When Toyota designed the Prius, engineers combined a gasoline-powered car with an electric motor to capitalize on each system’s advantages. A hybrid car increases the gas mileage and reduces the emissions of a gasoline-powered car while overcoming the shortcomings in speed and distance of an electric car. Increasingly, states looking to reform their public pension system are also merging different models to minimize limitations and build on strengths. States are adopting hybrid plans which can be more fiscally responsible for employers while retaining security for employees.
The public conversation often frames state employee pension reform as a binary choice: a 401(k)-style, direct contribution plan or a traditional, defined benefit pension. But there are problems with both models. In a direct contribution plan, several studies show that employees tend not to save enough, and they carry the total risk for underperforming investments. Defined benefit plans, however, place all of the risk on the employer. When the stock market tanks, the state must make up the shortfall— even if it means cutting funds for education and healthcare. Hybrid plans provide another, better option. By combining a direct contribution plan with a reduced defined benefit, hybrid plans balance retirement costs and risks between employer and employee.
According to the National Council on Teacher Quality’s State Teacher Policy Yearbook 2011, only four states have hybrid plans (actually five, assuming Rhode Island’s recent pension reform is upheld in the courts.) An additional 17 states, however, have defined benefit plans with an optional direct contribution supplement. As Ed Mendel wrote on his blog Calpensions, hybrid pensions are a new trend among the states. And at the National Conference of State Legislatures’ Fall Forum this past December, former legislators advocated for pension reform and specifically for the hybrid model. As states attempt pension reform that addresses their budget shortfalls and keeps their promise of a fair and secure pension to state employees, hybrid plans will continue to gain supporters.