Path to Healthy Pension Funding Laid out to Council

Planning and financial discipline are projected to help shore up East Lansing’s lagging pension fund, city officials were told recently.

As of the end of 2022, the pension fund is 63% funded, slightly more than a year prior but still in the bottom third among Michigan cities employee pension plans, according to the Municipal Employees Retirement System (MERS) of Michigan. The agency administers East Lansing’s pension system.

MERS representative Marne Daggett told council at its March 12 meeting that in the MERS system as of 2022, 94 Michigan municipal pension systems are 100% funded; 105 are in the 90s (percent); 138 in the 80s; 185 in the 70s; 126 in the 60s; 63 in the 50s and 35 are below 50% funded.

Daggett explained that it’s harder for older pension systems like East Lansing’s to pump enough money in to match what will be paid out to current and future retirees.

“It’s difficult when you have a cash flow going out, you’ve got a lot of people drawing, and fewer people in the system [contributing],” Daggett said.

A history of East Lansing’s pension funding that was included in the MERS report given to City Council at its March 12 meeting.

Ideally, the East Lansing pension plan will be at least 75% funded, according to City Manager Robert Belleman. East Lansing offers a hybrid pension of both a defined benefit and defined contribution plan. Employees pay 10% of their wages into the system.

Belleman told ELi that younger, wealthier municipalities tend to have a higher funding percentage.

“When you have a more mature municipality like East Lansing, that has existed for a long time, because they [the city] probably have not set money aside, their liability is going to be greater,” Belleman said.

“This plan will not be fully funded,” he continued. “There will always be liability as long as there are beneficiaries of this plan.”

As of the end of 2022, the city had 409 retirees drawing from their plans and 291 active employees paying into the system, Daggett said. Another 106 vested former employees will draw money from the system when they reach eligible age.

Pension fund ratios are calculated by dividing the value of assets – mostly invested money – by actuarial liabilities. Those liabilities include payouts to current pensioners and future retirees who are vested. Plans do not need to be 100% funded but East Lansing has had concerns for years about its low funding percentage.

In 2022, East Lansing paid about $17 million to fund the pension plan, well above its minimum requirement of about $9.8 million. Overall, the city has about $232 million in liabilities and $147 million in assets, leaving about $85 million in unfunded liability, Daggett said.

East Lansing pension funding if the city pays its minimum amount each year. Lately, the city has been paying significantly more than the minimum. (From March 12 agenda packet)

One MERS projection showed if the city puts in about $16 million per year, it will reach 80% funding around 2031, Councilmember Erik Altmann pointed out.

“I think it’s still within the doable realm of what you’ve been doing,” Daggett said. “It sounds like a lot of big numbers, and they are, but you have kind of a plan in place.”

Additionally, though not currently reflected in MERS projections, the city will receive a roughly $7.6 million boost in 2023 from the Protecting MI Pension program, Daggett said. The program dedicated around $750 million in grants to municipalities struggling with pension payments around the state.

There is work to do, but projections show a path to a healthy pension fund balance.

Much of Daggett’s presentation focused on predicting where East Lansing will be down the road based on projections like retirees life expectancy and how much the pension fund earns from investments. The projections assume the city will see a 7% return on its investments each year. Daggett said MERS uses “smoothing” calculation that spreads excess gains or shortfalls over five years to avoid volatile movements in funding.

A screenshot from a MERS video that explains how investing shortfalls or excess gains are spread over five years to avoid volatile funding. (From MERS website)

The year 2022 was a bad year for investments, with returns at minus 10.6%, Daggett said. On the other hand, investments returned “positive 13 or 14%” in 2020 and 2021.

In 2023, investments returned 11.9%, Daggett said. Those returns are not reflected in the projections being shared.

Daggett said it is “to be commended” that the city made a 2 percentage-point gain in its funding ratio in 2022 – to 63% from 61% – despite the market down year.

Notably, in 2031 the city’s income tax is set to expire. The income tax has been in place since 2019 and serves as a vital source of income for the city. The income tax is structured so 60% is dedicated to paying off the pension liability, 20% goes toward police and fire protection and 20% is spent on infrastructure.

The amount generated by the income tax fluctuates, but in fiscal year 2022, for example, the tax brought in $14.1 million.

East Lansing is not the only place where underfunded pension plans are a problem.

For some time, there was no government standard that included pension plans in audits. As a result, municipalities nationwide did not properly fund plans and the liability costs spiraled. Eventually, government standards required pension funding be included in annual audits, Belleman explained.

“When that came about, it really shined a light on a lot of municipal employers plans being underfunded,” he said.