Michigan Pension Reform Proposal May Be ‘Too Optimistic’

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

The unpredictability exhibited by the Trump Administration in the president’s first few weeks in office “represents a risk to international economic conditions and global sovereign credit fundamentals,” warned Fitch Ratings in a memorandum released late last week.

Fitch is one of three major credit ratings agencies that evaluate the risk of investing in foreign sovereign nations. The agency said that since Trump became president, the predictability of US policy has waned, which could lead to “sudden, unanticipated changes in US policies with potential global implications.”

The biggest risks, Fitch said, come from the current administration vowing to break with long-standing US foreign policy on multiple issues, particularly concerning trade relations and immigration. It said that disruptive changes to trade relations, limits on migration, and confrontational exchanges between policymakers “contribute to heightened or prolonged currency and other financial market volatility.”

These potential risks, the agency argues, would stunt economic growth and put pressure on public finances that could “have rating implications for some sovereigns.” External financing difficulties, particularly if accompanied by currency depreciation, could also alter a country’s ratings.

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The agency said that the countries most at risk from adverse changes to their credit fundamentals are those with close economic and financial ties with the US, and which are under scrutiny due to either existing financial imbalances, or perceptions of unfair frameworks or practices.

“Canada, China, Germany, Japan and Mexico have been identified explicitly by the administration as having trade arrangements or exchange rate policies that warrant attention,” said Fitch. “But the list is unlikely to end there.”

Any action the Trump administration takes that limit trade flows with one country will have cascading effects on others, according to Fitch. It added that regional value chains are especially well developed in East Asia, focused on China, and Central Europe, focused on Germany. Both countries have been accused of exploiting or manipulating their respective local currencies by Trump.

“In assessing the global sovereign credit implications of policies enacted by the new US administration, Fitch will focus on changes in growth trajectories, public finance positions and balance of payments performances,” the agency said, “with particular emphasis on medium-term export prospects and possible pressures on external liquidity and sustainable funding.”

Fitch also warned that countries hosting US direct investment are at risk of being singled out by the Trump administration for punitive trade measures. The countries with the highest US investment in manufacturing are Canada, the UK, Netherlands, Mexico, Germany, China and Brazil.

Despite the warnings, Fitch pointed out that some elements of the administration’s domestic economic agenda were positive for growth, such as increased spending on US infrastructure investment, deregulation, and tax cuts and reform – as long as they don’t cause the US government’s deficit and debt to balloon. It also suggested that the chaotic nature of the White House could just be a case of growing pains for a new administration.

“One interpretation of current events is that, after an early flurry of disruptive change to establish a fundamental reorientation of policy direction and intent, the administration will settle in, embracing a consistent business- and trade-friendly framework,” said Fitch.

Nevertheless, “the present balance of risks points toward a less benign global outcome,” Fitch said, citing the Trump administration’s exit from the Trans-Pacific Partnership, its objection to the North American Free Trade Agreement, its rebuke of US companies that invest abroad, and its accusations of currency manipulation against foreign countries.

“The full impact of these initiatives will not be known for some time, and will depend on iterative exchanges among multiple parties and unforeseen additional developments” said Fitch. “In short, a lot can change, but the aggressive tone of some administration rhetoric does not portend an easy period of negotiation ahead, nor does it suggest there is much scope for compromise.”

-Michael Katz