Pension 'Transition Costs' Remain a Myth

Package of bills would finally close school employee pension plan

In 2012, Michigan legislators discussed closing the state-run school employee pension system and offering new employees participation in a defined contribution retirement system.

Those legislators decided against the move, citing alleged "transition costs" as the reason for not making the change. New work from Andrew Biggs at the American Enterprise Institute reiterates that these transition costs are illusory.

The transition costs policymakers refer to are changes in how unfunded liabilities are treated when closing a retirement system. In the piece, Biggs shows that the rules for pension accounting only guide how pensions are reported and do not mandate a pension funding policy. In any case, newly adopted pension accounting rules should clear up the confusion.

This point is also contained in the 2012 study, "Five Options for Addressing 'Transition Costs' When Closing the MPSERS Pension Plan." The study also showed how legislators could deal with transition costs even if they wanted to adopt the reporting requirement.

In other states, some have argued that pensions will also need to convert to more stable investments that offer lower returns as fewer employees are in the system. This would require more cash and are also referred to as a "transition cost." Biggs shows that this is based on a flawed belief that the current system mitigates investment risk. As he states, "A closed pension plan that takes less investment risk imposes smaller contingent liabilities on future generations, and so the total cost of the plan remains unchanged."

While transition costs are illusory, there are real savings from closing retirement systems. When Michigan closed its state employee retiree system in 1997, the state saved itself from racking up $2.3 billion to $4.3 billion in unfunded liabilities.

Michigan Sens. Mark Jansen, R-Gaines Township; Arlan Meekhof, R-West Olive; Pat Colbeck, R-Canton; Bruce Caswell, R-Hillsdale; Joe Hune, R-Hamburg; and Phil Pavlov, R-St. Clair, recently introduced a package of bills that will close the school employee pension plan. They should not let mythical transition costs prevent this reform.

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.