A hybrid retirement plan combines parts of a defined benefit plan with parts of a defined contribution plan. Dan Doonan, the Executive Director of the National Institute on Retirement Security, and Elizabeth Wiley, a consulting actuary at Cheiron, wrote the book on hybrid plans – literally! Dan and Elizabeth penned The Hybrid Handbook, a white paper on hybrid retirement plans in the public sector. Listen as they share their insights on these plans along with some of their favorite case studies.
Some highlights from Not All Hybrid Plans Are Created Equal include:
01:27 – Hybrid Retirement Plans: The Case Studies
06:30 – The Best Time to Plant a Tree…
10:56 – Unfunded Liabilities and a Cause for Concern
14:35 – Risk Sharing vs Risk Shifting
19:03 – The Efficiency of Pensions vs Defined Contribution
24:30 – Thoughts on Pension Reform
Click on The Hybrid Handbook if you'd like to read or download a PDF of Dan and Elizabeth's white paper.Support the show
This is The World of Multiemployer Benefit Funds podcast with Traci Dority-Shanklin. If you're interested in labor 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
You are listening to The World of Multiemployer Benefit Funds. Today, we're continuing my two-part conversation with Dan Doonan, the Executive Director of the National Institute on Retirement Security, and Elizabeth Wiley, a consulting actuary at Cheiron. Dan and Elizabeth wrote a paper about hybrid plans in the public sector called The Hybrid Handbook. I invited them on the podcast because I wanted to get their thoughts on hybrid plans as a possible solution for distressed defined benefit plans when reform and other viable solutions have failed. In this episode, we pick up our discussion right after I asked Dan and Elizabeth if they could comment on any hybrid benefit plans that Cheiron or NIRS, the National Institute on Retirement Security may have advised on.
Dan Doonan 1:27
NIRS doesn't really advise on systems. But in the public sector, most of the conversations on risk-sharing start around Wisconsin and South Dakota. They've been doing this for a while. They both have a process that they go through regarding what happens if certain thresholds are crossed. And, you know, it's very process-oriented. For example, in Wisconsin, you have risk-sharing through post-retirement benefits -- COLA -- benefits are adjusted. Clearly, that's a give on the benefit side. But, the flip side of that is when Scott Walker was there, and he was going after public-sector unions, there were proposals to shut down WRS and start a defined contribution. They didn't go anywhere because this system was funded, very robust, nearly 100% funded with all the local governments participating were happy with the benefits and happy with the costs, which had been stable.
Dan Doonan 2:22
On the flip side, just like the multis with the need to have employers participating -- in the public sector, the strength of the system provided a lot of political strength for the system to be continued. And you didn't see major changes, we didn't see that system shut down. And in Wisconsin, they have - it is a variable benefit. But, they have a 1.6% multiplier that will replace about almost 50% pay after 30 years. And when it comes to post-retirement increases, the core you get a choice of two funds, but the core fund benefits have actually been reduced. Some of the increases had been clawed back -- five times since 1986. But, on average benefits have increased 3.6% per year. So, you see that the math is working over time. And there are these periods where you have a Great Recession-type event. And benefits are reduced. So, like in my mind, those are the core trade-offs here is there's increased security; there's in the public sector, that's political support for a plan that everybody agrees is sort of working well, you do get some variability, some benefits aren't locked down the same way.
Elizabeth Wiley 3:33
And on to South Dakota, they are also one of my personal favorites to point at as kind of a blue-ribbon example. And it's again about the process that they follow rather than the actual answers. But, one aspect of that I just want to highlight given previous conversation about communication, is they do a really good job of giving projections and forecasts and they go out for each of the next three years and look at based on what the investment returns are. What can the COLAS be for those years with just one of their key risk-sharing provisions so that all the involved parties, whether it's the members, the employers, have an idea of the range of likely outcomes for those upcoming years. And it really seems that that communication has helped this to be more popular and successful. Because even though like as the members, it's going to be limited some, I think two of the four years so far that it's been in place, there were limits as a result of the investment returns. But, they understand that those limitations are designed to ensure the long-term viability of the plan and it being there to make those payments so no one's happy to receive less of an increase in their benefits. But, at least from the outside, it's appeared that there's a lot more understanding and kind of begrudging acceptance if that makes sense. By having that clear communication.
