A recent article described the condition of the Michigan State Employees pension plan. This from the article[1] (emphasis added):
Michigan’s major government pension funds are underfunded and will require billions for the foreseeable future just to begin catching up. But some argue that multiple years of solid investment growth will eliminate this problem. While nothing would alleviate pension problems like a few years of solid returns, it is unlikely that such sufficient growth will occur.
A report from consultants R.V. Kuhns and Associates looks at the possibility that the state will return to full funding with investment growth. Currently, the state assumes that it will get an 8 percent return on the money it sets aside to pay for pensions (though a small percentage of the teachers’ fund assumes a 7 percent return). The state, however, has received on average 5.5 percent to 5.7 percent since 1997. This is one of the main reasons why the state government’s pension system for public school employees is underfunded by $17.6 billion. In order to catch up on liabilities, the report shows that returns would need to average 11.7 percent to 12.7 percent for the next decade.
The report also uses a series of assumptions about investment performance. Only under the rosiest of scenarios will the funds return to full strength by 2020, a “75th percentile” event (see report for more details).
The state can ensure that it has enough money to pay for retirement benefits already earned by closing its pension fund to new members. This contains the increase in unfunded liabilities while offering new employees affordable retirement benefits.
In order to catch up on liabilities, the returns experienced by the pension fund would need to average about 12% per year for the next ten years. Given how pension funds must invest under the law, this isn’t likely. It’s more likely in my view that newer workers under the pension system will end up paying more for less; or, be required to work longer to get the same level of benefits.
Sadly, this is not an isolated incident. In my book, “Economic Consequences,” I note that underfunded pensions at the state and municipal level is a $3 to $4 trillion problem.
[1] Hohman, James M. January 20, 2012. “Analysis: Michigan Cannot Grow Out of Pension Problems.” http://www.michigancapitolconfidential.com/16330
