Capping Retirement Contributions Changes Few District Incentives

The state’s 2012 retirement reforms changed the way that pension benefits offered in Michigan school districts are paid. It capped a school district’s contributions to the retirement system, with the state pledging to pay the amounts required above the district cap. But this may not have changed the policy picture as much as legislators hoped.

When a school district pays an employee, it also sends a check to Lansing to pay for the expected costs of providing that employee with retirement benefits. The district’s payments cover the benefits earned by employees and also the costs to catch up on the system’s unfunded liabilities for pension and retirement health benefits (the difference between what those benefits cost and how much the state has actually set aside to pay those costs). After the 2012 changes, the unfunded liability portion of the payments is capped at 20.96 percent of payroll.

Currently, the state is paying beyond its capped contributions. Unfunded liability payments alone cost 23.73 percent of payroll and the state is contributing 10.53 percent of payroll toward the 23.73 percent contribution, while districts contribute 13.2 percent of payroll.

These contribution rates take some of the burden off long-term school personnel decisions. Districts can more easily budget for personnel costs now that the state has limited their contributions to liability payments. This would encourage school hiring to the extent that superintendents in the past may have held off on hiring teachers because of an uncertain exposure to retirement costs.

Participation in the state’s school retirement plan is not an option for school officials; it is a statutory mandate. So the state may be acting responsibly by making these contributions instead of asking districts to look within their budgets when retirement system underfunding increases.

It is an expensive obligation, though. The extra payments cost $993.5 million for the current fiscal year. So far, the state uses School Aid Fund revenue to pay for these enormous retirement costs. This means there has been less money available to boost the state’s foundation allowance or any other areas of education budgets that policymakers may have been interested in funding. Charter schools, where employees generally are not in the pension system, receive no benefit from these extra state payments. But neither have they had the responsibility to look within their budgets to pay for growing retirement contributions.

The state has been good at paying for the contributions above the cap since starting this policy. This is no guarantee that it will do so in the future. The protections are set in statute, but the budgets needed to make good on the promise require annual legislative approval. A legislature that does not believe it has sufficient cash to pay for the capped amounts may find that it has the votes necessary to eliminate the statutory requirement and could push some or all those costs back onto school districts.

Thus, the impact of capping district contribution rates is uncertain. As long as the retirement funds continue to develop unfunded liabilities, there will be difficult discussions over how to pay for them. Mitigating the ability to develop unfunded liabilities in the system would do more to protect long-term district finances than this statutory contribution cap.