Traci Shanklin 5:07
The long-term viability is the big key that I'm taking away because following the 2008 bubble, many of the international unions committed resources to look at various types of hybrid plans. The urgency to find a solution died off as the markets improved. But, as we all know, the markets keep being highly volatile. And this volatility has placed an enormous strain on troubled pension plans. So, now with so many multiemployer plans facing critical or declining status, plan sponsors and labor unions are seeking solutions. So, in the end, I see hybrid plans as a potential solution to maintain long-term solvency of plans and ensure that participants are financially prepared for retirement. In the end, it's the retiree that we need to take care of. So, I know these plans can be controversial, but I have long held belief that short of significant pension reform, variable defined benefit plans or other hybrid plans structures offer a positive alternative to the options of not making good on the retirement promise. So, how do you think these hybrid plans can help plan sponsors, participants, and retirees?
Elizabeth Wiley 6:30
I'll steal a line from an executive director of a system that I like, and that is, they allow sharing the pain such that they're sustainable and intentional. So, there is volatility, and there is always the possibility that a plan is not going to function as you planned. And if you've got a plan design, where the pain of that is borne all by one party, it's less likely to be sustainable. And so, it's that feature of sharing the negative experience, but also the positive, keep in mind that there can be positive offsets that I think makes a big difference.
Elizabeth Wiley 7:17
And then the other point that I want to make on this in dealing with these plans, and going forward is that while the best time to plant a tree was 20 years ago, the second-best time is now. And I really think that this Chinese proverb applies very well to these multiemployer plans, because there are limitations in almost all cases that are going to mute the impact of changes, because they can only be applied to future service, or even only to new hires. And so, the impact of these changes is gradually recognized over time. It still is better than five years from now. And you could kind of put this in simple terms, and Dan's gonna laugh at me, because I kept trying to get this in the paper, but it didn't go there, is that while turning off, the faucet isn't gonna reduce the level of water that's already in the bathtub, it prevents that water from going up, which, by definition gives you a little more flexibility to deal with the water that is there.
Dan Doonan 8:20
Playing off of those comments, I think, but you have to look at your situation. If you're in the retirement system for the federal government, they're going to make the payments. They're going to be fine. The Federal pension system's pretty small compared to everything else they do. If you're working within an industry that is struggling or not growing, I think that's a different outlook. And it may even come down to who's involved in the public sector, some states are more supportive than others, or the idea of defined benefit, you need to take in these broader considerations and sort of use that as a basis of what do we need to do. What do we need to achieve here? Hybrid designs, again, it's such a range of things, I think we can both point to some that we think are working fairly well.
Dan Doonan 9:09
But, we also have Florida's FRS system, where you can choose a DB/DC combination, or you can choose DC only. A couple years ago, they changed the default. So, if you don't turn in your paperwork, you go DC only. And you're now in a self-saving plan. And given the administrative processes, half of the new workers are defaulting into a DC only. That's not a solution in my mind. You know, that's a process that isn't working well and people aren't making an affirmative decision, and they're losing their pension over it. So, you know, there's a wide range of situations that are out there. I think it's really important to be intentional about where you're at; what you need to accomplish, and then really think about features in terms of accomplishing those things?
Traci Shanklin 9:57
Back to an earlier point that you guys made really intentional about educating the participants and all of the employers and this plan sponsors and the in our case, the union trustees.
