Aon Hewitt survey data on pension plans are summarized, along with MPSERS and MSERS pension plans, in the series of bullet points in Graphic 3 on Page 10. The comparison is made to MPSERS and MSERS pensions based upon their Sept. 30, 2009, actuarial valuation reports, which were released in May and June 2010.[16] Some provisions of Public Act 75 and Public Act 185 are also included in the descriptions below. These descriptions are not meant to provide explanations of every detail of these benefit plans.
Notably, none of the 24 companies offered new employees traditional defined-benefit plans in which annual retiree pension benefits are based on the last few years of final pay, when an employee’s income is usually highest. In contrast, most MSERS and MPSERS retirees receive a traditional defined-benefit pension based on final years of pay (or strictly speaking, the highest years of pay, which are usually the final years).[*]
The formulas for these pension benefits generally mean that MPSERS or MSERS members who have 30 years’ service receive an annual pension of 45 percent of the average of their final years of compensation[†] (MPSERS members do make financial contributions toward their pension benefits, as described below). The pension benefits are in addition to payments from Social Security.
Some companies in the Aon Hewitt Survey maintained defined-benefit pension plans, but most of these were closed to new employees, while the remainder were “cash-balance” pensions, which are not based on final years of pay and are generally considered to have more-predictable costs and liabilities.[‡] In an important regard, the MSERS system compares favorably, since it likewise closed its defined-benefit plan to new hires and provided employees instead with a defined-contribution plan. Of note, all 24 of the companies in the survey offered defined-contribution pension plans.
The preference in retirement plan design among Michigan employers is apparent in the number of defined-contribution plans. It is common for employers to express the cost of retirement and other benefits as a percentage of employee pay, and data from the Aon Hewitt survey suggests that the overall maximum employer average contribution from the 24 Michigan companies was a little over 6 percent of employee pay. A recent survey of Fortune 100 companies found that a majority (58 percent) had a defined-contribution plan only. Typical Fortune 100 workers covered by only a defined-contribution plan received company contributions of 5.77 percent of pay.[17] Also of note, between 1985 and 2010, the percentage of Fortune 100 companies that offered traditional defined-benefit pension plans to new hires fell from 89 percent to 17 percent.[18]
This is consistent with the author’s experience that private employers are attempting to achieve an overall annual employer cost profile of 5 percent to 7 percent of pay in retirement costs. Private-sector employers that could not achieve this desired level of employer contribution in defined-benefit plans have generally transitioned into defined-contribution plans.
Predictability is another important aspect of effectively managing annual benefit costs. A defined-contribution plan provides a predictable expense each year, while the employer liability of a defined-benefit plan in the long-term can fluctuate in ways difficult to predict, with the annual funding proving easy to manipulate and often involving political considerations.
Of significant note, Michigan state government has already achieved predictability in its MSERS Tier 2 plan, a defined-contribution plan effective for members hired on or after April 1, 1997.[§] In the MSERS Tier 2 plan, the state provides a contribution of up to 7 percent of an employee’s pay. Similarly, the state of Alaska, effective July 1, 2006, implemented a mandatory defined-contribution plan for new state employees and for public education employees eligible for the teachers’ retirement system. The employer match ranges from 5 percent of pay for state employees to 7 percent of pay for members of the teachers’ plan.[19]
In contrast, the MPSERS defined-contribution plan established under Public Act 75 of 2010 did not significantly alter the basic challenges of MPSERS’ defined-benefit pension system. While the modifications introduced by Public Act 75 were generally positive, new MPSERS members continue to enter a relatively generous defined-benefit pension plan that has considerable unfunded liabilities.
