House Pension Reform Savings are Phony

Michigan House Republicans argue that their plan to reform the school retirement system offers superior savings over a Senate-passed bill that would close the system to new employees. But much of the supposed savings come from accounting gimmicks. A better idea is to close the plan to new members, where the state will not be able to play these games.

Much of the reported savings from the House bill come from a scheme to “prefund” optional retiree health care benefits. Unlike regular pensions, where the state attempts to set aside enough each year to cover the future cost as the future benefits are earned by current employees, the retiree health benefit cost comes out of current revenues on a “pay as you go” basis.

This means that the 192,435 Michigan school retirees are in effect still drawing pay (or at least payments) from taxpayers, even though they may not have provided any service for 20 years or more.

The cost of this insurance coverage will not decrease if the state begins prefunding them. Prefunding only allows the state to make accounting assumptions that cause the future costs to appear smaller.

This is done by assuming that state money managers can invest the prefunding dollars and earn an average annual return of 8 percent — gains that can cover part of the future costs. But this assumption is too optimistic. Over the past 15 years the state has actually earned far less on its pension funds.

The larger problem is that the state’s liabilities for retiree health care are ultimately unknown, since it relies on estimating the costs of an uncertain future. No one can predict what their cost will actually be in 10 years. The state assumes that the annual increases will decrease regularly over the next decade, but a change in direction and magnitude can have a huge impact on financial obligations.

A third issue is that unlike money in regular pension funds, nothing prohibits a future Legislature from “raiding” the prefunding account to pay for other government spending. The “savings” assumed by the House depend on this not happening — another prediction not supported by past experience.

In contrast to savings based on optimistic investment return assumptions, unknowable future health care cost estimates and a change in future politicians’ behavior, the Senate-passed version of school pension reform does something very real: it closes the pension system to new school retirees. Closing the plan phases out the state’s ability to underfund retirement benefits.

Michigan Capitol Confidential is the news source produced by the Mackinac Center for Public Policy. Michigan Capitol Confidential reports with a free-market news perspective.