State Dials Back Pollyannaish Pension Assumptions, Admits Deeper Hole

Accepting you have a problem a first step to solving it

Although the unfunded liability of the Michigan school employee pension system increased by another $2.4 billion in 2016, it wasn’t for the usual reasons. Instead, it was because Gov. Rick Snyder's administration became more conservative in estimating future returns on pension fund investments.

In 2016, pension managers stopped assuming that their investments would return an average of 8 percent annually in the future, dropping their predictions to 7.5 percent instead. If a fund’s managers expect lower investment returns than they did before, the fund needs to have more money in contributions up front to meet its obligations. The problem with the school pension system is that the state was already not saving enough.

So the change increased the pension system’s unfunded liability — the gap between how much it does have and how much it should have to cover its obligations — from $26.7 billion to $29.1 billion.

The burden of catching up on pension underfunding is having a serious impact on school budgets.

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For example, Plymouth-Canton Community Schools has seen its required payments to the Michigan Public School Employees Retirement System increase from $22.3 million in 2011-12 to $30.9 million in 2015-16.

James Hohman, assistant director of fiscal policy at the Mackinac Center for Public Policy, did an analysis of the system’s underfunding from the years 2007 to 2015. Hohman found that $12.7 billion of the $20.9 billion increase in unfunded liabilities in that eight-year period came from investment returns failing to do as well as projected.

The state projects it will take another 21 years to amortize, or catch up, on the past underfunding.

“Reducing the assumed rate of return on investments from 8 percent to 7.5 percent reduces risk to the state budget by providing a more conservative assumption to help ensure that Michigan is paying off its long-term liabilities in a responsible way,” said Kurt Weiss, spokesman for the State Budget Office, in an email. He continued:

“The more conservative 7.5 percent assumed rate of investment return will help to ensure that available funds will be sufficient to pay the benefits that have been earned. The state will reduce risk, remain on track to eliminate the liability by the year 2038, and protect the retirement systems that many older Michiganders will be relying on in their senior years. As a result of the reduction in the assumption, the unfunded liabilities for the pension system increased by $2.4 billion, but if not for the assumption change, the unfunded liabilities would have gone down by $1 billion.”

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