, it was a real roadshow across the state. I think it was somewhere like 88 different meetings in different cities and educating both employers and employees to really get the buy-in. And while that process took like a year and a half longer than it would have taken if just the board had implemented and got on, it really has resulted in understanding and appreciation. And so, this is a place where similar to multiemployer plans these individual employers can withdrawal from the fund, really increasing their understanding has made them more comfortable with the plan and it’s less likely to see those withdrawals and we’re not seeing them. On the member side, the education that was bad in kind of the awareness appears to have increased their kind of appreciation and understanding of the plan and what it means for them as individuals and their retirement security.
Traci Shanklin 24:55
That is something that is definitely going to be the topic of a future podcast. And it’s really the education and communication of what these plans are? What they mean? Dan, I might circle back to you on the economic impact of these funds because I think it’s a really important piece. I spoke with a labor leader who has made a transition in a plan to a variable plan. And she mentioned to me that she did countless town hall meetings for the members. Unfortunately for her, it wasn’t in-person because it was during COVID, but they hosted these regular weekly calls for people to jump on and ask any questions they had as they were making the adjustments in the transition. You are saying something that is highly important to anyone who’s thinking hybrid is a solution for their plan.
Dan Doonan 25:52
I think it’s really important to emphasize what Elizabeth was saying. These are difficult conversations and the situation she was talking about, you have this conversation on benefits on one hand, and it’s difficult. But, if local government stopped participating in the plan, all the labor represented workers would no longer have access to the plan. By addressing that aspect of it, they also got some assurances. And this is the sort of give and take that I think we’ve seen in a lot of these conversations. And sometimes it’s not as cooperative. But there are instances where I think, some good things come along with it as well. And the importance of identifying those things you’re trying to achieve is really important.
Elizabeth Wiley 26:35
Going back again to that example of the main PLDs. One of the things I really liked about it is they really considered every elements of the benefits that were offered, and whether it met their objectives and not. This was pretty extensive. And I’m not going to talk about all the pieces, but I’ll talk about two examples. One that they kept and one that they change, so they had early retirement benefits. And in the process of reviewing this and talking to the stakeholders, they concluded that it was important that they offered early retirement, but that it wasn’t really serving the objectives of the plan to offer it as they did then, which was with what we call subsidized early retirement factors, meaning that the total benefits we expect someone to receive over their life, if they retired early, were actually greater than if they waited to their normal retirement. So as a result, they decided to keep early retirement, but at just those factors, such that the early retirement was no longer subsidized.
Elizabeth Wiley 27:38
Then, they also looked at their disability and death benefits, which as actuaries we often refer to as the “ancillary benefits” in the plan, because the main benefit is the retirement. But, you can also work with a defined benefit plan, since you’re pooling people to manage these other events like death and disability. And after looking, they concluded that that was a very important role that the pension played for the workforce management as well as just the objective of providing security to families and things. And so, they decided that it was important to keep those benefits in a pretty similar format to what they did. In addition to this kind of work, looking at this is the cost of our plan if everything happens, as expected, how do we make it more efficient? The second thing they did is well, how do we manage the risks and the problems if things happen differently than it’s expected. And they ended up adding two related risk-sharing provisions.
Elizabeth Wiley 28:38
The first, as Dan said earlier, most public pension plans are different than multiemployer, in that they require employee contributions, whereas these are relatively rare in multiemployer. And with these changes, they changed the contribution structure from one where before the members paid a set percentage of their salary, kind of like the rest of us do for Social Security. And then the employers paid the rest of what was needed to fund the plan appropriately. And they change this to one where both the member and the employer contributions vary with experience. So, if they have better investment returns or better mortality experience than was expected, the contributions can go down. And on the flip side, if you have negative experience, they can go up. And in their case, they decided to do the split such that the employers pay 58% of the necessary contribution. And employees pay the remaining 42%. You know, that percentage, there’s nothing magical about it. It was just kind of discussion about relative obligations and the other elements of total comp and that’s where they landed.
Elizabeth Wiley 29:50
But, the other thing that they did, that really helped assure these different employers that are there participating local districts, is they added contribution caps such that while these rates can vary, they can’t exceed certain levels for either group. So, the variable contributions can’t go above 12.5% for employers or 9% for employees. But, you might be sitting there thinking to yourself, “Well, what about funding the plan,” because in circumstances where those caps are below the necessary level of contributions, this would result in the fund not receiving adequate funding, which would be a problem, right? They address this by adding a second risk-sharing provision. And there the cost of living adjustments in retirement, those payments, we talked to adjustments to your benefits to try to project purchasing power against the impact of inflation, those are actually reduced as necessary to have the contributions be sufficient to fund the plan. So, they made it more efficient. They shared the pain and the gain, in terms of funding it, and then they added a mechanism to automatically adjust the liabilities if they are growing to a point that they’re beyond what can be sustained by the funding.
Traci Shanklin 31:10
You have been listening to The World of Multiemployer Benefit Funds. My guests on today’s podcast are Dan Doonan, the executive director of NIRS, the National Institute on Retirement Security, and Elizabeth Wiley, a consulting actuary at Cheiron. Since I’m running a little low on time, I’m going to pause our conversation. Please tune in for our next episode, where we continue our discussion about hybrid plans, where Dan and Elizabeth share some of their favorite case studies. And we tackle the issue of unfunded liabilities and the differences between risk shifting and risk-sharing.
Traci Shanklin 31:48
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Traci Shanklin 32:26
And that’s it for this week’s episode of The World of Multiemployer Benefit Funds Podcast. We love to hear from you. And if you have any comments, questions or suggestions, head over to www.multiemployerfunds.com and let us know. Thank you for joining us and we look forward to next time.
Transcribed by https://otter.ai