As mentioned above, the phrase “transition costs” is misleading when applied to the unfunded liability, since the underlying cost of pension benefits does not change as a result of closing the plan. The shift in accounting treatment to a level-dollar schedule is a matter of the timing of the payments of that cost.
Moreover, if the state met the level-dollar payment schedule, it would actually lower the net cash necessary to pay down the unfunded liability. The earlier payments would essentially allow deposits into the plan to grow over longer periods of time. This, in turn, would allow the total deposits over time to be smaller than they would be under a backloaded level-percentage payment schedule.
The state’s current timing of payments is questionable. The amortization period for the net unfunded liability in the MPSERS defined-benefit plan was stated as 26 years in the 2010 annual actuarial valuation. Since the average active plan member was 45.2 years old in fiscal 2010, this amortization period far exceeds the likely remaining working life of the average MPSERS plan member. The better policy would be to ensure that the benefits are fully paid up — i.e., that the unfunded liability is completely paid down — as workers retire. This would imply a much shorter period for the amortization window — say, 15 years — and require more cash regardless of whether the payment schedule involves a level dollar or a level percentage.
In that sense, the state could consider embracing the level-dollar funding policy of a closed defined-benefit plan and simply paying more cash up front. In fact, it’s not clear the state should be using a level-percentage funding policy in the first place. The number of MPSERS active members and their corresponding payroll has been decreasing, rather than increasing, of late. According to the SFA, payroll hit a peak of $10.4 billion in fiscal 2004, but declined to $9.9 billion in fiscal 2009, the most recent year for which SFA provided data. This decreasing payroll and number of active members simulates the dynamics of a closed plan and would presumably call for the more conservative treatment of a level-dollar reporting schedule.
The state already has some precedent for devoting more cash to liabilities of the pension system. The 2012 budget includes $280 million in extra money from the state’s general fund to begin prefunding MSERS retiree health care costs.
The state has also recognized that more cash may be necessary to prefund MPSERS retirement benefits. In the past, the state has assumed an 8 percent annual rate of return on the investment of MPSERS’ assets, but Public Act 75 of 2010 revises the assumed rate of return to 7 percent for the assets of members who joined MPSERS on or after July 1, 2010. This lower rate assumption increases the amount of upfront cash required to prefund MPSERS pension benefits.
Regardless of whether the state pays its unfunded liabilities using a backloaded or a flat (and therefore relatively frontloaded) method, the payments do not represent an increased expense for the underlying benefits paid to participants. Hence, this discussion of level-percentage and level-dollar payments is entirely one of timing. The state developed its unfunded liabilities by deferring the costs of compensation into the future, so the difference has to be made up at some point. Doing it sooner rather than later is justifiable, even though it means that the state Legislature has to forgo other spending in the near term. In other words, simply abiding by the change to level-dollar payments may be appropriate.