Updating the Progress of Michigan’s State Employee Pension Reform

Over the past 20 years nearly every public sector pension plan in the country has undergone some degree of change. Some pension plan changes have been larger than others, including the Michigan State Employees’ Retirement System, which was closed to new members in 1996. MSERS is the longest operational closed public sector defined benefit plan, among the top state retirement systems in the country. As such MSERS represents an interesting case study to continue observing over time, particularly for how the state of Michigan manages the closure of such a large defined benefit plan.

MSERS recently released data through fiscal year end 2015, allowing us to update our Michigan pension reform case study and review the lessons being learned about the pension reform effort in the Wolverine State.

In our 2016 update, we find that closing the defined benefit plan in 1996 continues to have been a prescient move, particularly with underperforming rate of return the plan has experienced.

• Combining the assets and liabilities of the DB plan and DC plan for state employees, the funded ratio for the retirement system as a whole is 88% funded. We estimate that without reform the plan would be around 68% funded, with $2.5 billion more in accrued liabilities and over $560 million more in unfunded liabilities.
• Underperforming investments continue to be a problem for MSERS, as the average return for the plan since 1997 is 6.85%, compared to the long-term assumed rate of return of 8%. Because the MSERS board has not made substantive changes to the DB plan’s assumptions, the liabilities in the closed plan have continued to be exposed to the underperforming returns, which have translated into unfunded liabilities. Investment returns for plans with March and June fiscal year end dates in 2016 have almost universally reported poor returns, suggesting the 2016 data for MSERS is likely to provide continued disappointment and mean additional pension debt.
• The Michigan legislature has now gone two straight years with strong employer contributions, which stands out against the history of under contributions for MSERS. This is a positive trend for the plan, and should it continue it would mean the reversal of a funding policy that has contributed to the degraded solvency of the defined benefit plan since its closure.

Read the whole study here.

The lessons provided by the MSERS defined benefit plan closure continue to remain the same as in previous years. Michigan has avoided significant unfunded liabilities by closing the MSERS defined benefit plan to new hires. However, the state managed the process very poorly and that has resulted in pension debt growing into the multiple billions over the past two decades.

Had MSERS lowered its assumed rate of return of 8% over the past two decades as markets changed and an 8% target required more investment risk, and had the state employers paid 100% of their annual contributions every year, the state would not be sitting on over $5 billion in pension debt.

Contributions from new employees were not necessary to fund the system, responsible management was required. MSERS has made a few strides in the right direction the past two years, but its investment strategy and assumptions continue to expose the liabilities of the closed plan to the risk of losses and further decline in the funding ratio.