The fiscal challenges facing future taxpayers involve effectively managing MPSERS’ and MSERS’ unfunded liabilities, where the benefits have been overpromised and underfunded. Granted, as recently as 2001, following the stock market gains of the 1990s, MPSERS defined-benefit pension plan was 96.5 percent (or almost fully) funded, while MSERS defined-benefit pension plan was 98.7 percent funded in 2002.[*]

But these benefit plans, including the “pay-as-you-go” health plans, now operate within a state experiencing a significant net outflow of population, where the prospects for economic growth are already uncertain due to the decline of the private sector. Mounting federal deficits and the likelihood of higher federal taxes on personal income, investments and business income will only compound the problems at the state and local levels.[†] Interwoven into all this are federal health care reforms and unfunded liabilities associated with federal entitlement plans like Social Security and Medicare. Cumulatively, funding any deficits for these federal programs will reduce available investment capital and disposable income for many years to come.

The fundamental problem is that MPSERS and MSERS involve major long-term commitments, and state officials have historically chosen through public policy, both directly and indirectly, not to pay the necessary costs to keep the programs current with their liabilities. Rather than amend the programs’ benefits to make the costs affordable, the reaction has been to further defer paying these costs.

Part of this is prompted by pension and retiree medical plan provisions that are, as illustrated later, generous by Michigan marketplace standards. The problem has been further exacerbated by the economic downturns in 2001-2003 and 2007-2008, which have adversely impacted asset values within the major pension systems, where investment growth is relied on to fund future benefit obligations. As of Sept. 30, 2009, MPSERS’ and MSERS’ defined-benefit pension plans were 78.9 percent and 78.0 percent funded, respectively.

The actuarial calculations involved in financing these two major pension systems are based upon an annual 8 percent asset return assumption. Achieving and sustaining this 8 percent standard is all the more likely to prove a significant challenge due to the mounting federal, state and local deficits, which will consume private-sector investment capital and disposable income and thereby reduce business growth and gains in the stock market and other classes of assets.

Major statewide public pension systems, such as those in California and New York, are considering revising their investment assumptions to levels as low as 6 percent.[8] The federal Pension Protection Act of 2006 requires private-sector defined-benefit plans to use a lower funding assumption based upon an index that is currently at or about the 6 percent level.[9] Reducing MPSERS and MSERS assumptions to a similar 6 percent rate would increase the projected liabilities of their defined-benefit pension plans by billions of dollars.

The Pension Protection Act also requires private-sector plans to fully amortize (or “pay off”) any unfunded pension liabilities over shorter periods than those currently being used in MPSERS and MSERS. Combined with an assumption of a 6 percent investment return, this shorter amortization period would cause MPSERS and MSERS pension liabilities and required employer contributions — and therefore taxpayer contributions — to rise even further than they would under a 6 percent assumption alone.

In contrast, MPSERS and MSERS have shifted significant costs beyond the expected retirement age of the average active employee, meaning that in the aggregate, benefits are not fully “paid-up” when the employees retire. For example, in the 2009 actuarial reports, the unfunded liabilities for MPSERS and MSERS defined-benefit pension plans were scheduled to be paid off during the next 27 years, even as the average age of MPSERS and MSERS members in the plans was 45.4 and 52.1, respectively — far less than 27 years from retirement age.[10]

While all this is invisible to the retiree, funding deficits will result in significant deferred costs for the next generation of employees and taxpayers. Since prefunding the costs so they are paid up as they are earned is deemed not affordable (given the actions taken by policymakers), it is hard to imagine how it will be considered affordable in the future.

[*] “Michigan State Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), B-5; “Michigan Public School Employees’ Retirement System 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), B-5. MPSERS and MSERS retiree health plans, which are financed on a “pay-as-you-go” basis, are not prefunded and have almost no assets. See “Michigan Public School Employees’ Retiree Health Benefits 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), A-2; “Michigan State Employees’ Retiree Health Benefits 2009 Annual Actuarial Valuation Report” (Gabriel Roeder Smith & Company, 2010), A-2.

[†] Prospective federal tax increases include the sunset of tax cuts in the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003. See “The Budget and Economic Outlook: An Update” (Congressional Budget Office, 2010), (accessed Sept. 6, 2010).