CRC recently received an email message containing a few comments about our recent report on K-12 education funding, Making Sense of K-12 Funding, issued on October 16. Below is the message along with the response provided.
“In your recent article, “Making Sense of K-12 Funding,” you [CRC] repeatedly made the claim that, “While total state funding is up over $1 billion from FY2011 to FY2015, the increase is almost exclusively earmarked to satisfy school employee retirement costs, specifically legacy costs arising from the financial market downturn and state retirement system reforms.” You say that the fund imbalance in MPSERS is the result of “market downturn,” portraying it as an unfortunate set of circumstances that is nobody’s fault. You fail to point out the many, many years that the state has manipulated and “dipped into” that fund, leaving it depleted (far more than any “market downturn” could have) so that it no longer had the ability to support the retired teachers WHO PAID THEIR OWN HARD EARNED MONEY to build the fun in the first place. The result is that your article makes teachers who have spent their lives serving their communities and schools appear to be the villains in this whole debate, rather than the victims.
Furthermore, you refer to “state retirement system reforms” as if to represent that the courts haven’t already found that legislation on state employee retirement systems to be unconstitutional. What about the 3% of each and every public school teacher’s paycheck that is still sitting in an escrow account while the State Supreme Court is stalling (for years) in taking up the appealed case, wherein the unconstitutionality of the “reform” will most assuredly be upheld? I would think that as an “unbiased” institution, you would seek to better represent the WHOLE story so as not to mislead the public.”
Note: CRC withheld the name of the author.
State and local government contributions to defined benefit retirement systems have been growing for a number of years. Increasing retirement contributions are not unique to Michigan. States and localities across the country are dealing with this fiscal problem.
Nationally, the Pew Center on the States estimates that the gap between pension system liabilities and assets across all states and local governments was $1 trillion in 2012. This gap grew 14 percent from 2010 to 2012 in inflation-adjusted dollars.
In Michigan, all traditional public school districts and some charter schools participate in the Michigan Public School Employees’ Retirement System (MPSERS). This system provides both financial pension benefits and subsidized health insurance benefits to covered employees. The cost of providing these benefits is shared by school districts, school employees, and the State of Michigan. State law caps the amount that employees pay towards future benefits (generally as a percent of their salary). Also, state law caps the amount that school districts have to pay towards financing these benefits (expressed as a percent of covered payroll). Specifically, districts’ contributions to meet annual unfunded accrued liability payments are capped at 20.96 percent of payroll. Since 2012, unfunded accrued liability contributions above this cap are covered by the State of Michigan.
In a detailed 2013 report, CRC examined the escalating MPSERS costs and the impact that they have had on school funding. The report identified unfunded accrued pension liabilities as the primary driver behind the growth in employer contributions and state contributions to MPSERS.
Combined, employer contributions for pension normal costs and retiree health benefits hovered around 12 percent of payroll each year between 2004 and 2012. In contrast, contributions to meet unfunded accrued pension liabilities increased significantly; from 1 percent of payroll in 2004 to nearly 13 percent of payroll in 2012. Overall, unfunded liabilities increased from $7.7 billion in 2004 to $25.8 billion in 2013.
In a separate analysis, our report identified and quantified the underlying factors behind the increased contributions for unfunded liabilities since 2004. We examined the official MPSERS actuarial valuation reports issued by the Office of Retirement Systems to reveal that the primary cause was investment gains falling short of actuarial assumptions. Of the cumulative $16.6 billion actuarial loss between 2001 and 2012, $14.7 billion (89 percent) was due to poor market performance relative to assumptions (i.e., 8 percent annual gain). Specifically, the market losses of 2008 and 2009 resulting from the worldwide financial crisis were identified as the primary culprits. Because MPSERS uses a five-year smoothing method to spread the market losses across a number of years, 20 percent of the total 2009 market loss is reflected in the 2014 valuation.
Other minor factors contributing to pension liability growth include greater pay raises than assumed by the actuaries as well as people living longer than originally assumed. Additionally, decisions my state lawmakers in the past to make interest-only payments towards the unfunded liabilities or “mark to market” the value of the investment portfolio have helped school districts meet their MPSERS obligations in the short-term, but had longer-term consequences for the unfunded pension liabilities (e.g., extend amortization period). The official financial statements for MPSERS do not reflect any instances where funding was diverted from the trust fund for non-pension/retiree health care costs.
As a result of the growing costs of MPSERS retirement liabilities to public schools, legislation aimed at mitigating some of the upward cost pressure was enacted in 2007, 2010, and 2012. These reforms primarily rely on increased employee contributions, reductions in retiree health care subsidies, and/or reductions in pension benefits to offset the need for employer contributions to cover liabilities.
One aspect of the reforms enacted in 2010 included a mandatory employee three percent salary contribution towards retiree health care benefits. This contribution was challenged in court by school employee groups and the Court of Appeals ruled in August 2012 that the contribution was unconstitutional. The funds collected from school employees for about two years are being held in escrow until the issue is settled by the Supreme Court. As a result, the employer contribution for retiree health was increased by three percent of covered payroll.
The Supreme Court recently heard oral arguments regarding the employee three percent contribution being held in escrow. It is unknown, at this time, how the Court will rule. If the Court rules in favor of the employees, the money will be returned, with interest. However, if the contribution is ruled constitutional, then the escrowed funds will be used to reduce the amount of unfunded liabilities.
It should be noted that the three percent contribution was modified through legislation in 2012, soon after the Court of Appeals ruled. Specifically, the law now requires that an employee’s contributions will be reserved for retiree health benefits received by the employee, as opposed to others. This change effectively guarantees that employees will get a certain level of subsidized health care insurance in retirement.