Thank You! Happy New Year!

Happy New Year’s Eve!

Today is my final day as your State Representative. Thank you for the opportunity to serve you.

What I heard from the residents in District 55 during the campaign two years ago was:

· I am unemployed.

· Our son/daughter/neighbor/niece is unemployed.

· Our son/daughter had to move out of state to get a job. I was hoping to see my grandkids more.

· My employer has laid off many employees, but I am lucky to still be working.

· The house next door is in foreclosure. The value of the houses in our neighborhood is dropping like a rock.

· I can’t get financing for my small business despite my being in business for many years.

· I don’t know how much longer I can hang in there and stay in business; it’s been so slow….

· I am so tired of the inability to get things done in Lansing. Not being able to balance a budget before the October 1 deadline is ridiculous!

· We’ve got to control spending in Lansing to balance the budget.

· Our roads are terrible!

· No one is listening to us voters!

In short, we needed to create a better business climate to create jobs and address the state’s budgeting problems. We have made progress in the past two years:

· We eliminated the job-killing Michigan Business Tax which taxed small businesses twice, and replaced it with a simple, fair and efficient Corporate Income Tax.

· Numerous regulations were eliminated to create a more favorable regulatory environment.

· The personal property tax on business equipment (which discouraged existing equipment to be replaced by more competitive equipment and made Michigan less competitive for manufacturing businesses) was repealed.

· The Michigan Workplace Fairness and Equality Act makes it illegal to require a worker to be a member of a union as a condition of his/her employment.

· We have made major changes in our state’s budget structure by closing many “tax loopholes” (also known as tax expenditures), both for businesses and individuals. Some of these decisions have not been easy or popular, such as the elimination of the exemption from the Michigan Income Tax for pensions. We cut $1.4 billion of spending in the 2011-12 budget. We have paid down debt and have put some money away in the rainy day fund. We reduced the unfunded liability in the Michigan Public School Employee Retirement System (MPSERS) by over $15 billion.
And we did all this while passing a budget by the end of June in both years, in contrast to the inability to pass any budget in Washington in the past three years and face the “Fiscal Cliff”. The importance of this is that businesses can feel more certain that they will not face significant changes in the taxing and regulatory structure in the future, making planning easier and Michigan a more attractive place to locate and grow their businesses – and that means jobs for Michiganders!

In short, we are sending the message that “Michigan is open for business.” Michigan’s economy has improved since 2010, but we still have many people unemployed. We are still too dependent on the auto industry. The housing market has improved, but the loss of value has changed many people’s plans for the future. As much as we rejoice on the improvements, we cannot be satisfied; we cannot rest on what we have accomplished in putting our workers back to work and our state on a sound financial footing.

Looking into 2013:

We did not get everything done we need to do. Two major issues I have concentrated on are unfinished.

· The reform to the MPSERS program, as important as it was, had a major piece deleted in the last minute negotiations between the House and the Senate before passage of Senate Bill 1040 in August. Senator Kahn, Chairman of the Senate Appropriations Committee, wants my help getting that done next year.

· More funding for maintaining our roads and bridges is needed, or MUCH more will be needed in the future. This is a big need statewide, but in District 55 that I have represented the past two years, MUCH more important in Monroe County. A lot of my work on this issue can be found at a website I have set up at http://ourmiroads.com/

There were several education bills debated in the lame duck session after Thanksgiving that will reappear in 2013:

· the Education Achievement Authority (placing the bottom 5% performing schools under new management),

· the “parent trigger” bill (which would allow the parents of students to petition a failing school to be put under new management) and

· a major rewrite of how school funding is spent as proposed by a special study performed by the Oxford Foundation at the request of Governor Snyder.

My previous work in schools allowed me to contribute some expertise in those discussions, and much work remains to balance the needs of our current school system where most of the students will remain even after further reform, while giving hope for the future for those students stuck in non-performing schools.

My Future:

As I write this, I am not yet certain in what role I will be contributing my services to deal with these remaining issues. I expect to have options. However, one thing I will not forget is all of the input I have received from so many of you in the past three years in the campaign and while serving as your State Representative. It has certainly been a pleasure serving you, and I expect to continue to serve in some other capacity.

While I will not longer be able to be reached by the official State Representative office, my personal contact information will remain the same. Adam Zemke will be representing the portion of the old District 55 that is in Washtenaw County, while Dale Zorn will represent the six townships in Monroe County that I have had the opportunity to represent. For all official matters, I am sure they will be able to handle your concerns.

Thanks again!