Elizabeth Wiley 10:11
Definitely, that intentional communication. The other thing that I wanted to add, building on Dan's point, is one of the things is important to think about is who's paying the contributions, the members, the employers and some of the differences. If you're a state pension fund, that kind of thing, they likely are able to take on more risk in the funding contribution side of possible bad outcomes than employers in the multiemployer space that are much more focused on profitability. I think that that is one factor that's likely to be a little bit different in thinking through this process as a multiemployer versus the public plans that we were talking about in the Handbook.
Traci Shanklin 10:56
I've had several guests on this podcast who state one of the most significant issues facing defined benefit plans is the unfunded liabilities. For our listeners, unfunded liabilities happen when an employer withdraws from a plan, leaving the retirement benefit to be covered by the plan, i.e., the other employers in the plan. The specifics of unfunded liability are beyond the scope of our conversation. But, unfunded liabilities placed a strain on the entire fund and the remaining sponsoring employers in the multiemployer plan. Do either of you have any advice when addressing an employer who might opt out of transitioning to a hybrid retirement plan, due to unfunded liabilities?
Dan Doonan 11:42
In really basic terms, the unfunded liabilities is, in a way, what you've already bought. It's what you've already done in already promised, and going forward, I think Elizabeth mentioned in new plan design might affect future employees or future service. I don't see a real ability there to sort of undo the promises. And I think that's to the benefit of retirees who earned those benefits.
Elizabeth Wiley 12:09
The one specific point that I would add kind of on the multiemployer side is that I know in some of the cases where there have been changes to more of a hybrid-type structure, the boards have also adopted simultaneously the free-look provisions that apply where an employer can come in, and it's up to five years, and they can choose to withdraw and not have to pay withdrawal liability if they withdraw within that period. There are some limitations about, you know when this can be done; in what years it can be offered, and so the board has to go to each year, but it has been one of the ways some of these concerns, particularly if there's some concern, this is novel, and I'm not entirely sure, but so it's not so much dealing with the employers that are already there that might be leaving as a result, but it's employers that are out there that might be interested, but have some hesitancy, so coupling a new hybrid plan design with these free-look provisions is one thing that I know is being done.
Dan Doonan 13:16
I think when it comes to communicating with employers, you know, one of the things that plan would want to do if you're interested in doing this, is sort of show, how does this play out in different scenarios? Right, here's the baseline; this is what we expect; what if this happens; what happens with the hybrid design or risk-sharing design, and what happens under the status quo? And you can sort of show over time how these things would work. For the most part, I think employers would probably be favorable to some risk-sharing, at least if they're in a situation where the unfunded liabilities have grown, and there's an awareness of that.
Elizabeth Wiley 13:53
One more aspect of the communication is just an almost all circumstances -- one of the points that you're wanting to communicate and get clear to people is there kind of are two separate issues. One is your unfunded liability that exists today because of the past. And then the other is the ongoing operation of the plan, and the risks that you face of new liabilities emerging there. They're both important, but they're really quite different, and how you should manage and address them are going to be different. And so, getting your stakeholders to understand these two issues is very important to this process.
Traci Shanklin 14:35
Can you help our listeners understand the differences between risk shifting and risk-sharing? These are commonly used terms and for those considering a hybrid discretion, I think there is a critical distinction.
Dan Doonan 14:49
I think if you're talking about risk-sharing, but you have a pension fund, such as Wisconsin, you have a great recession that hits; the UAL goes up; there's triggers that impact benefits, impacts cost-sharing for current workers. So, there's these triggers. It automatically does some risk-sharing with other stakeholders that are involved in the system, right. And some of that could be employers who are paying in at the local level in the system as well; their costs may go up.
