SCHOOL EMPLOYEES RETIREMENT                                                          S.B. 1040 (S-2):

                                                                          SUMMARY AS PASSED BY THE SENATE

 

 

 

 

 

 

 

 

Senate Bill 1040 (Substitute S-2 as passed by the Senate)

Sponsor:  Senator Roger Kahn, M.D.

Committee:  Appropriations

 

Date Completed:  5-18-12

 

CONTENT

 

The bill would amend the Michigan Public School Employees' Retirement System (MPSERS) Act to make several substantial changes, including the following:

 

 --    Beginning July 1, 2012, future compensation for existing employees would no longer include tax sheltered annuities or longevity pay.

 --    For employees hired between July 1, 2012, and January 1, 2013, final average compensation, as used in the calculation of a pension, could not exceed $100,000, adjusted annually by inflation.  This cap would not affect the pension of employees hired before July 1, 2012.

 --    Employees hired before July 1, 2010, would have the following choices: 1) make higher contributions in order to continue receiving a 1.5% multiplier for future years of service; or, 2) either a) continue paying current contributions but have a 1.25% multiplier for future years of service, or b) freeze pension benefits earned to date and move to a defined contribution plan for future years of service.  "Hybrid" employees (those hired on or after July 1, 2010) would not be affected by these pension changes.

 --    Employees hired on or after January 1, 2013, would no longer receive a defined benefit pension and instead would become part of a defined contribution (401k) plan.

 --    For employees first hired on or after July 1, 2012, retiree health care premium coverage would be eliminated and replaced with matching employer contributions up to 2% of compensation, deposited into a 401k account; new hires would not have to remit the 3% employee contribution for retiree health that is in the law for current employees.

 --    The premium coverage paid by the State would decrease to a maximum of 80%, with retirees (both existing retirees and future retirees) paying at least 20% of health care premiums.

 --    Beginning July 1, 2013, MPSERS universities would be allowed to provide a retiree health care plan that would be separate from the MPSERS retiree health care plan currently provided.

 --    The Office of Retirement Services would be required to disclose, post, and e-mail additional information related to the financial statements, and to maintain an electronic mail address for retirement allowance recipients and members.

 --    The Office of Retirement Services would have to determine a fiscal year 2012-13 employer contribution rate not later than July 1, 2012.

 

The bill also would appropriate $1.0 million to the Office of Retirement Services for implementation of the legislation.

 

The proposed changes would address both pension and health care costs.  As of the most recent Comprehensive Annual Financial Report, the unfunded accrued liability (UAL) for MPSERS pensions was $17.6 billion and the UAL for retiree health care was $27.6 billion.  The bill would reduce the liabilities under both the pension and health sides, but most of the


impact would affect the health care liability. The bill also would increase cost exposure as discussed in the Fiscal Impact, related to closing the defined benefit pension plan for new hires.

 

Definition of Compensation and Final Average Compensation

 

Senate Bill 1040 (S-2) includes two proposals that would limit future pension payouts.  The first would amend the definition of "compensation" to exclude from future compensation, beginning July 1, 2012, tax sheltered annuities and longevity pay.  Any tax sheltered annuities or longevity pay earned before July 1, 2012, would be included in compensation earned in previous years, to the extent allowable under current law.  However, going forward, those items would be eliminated from the definition of "compensation". 

 

The second proposal would place a cap on final average compensation for employees hired between July 1, 2012, and January 1, 2013 (when new hires would enter the defined contribution plan).  Specifically, the cap for this group of employees would be $100,000, adjusted annually by inflation.  Since a pension is calculated by multiplying an employee's final average compensation by the number of years worked, times a specified multiplier, both proposals would work to limit the final pensions paid out, by limiting compensation used in the calculation of the pension.

 

Increased Employee Contributions or a Reduced Multiplier or Conversion to DC

 

The next series of changes under Senate Bill 1040 (S-2) relates to choices employees would have to make, as follows: 1) increase employee contributions and continue the multiplier (for pension calculation) of 1.5% for future years of service, OR, 2) keep the same level of employee contributions but have a reduced multiplier of 1.25% on future years of service, OR, 3) make no future contributions, but also receive no future years of service for a pension, and instead freeze existing pension benefits and convert to a defined contribution (DC), or 401k, plan.

 

Employees who wished to continue receiving the existing 1.5% multiplier for future years of service (for use in calculating a pension) would have to pay higher employee contributions than under current law.  Specifically, employees hired before January 1, 1990 ("basic" plan members) who chose to remain in the basic plan would have to pay 5% of compensation; these employees currently make no contributions to MPSERS.  All member investment plan (MIP) members hired before July 1, 2010, whether they switched from basic or were first hired into MIP, would have to pay a flat 8% of compensation; these employees currently make graded contributions based on salary, presently ranging from 3% to 6.4%.  The bill includes language stating that the contribution rate charged to employees could not exceed the normal cost of their pension; this means that if the normal cost fell below 8%, then the employee contributions would be reduced from 8% to a level not more than the normal cost rate.  Employees hired on or after July 1, 2010, are in the "hybrid" system and would not be affected by the proposed changes; they would remain in the hybrid plan at their current contribution levels. 

