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Foundation Examines Michigan Pensions and Finds - Mismanagement

'This mismanagement was caused by explicit underfunding'

Michigan’s retirement system for state employees has set aside 88 percent of the money needed to cover the benefits promised to current and future retirees. That's a better-than-average level for government systems, and the reason lies in part in a major reform adopted here 20 years ago.

That is one finding of an updated study on public pension reform conducted by the Los-Angeles based Reason Foundation. Had the state not reformed the pension program, it would only have 68 percent of what is needed to cover future benefits workers have already earned.

Through the reform, Reason estimates, the state avoided accumulating another $562 million in unfunded liabilities, or $56 per resident. Other estimates put the savings even higher.

The study, “Pension Reform Case Study: Michigan 2016 Update,” found that the 1996 reform brought savings. But a history of poor management means the system is still $5.5 billion short of the amount needed to pay the benefits already promised.

“A properly managed pension reform process would have added about $8.4 billion to the assets of state employee retirement plan as of 2015, meaning the plan would be overfunded instead of deep in the red,” author Anthony Randazzo said in a blog post.

“This mismanagement was caused by explicit underfunding of the defined benefit plan by state employers, as well as implicit underfunding by the MSERS board through the actuarial assumptions adopted by the plan,” said the study. The last item refers to the board using overly optimistic assumptions of future pension fund earnings and other factors in determining how much must be put aside each year for future benefits.

The 1996 reform closed the Michigan State Employees' Retirement System (MSERS) to employees hired since 1997. The state now makes contributions to each employee’s 401(k)-type account, similar to the practice of the private sector.

The study reported that from 1997 to 2005, investments in the system’s pension fund averaged a 6.85 percent return, while its managers were required to assume annual returns of 8 percent.

“Because the MSERS board has not made substantive changes to the DB [defined benefits] plan's assumptions, the liabilities in the closed plan have continued to be exposed to the underperforming returns, which have translated into unfunded liabilities,” Randazzo wrote in another blog post.

Randazzo also said so far in 2016, investment returns for plans have been poor, meaning this year’s data is “likely to provide continued disappointment and mean additional pension debt.”

MSERS drew Randazzo’s attention because in 1996 it was the first large government retirement program to be closed to new members, a reform that contains the growth of unfunded liabilities.

“MSERS is the largest retirement system in the country to have switched from defined benefit pensions to defined contribution pensions, and the oldest such major conversion, having done so in the mid-1990s,” he said in an email. “With nearly two decades of data, MSERS pension reform is the most robust effort that we can use to draw meaningful conclusions about what has gone right, and what has gone wrong in pension reform.”

Randazzo, who is a Michigan native, said other states looking for relief from an explosion in employee retiree costs should look at the Great Lakes State.

“This should be of interest to any state interested in similarly switching to defined contribution pension benefits for its public sector employees,” he said.