Dan Doonan 15:19
Risk shifting, I think is really what we've seen more on corporate plans where - not they used to offer pensions that were 100% paid for by the company; you go to work; you're in this pension plan, when you come time to retire; you continue to get some form of paycheck for life. So, you're hired into a corporate plan, now, it is probably your primary responsibility to be the saver. And they might throw in some money as a match. All the investment risk; all the longevity risk, whether you live five years from retirement or 40, that is all on the participant. So, all the investment decisions like this is in even the cost, the primary part of the cost has been shifted to the worker in those workplaces. So, I really see a lot of these hybrid designs as trying to find a middle ground to not end up in that position where we expect all workers to sort of master this really complex equation, and be expected to do this on their own.
Elizabeth Wiley 16:23
The other thing that I would add, I've actually been working for the last little bit on a presentation on a related topic for the International Foundation conference. And one of the things that I realized is that really communicating what are we talking about when we say risk? Because a lot of the time, we just toss risk and leave it there. But, there's a whole lot of risks that are faced by retirement systems. And there's three in particular that tend to be the most significant. It's investment risk of how are the assets invested and do they perform differently than you expected? It's longevity risk, and that's how long do the members actually live versus what you expected? And then there's inflation risk, and that really comes down to the retirement security of the members and kind of their purchasing power in retirement. If you think first about what are the risks, then it's easier to see the difference between a risk-sharing and a risk-shifting.
Elizabeth Wiley 17:23
So, let's take the example of the main PLDs that I did before. In terms of risk shifting, they could have gone through that process and come out at the end with the conclusion that they were just going to provide a defined contribution plan with individually managed assets, that everything at that point that longevity, inflation, and interest risk would be entirely shifted to the membership. In contrast, what they actually implemented, since it's a system that takes the full contribution and divides it, allows for those risks of mortality and investment risk do occur, but instead of going all to the members, like in the case of going to a DC, what they did is they did a 58/42% split, and so the member bears 42% of that pooled and that's an oversimplification. But, I think that that's the key idea.
Elizabeth Wiley 18:23
The other thing about risk shifting is, in theory, you get the full on the upside, too, but there's no way to kind of put limitations on that, like with a defined contribution plan an - my employer can't give me a "Well, you invest it yourself, but we'll promise you make at least 2% a year because there's no assets to back that." Whereas with a risk-sharing, you can put some portion of the risk in both positive and negative risk on the member but then also applies minimums or maximums such that you limit the potential of that risk-sharing in certain ways.
Traci Shanklin 19:03
Dan, you mentioned defined contribution providers working to get regulation that would allow defined contribution plans to look more like DB plans. What are the regulatory issues being addressed for DC plans?
Dan Doonan 19:18
In the Secure Act, they're making efforts to -- what I would say make their products a little bit more like pension systems. And I think there's a recognition of some of the things that work really well in pension systems. And DC plan providers are thinking more in terms of automatic enrollment, right? When you're hired into a pension, you're just participating there. There's no decisions; there's no sort of behavioral hurdles that you have to cross to sort of participate. They're also working to be able to offer lifetime income products within DC plans. Right now, if you go to buy an annuity on your own, the insurance company's likely going to say, "Well, they're probably healthy; they're probably going to live for a long time," you have to go price it out, go through the details, but you may not pick the best deal. If you institutionalize that, and put that in a defined contribution plan. Now you have a fiduciary, someone's fiduciary responsibility, who's going through and trying to find the best deal and you're purchasing on a group basis instead of an individual basis. So, it's very similar to health insurance situation between group plans and going out on your own. Before the health reform passed, I guess around 2009.
Dan Doonan 20:35
There's some convergence here, DB plans are trying to get cost to be a little bit more fixed in a lot of the reforms that we talked about in the hybrid paper. And DC providers are saying, "DB really have a good product here; we need to be able to do some of the things that pensions achieve regularly." And that's getting high participation. If you're offering a plan and a significant number of people aren't participating, you know, you're really not doing as much as you could be doing there. As well as addressing post-retirement, which I think is actually underestimated, and just how difficult that is for individuals post-retirement with a lump sum. You don't know how long you're gonna live, you don't know, expenses can vary widely.
