Analysis: Michigan’s Long History of Government Pension Problems

Michigan policymakers set aside $133 million to reform the school pension fund in the budget last year and convened a workgroup to brainstorm curbing the system’s growing $17.6 billion unfunded pension liability.

The workgroup’s report only reaffirms the earlier underfunding warnings: There is no easy way out of this mess.

What’s especially disappointing is that the drafters of the state’s constitution clearly wanted to avoid accruing liabilities, period. Article 9, section 12 of Michigan’s Constitution states that, “Financial benefits arising on account of service rendered in each fiscal year shall be funded during that year and such funding shall not be used for financing accrued liabilities.”

This essentially means that the state must pay for the pensions earned by employees in the period that workers earn them. The state can’t just pay pension checks as they are due; they have to set money aside today to pay for tomorrow’s expenses.

A constitutional delegate summarized the system:

Any public system that is set up should have put into it each year sufficient money to meet all of the liability accrued during that year. If that is done from the very beginning, the system is not an excessive burden; but when you go for years without putting in enough money to cover the liability accruing each year, then to try to catch up for the past deficiency becomes a problem of magnitude.

Indeed, delegates seemed to be conscious that the state ought to ensure that pensions were adequately prefunded “so that our children will not, 50 years hence, suffer from the fact that we failed to put in enough money to take care of the benefits attendant upon the service currently performed by public employees.”

The seemingly clear constitutional language and intent fell short. Currently, the school pension system has only saved 71 percent of its earned pensions, and policymakers have not saved anything for retiree health care expenses (Unlike public-employee pensions, retiree health care expenses are not constitutionally guaranteed.) The cost of paying for benefits already earned make up the vast majority — 86 percent — of required pension contributions.

For years both government officials and legal wranglings warned that these unfunded liabilities would be a thorny problem for the state. In a 1980 Michigan Supreme Court case on pension funding, the justice’s opinion observed that state officials were stuck “between the devil and the deep blue sea” when trying to develop means to catch up on its underfunded pension system.

More recently, former state superintendent Tom Watkins wrote a report about structural spending issues in Michigan’s conventional school districts stating that increasing pension contributions “leaves little room for increased spending directed to teaching and learning even if the economy improves.” The report was published in 2004, but the gap between what employees have earned in pensions and what the state has set aside to pay for pensions has only grown.

The 2012 report from the MPSERS reform committee reaffirms these alerts to the difficulty of reform. It explores some long-term fixes, but mentions that its short-term effects will be small. It explores short-term reforms that only shift responsibility for increasing contribution rates to members. The ultimate take-away is that the system is underfunded and catching up on pension benefits cannot be avoided. (Retiree health insurance benefits, on the other hand, may be avoided.)

The underfunding of the pension system is endemic to government pension accounting. Beyond failing optimistic estimates about investment returns, the political incentives faced by legislators ensure that the system remains underfunded — politicians bump benefits during good times and short-change the system during bad times. Even constitutional language prohibiting the state from pushing its retirement costs to the future wasn’t stronger than political prevarication.

The best alternative is to transition to a system that prevents the state from creating long-term underfunded promises. To do so, the state should offer new employees participation in a defined-contribution retirement system. A defined-contribution system will clearly ensure that retirement benefits meet constitutional standards, as well as meet the moral obligations of this intended government service.