Don’t Blame Employees for Pension Underfunding
Liabilities caused by wrong assumptions
It is unfortunate that government employees are often blamed for underfunded government pension systems. When concerns are raised that retirement systems owe members billions more than has been saved, high-earners and early retirees are viewed as the culprits. Policymakers in return cut the generosity of the plans. Yet these policy reforms will not fix the basic problems faced by pension systems.
In 2010, Michigan’s school employee pension system was underfunded by $12 billion, not including the value of promised retiree health care benefits. Lawmakers sprang into action. They increased employee contributions to the system and made new employees' benefits less generous.
In 2012, Michigan’s school employee pension system was underfunded by $22.4 billion, not including the value of promised retiree health care benefits. Once again, lawmakers sprang into action. They increased employee contributions to the system, made benefits offered to new employees less generous, and reduced some of the benefits of current retirement system members.
These reforms made lots of changes to Michigan public school employee retirement benefits, but their focus on generous benefits as the cause of underfunding was misguided.
The $10.4 billion growth in unfunded liabilities between the two reforms was not due to more people gaming the system (although it happens). It wasn't the result of employees not paying their fair share into the system. The real culprit was the state’s failure to meet the system’s own actuarial assumptions of how much needs to be contributed each year to cover future benefits.
A 2014 performance audit of the retirement system found that the lack of investment gains compared to their assumed returns was responsible for 93 percent of the underfunding over the past 10 years.
Lawmakers made the system less generous to employees based on assumption that generous benefits were behind the underfunding problem. But actually, it was the system's underlying assumptions about the pension fund's projected investment returns that caused the most damage.
A few minor things have been done about this. The 2012 reforms allowed new employees to participate in a defined-contribution retirement plan, and roughly 20 percent choose this option. The 2010 reforms also reduced the assumed return on pension fund investments from 8 percent to 7 percent for newer system members. These are improvements.
But in the end, the solution is clear: The state should stop putting new school employees in defined-benefit pension plans. Instead of tinkering with a failed model, all new school employees should be offered defined-contribution retirement benefits instead.
These plans belong to employees themselves and are are paid as they are earned, which makes it impossible for the state to generate billions of future unfunded liabilities on their behalf. Preventing new liabilities will help the state honor the pension promises already made to current staff and retirees. Because it's not their fault the state has failed to properly fund their retirement benefits.