 

If employees did not choose to make the higher contributions listed above, they would have two choices: 1) pay the existing employee contributions, but receive a 1.25% multiplier for future years of service, OR, 2) freeze the earned benefit to date and convert to a DC plan.  The DC plan would require the employer to deposit 4% of compensation into a 401k account, but no future pension benefits would accrue to an employee choosing this option.  Regardless of the option chosen, previously accrued service would be calculated at the 1.5% multiplier when determining pension benefits earned to date.

 

 

 

0New Hires on or after January 1, 2013 into Defined Contribution

 

The bill would require all employees hired on or after January 1, 2013, to participate in the "Tier 3" plan, which is designated strictly as a defined contribution (DC) plan, rather than a defined benefit (DB) plan.  The DC plan would require the employer to contribute 4% of the employee's compensation into a 401k-type account, and the employer would match an employee's contributions, up to another 3%, for total maximum employer contributions equal to 7% of compensation (if the employee contributed 3%). 

 

The changes in Senate Bill 1040 (S-2) related to this provision means that the existing DB plan, which was most recently reformed in 2010 to a "hybrid" system, would be closed to new hires on January 1, 2013.  The Office of Retirement Services would have to designate three or more entities to provide account plans for participants.  Those entities could be chosen only if they met several criteria, including already providing DC plans to public sector employees in at least 10 other states, offering an option that is an annuity contract, and being authorized to operate in this State.

 

The bill also would allow MPSERS employers (school districts, community colleges, intermediate school districts, etc.) to designate their own Tier 3 contracts or account plans by an alternate provider.  While the bill would require an employer designating its own provider to choose that provider in substantially the same manner as the State, the bill would allow for local plans to differ from the State 401k plans.  The contributions offered at the local level could not exceed the benefits prescribed by plans offered at the State level, although it appears they could be at a lower level than the "4% plus 3% matching" required of the State-operated plans.

 

Retiree Health Care

 

Two changes to retiree health care are proposed under Senate Bill 1040 (S-2).  First, beginning July 1, 2012, State premium coverage would be reduced to not more than 80%, with retirees paying at least 20% of retiree health care premium coverage, an increase from the current roughly 10% cost sharing.  This change would affect not only future retirees, but also people already retired.  The graded premium coverage in effect for people hired between July 1, 2008, and July 1, 2012, would be changed such that those employees would earn 3% coverage per year (after 10 years), rather than 4%, up to the maximum 80% coverage, but the graded premium would not be retroactively applied to people hired before July 1, 2008. 

 

Second, the bill would eliminate retiree health care coverage for employees first hired on or after July 1, 2012.  Mirroring changes made for State employees under Public Act 264 of 2011, the bill would require an employer to make up to a 2% matching contribution into an employee's 401k account in lieu of retiree health care coverage.  Employees would not be able to take loans out against the employer's contributions, under this proposal, which was also implemented under Public Act 264.

 

(The "Age 60" requirement for health care proposed in the introduced version of the bill is not included in Senate Bill 1040 (S-2) as passed by the Senate.) 

 

MCL 38.1303a et al.

 

FISCAL IMPACT

 

Table 1 is a summary of the sections proposed for amendment and their estimated fiscal impact, if available.  If Senate Bill 1040 (S-2) were enacted, the additional annual required contribution (ARC) costs attributable to adopting a DC plan for new hires, if fully funded, would cost $402.0 million in fiscal year (FY) 2013-14; the cumulative FY 2012-13 pension savings would be $250.0 million (representing the employer savings from increased employee contributions and the partially offsetting costs of the first-year DC plan); and cumulative FY 2012-13 health savings would be $80.0 million (representing "80-20" and partially offsetting costs of the "401k for health").  This means that the FY 2012-13 employer contribution rate would be an estimated 24% of payroll.  However, the rate for FY 2013-14 would increase by four percentage points if employers were required to pay the increased ARC costs, on top of the expected increase of four percentage points due to continued smoothing of 2008 and 2009 market investment losses.

 

Long-term pension liability would be reduced by $1.6 billion and long-term health liability would be reduced by $3.3 billion, for an estimated total reduction in unfunded liability of $4.9 billion.

 

                                                                                Fiscal Analyst:  Kathryn Summers

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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This analysis was prepared by nonpartisan Senate staff for use by the Senate in its deliberations and does not constitute an official statement of legislative intent.