Rick Olson, State Representative, 55^th District
525 Judd Road
Saline, MI 48176
734-944-0794

Pavement Preservation Concepts: Pay Me Now, or Pay Me MUCH More Later

Roads deteriorate over time, due to climate (water, freeze and thaw, sunshine, heat, etc.) and traffic. From the moment the road is constructed, it begins to age.

"Most pavements will deteriorate through the phases listed in the [PASER (Pavement Surface Evaluation and Rating)] rating scale. The time it takes to go from excellent condition (10) to complete failure (1) depends largely on the quality of the original construction and the amount of heavy traffic loading. Once significant deterioration begins, it is common to see pavement decline rapidly. This is usually due to a combination of loading and the effects of additional moisture. As a pavement ages and additional cracking develops, more moisture can enter the pavement and accelerate the rate of deterioration." PASER Manual - Asphalt Roads, page 14.

Water is deemed the roads' worst enemy. Most of pavement preservation is designed to prevent the damage that water causes. Once a pavement cracks, whether it be concrete or asphalt, water in the cracks freezes and thaws with enormous force, causing further damage to the pavement. Water in the cracks washes out particles of pavement as traffic hits the cracks and the cracks become potholes. Water infiltrating the surface into the subsurface or "base" begins to undermine the surface causing the surface to sag. Water infiltrating from the sides through improper drainage causes similar damage. So, when we are talking about pavement preservation, and particularly so in the early stages of the pavements' life, we are talking about preventing these water damages.

However, asphalt naturally aging is also something we need to be concerned about. Asphalt is composed of asphaltenes and maltenes. The maltenes are the volatile components that escape into the atmosphere over time, drying out the asphalt which causes the asphalt to shrink and ultimately develop cracks. Thus, some of the more recent pavement preservation methods involve replacing some of the maltenes to “rejuvenate” the asphalt. These relatively low cost treatments are usually applied very early in the asphalt’s life, to prevent the cracks from even starting. (So now you know one of the reasons road agencies are doing work on roads that look in perfect condition, while other roads in worse shape are left alone.) (For an excellent introduction to asphalt aging and the use of rejuvenators, see Bob Boyer’s presentation.)

The PASER pavement condition ratings are generally related to the maintenance or repair that is needed

Rating 9 & 10 No maintenance required
Rating 8 Little or no maintenance
Rating 7 Routine maintenance, crack sealing and minor patching
Rating 5 & 6 Preservative treatments (sealcoating)
Rating 3 & 4 Structural improvement and leveling (overlay or recycling)
Rating 1 & 2 Reconstruction

However, the potential treatments vary widely and must be matched to the age of the pavements, the specific defects in the pavements, the climatic conditions, and the traffic, as well as the budget.

Typical defects in an asphalt pavement include:

• Surface defects: Raveling, flushing, polishing.
• Surface deformation: Rutting, distortion—rippling and shoving, settling, frost heave.
• Cracks: Transverse, reflection, slippage, longitudinal, block, and alligator cracks.
• Patches and potholes
  See PASER Manual - Asphalt Roads, pages 3-13 for excellent descriptions and photos of these distresses for asphalt.

Source:Asphalt Pavement Rejuvenation, presentation by Robert E. Boyer, PhD, PE, Consultant Engineer-Asphalt Pavements, Lynn Haven, Florida, at the August, 2012 National Pavement Preservation Conference.

See descriptions of several asphalt pavement preservation methods demonstrated at the August, 2012 National Pavement Preservation Conference.

Asset Management and Pavement Preservation are “Best Practices” for Michigan’s Roads and Bridges

Getting value for our taxpayers’ money is critical in spending our limited dollars for road and bridge maintenance. Applying the principles of asset management and pavement preservation are ways Michigan road agencies are attempting to get the biggest bang for our bucks.

“The term ‘asset management’ means a strategic and systematic process of operating, maintaining, and improving physical assets, with a focus on both engineering and economic analysis based upon quality information, to identify a structured sequence of maintenance, preservation, repair, rehabilitation, and replacement actions that will achieve and sustain a desired state of good repair over the lifecycle of the assets at minimum practicable cost.’’ H. R. 4348 (2012) MAP-21 Sec. 1103(2) (The new law passed this summer authorizing the Federal highway program for fiscal years 2013 and 2014 named “Moving Ahead for Progress in the 21st Century Act”, but more commonly called MAP-21.)

“Pavement preservation” methods are the techniques used to implement "asset management", i.e., a structured sequence of cost-effective capital preventive maintenance, preservation, repair, rehabilitation, and replacement actions that will achieve and sustain a desired state of good repair over the lifecycle of the assets at minimum practicable cost.

