Study Discusses Five Ways to Close State’s Badly Underfunded Public School Employee Pension Plan
Author also questions ‘transition costs’ of closing the plan and concludes legislators can disregard these at their discretion
MIDLAND — In an 18-page study released today, Mackinac Center Assistant Director of Fiscal Policy James M. Hohman reviews ways that state policymakers can address the question of the “transition costs” in closing the pension plan in the Michigan Public School Employees’ Retirement System. Closing the plan to new members has become increasingly urgent due to its mushrooming unfunded liabilities, which have reached a whopping $17.6 billion. Several state agencies, however, including the Michigan Office of Retirement Services, have calculated that closing the plan could cost $360 million in the first year, despite saving money in the long run.
Hohman questions the way these “transition costs” have been viewed, but observes that there are numerous ways to address them if they are seen as barriers to reform. “First of all,” Hohman notes, “the state could reduce public school employees’ generous retirement medical benefits. Offering these is not constitutionally mandated, while paying pension obligations is. Retiree medical benefits, which are provided in addition to Medicare, are uncommon in Michigan’s private sector, and state government employers spent $795 million on them in fiscal 2011 alone. A modest reduction would ameliorate so-called transition costs, especially since the largest transition costs decline and become savings in subsequent years.”
Alternatively, or in conjunction, Hohman suggests state policymakers consider both closing and “freezing” the school employee pension plan. Closing the plan to new members would mean future public school hires would receive a 401(k)-style individual retirement savings account with employer matching deposits; freezing the plan would shift current employees to a 401(k)-style plan, too. “Current employees would still receive the pensions they have earned to date,” Hohman observes, “but because they would no longer earn new pension benefits, the potential for unfunded pension liabilities would be contained even further than if the plan were simply closed. This containment would improve the return on any upfront costs, and it could lower them, since the accounting standards driving transition cost calculations may be more flexible for a closed and frozen plan.”
Hohman writes that the state’s next-best option would be to simply pay any upfront transitional cost, since much of that payment would accelerate the reduction of the pension plan’s unfunded liabilities. “The plan’s unfunded liabilities have risen by more than 6,500 percent since fiscal 2000,” he notes. “The state has gotten badly behind, and the difference has to be made up at some point. One of the penalties for that is forgoing other legislative spending.”
Nevertheless, Hohman questions the current perception of the so-called transition costs. “The state agencies’ calculations are useful information, but they are only part of the picture,” says Hohman. “The agencies’ calculations of the largest upfront costs are based on a reading of Governmental Accounting Standards Board guidelines. GASB rules, however, dictate only how to track and measure payment decisions, not which payment policies to adopt. This means legislators will incur ‘transition costs’ only if they choose to.”
Hohman also discusses two other technical options: simply structuring a different, backloaded amortization payment schedule while tracking the figures using GASB guidelines, or spreading the amortization payments across the entire public school employee payroll, which would technically allow the state to avoid upfront costs by adopting a different amortization schedule. These options would allow legislators to transition to a 401(k)-style system while applying policies the state already uses in other areas.
Hohman’s study, titled “Five Options for Addressing ‘Transition Costs’ When Closing the MPSERS Pension Plan,” is available at www.mackinac.org/16589.