Testimony: Michigan Can Improve Pension Systems’ Assumptions, Funding Methods

Testimony before the Michigan House Appropriations Committee, February 24th, 2021. 

The bill package before you today continues this body’s effort to make Michigan’s pension systems financially stable for the long term, while keeping the promises the state has made to its employees and retirees. Rather than discuss each specific bill, in the interest of your time, I’d like to summarize the major pension changes that this package would bring to four of Michigan’s pension systems and why these changes align with best practices in pension funding.

The first change this bill package introduces is to require each retirement system to use up-to-date mortality tables.

Setting proper mortality assumptions plays an important role in pension funding. The most recent study from the Society of Actuaries shows that public employees, on average, have lower mortality rates and longer life expectancies than private-sector pension plan members. These longer lifespans, if not expected through accurate assumptions, mean more pension payments to retirees that were not previously accounted for by public pension systems like Michigan’s, leading to unexpected debt. In turn, the pension plan becomes more expensive, which necessitates higher contributions into the plan for it to stay properly funded.

Adopting the most recent mortality tables would keep the plan’s normal cost – a technical term meaning the costs of prefunding employees’ current-year retirement benefits – up to date, making the actuarially determined contribution rate more accurate, and thus not putting the burden on employers and taxpayers down the road to cover the costs of unfunded retirement benefits for today’s current employees.

The second change this bill package introduces is to require each system to use layered, level-dollar amortization to pay off any new debt within a new, fixed 10-year period.

A key reason that many public plans across the country—including those in Michigan—have yet to recover from the economic downturn from over a decade ago is due to using the exact opposite of this proposed approach. Those plans use antiquated amortization policies that allow unfunded pension liabilities to be paid down over terms of 20-30 years, sometimes more, which is too lengthy and exposes taxpayers to the risk of worsening pension debt that compounds on very high interest rates. Meanwhile, the public pension actuarial profession—including the Society of Actuaries—have begun to recommend amortization periods of 20 years or less.

With this reform package, Michigan would be adopting best practice amortization policies that would save the state money in the long-term by paying off any new unfunded pension liabilities within 10 years of the date they accrue and ensuring that the debt will, in fact, be paid in full quickly, saving taxpayers in avoided long-term interest and paying off new pension debt quickly after it arises. The level-dollar policy would also prevent future budget difficulties and underpayments towards the debt that could arise from payroll experience that doesn’t match expectations.

Had this policy been in place 30 years ago, unfunded pension liabilities, and in turn annual state and local pension contributions, would be far lower than today.

The third change this bill package introduces is to require the payment, within one year, of any difference between the actuarially determined contribution and actual retirement contribution. The current policy allows this difference to be paid off within five years.

A 2015 National Association of State Retirement Administrators (NASRA) publication pointed out that the states with the largest pension underfunding crises had consistently failed to pay the actuarially required contributions into their plans. On the flip side, the states that had consistently paid 95 percent or more of their required contributions were less likely to face insolvency in their pension plans. Tightening up the period that full contributions need to be made ensures that when projected required contributions fall short of what is needed, that money gets into the plan assets quicker allowing it to add to crucial investment growth right away.

The final change in this bill package caps the Assumed Rate of Return on investments and Discount Rate at the current levels for each respective system.

The investment return assumption is the most important of all actuarial assumptions in terms of its effect on pension finances. This is because earnings on investments typically account for over 60% of a system’s revenues. Earnings that consistently fall below the plan’s assumed rate of return will result in underfunding and will require larger contributions to make up the gap. Capping these systems at their current rates, which currently sit between 6.25% and 6.8%, is a more realistic outlook for what the next 10-15 years of investment returns are projected to be. For reference, the national average assumption is still sitting at just above 7.2% but has been trending downwards rapidly over the past 5 years.

In conclusion, the bills before you continue to build resiliency and sustainability into Michigan’s pension systems. The ongoing work to improve the resiliency and sustainability of MPSERS in recent years is a model that other states should follow to keep their pension plans solvent, and this package today furthers that work in a material way.

Thank you for your time, Mr. Chairman and members. I would be happy to take any questions from the Committee.