“The goal of infrastructure preservation is to cost-effectively and efficiently improve asset performance, as measured by attributes such as ride quality, safety, and service life.

Infrastructure preservation programs represent a departure from traditional approaches to maintenance, in which deficiencies are addressed as they occur. Preservation seeks to reduce the rate of deterioration.

The preventive approach is generally less costly and time-consuming than the traditional, more reactive approach. However, a strategy of prevention may be more difficult to justify because the public’s expectation is that the worst roads demand immediate attention. Furthermore, the public often interprets activities related to pavement preservation as “fixing something that isn’t broken.” . . . .

[T]ools such as life-cycle cost analysis . . . have the potential to demonstrate that implementation of a preservation strategy may cost less over the life of an asset than more “traditional” approaches that wait until the deficiencies are evident.” http://www.pavementpreservation.org/library/getfile.php?journal_id=628

In selecting an optimal pattern of preservation practices, one considers the normal life cycle of a specific stretch of pavement and performs the appropriate “fix” at the appropriate time to lengthen the useful life of the pavement at the lowest life cycle cost. Doing the preventive maintenance early in the pavement’s life extends the life of the pavement at a much lower cost per lane mile life than postponing any treatments until the pavement needs more drastic and more expensive treatments.

Most people understand this concept, which is why we change the oil in our cars rather than wait for the engine to fail. “Pay me now, or pay me MUCH more later,” as the oil change ad says.

So how do you incorporate a sound Capital Preventive Maintenance (“CPM”) element into an overall asset management program? In asset management we are MANAGING GROUPS OF PAVEMENTS not simply individual road segments. This is a critical distinction.

When considering an entire network of roads, whether it be a statewide network such as the state trunkline system MDOT is responsible for administering, or the roads that a county road commission is responsible for, an additional analysis is required.

This additional level of analysis is more complicated than will be discussed here (but discussed in exceptional clarity in Larry Galehouse’s presentation). Suffice it to say here that responding to political pressure and fixing the worst roads (“worst first”) will not purchase the optimal increases in lane mile lives. That is, not only do we need to select the right fix at the right time, but also on the right roads to fully implement pavement preservation into the asset management program. To preserve or increase the value of the transportation system asset the road agency is responsible for, the right combination of roads need to be worked on utilizing the limited resources utilizing the appropriate fix for the condition of the road.

With today's limited resources, pavement preservation must take top priority in the spending of our transportation dollars. Taxpayers are demanding value for money spent on all government services, including roads and bridges.

P.S. (Some of these cost effective pavement preservation methods implemented in Michigan were highlighted at the August 16 “Best Practices Conference on Road and Bridge Maintenance” held in Lansing. The presentations from the conference can be viewed at http://ourmiroads.com/ .

Lost Opportunity: MPSERS Reform and SB 1040

By Rep. Rick Olson, 55th District
August 16, 2012

Senate Bill 1040 as passed by both the House of Representatives and Senate today takes a major step forward in many respects, but also represents a lost opportunity.

The now $50 Billion unfunded liability and 27% and rising employer contribution were crying for a solution. The approximately $5 billion of savings achieved from benefit reductions and increased employee contributions and another about $10 billion of reduction in the calculated unfunded liability due to beginning prefunding the health care obligations are major steps forward.

Nonetheless, I regard this as a lost opportunity because:

1. A major cause of the skyrocketing employer contribution rate is what are called "stranded costs", about which I have written in detail in my blog at http://repolson.blogspot.com/2012/07/stranded-costs-in-mpsers.html, has not been addressed. The version of SB 1040 previously passed by the House as "H-3" contained the solution known as the "COE" approach. This provision was stripped in the ultimate compromise and pushed into merely study language. The ultimate resolution is put off until the lame duck session after the study report is received on or before November 15. If agreement is not reached at that time, the MPSERS system will fail and a future legislature will again be faced with the thorny issue of what to do about MPSERS.

2. Major cost savings were left on the table:

a. The provision that retirees pay a larger portion of the health care costs from 10% to 20% was watered down by exempting anyone over age 65 from that new requirement, significantly reducing the potential savings.

b. The cliff vesting provision of qualifying for retiree health care benefits after 10 years of service was not changed to a "graded premium" approach which was changed in 2007 for anyone hired after that. The cliff vesting approach was never actuarially sound and is no more sound today than ever before.

c. Retirees may still retire early and fully qualify for health care benefits, instead of having to wait until age 60 as the original SB 1040 provided.
Collectively, the lack of these changes deprives the system of billions of dollars of savings drastically needed in the system.

