New Bill Fixes a Pension Problem, Leaves Major Problem Untouched

Rep. Pat Somerville (R-New Boston) introduced a bill last week that would prevent local government employees from using overtime and other extra compensation to boost their taxpayer-funded pension benefits. The bill could can lower the costs of those benefits and make them more predictable, but unfortunately it will do little to contain the runaway costs of an underfunded pension system.

The problem with public pensions in Michigan is not how generous they are, but how politicians tend to kick the costs of funding them into the future.

When public employees work for one year, they earn credit towards a pension that they will collect when they retire. In order to pay for this, their employer puts money into a pension fund. This ensures that the pension credits employees earn in a year are paid for in that same year.

But to make this happen how much does the employer need to prefund the pension fund on behalf of each employee? Determining this amount requires making a number of assumptions about the future, for instance: how long a retiree will collect a pension, how large that pension will be, and — most importantly — how much will the pension funds' investments grow before money is needed to cover benefits.

The value of an individual's pension is typically determined by three things — average compensation, years of service and a multiplier applied to these. Excluding overtime and other salary boosters from the definition of compensation can help make the average amounts used in the benefits formula more predictable. There have been a number of cases in which individuals' pensions were artificially boosted (Michigan Capitol Confidential has covered several of them). The Somerville bill will make these cases rarer.

But this is not the core problem governments face with pensions. The multi-billion-dollar gaps between how much is owed to employees and how much has been set aside to pay are the real problems.

There are two fixes. The first is to lower investment return assumptions. On paper, this would appear to increase the gaps between the amount saved and the amount owed, and it would require larger contributions to prefund pension credits earned each year. But it would also help prevent this state's pension systems from becoming the kind of problem that drives governments toward insolvency.

Governments can also start getting out of the defined-benefit pension game altogether. Contributing money into a retirement fund that each employee controls would prevent governments from promising benefits that history shows they haven't been willing to pay for in advance.

The rising cost of meeting pension commitments means governments are spending more than ever paying for services that were delivered some time in the past. This is unfair to pensioners, taxpayers and current managers who have to dig deep into their budgets catch up on past pension underfunding. Tweaks to retirement rules can help, but lawmakers need to focus more on the real pension problem.