One assumption in the SFA, HFA and ORS analyses will
be addressed directly, however: the idea that the current normal cost is an
adequate reflection of the cost of prefunding employees’ benefits as they are
earned each year. Currently, the normal cost — and particularly the employer’s
normal cost — for the MPSERS defined-benefit plan is artificially lowered by
the state’s optimistic assumption that nearly all of the plan’s assets will
achieve an 8 percent annual rate of return.[*]
But from the end of fiscal 1997 to the end of fiscal 2011 — a 14-year period
that includes the substantial market returns of the late 1990s — MPSERS’
defined-benefit portfolio realized an approximately 5.4 percent annual
rate of return. This performance
raises doubts about the reliability of the 8 percent assumption.
Assuming an 8 percent rate of return, however,
has reduced the plan’s apparent normal cost (and, of course, led to additional
unfunded liabilities). It also means the SFA, HFA and ORS analyses, which
implicitly relied on this assumption, have almost certainly overstated the
difference between the normal cost of the MPSERS defined-benefit plan and the
annual employer deposits to the MSERS defined-contribution plan.
But even taking the SFA, HFA and ORS comparisons at
face value, the transition costs due to the “lower” normal cost of the MPSERS
defined-benefit plan can be addressed without increasing the employer’s annual
obligations. There are no requirements to duplicate the MSERS
defined-contribution provisions in every regard.[†] An employer can choose the
cost of benefits in a defined-contribution system.
For instance, if the state simply wants to duplicate
its employer costs for pension contributions, it can structure a
defined-contribution plan accordingly. The state’s most recent actuarial
valuation, with figures more recent than those in the SFA analysis, shows that
MPSERS’ active members pay an average of 5.38 percentage points of the
total 9.22 percent normal cost.
This leaves school districts paying only 3.84 percentage points of the
normal cost. To maintain the same employer-employee contribution ratio and
overall costs, the state would simply require school districts to offer 71
cents for every dollar contributed by the public school employee and cap the
schools’ payments at an employee contribution of 5.38 percent of salary.[‡]
Note that the
figures above involve average contributions from employers and employees
for a single year (fiscal 2010). Individual employees contribute
varying percentages based on when they were hired and their annual
salaries. The overall normal cost contribution also varies from year to year
based on new actuarial assessments of the plan; for example, the figure was 9.55 percent
in fiscal 2009.
In a defined-contribution plan, however, the
Legislature can choose a particular employer contribution rate, and legislators
should recognize that the plan described here is in fact similar in size to the
MSERS defined-contribution plan. The money currently set aside for the MPSERS
defined-benefit plan is the sum of a 5.38 percent employee contribution
and a 3.84 percent employer contribution — a total of 9.22 percent of
payroll. The MSERS defined-contribution plan, on the other hand, is a
6.55 percent employer contribution and a 2.55 percent employee
contribution — a total estimated 9.10 percent of payroll.[§] In
other words, these two plans would set aside similar payroll percentages to pay
for retirement benefits.
The remaining question, then, is to address the change
in unfunded liability payment assumptions that accompanies the closing of a
defined-benefit pension plan.
[*] Statutory reforms in 2010 required that
assets set aside for MPSERS Pension Plus members — i.e., MPSERS members hired
on or after July 1, 2010 — be discounted at 7.0 percent, rather than the
traditional 8.0 percent. Public Act 75 of 2010, Sec. 41(11),
(accessed March 12, 2012).
[†] As mentioned earlier, the MSERS plan
contained a 4 percent automatic deposit and a 3 percent matching
[‡] This figure of 71 cents is simply the ratio
of 3.84 percent to 5.38 percent — approximately 0.714.
[§] Author’s calculations based on Kathryn
Summers-Coty, “Examining a Change from Defined Benefit to Defined Contribution
for the Michigan Public School Employees’ Retirement System,” (Michigan Senate
Fiscal Agency, 2009), 3, http://goo.gl/jnzaB (accessed March 12, 2012). Total
contributions in the MSERS plan could reach 10 percent of payroll if employees
contribute the maximum amount matched by the state.