3. Conversely, the requiring of the retirees to pay a larger portion of their health care premiums may be harsher on low income retirees than necessary. I have previously proposed a sliding scale approach from 10% to 20% based on certain percentages above the household income poverty level. This has never been seriously discussed. This surely would reduce the savings needed by the system but may be the more humane approach, especially for the numerous retired support service people who worked for very low wages and who will have a very small pension, but with the expectation for the retiree health care benefits.

Despite the shortcomings I perceive listed above, I voted with the majority to take a major step forward, with the hopes that the legislature can adequately address the stranded cost problem in lame duck. At the same time, we will review the results of the study on the closing of the defined benefit program and substituting a defined contribution program for new hires. I trust that the study will be done on an objective basis without bias for or against the conversion. Bottom line, we have much more work to do before we can say we have reformed the system in a lasting manner, and I pledge my efforts to getting that result achieved.

Stranded Costs in MPSERS

Definition and Causes of Stranded Costs

“Stranded costs” are caused when an employee leaves the system as an employee with vested retirement or health care benefits, with unfunded liability associated with them, but with no requirement for either the employee or any employer to fund that unfunded liability. Examples:

• Normal retirements of employees where benefits are not fully funded.
• Early retirements induced by early retirement incentives with benefits not fully funded.
• “Retire-rehire” schemes to shift responsibility of unfunded liabilities to remaining system
• Privatization of support services (custodial, transportation, food service) – if the released employees have vested benefits but neither employee or employer no longer contributes to the funds
• Privatization of substitute teachers – if these subs have vested benefits
• Charter schools, if the schools caused a departure of employees from the MPSERS with vested benefits with no contributions being made for them in the future.

Note: Of course, if there were no unfunded liabilities (caused by unrealized investment rate of return, mortality and other assumptions used in calculating the “normal costs”, there would be no “stranded costs”.

Misconception

The fact that there are fewer people as active current employees does NOT cause the unfunded liability, although the “missing” employees will not be there to share the burden of prior incurred unfunded liabilities. I.e., the problem is that there were benefits “promised” that have not been funded and now there aren’t new people to shift the cost to, similar to a Ponzi scheme that ultimately fails, but that in itself does not cause “stranded costs”.

Conclusion re Charter Schools

Future potential rapid expansion of charters or charter school enrollment has the potential of creating stranded costs IF they cause displacement of employees from MPSERS participating districts with vested benefits.

Why Current Operating Expenditures ("COE")?

Many districts over the years have converted significant payroll costs to contracted services. Many of the former employees had unfunded pension and health care costs associated with them which was shifted to the remainder of the MPSERS system. A mechanism is needed to restore onto the districts responsible for those "stranded" unfunded liabilities the responsibility to pay for them. Applying a percentage charge to Current Operating Expenditures ("COE") statewide that will collect the current year charge for those unfunded liabilities spreads the responsibility more broadly, including onto contracted services which is included in COE.

Why Current Operating Expenditures ("COE") Instead of a Simpler Allocation Per Pupil?

There is an "equity gap" currently, with some districts receiving a larger foundation grant per student than others. We should not increase this equity gap.

Payroll per pupil is higher in high foundation grant districts than in lower foundation grant districts. If the unfunded liability were recovered charging the districts their proportionate share on a per pupil basis, the high foundation districts' share would be lower than their proportionate share of the state total payroll costs. Therefore, a per pupil allocation of the unfunded liability would disproportionately favor the high foundation districts, contrary to our attempt to ultimately close the "equity gap" between the high and low foundation grant districts.

Stated another way, 12.49% (the current calculated UAL percentage) of a districts payroll per student is a different amount from district to district. The higher the payroll per student in a district, the more MPSERS burden is taken off that district with a flat across the board per student categorical. The districts with high payroll per student would be the winners and the low payroll per student would be the losers in a flat across the board per student categorical.

The flat across the board per student categorical would increase the equity gap, and therefore is not a preferred solution.

The H-3 Approach to Stranded Costs

The H-3 House approved version of SB 1040 contains a solution to the stranded cost problem via the COE or "current operating expenditures" mechanism. Beginning in 2013-14 fiscal year for traditional public schools, their total MPSERS assessment will be split into two parts:

• 11.9% will be applied to Current Operating Expenditures and
• 3.5% will be applied to payroll to cover the normal costs for the revised retirement and healthcare benefits.