None of the Michigan companies in the Aon Hewitt survey reported defined-benefit pension plans with an automatic “cost-of-living adjustment,” which is a periodic — sometimes annual — increase to pension payments in order to account for inflation or increases in overall costs. The presence of an automatic annual cost-of-living adjustment can easily add over 25 percent to the ongoing cost of a pension plan. Public Act 75 of 2010 therefore represents a step in the right direction in eliminating the 3 percent pension cost-of-living adjustment for new public school employees. The $300 annual cap on the cost-of-living adjustment to MSERS’ defined-benefit pension also mitigates the financial impact of MSERS’ cost-of-living benefit.[20]
Still, MPSERS Member Investment Plan members hired before July 1, 2010, represent most of the current employees, and the 3 percent cost-of-living adjustment in their pension plan stands in contrast to the companies in the Aon Hewitt Survey. It can be argued that the cost of MPSERS cost-of-living benefit is generally offset by the required employee contribution to the plan, a place where MPSERS exceeded private-sector norms, since none of the companies required employee contributions. Nevertheless, offsetting the cost-of-living benefit with the employee contribution would lead roughly to an annual “net” benefit provided exclusively by state taxpayers of 1.5 percent of final average three (or five) years’ pay times years of service. Such a benefit level is generous by marketplace standards, especially given the trend to defined-contribution plans. As noted, MSERS defined-benefit plan (MSERS Tier 1), which was closed to new members on March 30, 1997, does not require an employee pension contribution.
While the Aon Hewitt survey did not review the conditions under which employees could begin receiving an unreduced pension benefit, traditionally such salaried plans have included requirements such as reaching ages 60 to 62 with 25 to 30 years of service. In comparison, MPSERS and MSERS requirements are more generous.[21]
- 0 (0%) had a final pay defined-benefit plan for new employees
- 6 (25%) had a cash-balance defined-benefit plan[¶]
- 10 (42%) had frozen or discontinued their defined-benefit plans
- 8 (33%) did not sponsor a defined-benefit plan of any kind
- No plan reported automatic pension cost-of-living adjustments
- No plan required employee contributions
Defined-Contribution Plans
- All 24 companies (100%) had at least one defined-contribution plan, typically a 401(k) plan
- 6 companies (25%) have currently suspended their 401(k) employer match
- 8 companies (33%) had additional defined-contribution plans, such as a profit-sharing and Employee Stock Ownership Plans;[**] most of these supplemental plans did not require an employee contribution
- Overall, employers’ potential contributions to their various defined-contribution plans averaged 6.16% of total employee salary[††]
Source: 2010 Aon Hewitt Benefit SpecSelectTM.
Hires before July 1, 2010:
Final average 3 years’ compensation[§§] x 1.5 percent x years of serviceHires on or after July 1, 2010:
Final average 5 years’[***] compensation x 1.5 percent x years of service
Hires before July 1, 2010:
Annual pension cost-of-living adjustment of 3 percent (MIP member who retired on or after Jan. 1, 1987)[23]Hires on or after July 1, 2010:
No annual pension cost-of-living adjustment
Source:
Michigan Public School Employees’ Retirement System 2009
Annual Actuarial
Valuation Report; Public Act 75 of 2010.
- Closed to new entrants after March 31, 1997. (New entrants joined a defined-contribution plan with an employer match varying from 4 percent to 7 percent of pay, depending on employee contribution)[†††]
- Annual pension benefit formula (in general):
Final average 3 years’ compensation[‡‡‡] x 1.5 percent x
years of service
- Unreduced retirement benefits (in general): Age 55 with 30 years’ service, or age 60 with 10 years’ service[25]
- A cost-of-living adjustment of 3 percent annually for members retiring on or after Oct. 1, 1987, though a retiree’s annual upward adjustment is capped at $300[26]
- No employee contributions[27]
Source: Michigan State Employees’ Retirement System 2009
Annual Actuarial
Valuation Report.
[*] MPSERS employees hired after July 1, 2010, receive an annual benefit based on the average of their final five years of pay. Bethany Wicksall, “Legislative Analysis: Public School Retirement Revisions, Senate Bill 1227 as Enacted” (Michigan House Fiscal Agency, 2010), 2, https://www.legislature.mi.gov/documents/2009-2010/billanalysis/ House/pdf/2009-HLA-1227-7.pdf (accessed Aug. 3, 2010).
