State Officials Caused Michigan's Pension Crisis

No accident that school pension system is underwater

The Ann Arbor public school district was required to contribute $30.0 million to the state’s underfunded school employee pension system in 2016. That represented a $16.8 million increase in just five years: In 2011, the Washtenaw County district paid $13.2 million.

Across the state, skyrocketing costs resulting from the failure of those in charge to properly fund Michigan’s school pension system are causing problems for the budgets of virtually every conventional public school district.

The crisis has been decades in the making. One factor has been the agency that manages state and school pension systems; it has consistently made decisions based on overly optimistic assumptions. This failure combined with others has put taxpayers on the hook for $26.7 billion worth of unfunded promises in the school pension system.

In the coming weeks, Michigan Capitol Confidential will examine how officials in the state’s Office of Retirement Services and elsewhere have created this unsupported debt.

For at least 41 of the past 42 years, the school pension fund has not held enough assets to meet the promises made to those who have earned pension benefits. The underfunding has compounded over time to create the current unfunded liability.

The ORS has consistently low-balled its official estimates of how much needs to be contributed to the pension fund each year to catch up on past underfunding. And in 14 of the past 20 years, the Legislature has compounded the damage by failing to appropriate enough money to cover even those understated estimates.

The pension system’s managers have continually shunned best practices by assuming that they have an unreasonably long time to catch up on the past underfunding. For example, records show that in 1975, the state was using a 50-year amortization window, which is 20 years longer than current industry recommendations.

Just like going from a 15-year mortgage to 30-year one greatly increases how much a homeowner pays over the life of a loan, this bit of practice could cost taxpayers billions of dollars more in the coming decades.

Yet the retirement office defends its management record.

For example, it points to the fully funded status of a slightly less generous defined benefit pension option the state began offering to new school employees in 2010. This plan also includes employer contributions to a 401(k)-like account owned by each employee. (Politicians call this a hybrid system.)

Importantly, 401(k)-like defined contribution retirement plans by definition create no long-term employer liabilities, funded or unfunded. The employer’s obligation is met completely each time it deposits a periodic contribution to an employee’s tax-deferred account. The employer who has promised these contributions gets no more credit for making them than for making payroll on time.

For that reason, there may be less than meets the eye in the following defense offered by the retirement office’s spokesperson, Kurt Weiss:

“This administration is proud of the way we have managed all of the state’s retirement systems and particularly proud of the needed reforms that have been made that have reduced the state’s long-term liabilities by more than $20 billion. It’s important to understand that the defined benefit system is closed to new enrollees and equally important to understand that the hybrid system is funded at 100%.”

The closed system Weiss refers to covers employees hired before 2010, who get a defined benefit pension but no employer 401(k) contributions. Employees hired since 2010 get a defined benefit pension with a slightly less generous payout formula as well as modest employer 401(k) contributions.

Both the old approach and the new one generate long-term taxpayer liabilities. Whether either is funded or underfunded depends on how it is managed. Contributions to the school pension fund made on behalf of employees hired since 2010 have gone into investment markets that have not experienced a serious drawdown in that time.

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.