Together, this is equivalent to 24.46% of systemwide payroll.

Non-K-12 entities (i.e., libraries, community colleges, ISD's and MPSERS participating charters) would pay 24.46% on payroll, because of their vastly different cost structures. Universities would continue paying their remaining liability under the current plan.

Key Point: The foundation grant received by the districts would not change. However, the MPSERS payments made by the district would be in two pieces,

(1) the lump sum UAL amount based on Current Operating Expenditures and

(2) the remaining MPSERS contribution percentage of wages.

For example, assuming we wish to collect 24.46% total MPSERS contribution rate across all payroll, first we would subtract the amounts due from the libraries, community colleges, ISD’s, MPSERS participating charters and the universities. Next we subtract 3.5% (the percentage set in the bill) of payroll from the remaining K-12 districts. The remainder is then divided by the total COE of the remaining K-12 districts, which based on historical data, equals 11.9%. A computation similar to this would be done each year to set the COE rate.

Because the UAL would be paid by the districts as a percentage of their combined COE (a much larger number than total payroll), the remaining MPSERS contribution rate based on wages can go down accordingly. Thus, the payment made for their share of the UAL based on COE would be offset by a lower MPSERS contribution rate on their wages. However, because districts which have privatized significantly will now be paying the UAL based on their Current Operating Expenditures rather than their wages, the stranded costs of their privatizing will now be covered.

Other Options Explored

Several other options were investigated, but allocating the UAL according to the Current Operating Expenditures (COE) appears to match the district's responsibility for the unfunded liability the best. It is not perfect, but it works as it is a readily accessible figure to obtain by the state due to its being reported by the school districts and published in the DOE annual bulletins 1011 and 1014. See Appendix A for definitions and what is included and what not included.

Cost Control Encouraged

Also, to the extent that we wish to encourage cost control, using current operating expenditures as the factor which affects the UAL allocation creates the most incentive. The higher the Current Operating Expenditures per Pupil, the higher the District UAL per Pupil, which reduces their remaining unallocated funds.

Conclusion

If the stranded cost problem is not addressed now, it is equivalent to sitting in a boat swamped with water, bailing furiously to get the water out of the boat, but failing to plug the hole in the bottom of the boat. Privatization of support services is expected to increase in the future, because of the lower cost usually of the contracted for services (due to a combination of lower retirement benefit costs, health care costs and wages). Any MPSERS reform that does not account for and deal with these stranded costs which are expected to increase in the future will be a reform that does not last.

Appendix A: Definition of “Current Operating Expenditures” from H-3, page 18.

“(17) AS USED IN THIS SECTION, "CURRENT OPERATING
3 EXPENDITURES" FOR A PUBLIC LOCAL SCHOOL DISTRICT INCLUDES
4 FUNCTIONS 1XX, 2XX, 45X, AND ALL OBJECT CODES EXCEPT 6XXX, AS
5 DEFINED IN THE MICHIGAN PUBLIC SCHOOL ACCOUNTING MANUAL BULLETIN
6 1022, AND IS EQUAL TO THE TOTAL OF INSTRUCTIONAL AND SUPPORT
7 SERVICES EXPENDITURES, INCLUDING THE TOTAL GENERAL FUND CHARGES
8 INCURRED IN THE GENERAL, SPECIAL EDUCATION, AND VOCATIONAL
9 EDUCATION FUNDS FOR THE BENEFIT OF THE CURRENT FISCAL YEAR,
10 WHETHER PAID OR UNPAID, AND ALL EXPENDITURES OF THE INSTRUCTIONAL
11 PROGRAMS PLUS APPLICABLE SUPPORTING SERVICE COSTS REDUCED BY
12 CAPITAL OUTLAY, DEBT SERVICE, COMMUNITY SERVICES, AND OUTGOING
13 TRANSFERS AND OTHER TRANSACTIONS. CURRENT OPERATING EXPENDITURES
14 FOR A PUBLIC LOCAL SCHOOL DISTRICT ALSO INCLUDE OPERATING FUNDS
15 FOR ANY PUBLIC SCHOOL OR OTHER PUBLIC EDUCATIONAL ENTITY FIRST
16 AUTHORIZED OR ESTABLISHED BY THE PUBLIC LOCAL SCHOOL DISTRICT ON
17 OR AFTER THE EFFECTIVE DATE OF THE AMENDATORY ACT THAT ADDED THIS
18 SUBSECTION.”

