Hybrid or Frankenpension?

Rhode Island state treasurer Gina Raimondo is running for governor on the strength of the pension reform she spearheaded in in 2011. The hitch? The new plan—a hybrid between a traditional defined benefit (DB) pension and a 401(k)-style defined contribution (DC) plan—actually increases costs for taxpayers while leaving most state employees and teachers worse off, as Robert Hiltonsmith lays out in a new EPI briefing paper.

Raimondo managed to pull off this sleight of hand because she did save taxpayers money—not through the new hybrid plan, but by slashing pension benefits already earned by workers and retirees, a move that is being challenged in court. These cuts came on top of cuts made in earlier rounds, which in a companion brief I estimate amount to a 34 reduction in benefits for a prototypical career worker, with some workers experiencing cuts of 40 percent or more.

Why introduce a poorly-designed hybrid that costs more without benefiting workers? Good question. Hybrids are hot in policy circles, mostly for good reason. Many private-sector employers aren’t in a position to take on long-term pension obligations, yet 401(k)s have proven to be a disastrous substitute, raising costs and placing inordinate risk onto workers, even the few who manage to play their cards exactly right. EPI (pdf) and others have estimated that DC plans cost roughly twice as much as DB plans to provide a similar level of retirement security.

Though a family-owned diner would be hard pressed to provide its workers with a traditional pension—hence the search for a good hybrid plan—DB pensions work well for government entities and other large, stable employers. The promise of a secure pension is a major reason—probably the major reason, aside from job satisfaction—that school systems and other government employers are able to attract and retain a skilled workforce despite offering lower pay than private-sector employers. So there is much less reason to consider hybrids in the public sector than the private sector, where half of workers have no retirement benefit at all.

Collectively, American families face a retirement income deficit of $7 to $14 trillion (the higher estimate comes from a report released yesterday by the National Institute on Retirement Security). But the real retirement crisis in America is in the private sector, despite misplaced fears about Social Security and public pensions, which face more manageable challenges.

Though the financial crisis has left public pensions with a shortfall equal to one fourth of projected liabilities, many states have implemented cuts that fully offset the impact of the 2008 downturn, and most will be able to gradually build up their funds with a moderate impact on state budgets (pdf). Talk of a “public pension crisis” therefore relies on claims that the hole is much bigger than it appears, using very low discount rates to value future pension obligations and implicitly assuming that the rate of return on pension fund assets will be much lower than the long-run historical average. The public campaign in support of Raimondo’s plan in Rhode Island was largely funded by a Texas hedge fund billionaire and former Enron trader, whose foundation published a hyperbolic report (pdf) claiming public pension costs “are potentially crippling to our nation.” Raimondo echoed many of the same arguments in her report, misleadingly entitled “Truth in Numbers,” (pdf) which similarly raised the specter of state bankruptcy. Nowhere in the report does it acknowledge that the hybrid plan she supports actually increases costs.