Oklahoma Shows Pension Reform Can Boost a State's Credit Rating

Opponents of closing the Michigan Public School Employees' Retirement System have pitched an argument that doing so might have a negative impact on the state’s credit rating. That may seem an unlikely argument given the system's chronic underfunding — and one state's experience suggests the opponents have it exactly backwards.

Persistent underfunding has contributed to an unfunded liability of nearly $26 billion in the state's school pension system. This is up from $17.6 billion as recently as 2010, despite two rounds of partial reforms (in 2010 and 2012) that did not prevent new employees from being enrolled in the current system.

In addition, the “annual required contribution” — the amount estimated to cover another year of benefits earned by all school employees and also gradually get “caught up” on past underfunding — has increased from $989 million in 2009 to $2.1 billion in 2014. Some 30 percent of school payroll costs go into the system, and 87 percent of that is used to catch up on past underfunding.

Both the House and Senate have placed closing the system at the top of their legislative agendas. But this doesn’t necessarily mean it will happen. It's likely the administration of Gov. Rick Snyder would have to agree, and a few in the House and Senate Republican majorities may need to be convinced as well.

Opponents of the idea say it may damage the state's credit rating. Given the current system's liabilities, this may seem an unusual objection, but the complexities of pension accounting mean it could sway some lawmakers.

Michigan is not alone in wrestling with this problem. In Oklahoma a bill called the “Retirement Freedom Act” was recently enacted. It closes that state's defined benefit system and replaces it with a defined contribution model. Michigan Capitol Confidential asked the bill's sponsor, Rep. Randy McDaniel, R-Oklahoma City, whether the move has harmed Oklahoma’s credit rating.

“No it didn’t,” McDaniel said. “In fact one of the reasons we did pension reform was to have a better credit rating, from my perspective.”

McDaniel says he is unaware of anyone raising possible credit rating problems when the Retirement Freedom Act was debated in the Oklahoma Legislature.

“What we heard were mostly the more customary arguments that centered on transition costs,” McDaniel said. “The only way making a change would hurt a state’s credit rating would be if it caused liabilities to go up. But the reason for closing a pension system is to prevent them from increasing. If anything, practicing sound financial policy by moving away from traditional pension systems should improve a state’s credit rating. It limits liabilities and is a positive movement financially. That’s why thousands and thousands of businesses have made the change and they’ve done so without hurting employee recruitment or retention.”

“Pension reform was one of many reforms we’ve made in Oklahoma,” McDaniel continued. “We have reduced our liability by $6.5 billion. Our liability in 2011 was $16.1 billion, last year it was down to $9.6 billion. In my experience, the major objection to pension reform is the transition costs. To me, the best argument against those transition cost claims is the fact that private sector companies have deliberately been making the change.”

Richard Dreyfuss is a business consultant, an actuary and a senior fellow at the Manhattan Institute. Michigan Capitol Confidential asked Dreyfuss if it was plausible that closing MPSERS might have a negative effect on Michigan’s credit rating.

“That’s not the typical argument against closing a pension system that I’ve heard,” Dreyfuss said. “In Michigan, you closed your state employee pension system in the 1990s when the economy was very strong. Then from 2001 to the Great Recession, Michigan suffered through very tough economic times and you were better off because you had closed that pension system than you would have been otherwise.”

“I guess if someone claimed closing a pension system could hurt your credit rating, I’d ask them to show me one company in the private sector that had its credit rating downgraded because it closed its pension system,” Dreyfuss continued. “Actually it is the other way around; pension reform would be more likely to improve a state’s credit rating. If something you’re doing is preventing you from being able to contain costs, how could it cost you even more if you stop doing it?”