“Expenditures

(Note: To avoid counting the same expenditure multiple times, Statewide and Groupings reports DO NOT INCLUDE expenditures paid to another public school (Function 411 and/or object codes 82xx.) )

Instruction - The cost of activities dealing directly with the teaching of students in the classroom or in a classroom situation. These expenditures do not include capital outlay. Per pupil expenditures for Basic and Added Needs Instruction are calculated using only K-12 and Special Education pupil fte as the divisor. Adult Education Instructional Costs per pupil are calculated using only Adult Education Participants as the divisor.

Basic Programs (Function 11x)- The classroom costs related to basic instructional classroom programs. This includes pre-k, elementary, middle, and high school programs.

Added Needs Programs (Function 12x) - The classroom costs of added needs instructional programs offered by the district. These include special education, compensatory education, or career/technical education.

Adult Education Programs - (Function 13x) - The classroom costs of adult/continuing education programs offered by the district.

Supporting Services - The cost of activities which provide administrative, technical, and logistical support to facilitate and enhance instruction. These expenditures do not include capital outlay. Per pupilexpenditures are calculated using the total pupil fte (k-12, special education, and adult education participants.)

Support Services - Pupil (Function 21x) - Those activities which are designed to assess and improve the well-being of pupils and to supplement the teaching process. These include attendance, guidance, health, and social work services.

Support Services - Instructional Staff (Function 22x) - Those activities associated with assisting the instructional staff with the content and process of providing learning experiences for pupils. It includes teacher in-service, curriculum development, educational media services, computer labs, educational television, and program directors.

Support Services - School Administration (Function 24x) - Those activities concerned with the administrative responsibility of a single school (commonly referred to as the principal's office.)

Support Services - General Administration (Function 23x) - Those activities concerned with establishing policy, operating schools and the school system, and providing essential facilities and services to staff and pupils. It includes the activities of the Board of Education and the superintendent of schools.

Support Services - Business Administration (Function 25x)- Those activities concerned with budgeting, accounting, payroll, purchasing, and internal services.

Support Services - Facilities Acquisition (Function 45x) -Those activities concerned with capital leases/purchases of land or buildings.

Support Services - Operations and Maintenance (Function 26x) -Those activities concerned with keeping the physical plant open, comfortable, and safe for use.

Support Services - Pupil Transportation (Function 27x) - Those activities concerned with the conveyance of pupils to and from school and to and from school activities.

Support Services - Other (Function 28x) - Activities other than those mentioned above which support each of the instructional and supporting service programs. It includes research, personnel, and data processing.”

http://www.michigan.gov/documents/mde/b1011-11_381977_7.pdf

SB 1040 H-3 House Floor Speech

Rick Olson, 6/13/2012

I rise to support this proposal to reform the MPSERS program. The changes proposed will put the program on a sound footing and ensure that the benefits offered by the program will in fact be able to be paid when they come due.

The first step in solving any problem is clearly defining it. Here the problems are:

1. An Unfunded Liability totaling $45.2 Billion according to the last Comprehensive Annual Financial Report, and the CAFR expected soon will probably show that to be over $50 billion.

2. The contribution rates that employers pay into the system are projected to grow from 25.7% this year to 35% in just 5 years. This is compared with 12.17% in 2000 that we thought was outrageous when I became the business manager at Adrian Public Schools.

3. This is a tremendous burden on our schools which takes away money that could otherwise be used for educating the kids. This year, the total contributions into the system is about $1,635 per student, and if we do nothing, $2,552 in 2016-17.

Three Potential Solutions

• Increase employee contributions
• Decrease benefits
• Find additional money
• This proposed solution uses all three

This H-3 Proposal:

• Increases employee contribution to 4% for Basic members and 7% for Member Investment Plan (MIP) members. This is not much of an increase from 6.4% for some employees who have been employed since July 1, 2008, while the increase will be a bit higher for longer term employees. Nonetheless, we cannot continue retirement plans that promised more than the state can afford to fund. At the same time, we should acknowledge the efforts of prior legislatures that have tightened the programs through the years. For example,
• Hybrid retirement plan adopted in 2010 will be continued for new employees
• Same health care options for new employees as state employees
• Retirees would pay 20% of their health care, other than those who are age 65 and retired by 1/1/2013
• Total prefunding of health care – instead of the fiscally irresponsible “pay as you go” method of not paying for the benefits as they are earned
• Partially fund the health care plan by continuing employee 3% contribution for health care, placed into individual accounts
• Total prefunding of health care by $603 million additional funding, spread over 2013-2018
• $470 million in health care escrow account
• $133 million in 2011-12 MPSERS set aside

Goals of Reform

• Decrease the unfunded liability
• Lower future projected contribution rates
• Be reasonable with current retirees, current employees and offer reasonable fringe benefits to prospective employees

This proposed solution achieves all three

Fiscal Impact of H-1

• Unfunded liability reduced by $15.6 billion. This is a "game changer" and will send a strong message that Michigan is serious about addressing its fiscal challenges. In all fairness, note that this is comprised of about $5 billion of real savings and about another $10 billion of reductions to the unfunded liability due to changed actuarial assumptions allowed by the GASB rules because we are beginning to fully fund the health care portion of the program.
  
