Pension Funding Best Practices Remembered

Last year, the state’s Office of Retirement Services testified against a plan that would offer new employees in the school retirement system 401(k)-style benefits. The office claimed that shifting employees would require increased costs in order to follow industry best practices. But state officials are already ignoring a large number of best practices when it suits them.

In a memo on the issue, the state’s actuaries note that the Government Finance Officers Association recommends, “[F]or plans that are closed plans that still have active members, the continued use of a level percent of member compensation remains appropriate, but not for a long period (i.e. as the number of active members decreases).”

Given that the state is paying off the retirement system’s unfunded liabilities over the next 22 years, this seems to imply that it ought to pay more of the costs upfront. But this isn’t the only best practice that the organization recommends. The report includes a number of practices that the state has ignored. These include:

The actuarially determined contribution should be calculated in a manner that fully funds the long-term costs of promised benefits while balancing the goals of 1) keeping contributions relatively stable and 2) equitably allocating the costs over the employees’ period of active service.

ORS is not doing this for the school retirement system. Contribution rates have not been stable and the costs of service are spread beyond employees’ working years. Contribution rates have steadily increased between 2000 and now, going from 12 percent up to 37 percent.

The average employee in the system is 46 years old, but the state is paying off unfunded liabilities over the next 22 years. This means that costs would be spread over the working lifetimes of the current workforce if its members worked until they were 68. But they won’t: The state assumes that most employees will retire when they are between 57 and 62. In other words, the state is taking longer to pay off the costs of retirement than industry best practices recommend.

This is not the only best practice that the state ignores. The association of finance officials further recommends:

Every government employer that offers defined benefit pensions or other post-employment benefits should make a commitment to fund the full amount of the ADC each period.

In contrast, Michigan has put in less than the actuarially determined calculations in 7 out of the past 10 years and 20 out of the past 29. Sometimes this is due to decisions made directly by policymakers, and those overseeing the pension system do little to influence lawmakers violating these best practices.

The method used for asset smoothing should: Be unbiased relative to market. For example: The same smoothing period should be used for both gains and losses[.]

The state reset its 5-year smoothing of pension assets in 2007 so it could put fewer dollars into the pension system that year. It did the same in 1997.

Amortization of the unfunded actuarial accrued liability should: Use fixed (closed) periods that … never exceed 25 years, but ideally fall in the 15-20 year range.

Michigan’s current schedule pays unfunded liabilities off over 22 years, which is a little above the recommendation. But when the state adopted this schedule in 1996, it was a 40-year schedule.

The evidence is clear: The state’s Office of Retirement Services ignores or claims best practices when it suits its interests. That attitude is why Michigan’s pension systems are tens of billions of dollars in debt.