School Pension Fund Needs Fewer Gimmicks

Michigan legislators are considering a bill to rework the school pension underfunding problem but the legislation will do nothing to stop the state from continuing to improperly fund the system.

Indeed, the bill represents just another pension gimmick, and a harmful one at that. Lawmakers should instead consider real pension reform.

House Bill 4190 would change the way that the state apportions the costs of catching up on years of school pension system underfunding. The $22.4 billion gap between what has set aside to cover future employee retirement benefits and what the system expects to pay out in pensions must be closed. To do so under current law, for every dollar that a school district pays in employee salaries, it must send in a certain amount for deposit into the statewide pension fund.

Under HB 4190, instead of assessing this amount as a percentage of payroll, districts would send in an amount determined by their "current operating expenses." These include payroll as well as other expenses, including payments to vendors.

The bill's proponents believe payroll-based assessments are a problem because there are fewer people in the system due to contracting out. The trend to privatization is well-documented. But by itself, contracting out does not cause pension problems. In fact, by having fewer people in the system, it has decreased the total liabilities of the system.

Still, proponents recognize that the state has not met its assumptions about payroll growth.

The direct solution is to lower the estimates of future payroll growth. However, this legislation would instead switch the pension cost assessment basis to one that includes most school operating expenditures. Its proponents repeat the mistake they think they're solving by assuming these costs would increase at the same rate as those faulty payroll projections.

Legislators who have not examined the divergence between past projections and actual performance should be especially skeptical of this approach.

In addition, catching-up on the unfunded liabilities by anticipating growing payrolls or operational expenses backloads pension fund contributions into future years. Kicking the can down the road in this way may be a standard practice, but it's one that has served the state poorly.

Without backloading the contributions, the state would have to put more money into the system in the near-term. There's little political desire to do such a thing — especially after school officials complaints about the system's already-high contribution rates.

A better alternative is to contain the already inflicted damage by closing the current defined benefit system to new employees, instead providing them with a defined contribution retirement system. These defined contribution plans do not require the state to make such risky projections, and transitioning will contain the state's ability to rack up unfunded liabilities. This can be accomplished without paying alleged "transition costs."

Closing the defined benefit pension system and switching new hires a defined contribution retirement system will ensure that henceforth benefits are paid as they are earned, as required by the state constitution. That is decidedly not the case with the current system.