Dan Doonan 21:20
Some of the regulatory issues that they're facing is they're afraid to offer products in defined contribution plans that might lead to lawsuits. There's been a number of lawsuits over fees already. On one hand, I think it's frustrating for sponsors. But, I think it has caused DC plan fees to drop over the last 10 years. And I think that's a factor focusing the attention of plan sponsors on fees. When it comes to life income, where are the guidelines that if we do XY and Z, we're legally safe. We won't be sued for offering this option. Those are fuzzy lines now. And I think there's an effort to clarify and make it, you know, more viable for them to offer these things.
Traci Shanklin 22:03
Most unions in the multiemployer world don't view defined contribution plans as sufficient pension benefits. How are these DC providers positioning that these proposed DC regular changes can offer a retirement benefit that is better, or at least comparable to a well-designed DB plan?
Dan Doonan 22:24
There's an economic advantage in the efficiency of pensions versus defined contribution. We're pooling all the investments; we're pulling all the longevity risk; you don't have to get to age 65 and say, "Oh, my gosh, I have to buy bonds?" And bond yields are terribly low. Because the actives and retirees are pooled together, a pension fund can continue to invest for the long term. And that's a tremendous benefit, I don't think you can design that away. But, you can take away some of these problems; you can fix for some of these issues. And, for example, if you offer a lifetime income option in a DC plan, now, you're going to an insurance company that can't put a lot of money in equities. The basis for that conversion is going to be less efficient than a pension. But, it would be better than what an individual can go do by themselves. So, I think there's some opportunity to improve. But, I think the advantage will still stay with the pensions and getting the most for your money in a retirement system.
Elizabeth Wiley 23:28
One key concept that I find is often very useful for educating trustees that are considering these kind of issues. And that is if you're on a defined benefit plan, you really need the assets to fund the retirement benefits through the average longevity. So, the average period someone is alive, recognizing that some will be longer and some will be shorter. Whereas if you're in a defined contribution plan, and you're managing that corpus of assets yourself, you really have to manage it or the oldest you think you might be and not managing to that expectation. That difference is part of why you know as Dan was saying, offering annuitization of these even though it's at much less advantageous rates than like a pension plan doing it directly can do, but they still can benefit the members because of that difference between the average life expectancy and the maximum life expectancy.
Traci Shanklin 24:30
I'd be interested in getting your thoughts on pension reform, since we just talked about reform of defined contributions. I have been doing a series of episodes on multiemployer pension crisis in America. And I'm glad that Democrats passed the American Rescue Plan that a lot of 85 billion in rescue funds that support millions of hardworking Americans, but I'm disappointed that pension reform couldn't be included and feel that this has just kicked the can again down the road. Back in December 2020, Democrats and Republicans were so close to an agreement until the Republicans walked away. And there were some really great ideas on the table from low-interest loans from the Democrats. This idea to partition liabilities proposed by Senator Grassley and Senator Lamar and the Republicans. Do either of you have an opinion? Or does your company have an opinion on what they would like to see or what is needed in real pension reform so that we never faced another crisis like this again?
Elizabeth Wiley 25:38
I'll defer to Dan on this one.
Dan Doonan 25:40
We really don't take positions on bills. We do talk about things in a more general sense. On that front, we really don't get involved, I do think it's worth noting, there are a lot of healthy multiemployer funds. There are a number that aren't as healthy that draw a lot of attention. And getting back to the demographics, if you have a lot of retirees per worker, it starts to become really difficult when you come out of a deep recession, like the Great Recession. I think that knocked some of these plans off-track. I think it's a really good thing that they finally stepped up and addressed this. We often see the federal government very low, very slow to get to these major retirement issues. Multiemployer pension systems have $44 billion being paid out that 3.8 million beneficiaries. That's important; that's helping a lot of people; that money goes back into their communities. It's very important when we talk about the cost. The other side of it is what is the benefit, and those dollars are going into communities and spurring economic activity. But, we really didn't get into specifics on what we wanted to see in that bill.
