Study Finds That Teacher Pension Plan Unlikely to be Fully-Funded

Michigan’s school pension system is unlikely to be fully funded while operating under the state's current assumptions about pension funding, according to a new memo from the Laura and John Arnold Foundation.

Unless these issues are addressed, the state will not set aside enough money to pay for teachers and other school employees' pensions as they are earned, the Texas-based foundation said in the memo it authored for legislators.

The memo highlights the state's investment analysis, showing that there's only a 49 percent chance that the state will meet the 8 percent assumption used to discount most of its pension assets. The state uses a more conservative 7 percent estimate for contributions set aside for new employees in the system — those hired after July 1, 2010.

Even with the lower return assumption, the plan is still risky, according to the memo. Using some conservative assumptions about pension funding, the annual employer costs would be 3.19 percent of payroll higher if pension assets grow at only 6 percent while simultaneously assumed to grow at 7 percent. That discrepancy would translate into a $303 million annual-cost increase when applied to all current member payrolls.

The memo explains that under this scenario, state retirement office estimates of savings from retaining a slimmed-down defined benefit pension system (as proposed by the state House) instead of providing defined-contribution plans to new employees would not pan out. In other words, taxpayers would be better protected with the defined-contribution conversion.

The Arnold Foundation memo also addresses policymakers' concerns that accounting rules may require large upfront cash contributions when converting to a defined-contribution plan. It cites the Government Accounting Standards Board revisions released last month to reiterate that funding policies are entirely in the hands of legislators.

"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," GASB wrote in its recent rules revision. "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."

Policymakers sometimes are concerned that implementing a different funding policy will impact the state's bonding rate. But the memo shows that closing a state's pension system typically results in improvements in a government's credit ratings. Alaska, for example, started converting to a defined-contribution retirement system in 2005 and used a back-loaded payment schedule for paying down its unfunded pension liabilities. In other words, it did not choose to pay millions in so-called "transition costs" for several years. Reports from credit-rating agencies rated the pension changes positively.

The Memo addresses the question, Does the plan offered to new school employees offer a reasonable level of cost and risk compared to those available in state plans? The complete memo is available here: Arnold Foundation Response to Questions from the Michigan Legislature