Michigan Business Leaders Propose Pension Overhaul

A group of Michigan business leaders is calling for a complete overhaul of the state’s pension system, including moving all new public employees into defined contribution plans, and revising all assumptions.

“Defined benefit plans and other postemployment benefit obligations represent significant long-term risks to the fiscal stability of schools, local governments and, indirectly, the state,” said Business Leaders for Michigan in a recently released report.

The report said Michigan’s pension funds’ unfunded liabilities were a major reason for the need to revamp the state’s pension system. It cited the Michigan Public School Employees Retirement System (MPSERS) and the state’s Municipal Employees’ Retirement System (MERS) as having unfunded liabilities of $25 billion and $3.6 billion, respectively.

The group said that other reasons for the need to change the pension system included unrealistic assumptions and increases in retiree benefits. Business Leaders for Michigan is composed of the chairpersons, CEOs, and senior executives of the state’s largest employers and universities.

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“The assumptions supporting how much to be saved each year may be faulty,” said the report. “All assumptions supporting DB plans should be thoroughly reviewed. The percent rate of return assumed on DB plan assets is often criticized, but other assumptions, including the discount rate and assumed payroll growth, should not be ignored.”

According to the group, reducing the assumed rate of return for MPSERS by one percentage point increases the unfunded liability by 29%, from $25 billion to $32.1 billion, the equivalent of $40,000 per active plan member, or approximately one year of payroll for active plan members.

“However, keeping faulty assumptions in place because of concerns over the current cost of making a change is what leads to fiscal instability in the long term,” the report said

The report also said that “increasing benefits when employees are close to retirement can create a shortfall.” It said a common example of this are so-called “early out” programs, in which early retirement incentives that increase an employee’s retirement multiplier are offered in exchange for the early retirement.

In addition to pension funds, changes to other postemployment benefit (OPEB) obligations are also necessary, the group said, adding that Michigan’s unfunded OPEB liability for schools, cities, villages, townships, and counties currently exceeds $20 billion.

“Rising healthcare costs and an increasing ratio of retirees to active workers has resulted in OPEB liabilities consuming an ever-increasing share of government budgets,” said the report. “Funding OPEB shortfalls and, for that matter, DB plan shortfalls, means using current taxes to pay for services consumed in the past. Levying taxes on current residents without using the funds to provide services to those residents can make cities uncompetitive, leading to population loss.”

Tags: DC plans, Defined benefit (db) pension plans, Michigan, MPSERS, Pension

Pennsylvania Treasurer Joe Torsella is moving all of the treasury’s $2.4 billion public equity investment holdings to a passive investment strategy, which he says will save the state an estimated $5 million a year in fees.

“We shouldn’t treat investing public funds like a casino game, trying to ‘beat’ the market, and paying casino prices to do it,” said Torsella in a statement. “Instead, we should capture the underlying market return at the lowest possible cost. The broad strategic allocation of investment funds is the single most important decision for any investment portfolio. We can’t control investment performance or consistently beat the market, but the one variable we can control is costs.”

Torsella said the move will also reduce investment risk and improve return to taxpayers.

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“Study after study has shown that a passive investment approach for stocks, by dramatically reducing the costs to taxpayers, has a high likelihood of performing much better than a high-fee active investment approach over the long term.”

According to the Pennsylvania state treasurer’s office, the total savings from shifting to passive investments would translate to approximately $195 million when compounded over 20 years.

Torsella instructed the state treasury’s investment team to transition all public stock holdings to passive strategies over the next six months. Approximately $1 billion of the total $2.4 billion equity portfolio is currently actively managed, and will be redirected to lower-cost passive investments.

Torsella cited research by Standard and Poor’s that shows over the most recent 10-year period, more than 87% of all actively managed US stock funds underperformed a broad market index.

“Overwhelming research shows that while some active managers will, of course, manage to outperform the markets in any given period,” said Torsella, “it is both extremely difficult for a manager to do so consistently over time, and extremely difficult for investors to identify which managers will outperform in the future. And trying to find those managers by looking in the rearview mirror doesn’t help.”

Tags: active vs. passive, passive investments, Pennsylvania