Executive Summary*

The state manages two major statewide retirement systems for public employees. The Michigan Public School Employees’ Retirement System, known as “MPSERS,” provides both pension and retiree health care benefits to eligible public school employees. The Michigan State Employees’ Retirement System, known as “MSERS,” provides similar post-employment benefits to eligible state employees, though MSERS is distinguished from MPSERS by the Michigan Legislature’s major pension reform to MSERS in 1997. There are more than 300,000 active employees in the two retirement systems. With the inclusion of retirees and beneficiaries, the systems cover more than half a million people.

As of Sept. 30, 2009, the most recent date for which data are available, MPSERS and MSERS pensions had unfunded liabilities of $15.1 billion, while MPSERS and MSERS retiree health care plans had unfunded liabilities of between $24.6 billion and $40.2 billion, depending on how the liabilities are calculated.

The combined $15.1 billion unfunded liability for MPSERS and MSERS pensions results specifically from the two systems’ “defined-benefit” pension plans. In these defined-benefit plans, the members’ government employer assumes the responsibility of annually investing employer and employee pension contributions in amounts sufficient to finance a projected annual retirement income. These plans place all of the investment risk on the government employer — in this case, on the taxpayer.

MPSERS provides defined-benefit pensions to both new and existing public school employees, while MSERS provides defined-benefit pensions only to state employees hired before April 1997. State employees hired after March 1997 are members of MSERS’ “defined-contribution” pension plan, established by the Michigan Legislature in 1997. In this plan, the state makes ongoing contributions to a tax-favored account, with the employee able to contribute as well. The employee directs investment of the monies, and the accumulated capital is available to the individual at retirement. State government and state taxpayers do not assume investment risk, and the plan incurs no unfunded liability; the amount of money at retirement largely depends on investment returns over time.

State government and school districts are attempting to prefund MPSERS and MSERS defined-benefit plans by accumulating sufficient assets to finance current and future benefits. In contrast, MPSERS and MSERS retiree health care plans are being financed on a “pay-as-you-go” basis.

As recently as 2001, following the stock market gains of the 1990s, the MPSERS defined-benefit pension plan was 96.5 percent (or almost fully) funded, while MSERS defined-benefit pension plan was 98.7 percent funded in 2002. Unfortunately, the economic and public policy realities in Michigan — an increasing outflow of residents, a declining private sector and the uncertainties caused by federal tax and health care policies — compound the problems now faced by the MPSERS and MSERS systems. As of Sept. 30, 2009, MPSERS’ and MSERS’ defined-benefit pension plans were 78.9?percent and 78.0?percent funded, respectively.  

Another potential roadblock facing MPSERS and MSERS defined-benefit pension plans involves actuarial assumptions and accounting methodologies. Both plans assume an 8 percent annual investment return on assets; however, public pension plans nationwide may begin lowering this key rate assumption due to the prospect of changes in national government accounting standards together with less optimistic financial forecasts. If MPSERS’ and MSERS’ assumed investment rate is lowered, the unfunded liabilities calculated for MPSERS and MSERS defined-benefit pension plans could be significantly larger.

In recent years, MPSERS and MSERS pension and retiree health care plans have been modified by the Michigan Legislature, most recently in Michigan Public Acts 75 and 185 of 2010. While these revisions have generally been positive, they have not significantly altered the fundamental challenges facing the two systems.

Benchmarking MPSERS and MSERS benefit plans to the entire Michigan marketplace should be a priority in redesigning them to be affordable to Michigan taxpayers. Given the number of employees involved in MPSERS and MSERS, the public sector will struggle to sustain any benefits systems that have proven to be unaffordable in the private sector, especially since the public sector is dependent upon the private sector for funding the benefits.

Benchmarking with Michigan’s private sector is possible given data from a proprietary survey conducted in 2010 by Aon Hewitt, an international human resources firm. Twenty-four major Michigan businesses, including very well-known, publicly traded companies, participated in the survey, providing data for a median of 10,122 salaried employees per company.

The pension plans offered to new hires by these 24 Michigan companies stand in contrast to the two defined-benefit pension plans offered by MPSERS and MSERS. These public plans provide traditional defined benefits based on final pay (or highest pay), a design that often results in underfunded plans. The MPSERS and MSERS defined-benefit plans also include cost-of-living adjustments.

None of the 24 companies offered new employees traditional final-pay defined-benefit pension plans. Some companies still maintained defined-benefit pension plans, but placed new employees in defined-contribution plans, which by definition have no unfunded liabilities. Other plans were “cash-balance” pensions, which are not based on final years of pay and are generally less expensive. Also of note, none of the 24 companies offered plans with cost-of-living adjustments.

Significantly, all 24 companies offered defined-contribution pension plans. Notably, MSERS compares well to the companies in the Aon Hewitt survey, since it offers new hires defined-contribution pension plans only. In addition, by design, the state’s cost for this plan varies between 4 percent and 7 percent of employee compensation, a figure similar to the average employer contributions made by the 24 private companies. The benchmarking also shows that through the enactment of Public Act 75 of 2010, the Legislature moved closer to private-sector norms in Michigan by ending pension cost-of-living adjustments for new MPSERS employees.

The large Michigan companies in the Aon Hewitt survey generally differed from MPSERS and MSERS on retiree health care provisions. MPSERS and MSERS retirees currently receive employer subsidies of up to 100 percent and 90 percent, respectively, of their retiree health insurance premiums; retirees receive lower subsidies for dental and vision insurance, but these are similarly above market norms. Only three of the 24 Michigan companies offered new hires employer-subsidized retiree medical coverage in 2010; 17 provided no retiree medical subsidies to new hires, though some were also transitioning away from retiree medical plans that covered existing employees.

Legislative changes in 2007 slightly reduced the retiree health care benefits offered to new MPSERS employees, and the recently passed Public Act 185 of 2010 would make minor reductions to retiree health care benefits for new MSERS members as well. The requirement in Public Act 75 of 2010 that public school employees begin contributing 3 percent of their income toward an irrevocable trust for MPSERS retiree health care benefits should reduce the cost of these benefits to taxpayers. Nevertheless, MPSERS’ retiree health care provisions remain above private-sector norms, and with the 3 percent payments currently being challenged in court, it is unclear how much relief these employee contributions will ultimately provide. It is even less clear how effective a Public Act 185 provision requiring MSERS active members to make a similar 3 percent contribution toward retiree health care will be. The contribution may be open to similar legal challenges, and in any event, the legislation requires the 3 percent payment only through fiscal 2013, limiting the overall impact.  

Michigan policymakers should redesign public-employee pension and other retiree benefit plans by considering market trends and the best-demonstrated practices in both the private and public sectors in Michigan and the rest of the country. With MPSERS, the Michigan Legislature should mirror its 1997 shift for MSERS and place all new public school employees in a defined-contribution plan to achieve affordable, predictable and fully funded costs. The state should also begin to better manage MPSERS and MSERS retiree health costs through a combination of plan design and eligibility reforms. A 2005 Michigan Supreme Court ruling even suggests that the Michigan Legislature is able to modify retiree medical liabilities for current MPSERS and MSERS retirees.

In addition, public understanding of the projected costs of MPSERS and MSERS pension and retiree medical benefits would be significantly enhanced if the Legislature required the Office of Retirement Services annually to publish a 20-year forecast of expected liabilities and expected taxpayer contributions. Such a projection would likely affirm the belief that these programs are unsustainable, that they defer significant costs to the next generation, and that they need substantial reform.

*Citations provided in the study’s main text.