Commentary: School Pension System Impacts Everyone’s Future

For every 17 Michigan residents, one person is collecting or will collect generous retirement benefits from the school pension system, including comprehensive health insurance and monthly annuity payments. Proposed reforms to the system — or alternatively just doing nothing — will have a substantial impact on the future of every person who lives here.

There are 445,316 current and former school employees in this enormously expensive system. The cost projected by state officials to prefund a year’s worth of pension benefits for still-active employees was $875.9 million in 2010. Employees kicked-in around 60 percent of this, and taxpayers the rest.

That’s only part of the cost, however, and it’s probably understated. If the state’s payments on prefunding were accurate, then the state would not have an unfunded liability. An additional $1.3 billion must be paid annually because the state ran up $17.6 billion in unfunded liabilities.

And all that just applies to the annuity portion of the benefits. The system also provides health insurance to retirees, and practically nothing has been set aside to cover these expenses, which are disbursed on a “pay as you go” basis. Currently, $794 million annually comes out of taxpayers’ pockets to pay these expenses.

As mentioned, state legislators are considering some major reforms to the system. Among these, new hires would no longer be promised post-retirement health insurance coverage, and instead would be offered a “defined-contribution” health savings account. (They will also all be eligible for Medicare at age 65.)

These reforms will go a long way to fixing the problem, although another generation must pass before all the employees receiving the unfunded health insurance benefits retire and eventually expire, as we all do.

The bill does not, however, fix the problem in pension benefits. The state is still on the hook to develop further substantial unfunded liabilities — the largest factor in pension contributions. The bill does not address reasons why unfunded liabilities occur; it simply shifts the responsibility between employees and employers.

Nor does the bill eliminate the unavoidable political risk inherent in government pension systems: the temptation for politicians to promise higher benefits when cash is flush and defer paying for them when it is not.

At a minimum, the state should close the “defined-benefit” system to new employees (as was done for new state employees starting back in 1997), and instead simply offer these workers 401(k)-style benefits. Among other things this would phase out the temptation for politicians to underfund its promises while offering workers benefits more in line with today’s marketplace.

The enormous school employee pension system is a large part of why Michigan government employee benefits are so far out of line with those received by workers in the private sector — $5.7 billion out of line, as of 2009. Closing the school pension system is essential to getting those benefits back in balance.