The “normal cost” of a defined-benefit plan is the annual employer cost of the future liability associated with the benefits earned in that particular year.[*] State government’s normal cost for the MSERS defined-benefit plan in fiscal years 1997 through 2010 has averaged 8.1 percent of the previous year’s payroll.[†] This actuarially determined normal cost is based on a number of assumptions, including a projection of 8 percent annual returns on the plan’s invested assets. The defined-contribution plan has an annual employer cost of between 4 percent and 7 percent of the current year’s payroll.[‡]
To estimate the normal cost savings from placing new MSERS employees in a defined-contribution plan, the author compared the cost of pension benefits for employees under the MSERS defined-contribution plan to the normal cost of the benefits for employees remaining in the MSERS defined-benefits plan. To perform this calculation, the author used several sources of data.
Data for the MSERS defined-benefit system for fiscal years 1996 through 2010 was taken from a series of MSERS comprehensive annual financial reports. The reports provided both the MSERS defined-benefit payroll figures and the MSERS defined-benefit normal costs.
Payroll data for MSERS defined-contribution employees for fiscal years 2000 through 2009 were provided by the Michigan Office of Retirement Services. The ORS did not have this data for fiscal year 2010 at the time of this writing, and the office is unable to provide the data for fiscal years 1997 through 1999. The 2010 payroll figure was obtained from the Michigan State Employees’ Retiree Health Benefits 2010 Annual Actuarial Valuation Report. The defined-contribution payroll figures for fiscal years 1997 through 1999 were estimated as a linear increase from an MSERS defined-benefit payroll of $0 in fiscal 1996 (before the MSERS reform) to the known value of $531 million in fiscal 2000.
State government is unable to provide data for the state’s defined-contribution payments for MSERS members for the fiscal years 1997 through 2010. The Michigan Senate Fiscal Agency, however, was able to provide the state’s defined-contribution payments and payroll for all employees in state-managed defined-contribution systems: MSERS, the Michigan Legislative Retirement System and the Michigan Judges’ Retirement System. In order to develop the estimate below, the author assumes that the MSERS defined-contribution payments as a percentage of MSERS defined-contribution payroll will be approximately the same as this same percentage for the three state systems combined. Given that MSERS employees comprise the vast majority of employees in the three systems, this assumption seems reasonable.
It could be questionable, however, to compare this estimated percentage for the MSERS defined-contribution plan to the percentage obtained when the state’s normal cost for the MSERS defined-benefit plan is expressed as a percent of the MSERS defined-benefit payroll. The author recognizes that closing the MSERS defined-benefit plan to new entrants in 1997 probably raised the plan’s normal costs, since these costs tend to trend upward with an aging plan population.[§]
Graphic 1: Estimated Total Normal Cost Savings From Shifting New MSERS Employees to a Defined-Contribution Pension Plan, 1997-2010
Sources: Michigan Office of Retirement Services, Michigan Senate Fiscal Agency, MSERS comprehensive annual financial reports and Michigan State Employees’ Retiree Health Benefits 2010 Annual Actuarial Valuation Report. All dollar figures were rounded to the nearest million, though precise figures were used in the calculations wherever state government has provided them for a particular data series.
¤The figures for fiscal years 1997 through 1999 are not available. The figures provided for these years are linearly interpolated between the $0 figure for fiscal 1996 and the $531 million figure for fiscal 2000. The figure for fiscal 2010 was not available from the Office of Retirement Services at the time of this writing, so the figure provided was drawn from the Michigan State Employees’ Retiree Health Benefits 2010 Annual Actuarial Valuation Report.
§The figures for the MSERS defined-contribution payments as a percentage of payroll are not available. The figures provided are based on the calendar-year defined-contribution payments and defined-contribution payroll for three combined state retirement systems: MSERS, the Michigan Legislative Retirement System and the Michigan Judges’ Retirement System. The figure for 2010 was not available from the state at the time of this writing, so the value for 2010 was assumed to be the same as it was in 2009.
† Percentage calculated with normal cost for current year and payroll cost for previous year.
Þ This value was taken from the Michigan State Employees’ Retirement System 2010 Annual Actuarial Valuation Report, since 2010 payroll data was not available from the most recent MSERS comprehensive annual financial reports at the time of this writing.
‡ Total may not reflect sum of figures above due to rounding.
To attempt to account for this fact and to help ensure that the normal costs savings of switching employees to a defined-contribution plan was not overstated, the author subtracted 0.5 percent from the state’s defined-benefit normal cost as percentage of payroll before comparing that percentage to the annual payroll percentage cost of the MSERS defined-contribution plan. This reduction is simply meant as a general estimate, based on the author’s experience, of the increase in the normal cost that may have occurred after closing the MSERS defined-benefit plan. This downward adjustment, together with the other data, produced a cumulative estimated savings of about $167 million from fiscal 1997 through fiscal 2010 (see Graphic 1).
[*] This normal cost is distinct from payments made to address “unfunded liabilities” carried over from previous years. These liabilities are discussed in the next section.
[†] Author’s calculations based on figures from the comprehensive annual financial reports for the Michigan State Employees’ Retirement System in fiscal years 1998, 2000, 2002, 2004, 2006, 2008 and 2010. See “State Employees Defined Benefit Plan: Comprehensive Annual Financial Reports (CAFRs),” (Department of Technology, Management & Budget, Office of Retirement Services, 2011), http://goo.gl/AE6zU (accessed May 10, 2011). Normal costs were calculated as a percentage of the previous year’s payroll, as opposed to the current year’s payroll, because this approach has been adopted in the comprehensive annual financial reports for the MSERS defined-benefit plan.
[‡] The exact employer cost depends on how much personal money each employee chooses to contribute to the plan (see earlier discussion in main text). “State of Michigan 401(K) & 457 Plans Key Features,” (Michigan Office of Retirement Services), https://stateofmi.ingplans.com/csinfo/pdfs/ forms/michigan/640002/key_features.pdf (accessed September 23, 2009).
[§] With a defined-benefit plan using the “entry-age normal” cost method (the method used by MSERS defined-benefit plan), it is possible to argue that the normal costs would not materially increase when the plan is closed to new entrants. The author has chosen, however, to assume higher normal costs in part because of his own knowledge of these plans and in part to ensure that his estimate of any possible savings remains conservative.