• Cap the employer contribution rate at 24.46%, assuming state payments continue to fully fund the health care program in future years. In the spirit of full disclosure, it must be noted that the cap on MPSERS contributions will have an Impact on future Per Pupil Foundation Grant amounts, dampening the potential future foundation grant increases.

We need to strike a balance between the effects on employees vs. making a difference long-term in reforming the system. I am well aware of the many good people I have worked with in our schools through the years. Again in the spirit of full disclosure, my wife is a vested member of the MPSERS system and I am a non-vested member.

Let's look at the Reasonableness to Employees Under the H-3 proposal:

• The current employee contribution rates of 4% and 7% are on the high side when compared with other states, although comparing apples to apples is difficult
  
• When we compare the ratio of the burden placed on the employee versus the burden placed on the employer, the proposal's implied employee responsibility of 20% for Basic members and 33% for MIP members is less than the 43% borne by state employees’, and yet the school employees do not bear the market risks of the defined contribution plan that state employees do.
  
• The employees (past, current and future) bear about $9 billion of the total $45.2 billion unfunded liability prior to changes, or 20% of the total burden, with the employer picking up the remainder. From these last two comparisons, you can see that any claim that we are "balancing this problem solely on the backs of the employees" is totally wrong.
  
• Retirees will pay more, but the "granny" provision retaining the 10% cost share for those who are age 65 and retired on January 1, 2013 will protect the aged.

Conclusion: No one wants to pay more or receive less. Nonetheless, the $45-50 billion unfunded liability problem must be solved. On balance, this is a reasonable sharing of the burden.

Stranded Costs: “Stranded costs” are caused when an employee leaves the system as an employee with vested retirement or health care benefits, with unfunded liability associated with them, but with no requirement for either the employee or employer to fund that unfunded liability.

If the stranded cost problem is not addressed now, it is equivalent to sitting in a boat swamped with water, bailing furiously to get the water out of the boat, but failing to plug the hole in the bottom of the boat.

I am pleased that the proposal contains a solution to the stranded cost problem via the COE or "current operating expenditures" mechanism. Beginning in 2013-14 fiscal year for traditional public schools, their total MPSERS assessment will be split into two parts:

• 11.9% will be applied to Current Operating Expenditures and
• 3.5% will be applied to payroll to cover the normal costs for the revised retirement and healthcare benefits. Together, this is equivalent to 24.46% of systemwide payroll.

Other entities would pay 24.46% on payroll, because of their vastly different cost structures.

It is unfortunate that this reform proposal is complex, but this is just one of many complex issues we have been given the opportunity to address. Please join me in supporting this historic reform measure.

My Reaction to the Senators Jansen and Pavlov MPSERS Proposal:

Rick Olson
July 18, 2012

[On Wednesday, July 18, Senators Jansen and Pavlov presented an alternative to the House “H-3” version of SB 1040. H-3 was ultimately voted down in the Senate 16-22, so SB 1040 will next be discussed in a conference committee with the hopes of a resolution of the issue at the one-day August 15th session.]

1. Stranded Costs Left Unaddressed. I will have a hard time supporting any proposal that does not make some effort to deal with stranded costs. To do otherwise is to kick the can down the road again, leaving it for a future legislature to again “fix the problem past legislators failed to do”. This “compromise” proposal fails in that regard.

2. Cost of Conversion to Defined Contribution ("DC") Plan. The major reasons our House Work Group recommended against closing the current hybrid plan for new employees in favor of substituting the a defined contribution plan equivalent to that available to state employees were (1) our belief that the DC plan normal cost was less than the cost of the proposed DC plan (with our desire to control costs, not raise them, the DC plan did not seem to make sense) and (2) with the inability to prefund the health care benefits AND fund the faster amortization indicated by the GASB guidelines, we were uncertain how negative the bond rating agencies would be if the state were unable to fund the calculated Annual Required Contribution. However, the DC plan has a number of very attractive features, and we did not wish to reject the idea without further study. So, we asked that a study be completed to assess the risk that the assumptions used to calculate the normal cost would not be realized, raising the risk of future unfunded liabilities for the hybrid plan that in total would cause the DC plan to actually be less costly, rather than more costly as our initial information indicated. The study was also to explore the variance from GASB issue.

