Hybrid Plan Did Not Fix School Retirement System

It is at risk of underfunding and has barely enough assets

When lawmakers last considered offering new school employees in Michigan only a defined-contribution retiree plan, the system’s administrators said that the newer “hybrid” plan being offered to new employees has fixed the pension system. They are wrong.

The hybrid retirement plan was created during the Granholm administration as part of a larger package of bills that also provided an early retirement incentive to workers. This hybrid plan is just a less generous traditional pension with a small 401(k) benefit added on. The pension portion of the hybrid is a defined-benefit plan where taxpayers are ultimately responsible for ensuring that enough money is saved to pay for benefits.

The hybrid plan is at risk of becoming underfunded. The state is supposed to set aside enough money to pay for the pensions that workers have earned. This prevents the benefits being earned today from being a burden on future taxpayers. But, if policymakers put in less than is required to keep these pensions funded, future taxpayers will be required to step in to make up the difference.

The current hybrid system has only existed since 2010, and although this has been a period of market growth, it barely has enough assets to pay for the pensions its members have earned. Investments are assumed to grow less than the retirement system’s other plans, with a 7 percent expectation instead of 8 percent. This lowers the risk that the plans will be underfunded, but does not eliminate it. Despite strong market gains, and investment returns that have beaten assumptions, the state has only $23,000 more saved than its $177 million in liabilities.

That ought to raise concerns among lawmakers about the viability of this system. There’s not much breathing room if there’s ever a slow year or recession, and the state is supposed to have pensions covered in good times and in bad.

It’s not the first time that the state has created new tiers of benefits. The state started the Member Investment Plan, which provided a cost-of-living adjustment but required employee contributions, a generation ago. The MIP and other older plans have accumulated $26.7 billion in unfunded liabilities. This underfunding has made school employees and retirees the state’s largest creditors.

Pension administrators have held enough money to pay for the value of pensions earned by employees and retirees in only one out of the past 42 years. Based on this history and the facts of the current state of the hybrid system, one should be skeptical that the hybrid plan will remain fully funded.

In addition to all of this, the hybrid plan does not do a particular good job of serving school employees. It takes 10 years to “vest” — legally earn the right to a state-funded pension — and half of all school employees never vest, which means they don’t benefit at all from this expensive and underfunded pension system.

To prevent future underfunding and to put retirement back in the hands of employees, the state should stop offering the hybrid plan to new workers and only offer defined-contribution benefits, which do not get underfunded.

Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.