Under most pension funding policies, employers calculate payments toward unfunded liabilities for a particular benefit as a percentage of the payroll of the employees who will receive those benefits. This convention can be changed, however. For instance, Michigan began computing employer contributions toward the unfunded liability for the MSERS defined-benefit plan by using a percentage of the payroll of the employees not just in the defined-benefit plan, but in the defined-contribution plan as well, even though the latter will not receive pension benefits from the defined-benefit plan.[1],[62]

This general approach could be applied consistently to other pension funding policies. For instance, the state could keep its current level-percentage amortization policies and apply the percentage to the payroll for both the new defined-contribution plan and the closed defined-benefit plan.

A similar approach was recently taken in Utah, which passed substantial reforms of a number of its government pension systems. State legislators there were similarly concerned about the immediate cost of the level-dollar payment schedule that is typically applied to a closed pension system.

So the Utah Legislature did not close the system. Instead, it maintained the same backloaded, level-percentage method for paying down unfunded liabilities by adding a “tier” for new employees to the existing pension system. Members of the new tier can opt for a defined-contribution pension plan or for a “hybrid” plan that caps the employer contribution at 10 percent of pay[†] and requires employee contributions to cover any actuarially determined cost above that. State employers set aside a percentage of the payroll for all employees — not just employees in the original tier — as payments on the unfunded liabilities of the existing defined-benefit system. In other words, each new employee’s income was included in the payroll calculations for the unfunded liabilities, regardless of his or her choice of plans as part of the new tier.[63]

In Michigan, members placed in a new MPSERS tier would be treated like the participants in MSERS defined-contribution plan following the 2011 MSERS reform. Under that reform, the state began applying amortization payments to participants in the MSERS defined-contribution plan, not just to participants in the (closed) MSERS defined-benefit plan.64 With MPSERS, then, the state would still use the payroll of new employees — that is, participants in the defined-contribution plan — when calculating the payroll percentage that school districts and other MPSERS employers would need to contribute to the unfunded liability in the MPSERS defined-benefit plan.

Under this approach, the state would not have to alter its amortization schedules and would still be able to use its backloaded method for catching up with its unfunded liabilities. Because there would be no switch to the level-dollar schedule typically recommended for a closed system, there would be no “transition costs” associated with paying unfunded liabilities.

[*]  While this may diverge from more commonly used funding mechanisms, this approach is entirely constitutional, since accrued financial benefits are not mitigated and contractual obligations are maintained.

[†]  This 10 percent employer contribution is more generous than the private-sector norm of 5 percent to 7 percent, according to actuary and Mackinac Center Adjunct Scholar Richard C. Dreyfuss. See Dreyfuss, “Michigan’s Public-Employee Retirement Benefits: Benchmarking and Managing Benefits and Costs,” (Mackinac Center for Public Policy, Oct. 25, 2010), 4, 9, http://www.mackinac.org /archives/2010/S2010-05.pdf (accessed March 28, 2011).