Traci Shanklin 26:53
Do you think hybrids might be the better discussion for now to address -- I know, aside from the plans that are fine, because I am not a proponent in changing anything about a plan that is funded properly. Do you think defined benefit reform proposals that have helped save critical or declining DB plans or are hybrids the better discussion for funds in critical status?
Dan Doonan 27:20
There's a strong correlation in the information I've seen between plans that are having trouble getting employers to come in, keeping a number of actives reasonable versus retirees. If you can design a hybrid plan that you think employers will buy into, and will be more comfortable with, I think that helps the sustainability of the system. When you're paying out a lot of money and benefits and the contributions are low, a big market event has a big impact on your plan, and it's hard to recover from. When you're talking about a potential hybrid design, if your plan has very mature demographics, then I think really a lot of that conversation could be geared towards will employers be comfortable coming in and participating with this design?
Dan Doonan 28:07
And there's really two sides of it. What are the benefits? Are the benefits adequate? And the other side of it is that sustainability and covering more workers, frankly. If the benefits are a little bit different, but you're covering a whole lot more people, there's a benefit there as well. So, I think it's just weighing these different priorities. It's a challenge, but I think it starts with an honest conversation of where you are and what you need to accomplish.
Elizabeth Wiley 28:32
And I do think that some of the uncertainty about what will be done in terms of pension reform, and some of the changes under consideration the various proposals for PBGC premiums and things have led to some hesitancy to make changes now because of ugliness of how making that change would impact where they stand in terms of the ultimate regulations that apply there. So, I do think that that uncertainty in some cases is leading to kind of a wait and see approach where otherwise there might be steps that were already being taken and implemented.
Traci Shanklin 29:14
I want to congratulate both of you on The Hybrid Handbook. It does a really good job of laying out possible solutions for sustaining pension funds, or funds talking about making the conversion to hybrid funds. Is there anything else either of you would like to add?
Elizabeth Wiley 29:31
I just want to say that I appreciate the opportunity to discuss these issues with you and the audience. And then I guess I'll also add that I'm confident enough that I'm willing to risk extending Dan as well as myself and saying that both of us are happy to have conversations about these plans and design considerations to parties that might be exploring making these types of changes.
Dan Doonan 29:52
I share that sentiment. We're happy to have people reach out. We like talking to folks in the retirement community. I know there's a wide range of situations that different plans are in. But, you know, we really try to continue to focus on workers having access to a good adequate plan, and having those plans be viable in the future. So, that is a big part of our goal. If you do want to find the report, you can go to our website; it's nirsonline.org. And you click on the “Research” tab, you'll find The Hybrid Handbook, as well as other research we've done. And again, feel free to reach out if you're interested or have any questions about it.
Traci Shanklin 30:32
And we will also link the white paper in our show notes. As we close our conversation. I think the big takeaways are that there are many variations in hybrid plans, and that the ability to customize a plan to meet the specific needs of each plan is there. They offer sustainability through proper planning, education and communication. Thank you, Dan, and Elizabeth, for joining me on the podcast today and participating in the conversation.
Dan Doonan 31:05
Thank you for having us.
Elizabeth Wiley 31:05
Thank you so much. Yes.
Traci Shanklin 31:07
Please visit our website where you can find more information about hybrid plans that we just talked about on the podcast along with links to the National Institute on Retirement Security and Cheiron. If you've enjoyed today's podcast, please subscribe to us and give us a five-star review. You can find us on Apple Podcasts, Spotify, Google Podcast, and many of your favorite podcast platforms. You may also subscribe to our newsletter or listened to one of your favorite episodes on our website at www.multiemployer funds.com. That's www.multiemployer funds.com. Thanks again for joining the conversation where listeners connect with leading experts throughout the multiemployer world. Be part of the change.
Traci Shanklin 31:54
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.