Commentary: Pension Liabilities Larger Than Reported

Report shows that taxpayers could be on the hook for even larger pension costs than previously thought

As Michigan legislators consider whether to close the defined-benefit school pension system to newly hired employees, instead giving them generous 401(k) contributions, a report from State Budget Solutions shows that the unfunded liabilities of defined-benefit systems may be even larger than previously reported, not just in Michigan, but all around the country.

Using data from 2008, when unfunded liabilities were much lower than current amounts, the report compares the gaps between assets and liabilities in state financial statements to some alternative ways of calculating taxpayer obligations. In its financial statements, the state uses an optimistic investment assumption. Lowering it vastly increases estimates of the state’s liabilities. In addition, applying a different kind of analysis based on option pricing also shows that taxpayers may be providing more generous benefits than expected.

Specifically, the older estimate for all Michigan state government pension systems — not just the one for school employees — showed unfunded liabilities of $11.5 billion using the optimistic “official” investment return assumptions. However, when the alternative methods were applied to the systems, the unfunded liabilities skyrocketed to $63.6 billion and $72.2 billion.

In other words, in automobile terms, the current defined-benefit pension system is a lemon — its actual lifetime costs are likely to be more than advertised.

The underfunding problem has only increased since 2008. The unfunded liabilities in just the school pension system are now projected at $22.4 billion, using the same optimistic assumptions as that “official” 2008 estimate. The other methods suggest that the problem can be much worse than even the state acknowledges.

To contain the underfunding problem, the state should place new employees into a system that no longer puts taxpayers on the hook for benefits payable many decades into the future. That is, the state should close these defined-benefit systems to new employees.

In contrast, giving employees defined-contribution 401(k)-type benefits creates no new long-term taxpayer liabilities or uncertainties. The Michigan Senate has already passed a bill that does this. The state House, however, has passed a bill that keeps racking up promises of an uncertain cost. Voters and taxpayers can decide for themselves which is the better approach.

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.