MPSERS’ defined-benefit plan for Member Investment Plan members, who were hired before July 1, 2010, and represent about 85 percent of current active participants, is based on the average of the employee’s final three years of pay. Calculations based on “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), D-4. “The Basic Plan and the Member Investment Plan” (Michigan Office of Retirement Services, 2009), https://www.michigan.gov/orsschools/0,1607,7-206-36450_36452---,00.html (accessed Dec. 2, 2009).
There is a MPSERS Tier 1 defined-benefit pension plan for MPSERS “Basic Members” who were hired before Jan. 1, 1987; the benefit involves the highest five consecutive years of compensation (see “The Basic Plan and the Member Investment Plan” (Michigan Office of Retirement Services, 2009), https://www.michigan.gov/orsschools/0,1607,7-206-36450_36452---,00.html (accessed Dec. 2, 2009); “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), F-1).
MSERS’ formula in most cases is based on the final three years of pay. “Michigan State Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), F-1.
[†] The formula is generally (average pay over the final years of service) x (years of service) x (1.5 percent). See, for instance, “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), F-1, F-2.
[‡] A cash-balance type of defined-benefit plan expresses the accrued benefit as an account balance that grows with pay-based credits and a formula-based “interest rate.” See also first footnote in Graphic 3.
[§] People hired before April 1,1997, could opt into MSERS Tier 2.
[¶] A cash-balance type of defined-benefit plan expresses the accrued benefit as an account balance that grows with pay-based credits and a formula-based “interest rate.” However, the investment risk is the responsibility of the plan itself and not the participant. In many plans, the entire account balance may be withdrawn as a lump sum or converted into an annuity. Cash-balance plans tend to be more predictable than traditional pension plans.
[**] Employee Stock Ownership Plans provide retirement benefits to employees through such mechanisms as selling or providing company stock to employees.
[††] An employer’s exact contribution to such plans depends on more than company policy; it usually also depends on the amount of money employees are contributing, how many employees elect to participate in voluntary plans, and, in the case of profit-sharing plans, the company’s recent financial results.
[‡‡] Calculations based on “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), D-4. “The Basic Plan and the Member Investment Plan” (Michigan Office of Retirement Services, 2009), https://www.michigan.gov/ orsschools/0,1607,7-206-36450_36452---,00.html (accessed Dec. 2, 2009).There is a MPSERS Tier 1 defined-benefit pension plan for MPSERS “Basic Members” who were hired before Jan. 1, 1987 (see “The Basic Plan and the Member Investment Plan” (Michigan Office of Retirement Services, 2009), https://www.michigan.gov/orsschools/0,1607,7-206-36450_36452---,00.html (accessed Dec. 2, 2009).)
[§§] The annual actuarial valuation report states that the pension benefit depends on the highest three consecutive years of compensation for MIP members (see “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), F-1). These will typically be the final three years.
[***] Public Act 75 of 2010 actually sets this as the highest five years of compensation (see “Public Act 75 of 2010,” Sec. 4 (12), https://www.legislature.mi.gov/documents/2009-2010/publicact/pdf/2010-PA-0075.pdf (accessed Aug. 3, 2010)). These will typically be the final five years.
[†††] In MSERS’ defined-contribution plan, the state employer contributes an amount equal to 4 percent of the employee’s pay to a personal defined-contribution account. The state also matches any additional employee contribution up to 3 percent of the employee’s pay, making a maximum employer contribution of 7 percent of the employee’s pay. See “State of Michigan 401(K) and 457 Plans” (State of Michigan), 1-2, https://stateofmi.ingplans.com/einfo/pdfs/forms/michigan/plans_guide.pdf.
[‡‡‡] The annual actuarial valuation report states that the pension benefit depends on the highest three consecutive years of compensation for most MSERS members (see “Michigan State Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), F-1). These will typically be the final three years.