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Matt Dunning

Hybrid pension plans gain ground with smaller, consistently profitable firms

Alternative structure appeals to smaller, consistently profitable firms

May 25, 2014 - 6:00am

Hybrid Pension Plans


Hybrid pension plans remain a viable option for employers seeking to reduce their exposure to retirement cost increases, even though their popularity among certain segments has waned in recent years.

Predominantly, hybrid pension plans are offered to replace traditional defined benefit plans that have been frozen or closed. While upward of a dozen variations of hybrid pension plans have emerged during the past 15 years, experts say the most popular hybrid models remain cash balance plans and, to a lesser extent, pension equity plans (see related story).

Employers offering hybrid pension plans do so primarily to shrink their exposure to the longer-tail risks associated with traditional pensions while still providing employees a guaranteed retirement benefit, experts say.

“A lot of the employers looking to move away from traditional defined benefit plans wanted something that could help them manage the risk a little better than those older plans, but they didn't want to fully replace that plan with a defined contribution strategy on its own,” said Alan Glickstein, a senior retirement consultant at New York-based Towers Watson & Co. “If, as an employer, you're not comfortable with the idea of your employees bearing all of the financial risk of retirement, hybrid plans offer a way to share some of that risk.”

Because the formulas by which employees' retirement benefits accrue in hybrid pension plans tend to be simpler and more transparent compared with accrual formulas in traditional pensions, experts say hybrid pensions are typically less burdensome for benefit administrators.

Depending on its specific structure, a hybrid pension plan “sort of runs by itself,” said Ken Frandsen, chief financial officer of Tri-City Cardiology Consultants P.C. in Mesa, Arizona.

In addition to a 401(k) plan already in place, he said Tri-City Cardiology began offering a cash balance pension at the suggestion of some of its 170 staff and member physicians in 2009.

“From an administrative perspective, we make our contributions to the plan and collect the employees' contributions; and then every six months we check on the performance of the investments and make sure that we're maintaining our proper funding level,” Mr. Frandsen said. “It's really not that difficult at all.”

The number of employer-sponsored hybrid pension plans insured by the federal Pension Benefit Guaranty Corp. nearly tripled between 2001 and 2010, even as the total number defined benefit plans decreased roughly 20% over the same period (see table, above).

By the end of 2013, hybrid plans comprised an estimated 24% to 32% of all defined benefit plans, including as much as 21% of defined benefit plans that remained open to new hires, according to several employer surveys and market analyses.

The vast majority of that growth in hybrid pension plan offerings has occurred among employers with fewer than 1,000 participants, experts say.

Meanwhile, larger U.S. firms' interest in cash balance and other hybrid pension plan models has faded during recent years (see chart, below).

“Industries that are more consistent in their profit performance year-over-year are generally the ones driving the growth in cash balance plans,” said Dan Kravitz, principal at Los Angeles-based retirement consultant Kravitz Inc. “It's primarily popular with professional services companies such as law firms and medical groups, particularly with specialty medical groups. It's also extremely popular with smaller companies and that, too, is where we're seeing the most growth.”

Ultimately, experts say the deciding factor in an employer's evaluation of hybrid models as an alternative retirement funding arrangement likely comes down to the company's risk appetite.

“Because there is still some risk in there, there are some employers that are going to determine that they can't withstand the risk of short-term (investment) volatility, even if they understand that over the long haul the hybrid approach winds up being more efficient than even some (defined contribution) plans,” said Stewart Lawrence, New York-based senior vice president and national retirement practice leader at The Segal Group.

In addition, experts say some employers may be deterred by the substantial regulatory uncertainty that continues to loom over certain key elements of hybrid plan designs.

“Nine years later (after the enactment of the 2006 Pension Protection Act) employers still don't know what fixed-interest crediting rates they can use,” Mr. Glickstein said. “That may well be an impediment to a lot of employers, especially if they're at all risk-averse when it comes to compliance.”

 



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