On March 31, 1997, Michigan took what is still considered a dramatic step towards reforming the state’s public-sector “defined-benefit” pension system. This change required state hires who qualified for the Michigan State Employees’ Retirement System from that day forward to enroll in a “defined-contribution” pension plan, rather than the existing defined-benefit pension plan.[1] This new policy was effected by legislation passed in December 1996 by Gov. John Engler and the Michigan Legislature. The same legislation provided continuing MSERS defined-benefit members a one-time chance to voluntarily switch to the new defined-contribution plan.[2]

The author describes the difference between the two types of retirement plans in a Mackinac Center Policy Brief published in October 2010:

In … 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.

… In [a defined-contribution] 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.[3]

Informally, a defined-benefit plan is the kind common 20 years ago, where an employer promised to pay a “guaranteed” pension, while a defined-contribution plan is an individual account — often a 401(k) — in which an employer helps an employee save for retirement.

Michigan continues to maintain the MSERS defined-benefit plan for members hired prior to March 31, 1997.[*] A separate statewide defined-benefit plan covering public school employees (“MPSERS”) was unaffected by this 1997 change and remains in effect today.[†] As of September 30, 2010 (the most recent date for which full data are available), the significant unfunded liabilities of the MSERS and MPSERS defined-benefit plans — approximately $4.1 billion and $17.6 billion, respectively[4] — raise significant questions regarding sustainability and exactly how this can be viewed as a favorable incentive to live, work and invest in Michigan.

Given that approximately 14 years have passed since the adoption of the MSERS defined-contribution plan, it is possible to review the plan’s current status to determine the financial impact of the 1997 change. Such a topic is difficult to analyze precisely, given that it effectively requires certain assumptions regarding the current status of the MSERS pension plan had this change not occurred. Nevertheless, because the MSERS defined-benefit plan still exists, one can develop reasonable estimates and general conclusions, presenting the results in terms of ranges where appropriate. This Policy Brief is intended to produce such estimates for policymakers to consider.

[*] The MSERS defined-benefit plan is also referred to as the “MSERS Tier 1” plan, while the MSERS defined-contribution plan is referred to as “MSERS Tier 2.”

[†] MPSERS stands for Michigan Public School Employees’ Retirement System.