CHICAGO — In a blow to state pension overhaul efforts, a Michigan appellate panel upheld a lower court decision striking down as unconstitutional provisions in a 2011 law requiring a minimum pension contribution from state employees who want to remain in the state's defined benefit plan.

Under those provisions, if employees opt not to make a 4% minimum contribution they are shifted over to what's known as the tier 2 plan which is structured like a 401(k). The panel also affirmed the Ingham County Circuit Court judge's 2012 ruling that a change in the number of years used to calculate the amount of overtime that could be considered in final average compensation violated the state constitution.

The Michigan Court of Appeals panel, however, reversed the lower court's decision overturning the entire law that made changes to the State Retirement Employment Act and sent the case back to the lower court for further review to determine the validity of other provisions. The latest court decision comes in a complaint filed by unions in 2012 challenging the 2011 law.

The central argument before the panel about the 4% contribution requirement was whether it altered the rate of compensation or a condition of employment and whether "compensation" fell into the category of a fringe benefit and included pensions.  Rates of compensation and changes in the condition of employment fall under the purview of a State Civil Service Commission and not the Legislature, unless two-thirds of the Legislature votes to reject or reduce an increase.

The panel agreed with the lower court which had sided with the unions' position.

"We conclude that the ratifiers [of the state constitution] in 1963 would have considered 'rates of compensation' to include fringe benefits provided to civil service employees, and that would include the pension plan offered as part of the compensation package," the panel wrote.

"Changing the nature of the plan changes the nature of the benefit, and thus it amounts to a change in the rate of compensation or in the conditions of employment. This is within the authority of the Commission, not the Legislature" and so is unconstitutional, the panel's decision read. It reached a similar conclusion on the subject of the overtime calculation.

Gov. Rick Snyder's administration said in a statement it was reviewing the decision. It has 42 days to decide whether to appeal to the Michigan Supreme Court.

"No decision has been made as of yet, but the state must remain focused on resolving the long-term liabilities that these retirement reforms have helped solve," the statement read.

The state said the 4% rule is projected to generate a gross amount of $56 million if all defined benefit participants elect to make the contribution. It has collected $59 million since April 2012. All but 600 stuck with the defined plan that has 17,800 active members, or 32% of the workforce, and 56,200 retirees. The other 68% of the workforce participate in a 401(k)-style defined contribution plan. Workers hired after 1997 are not eligible for the defined benefit plan. Before the 2011 law, participants in the defined benefit plan were not required to contribute any amount of their pay.

The state employee fund carries unfunded liabilities of $5.4 billion for a funded ratio of 65.5%. In upgrading the state to AA earlier this year, Fitch Ratings called the state's debt and retiree obligations manageable. Its outlook is stable.

The 2011 law did not apply to a separate state teachers' pension system which carries $22.4 billion of unfunded liabilities for a 65% funded ratio. The legislature passed a separate set of reforms impacting that system last year.

Standard & Poor's rates Michigan AA-minus with a positive outlook. Moody's Investors Service assigns an Aa2 with a positive outlook. The latter two revised their outlooks to positive from stable earlier this year.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.