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Michigan Pension Reform Proposal May Be ‘Too Optimistic’

Could it be a stretch to assume a 7.5% return?

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.

“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