Michigan Pension Reform Analysis

Commentary

Michigan Pension Reform Analysis

Over the past two decades, the Michigan Public School Employees’ Retirement System (MPSERS) has experienced volatile changes in its funded level. Between 1997 and 2015, unfunded liabilities increased by $26 billion, and the funded ratio decreased from 100% to 61%.

In November 2016, we presented actuarial analysis of MPSERS that examined how this unfunded liability problem has been created, forecasted what is likely ahead for the pension plan without changes, and offered a framework for considering solutions.

See our presentation for the full scope of this historic and forward looking analysis.

Learn more about MPSERS pension reform —

 

Summary Information

1. Underperforming Investment Returns

Our analysis finds that underperforming investment returns have been a key driver of this problem of degrading solvency. MPSERS has long assumed an 8% rate of return, but has average returns much lower than this in recent years. Average over 30-years and 40-years are closer to 8%, but these averages are relatively meaningless for understanding future performance because markets today are structurally different than several decades ago.

2. The Hybrid Plan Did Not Fully Fix the Problem

In 2010, Michigan created a hybrid-style plan for new hires called the Pension Plus Plan, which uses a 7% assumed rate of return. Some have argued that this fixes the problem, but in fact even a 7% assumption is too high. Plus, there are other aggressive actuarial assumptions used by MPSERS that have contributed to the funding problems. The Pension Plus Plan is exposed to the same patterns and practices threatening the Non-Hybrid plan.

At best, the 7% return assumption used by the Pension Plus hybrid plan has a 50/50 chance of being accurate. The hybrid plan is thus exposing taxpayers to underperforming investment returns. Consider that the average 10-year return for MPSERS is 5.8% and the average 15-year return is 6.5%.

Many market forecasts suggest average returns for pension plans like
MPSERS are likely to be around 6% (or less) in the coming decades.

3. Doing Nothing Will Mean Growing Pension Costs for Schools

If Michigan continues to ignore the problems with MPSERS, then pension costs are likely to more than double over the next two decades. Specifically, the actuarially determined contribution for the state and school districts will likely spike from around 30% of teacher payroll to around 60% of teacher payroll. (See figure here.)

The growing costs to fund pension benefits are only going to continue crowding out the school aid fund, education resources, and the ability to increase teacher compensation.

4. Pensions Are Hurting the State’s Bond Rating

Surging pension liabilities for the state budget are an “uncertainty” that is keeping Michigan’s bond rating from improving, according to Moody’s Investor Service.

5. Learning from the History of Michigan State Employee Pension Plan

In 1996, Michigan became the first state to adopt a defined contribution only plan for state employees. There have been a number of benefits to this forward thinking policy change, but also a number of failures. In August 2016, we updated a case study of the pension reform for the Michigan State Employees Retirement System (MSERS) and we discuss how Michigan could have managed the reform process better. The lessons of MSERS are relevant to ensuring MPSERS reform is done correctly.

Anthony Randazzo

Anthony Randazzo is a senior fellow at Reason Foundation, a nonprofit think tank advancing free minds and free markets.