Note that the total cost of a defined benefit plan is the "normal cost" (what the actuaries estimate the future cost to be based on a set of assumptions) plus or minus the costs or savings achieved by the fund actually experiencing less or more favorable results. If investment returns are less favorable than the assumed 7% of the hybrid plan, then additional costs in the form of "unfunded liabilities" would occur. The study is intended to evaluate how likely the assumptions would not be realized and what the impacts would be if various departures from the assumptions were to occur.

Investment Rate of Return Assumptions. Since our H-3 House version of SB 1040 passed the House in June, we have recently received more information. In summary, the DC plan is highly likely to cost more than the current hybrid plan, even according to the latest Arnold Foundation memo publicized by the Mackinac Center. The long term investment rate of return would need to average below 6% for the hybrid plan to be of equal cost to the state employees’ DC plan. Kathryn Summers’ estimates put the breakeven investment rate of return at about 5.5% (or even lower if the .55% cost of the disability and life insurance elements of the plan are included to get the total of 6.75% cost of the DC plan).

The difference between the Arnold Foundation results and the ORS paper dated 6/25/2012 (from which one would conclude that the normal cost is not sensitive to a change in the investment rate assumption) is a difference in assumption regarding the size of the fund investment portfolio. ORS looked at it from its current stage with a very small asset balance, while the Arnold Foundation study looked at it when the hybrid plan would be mature and fully funded. With a larger portfolio, the investment rate of return gets proportionately more important to the final, actual cost of the system. However, even by the Arnold Foundation numbers, it is 78% probable that the 6% rate of return will be achieved, and 84% likely that the 5.5% “breakeven” rate of return be achieved. Now, I admit, that leaves a 16% chance the hybrid plan might be more expensive, but that appears to be a small risk compared with the chance to avoid the higher cost of the DC plan.

The historic MPSERS Investment returns have averaged 9.78% over the 30 years through 2010, 8.93% over 25 years, and 8.15% over 20 years. Of course, past results are no guarantee of future performance, so what we will achieve in the future is cloudy in my crystal ball. Fitch believes the 8% used in the other MPSERS fund is optimistic and is evaluating risk based on 8%, 7% and 6%. The current hybrid plan uses a statutorily established 7%. The Arnold Foundation used information from the MPSERS CAFR to calculate the probabilities of various rates of return, but the reasonableness of any assumption depends on how optimistic one is concerning the future of our country and the world's economy.

Those two "studies" are not the end of the investigation needed, however. The Arnold Foundation is hardly an unbiased organization of the type we, as policy makers, should be engaging to get objective, third-party, unbiased information on which to make these serious policy decisions. Which view of the sensitivity of the investment rate is the better view: ORS's or Arnold Foundation's? Further, the investment rate of return is just one of the many assumptions used by actuaries to calculate the normal costs. We do not know what the assumption of 3.5% payroll increase does to the calculated normal cost and now much the actual total costs may vary if payroll actually grows at a slower or faster rate. Similarly, the retiree mortality rate has varied significantly from the actuaries' assumption in the past. Has a modified assumption been substituted? If not, how sensitive is the calculated normal cost to a different assumption? We don't know, but will know if the study called for in H-3 is completed.

When we get the results of the study, we might very well conclude that the attractive features of the DC plan (most importantly being the certainty funding a DC plan achieves) outweigh the risks that the hybrid plan might ultimately be more costly. I am just reluctant to make that decision on incomplete and biased information.

GASB Variance. It has become clear that the GASB guidelines are intended for reporting purposes, and are not funding mandates, despite the unfortunately named "annual required contribution". However, even if not actually required, the question remains what the bond rating agencies response would be if the ARC were not fully funded. My research indicates that Fitch does not see a variance from ARC as an automatic negative, if the variance is small. Their ratings are dependent upon a wide range of factors, however, so I would not expect that a negative reaction would occur if the reforms enacted, in total, reduced costs and more fully funded the liabilities than before, as our H-3 does. So, I believe that moving to a DC plan, with the result of closing the DB plan and needing to amortize the unfunded liabilities on a faster basis than our cashflow would allow, would not result in a negative bond rating agency reaction. However, getting some direct responses from bond agencies would make the answer to that question more certain, which the proposed study contemplates.