Management Model No Guarantee of County Pension Soundness

When a Michigan county offers employees a traditional defined benefit pension plan, it has two options for management: keep it in-house or farm out the management to the Municipal Employee Retirement System of Michigan (MERS). Most counties in Michigan, 68 out of 83, outsource managemennt to the nonprofit MERS.

A review of the financial data for all 83 Michigan counties shows that those that manage their own system tend to do no worse than MERS. In some cases, they do a better job of keeping their pension promises funded at sustainable levels.

On average, county pensions managed by MERS have funding levels 9 percentage points lower than self-managed systems. The 15 counties outside MERS are 80 percent funded, and the 68 counties in it are 71 percent funded. (They only have 71 percent of the amount actuaries estimate they should have to pay the pension promises they have made).

According to Oakland Deputy County Executive Robert Daddow, underfunding in the MERS system is caused by overly generous assumptions about future investment returns and mortality rates. An expectation of higher returns means that less money must be saved to fully fund benefits, while higher life expectancy estimates mean more must be saved to pay benefits for a longer retirement.

Oakland County assumes a 7.25 percent investment rate of return and uses updated life expectancy projections from the 2014 edition of an industry resource called the Health Annuitant Mortality Table.

MERS, by contrast, assumed an 8 percent rate of return, according to its 2015 financial report, though that number has recently been changed to 7.75 percent. Since 2000, MERS has achieved an actual rate of return of over 6 percent.

“In this market going forward, I don’t think 8 percent is achievable anytime soon,” Daddow said. “If you can’t hit your investment performance, then the inevitable problem is unfunded liabilities. That’s just going to happen.”

Also, Daddow says, MERS still uses mortality estimates from 1994 that assume shorter lifespans. MERS plans to increase its life expectancy assumptions next year.

Making changes to these assumptions and projections has serious implications for current budgets. But getting them wrong can have catastrophic consequences for future retirees and taxpayers. If pension beneficiaries live longer and investments return less than a system’s projections call for, then up-front deposits to the fund must increase. That means less money to spend on other things.

Daddow says Oakland County takes its pension management responsibilities very seriously. “If someone’s not doing the job, then there are more vendors who can do the job,” Daddow said. “Not only do we have those managers dealing with individual portfolios, but we also have a manager that manages the manager. Sometimes managers want to puff up their portfolios, so we need someone who gets into the real numbers.”

A county that manages its own pension system has no one else to blame if something goes wrong. Accountability is more dispersed and less direct in MERS, whose portfolio-selection board members are elected by the system’s more than 800 members statewide.

Two Michigan counties — Bay and Kalamazoo — have pension funds that are fully funded, and neither invest with MERS. The counties use a 7.5 percent assumed investment rate of return and mortality rates from 1994.

All five of Michigan’s largest counties administer their own retirement system. They are Wayne, Oakland, Macomb, Genesee and Kent.

Oakland, Macomb, and Kent’s pension plans are 98, 96 and 96 percent funded, respectively.

Like Oakland, Macomb and Kent counties use updated 2015 mortality rates. Macomb’s assumed investment rate of return was 7.5 percent and Kent’s was 7 percent.

Oakland and Macomb counties have closed their defined benefit pensions to new employees, who instead receive contributions to 401(k)-type accounts. Kent County’s pension is still enrolling new hires. Oakland County estimates that closing the system has saved its taxpayers some $115 million since the change was made in 1994.

Genesee and Wayne counties used different assumptions in managing their retirement systems.

Genesee County assumed an 8 percent return on investment in 2015 and uses mortality rates from 2000. Its pension fund holds only 69 percent of the assets it projects are needed. The county plans to close its defined benefit pension in 2017 and begin to pay down the $109 million unfunded liability it has accumulated.

Wayne County's pension assumptions include a 7.75 percent rate of return and mortality rates from 2000. Its pensions are just 49 percent funded and have an $842 million in unfunded liabilities. The county is also still enrolling new hires into a slightly less generous defined benefit plan that also comes with a defined contribution (401k-type) benefit.

(Politicians call such plans hybrids, but if they are not adequately funded, the liabilities they generate are just dangerous to future taxpayers — and the incentives for politicians to underfund them are just as strong.)

Daddow emphasized that even if governments make all the pension fund contributions called for by the assumptions about mortality and investment returns, things can still go bad if those assumptions are not valid.

There is only one guaranteed way governments can avoid generating unfunded pension liabilities that can shortchange retirees, workers, and taxpayers: Don’t create them in the first place. In other words, gradually shift county workforces away from defined benefit pension systems and into defined contribution 401(k)-type plans.