Pension Sustainability: Michigan

2011 Retaining Effective Teachers Policy

Goal

The state should ensure that excessive resources are not committed to funding teachers' pension systems.

Meets a small part
Suggested Citation:
National Council on Teacher Quality. (2011). Pension Sustainability: Michigan results. State Teacher Policy Database. [Data set].
Retrieved from: https://www.nctq.org/yearbook/state/MI-Pension-Sustainability-9

Analysis of Michigan's policies

As of September 30, 2009, the most recent date for which an actuarial valuation is available, Michigan's defined benefit pension system for teachers is 78.9 percent funded and has a 27-year amortization period. This means that if the plan earns its assumed rate of return and maintains current contribution rates, it would take the state 27 years to pay off its unfunded liabilities. While its amortization period meets regulatory benchmarks, Michigan's funding level is just below the conventionally recommended minimum funding level of 80 percent. The state's system is just short of being financially sustainable according to actuarial benchmarks.

However, Michigan commits excessive resources toward its teachers' defined benefit retirement system. The current employer contribution rate to the defined benefit plan of 10.1 percent is too high, in light of the fact that local districts must also contribute 6.2 percent to Social Security. Participating employers are required to contribute at an actuarially determined rate. While this rate allows the state to pay off liabilities within 27 years, it does so at great cost, precluding Michigan from spending those funds on other, more immediate means to retain talented teachers. The mandatory employee contribution rate to the defined benefit plan of 3 percent on income up to $5,000, 3.6 percent on the next $10,000 of income, and 6.4 percent on all compensation above $15,000 is reasonable.

Michigan closed its defined benefit system to new members as of June 30, 2010. All teachers hired on or after July 1, 2010 are entered into the new hybrid system with a defined benefit component (which has the same benefit multiplier as the closed defined benefit system) and a small defined contribution component. Funding levels and employer contribution rates to the defined benefit component are not yet reported. Unfortunately, teachers now must commit excessive resources to the defined benefit component. 

The mandatory employee rate to the defined benefit component of "about" 9.4 percent is too high, in light of the fact that teachers must also contribute 6.2 percent to Social Security. Additionally, this may leave teachers with very little flexible income to contribute to the optional defined contribution component. Employees are automatically enrolled to contribute 2 percent of salary; however, they may elect to increase or decrease this amount. Employers contribute a 50 percent match up to a total of 1 percent.

Citation

Recommendations for Michigan

Ensure that the pension system is financially sustainable.
While the state is commended for closing its financially unsustainable defined benefit system, the remaining members and unfunded liability still place a burden on local districts. The state would be better off if its system was over 95 percent funded. However, Michigan should consider ways to improve its funding level without raising the contributions of school districts. In fact, the state should work to decrease employer contributions. Committing excessive resources to pension benefits can negatively affect teacher recruitment and retention. In addition, Michigan should ensure that its new system is financially sustainable without demanding excessive contributions from its teachers.  

State response to our analysis

Michigan recognized the factual accuracy of this analysis.

How we graded

Many states' pension systems are based on promises they cannot afford to keep.

Teacher salaries are just one part of the compensation package that teachers receive. Virtually all teachers are also entitled to a pension, which, upon vesting, provides compensation for the rest of their lives after retirement. In an era when retirement benefits have been shrinking across industries and professions, teachers' generous pensions remain fixed. In fact, nearly all states continue to provide teachers with a defined-benefit pension system, an expensive and inflexible model that neither reflects the realities of the modern workforce nor provides equitable benefits to all teachers.

Under defined benefit systems, states have made an obligation to fund fixed benefits for teachers at retirement. However, the financial health and sustainability of many states' systems are questionable at best. Some systems carry high levels of unfunded liabilities, with no strategy to pay these liabilities down in a reasonable period, as defined by standard accounting practices. Without reform, these systems are a house of cards, vulnerable to collapse as funding cannot keep up with promised benefits. And it is taxpayers who will have to pay if it all tumbles down.

Pension plans disadvantage teachers early in their careers by overcommitting employer resources to retirement benefits.

The contribution of employers to their workers' retirement benefits is a valuable benefit, important to ensuring that individuals have sufficient retirement savings. Compensation resources, however, are not unlimited, and they must fund both current salaries and future retirement benefits. Mandated employer contributions to many states' teacher pension systems are extremely high, leaving districts with little flexibility to be more innovative with their compensation strategies. This is further exacerbated for states in which teachers also participate in Social Security, requiring the district to pay even more toward teacher retirement. While retirement savings in addition to Social Security are necessary, states are mandating contributions to two inflexible plans rather than permitting options for teachers or their employing districts.

This approach to compensation disadvantages teachers early in their careers, as the commitment of resources to retirement benefits almost certainly depresses salaries and prevents incentives. Lower mandatory employer contribution rates (in states where they are too high; in some states they are shamefully low) would free up compensation resources to implement the kinds of strategies suggested elsewhere in the Yearbook. In addition, some states require high employee contributions; the impact this has on teachers' paychecks may affect retention, especially early in teachers' careers.

Research rationale

NCTQ's analysis of the financial sustainability of state pension system is based on actuarial benchmarks promulgated by government and private accounting standards boards. For more information see U.S. Government Accountability Office, 2007, 30 and Government Accounting Standards Board Statement No. 25.

For an overview of the current state of teacher pensions, the various incentives they create, and suggested solutions, see Robert Costrell and Michael Podgursky. "Reforming K-12 Educator Pensions: A Labor Market Perspective." TIAA-CREF Institute (2011).

For evidence that retirement incentives do have a statistically significant effect on retirement decisions, see Joshua Furgeson, Robert P. Strauss, and William B. Vogt. "The Effects of Defined Benefit Pension Incentives and Working Conditions on Teacher Retirement Decisions", Education Finance and Policy (Summer, 2006).

For examples of how teacher pension systems inhibit teacher mobility, see Robert Costrell and Michael Podgursky, "Golden Handcuffs," Education Next, (Winter, 2010).

For additional information on state pension systems, see Susanna Loeb, and Luke Miller. "State Teacher Policies: What Are They, What Are Their Effects, and What Are Their Implications for School Finance?" Stanford University: Institute for Research on Education Policy and Practice (2006); and Janet Hansen, "Teacher Pensions: A Background Paper", published through the Committee for Economic Development (May, 2008).

For further evidence supporting NCTQ's teacher pension standards, see "Public Employees' Retirement System of the State of Nevada: Analysis and Comparison of Defined Benefit and Defined Contribution Retirement Plans." The Segal Group (2010).