Table 1

Section-by-Section Analysis of MPSERS Reform Legislation

(Senate Bill 1040 Substitute S-2, as Passed the Senate)

Section Number and Purpose

Proposed Change

Estimated Fiscal Impact

Sec. 3a Definition of Compensation

Beginning July 1, 2012, future compensation would no longer include tax sheltered annuities or longevity pay.

No estimated fiscal impact available because, until this point, compensation was not broken down into categories.  Could slightly reduce payroll; which could increase employer contribution rate.

Sec. 4(12) Definition of Final Average Compensation

For new hires, compensation used to determine Final Average Compensation could not exceed $100,000, adjusted annually by inflation.

Year 1: $1 million savings

Year 2: $3 million savings

Year 3: $5 million savings

…Year 10: $18 million savings

 

Long-term hybrid employer rate reduced by 0.13% of payroll. Unfunded accrued liability (UAL) reduction of $55.0 million.

Sec. 43a Existing Employee Contributions

Sec. 43g Proposed Employee Contributions

Employees would be given a choice to either 1) continue to pay existing contributions under Sec. 43a, but receive a reduced pension multiplier of 1.25% (rather than 1.5%) for future years of service, or 2) pay higher contributions under Sec. 43g in order to continue receiving the 1.5% pension multiplier. 

 

Basic Employees (hired before 1990) choosing option #2 would pay flat 5% of compensation (up from 0% current contribution) into pension system.

 

Member Investment Plan (MIP) employees (hired between 1990 and 2010) would pay flat 8% of compensation (up from a graded system where contributions range from 3% to 6.4%, based on hire date and salary) into pension system. 

 

Hybrid members (hired after July 1, 2010) would remain in the hybrid plan, and continue contributing existing amounts.

5% Across the Board for Basics = $74 million

 

8% Across the Board for MIP (nonhybrid) = $279 million

 

Total Additional Employee Contributions = $353 million

 

Long-term reduction in employer contribution rate if employee contributions were directed to reduce employer costs is 2.8%.

 

UAL reduction of $1.6 billion.

Sec. 59 Employee Choices:

 

Higher Contributions/Retain 1.5% multiplier for future years of service

 

Same Contributions/Reduced 1.25% multiplier for future years of service

 

No Contributions/Freeze Pension Earned to Date/Switch to DC for future years

All existing employees hired before July 1, 2010, would be given a choice to either pay higher contributions and retain the 1.5% pension multiplier, or, if choosing not to pay the higher contributions, then either retain the existing contributions with a reduced multiplier (1.25%) OR freeze earned pension and transfer to a Defined Contribution plan.

 

An employee choosing to make the higher contributions to retain the existing 1.5% multiplier for future service would be given a further choice to pay the higher contributions until termination or until reaching "attainment date" (i.e., 30 years of service).  Employees choosing to pay the higher contributions until attainment date, after reaching 30 years of service, would return to the lower contribution levels, but at a 1.25% multiplier for years in excess of 30.

 

An employee choosing not to pay the higher contributions who further chose to freeze the earned pension to date and transfer to DC, would make no contributions and would receive an employer contribution of 4% of pay into the employee's 401k account.

This section would implement the employee contribution sections referred to above, and therefore would have no stand-alone fiscal impact.

Sec. 84b Pension Calculations Based on Choices Made in Section 59

People choosing to make the higher contributions under Sec. 43g would retain the 1.5% multiplier for future years of service, in the calculation of their pension.  If they chose to make the increased contributions only until attainment date, the 1.5% multiplier would be used for service accrued until they reached the attainment date, and a 1.25% multiplier would be used for years of service after the attainment date was reached.

 

People choosing not to make the higher contributions under Sec. 43g, but choosing to continue making the contributions under Sec. 43a, would receive a 1.25% multiplier for future years of service, when calculating their pension. 

People choosing not to make any future contributions would be frozen at the pension accrued to date, and switched to DC for future years of service. 

 

All previously accrued service would be calculated at a 1.5% multiplier.

This section would implement the employee elections section referred to above, and therefore would have no stand-alone fiscal impact.

Sec. 91 Retiree Health Care

"80/20"

All existing retirees would have State retiree health, dental, vision, and hearing coverage of 80%, rather than the existing 90% coverage.

 

Retiree health care coverage would be eliminated for any employee first hired on or after July 1, 2012.

"80/20"

Year 1: $90 million savings

Year 2: $100 million savings

Year 3: $110 million savings

…Year 10: $183 million savings

UAL Reduction of $3.3 billion.

 

 

Sec. 91a "401k" for Retiree Health

Combined with Sec. 91(15), retiree health care premium coverage would be eliminated for employees first hired on or after July 1, 2012.  In place of retiree health care coverage, the employer would pay up to 2% in matching contributions to an employee's 401k account.

