Thursday, April 08, 2010

Michigan's Pension -- Who Will Pay The Bill?

The following is from my article in The Center for Michigan's Newsletter -- this version contains the supporting links to pension documents:


The Michigan Public School Employees Retirement System (MPSERS) is on a doomsday course to fiscal ruin, while continuing to assert its own financial health as “good.” Using aggressive accounting and market assumptions, the appointed board of MPSERS is growing the funding deficit by billions each year beyond the funds reported deficit. This hidden and unreported underfunding amounts to as much as $12 billion and is in addition to the reported loss of over $17.9 billion in assets for the last two years. Warren Buffett has said, “pension accounting encourages cheating,” and MPSERS engages in aggressive pension accounting.

To clarify, MPSERS manages two programs for all public school and university employees and retirees; a pension fund and an “Other Post Employment Benefits” (OPEB) fund which pays for health, dental, and vision benefits for retirees. Both funds are currently underfunded with significant ongoing liabilities. In forecasting the future funding requirements and current shortfalls for both funds, MPSERS uses three significant accounting and assumption manipulations which lead to significant distortions of the total underfunding.

The first issue is called “smoothing,” a reporting technique designed to minimize the impact of short term adjustments or market fluctuations. Smoothing works for short periods, but it results in understating pension funding needs during a downturn. With the use of smoothing MPSERS currently reports it has unfunded liabilities of only $34.9 billion. While a $35 billion deficit is very severe, the actual picture is much worse.

By removing smoothing the unfunded liability balloons to between $45 to $47 billion or more. This unfunded liability represents an obligation of nearly $30,000 per student for every child in Michigan’s K-12 system as of today.

For context, the funding required to meet MPSERS obligations (pension and OPEB) is over $4.0 billion annually, with a recent annual growth rate of over 5.8% However, contributions to the MPSERS system totaled only $2.1 billion representing an increase of 0.6% over the prior year. So while payouts are growing at nearly 6%, contributions have been growing at less than 1%. This creates an accelerating financial death spiral where assets are continuously withdrawn faster than they are being replaced.

This highlights the second issue -- the ability for MPSERS to continually defer the necessary contributory requirements. MPSERS’ 2009 fiscal year financial statement shows that total contributions for OPEB should have been nearly $1.8 billion higher than they were. So while schools transferred $1.5 billion out of operating budgets and shifted it to MPSERS, the contribution should have been $3.3 billion. Viewed on a per student basis the actual contribution was over $1,015/student. Yet MPSERS footnotes that it should have been over $2,184/student, or nearly 26% of the net foundation allowance of $8,324 (after the $165 proration). Left unchecked, the full cost of OPEB benefits will break school operating budgets.

The third issue is MPSERS use of aggressive assumptions for annual investment returns. Over the past 5 years, MPSERS investment return has been 4.2% The 2009 FY MPSERS projection model used an investment rate of return of 8.0%, nearly double the return of the past 5 years. Reducing the projected investment performance to 6% (closer to the 6.5% Warren Buffett employes for his pensions), the unfunded liability increases an additional $13 billion to nearly $60 billion. By using unduly optimistic projections, MPSERS disguises the size of the reported unfunded liability.

This leads to one final point. The actuarial firm charged with developing and validating the assumptions used in MPSERS’ model states that the data is audited annually. However, the Auditor states in its annual letter to the fund that, “The introductory, investment, actuarial [emphasis added], and statistical sections have not been subjected to the auditing procedures applied in the audit of the basic financial statement and, accordingly, we express no opinion on them.” In essence, no one is checking the underlying assumptions thus allowing MPSERS’ board to determine its own financial health while smoothing massive losses, underfunding contributions, and employing aggressive assumptions for forecasted returns. Stripped of manipulations, it’s clear that MPSERS has mortgaged the future of Michigan’s taxpayers and children with a debt we cannot afford.

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