Two States Announce Changes to Their Pension Funds

South Dakota and Michigan are the latest states to announce changes to their state pension systems as a result of lowered expected investment and funding concerns.

In South Dakota, Gov. Dennis Daugaard on February 9 signed into law a bill that changed the cost-of-living-adjustment requirement formula for the $10.5 billion South Dakota Retirement System (SDRS).

Under the new formula, the retirement system’s COLA will not exceed 3.5% and will not be less than 0.5% a year, provided the retirement system is 100% funded. However, if the funding ratio falls below 100%, the retirement system’s board can enact a “restricted COLA maximum” so the funding ratio can increase back to 100%.

Previously, the South Dakota COLA formula was linked to the system’s funding ratio. When it was fully funded at 100% or more, the COLA was 3.1%, but when it was less than 80%, the COLA fell to 2.1%. Between 80% and 100%, the fund reverted to a formula based on a combination of the funding ratio and the consumer price index. South Dakota enacted the COLA changes based on an actuarial study done in November 2016 when the fund’s assumed rate of return was reduced to 6.5% from 7.25%.

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The SDRS also plans changes for its participants this spring. A bill will enact a new benefit design for members joining SDRS on or after July 1, 2017. This benefit design does not impact the one for current SDRS members. SDRS will continue as one plan with two benefit designs, according to a release on the SDRS website.

Under the new plan, the retirement age was raised by two years (from 65 to 67 for judicial, and from 55 to 57 for public safety employees) and early retirees will face a 5% per year reduction in benefits. In addition, members who enroll on or after July 1, 2017, will be eligible for a Variable Retirement Account (VRA) that will include an annual contribution of up to 1.5% of compensation; credited with South Dakota Investment Council earnings; available to members at retirement, disability, or death.

These changes were made to address longer life expectancies, increasing market volatility, and “evolving employer workforce objectives. By applying the benefit design changes for future members only, legal issues and retirement planning concerns for Foundation members are avoided,” according to the SDRS website.

Michigan to Reduce Assumed Rate of Return

In Michigan, the state is assuming a reduced expected return rate for its retirement plans and has established a taskforce charged with addressing the unfunded liability for the state’s four retirement plans. A new state budget proposed this month included more funding to the $55.7 billion Michigan Retirement Systems as a result of lowering the pension system’s assumed rate of return to 7.5% from 8%.

The goal of reducing the assumed rate of return, while simultaneously raising state contributions to the four public defined benefit plans the state administers, will reduce risk and “remain on track to eliminate the liability entirely by the year 2038,” according to a statement released by Gov. Rick Snyder.

The unfunded pension liabilities of the four state retirement systems as of Sept. 30, 2015, (the latest available date) were $33.2 billion, according to the Michigan State Office of Budget.

The state’s largest public plan, the $43.2 billion Michigan Public School Employees Retirement System (MPSERS), faced an unfunded liability of $26.7 billion. The new lower 7.5% return target will be implemented over a two-year period for MPSERS, according to the governor’s proposed 2018 budget.

As of Sept. 30, 2015, two of the state’s three pension plans were frozen: the $10.9 billion Michigan State Employees Retirement System had an unfunded liability of $5.8 billion, and the $255 million Michigan Judges Retirement System, with an unfunded liability of $8 million. The $1.3 billion Michigan State Police Retirement System, which was not frozen, had an unfunded liability of $654 million.

- By Chuck Epstein

In a move to prevent future generations from being burdened by the unaddressed costs of previous generations, Michigan Gov. Rick Snyder has proposed lowering the assumed rate of investment return for the state’s retirement systems from 8% to 7.5%.

“This more conservative assumption will require additional state investments into the retirement systems now, but will ensure that pension trust funds will be sufficient in the future to pay the benefits that have been earned, ” said the governor’s proposal, which was released last week.

But will it be enough? Snyder said that a more conservative rate of return on investments will help Michigan pay off its long-term liabilities. In his proposal, the governor said the state would eliminate the liability entirely in 20 years, and “protect the retirement systems that many older Michiganders will be relying on in their senior years.”

However, according to Joe Nation, a professor of public policy at Stanford University who researches public employee pensions, this conservative assumption isn’t nearly conservative enough.

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“Public pensions systems across the country are far too optimistic,” Nation said. “Lowering the discount is a good thing, it’s a step in the right direction, but in this case, it’s a step that’s probably inefficient,” he said.

“If they were to go from 8% to 5%, then that’s where they need to be to make sure they can fund benefits over next 10, 20, or 50 years.”

Nation says that it’s a stretch to assume a 7.5% return with any degree of confidence, and that fund managers should only be about 50% confident they will hit that. “You can assume a 7.5% return, but the odds of that are a coin flip,” said Nation. “Then if you don’t make it, you have all these obligations that you made.”

And that’s only if a fund is 100% invested in equities, which would be a pretty big risk for a pension fund. “But they don’t only invest in equities,” says Nation, “they invest in bonds where yields are much lower,” which makes hitting that 7.5% target more difficult.

According to Michigan’s Municipal Employees’ Retirement System (MERS), its Total Market Fund returned 11.1% in 2016, which appears to have been an exceptional yea. Over the past 10, 20, 30, and 40 years, the fund has returned 5.38%, 7.07%, 8.47%, and 8.95%, respectively, according to MERS.

Earlierthis week, Gov. Snyder formed a task force to address the problems retirees and municipalities are having with pension and healthcare costs.

“My goal for this task force is to have collaboration among legislators, state and local government officials, and employee representatives to ensure the financial stability and effective delivery of local government services for the coming decades,” Snyder said.

The total unfunded pension liability is estimated to be around $4 billion, according the governor’s office. The task force =contains experts who represent labor and management, investment managers, insurance and finance professionals, and legislators. They have been directed by Snyder to provide recommendations on pension reforms by this spring.

Included on the board is Chris DeRose, chief executive of MERS. MERS is an independent professional retirement services company operating on a not-for-profit basis, and is governed by an elected board. It covers about 84% of local units of governments, but does not include teachers or state workers

“Our hope is to bring municipal retirement administration expertise to the discussions,” said Jennifer Mausolf, a director at MERS of Michigan. “In fact, over the last five years 73% of our customers have taken additional steps to reduce their unfunded liability. We are hoping this experience can help guide the group in its deliberations.”

-Michael Katz