Policymakers Still Tripped Up By Pension Transition Costs

Policymakers are still concerned that closing the Michigan school pension system to new members will cost the state in one of two ways: Either it will require additional cash to meet a new front-loaded payment schedule for “catching up” on the system’s unfunded liabilities (the so-called “transition costs”); or, if this is not done, it will damage the state’s credit rating.

That is essentially what state budget director John Nixon told The Detroit News, characterizing the choice not to frontload those “catch up” payments as diverting from government accounting rules.

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But no one is calling for the state to ignore proper accounting practices — just for it to determine its own funding policies. The Government Accounting Standards Board explicitly supports legislatures setting their own reasonable schedules for these catch-up payments, so leaving the current amortization plan in place won’t impact assessments of this state’s credit worthiness.

Here are GASB’s own words on the subject, quoted from the Board’s plain-English description of new guidance released just last month, which covers accounting and financial reporting for pensions:

While there has been a close relationship between how governments fund pensions and how they account for and report information about them until now, the new guidance establishes a decided shift from the funding-based approach to an accounting based approach. The board crafted its new statements with the fundamental belief that funding is squarely a policy decision for elected officials to make as part of the government budget approval process.

A recent Memo from the Arnold Foundation provides a real-world example of a state that made its own funding-pace decisions. The State of Alaska closed its defined-benefit pension plan to new members in 2005, and after the first year chose not to pay millions in so-called "transition costs.” Yet the bond market did not punish Alaska, and in fact credit agencies cited the state’s pension reform as playing a positive role in credit-rating upgrades in 2008 and 2012.

Policymakers here should feel free to close Michigan’s school pension system without paying large transition costs. Given that the system is already underfunded by $22.4 billion, closing it may well be the state’s most important fiscal reform since 1996.

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