 

New hires would not pay the 3% retiree health contribution required under Sec. 43e for all current employees, since they would not receive retiree health care upon retirement.

This would be a new cost in addition to payment of the cash costs of existing retirees, which would grow until a break-even point was reached in roughly 30 years, after which costs would decline, with significant savings achieved in 60 years.  Eventually, long-term costs for retiree health care would max out at 2% of payroll.

 

Year 1: $11 million additional cost

Year 2: $22 million additional cost

Year 3: $31 million additional cost

…Year 10: $110 million additional cost

Sec. 151 Defined Contribution for New Hires (effective January 1, 2013)

Employees first hired on or after January 1, 2013, would be enrolled in a defined contribution (DC) plan for retirement savings, rather than the existing "hybrid" plan, which provides both a DC component and a defined benefit pension allowance.  The State-sponsored plan would provide a 4% employer contribution, plus an additional 3% matching contribution, for maximum employer contributions of 7%, if the employee contributed 3%.  Local employers would be allowed to adopt plans outside of the State system, but the fiscal impact shown reflects an assumption of uniform benefits provided.

According to GASB (Government Accounting Standards Board) recommendations, the reported Annual Required Contribution (ARC), associated with closing out the old defined benefit (DB) plan, would increase by $402 million in FY 2013-14, $338 million in FY 2014-15, $273 million in FY 2015-16, $206 million in FY 2016-17, $138 million in FY 2017-18, and $67 million in FY 2018-19.  These increases in the ARC reflect an accelerated funding schedule for the unfunded accrued liabilities of existing DB members.  They do not reflect an added cost of new benefits, but reflect the fact that there would be fewer employees in the old system, and thereby less revenue flowing into the system to cover pensions for current retirees and the active employees remaining in the old system.

 

If the increased ARC were fully funded, this would equate to a four percentage point increase in employer contribution rate, if this additional cost were passed along to employers.  If the additional ARC were fully funded, and a decision were made not to pass the cost along to employers, then an appropriation of $400 million would be required.  (When the State closed the State Employees' Retirement System and converted to DC, it did pay the additional recommended ARC.)

 

Turning to the yearly cost of the DC plan in comparison to the existing hybrid plan, the current "normal" cost of the hybrid plan is about 3.7% of payroll, and the "normal" cost of the DC plan would be between 6.2% and 7.0% of payroll.  The difference between these two costs (at a minimum, 2.5% of payroll, and at a maximum, 3.3% of payroll) equates to additional costs of the DC plan between $9 million and $12 million in Year 1, $20 million to $27 million in Year 2, $32million to $42 million in Year 3, and growing over time as more new employees became part of the DC plan.

 

The hybrid plan, which has been operating only for two years, currently has $0 unfunded accrued liability.  If actual experience in market returns or other actuarial assumptions on payroll growth, mortality tables, etc., were less favorable than anticipated, then unfunded accrued liabilities could occur in the hybrid plan, raising the total cost of that plan.  However, the hybrid was designed to reduce the potential risk for exposure to unfunded liabilities, which currently exists to a greater extent in the older MPSERS plans (basic and MIP). 

 

The hybrid does continue, though, to carry some amount of risk with respect to unfunded liabilities, which a DC plan does not.  For example, if the market returns are unfavorable, under the hybrid plan, the employer has to make up the losses, but under a DC plan, the employees are faced with the losses in their 401k accounts.  Therefore, the DC plan does ensure stability in known costs over time, although it cannot be said with certainty that a DC plan would be less expensive over time, and, given current actuarial assumptions, the DC plan would cost more on a yearly basis than the current hybrid plan.

 

Appropriation for ORS to Implement

$1.0 million appropriation to the Office of Retirement Services for implementation of the bill.

$1.0 million appropriated from the retirement system's assets.

Total Fiscal Impacts

 

SFA estimated FY 2012-13 reduction in MPSERS employer contribution rate, compared to the anticipated rate without any reforms, if all savings were used to reduce employer contributions:  3.5%

 

Note: FY 2011-12 MPSERS employer contribution rate is 24.46% of payroll, and, in the absence of any changes, the FY 2012-13 rate will be 27.37% (an increase of 2.91% of payroll over FY 2011-12) and the FY 2013-14 rate will be 31.21% (an increase of 3.84% of payroll over FY 2012-13).

 

As mentioned above, if the recommended Annual Required Contribution associated with closing out the DB plan and converting to DC were funded, the FY 2013-14 employer contribution rate would increase four percentage points above what it otherwise would be, if the ARC costs were borne by employers.  If the ARC instead were paid via an appropriation, that cost would be $402 million.

 

The DC plan provision would cost more on an annual basis than the existing hybrid plan, as explained above, unless unfunded accrued liabilities in the hybrid plan manifested and grew to more than additional cost of the DC "normal" cost.