Recently passed Senate Bill 1227 made substantial changes to the Michigan Public School Employees' Retirement System (MPSERS). The main goal of the legislation is to save the Michigan public school system money by encouraging older employees to retire and replacing them with younger, less expensive teachers on a less generous retirement package. The House and Senate Fiscal Agencies assume 50% of eligible employees will take advantage of the retirement incentive and 90% will be replaced. With these assumptions, they estimate a net savings of $679.6 million in FY 10-11 and $3.15 billion after 10 years. Our analysis of the bill is below. You can see the bills in its entirety as well as committee and floor summaries on the Michigan Legislature website.
Senate Bill 1227 really does three main things with which we are concerned:
1. Creates Retirement Incentive
Senate Bill 1227 increases extends retirement eligibility and increases the multiplier for those who retire this year. Currently, the accrual rate for MPSERS employees is 1.5%. The recently passed law increases the multiplier to 1.6% for those who retire between July 1 and September 1, 2010, which is equivalent to a 6.7% pension increase. The new law also allows anyone whose age and years of service totals 80 or more to retire this year with a 1.55% multiplier (a 3.33% increase). According to the House and Senate Fiscal Agencies' estimates, the added cost of the retirement incentive (assuming 50% participation) minus the wage savings (assuming 90% replacement) should save close to $500 million over the next ten years.
Overall, this was probably a necessary part of the bill in order to pass the House. If the predictions are correct and it saves the public school system $500 million, that is also a good thing. However, this does not help the health of the pension system itself and it raises some equity issues. Any employees who retire soon will already be getting pension benefits that have not been fully funded, and retroactively increasing their pensions will add to MPSERS $9 billion in unfunded liability. These reforms will give those that retire this year even cushier retirements for a longer period and place the burden of paying for these benefits on the backs of their replacements.
2. Increase Contributions towards Retiree Health Care
In addition to existing contributions, all employees will now contribute 3% of salary to an irrevocable trust to pay for future retiree health benefits. The retirement health care system is greatly underfunded, and this will help take a significant piece of that burden off of employers. The House and Senate Fiscal Agencies estimate this will save $3.520 billion over ten years. The only danger in this is that it might make it more difficult to change retiree health care benefits in the future. Pension benefits for public employees are legally guaranteed and cannot be retroactively diminished, but retiree health care is not protected in the same way. Even with these increased contributions, retiree health care will still be far from fully funded, and, ideally, these benefits will be curbed in the future.
3. Creation of Hybrid Plan for New Hires
Finally, this bill creates a new hybrid plan for all MPSERS employees hired after July 1, 2010. It would be similar to the current MIP plan, but would have a defined contribution element. In this new plan final average compensation will use a 5 year calculation instead of a 3 year calculation, and the retirement age will be increased to 60 (currently it is 55 or simply 30 years of service depending on the plan). It would also create an optional defined contribution portion, where the employer would contribute a maximum of 1% of salary on a 50% match with the employee. The employee would be vested in the employer match 50% after 2 years, 75% after three years, and fully vested after four years. Lastly, the hybrid plan eliminates all cost of living adjustments and prohibits an employee from purchasing service credits.
We fully endorse the creation of a hybrid plan. Increasing the final average compensation period is an idea we discuss in detail on our Pension Spiking page. A 5 year period for calculation final wages will decrease retirees' FAC overall and mitigate the effects of pension spiking. An increase in the retirement age is another idea we support. This better ensures that the necessary funding for a pension is being paid while the beneficiary is still working and helps keep a pension fund's liabilities manageable. The defined contribution portion of the hybrid plan is good in that encourages employees to save even more than is required for retirement, although it does potentially add a slight additional burden for school districts. The elimination of cost of living adjustments and the purchasing of service credits also help keep pension costs under control and discourage early retirement.