Council Indicates Continued Support for Pension Credit Purchases

Responding to a report published on February 12 by ELi, on Tuesday the East Lansing City Council discussed continuing to allow City employees to invest their own money in the East Lansing pension system through Council-approved purchases of “pension service credits.”

Council has been voting unanimously in favor of these employee requests, and several members of Council indicated at this week’s meeting they plan to continue to do so, primarily because they see the financial risk to taxpayers as very low and the benefits to employees as a positive. Some Councilmembers also urged the City Manager to use the new e-newsletter of the City to explain the issue to residents.

As we reported, service credit purchases are paid for by employees but must be approved by City Council. If the assumptions put into the cost calculations turn out to be wrong, it could cost the City in the long run.

At this week’s meeting, Councilmember Aaron Stephens summed up his support of the service credit purchases this way: “It is beneficial on both ends because money goes into our system and goes into their pockets.”

Mayor Pro Tem Erik Altmann emphasized that, because these service credit purchases make up such a tiny amount of East Lansing’s pension system, the risk is almost infinitesimally small. “I don’t think it impacts us in a material way,” he said.

Throughout the meeting, in his remarks, Altmann framed the issue as one of support or lack thereof for City employees and their pensions: “If you think pensions are bad, then you should attack service credit purchases.”

Altmann noted that the assumptions going into the service credit purchases were more conservative than general pension assumptions, and “they are fully funded by the employee. They don’t cost us a dime.” He said criticism of Council’s approval of service credit purchases “is really an attack on pensions.” He strongly supported City employees having the opportunity to buy service credits.

A response to this came from Councilmember Ruth Beier, who is a labor economist with the Michigan Education Association, the teachers’ union. “I will play the devil’s advocate,” she said, noting that the standard of the Pension Benefit Guarantee Corporation (PBGC) is that pension systems with low funding ratios should not approve purchase of additional service credits. (The PBGC does not insure public employee pension systems.) Right now, the City’s pension system is funded at only about 50%, and at such a level, the PBGC would say “you’re not allowed to offer service credits,” according to Beier.

She explained, “Somebody thinks that adding more years to an unfunded system is dangerous.” But, Beier said, the particular assumptions made today by MERS for individual service credit purchases are “actuarially sound” in their particular assumptions.

At the meeting, City Manager George Lahanas presented a memo that the City requested from the Michigan Employees’ Retirement System (MERS), which East Lansing uses to manage its pensions.

The memo emphasized that, in determining how much employees must personally pay to buy an extra month or year of pension, “the MERS Board adopted a more conservative investment assumption of 6.75% [average annual rate of investment return] to insulate employers from potential additional liability.” Lahanas described the MERS service credit system to Council as “a rather methodical process with a conservative approach.”

In our report, we explained that “if the market does not perform at the average anticipated rate of 6.75% annual return, or employees live longer than expected, or the credits lead an essential employee to retire sooner than she or he otherwise would (necessitating replacement, leading the City in some cases to pay health benefits for both the retiree and new employee), the City could end up paying more for employment-related costs than it otherwise would.”

East Lansing’s Financial Health Team reported in 2016 that one reason East Lansing and many other Michigan cities are in trouble with their pensions is that MERS’ prior assumptions about life expectancy and rates of return turned out to be incorrect. Assumptions have been adjusted in recent years in response to new standards. If retirees who purchase service credits die sooner than expected or the rate of return is better, the City will benefit from the service credit purchases.

In our February article, we noted that the MERS actual rate of return from 2000-2016 (a period including the Great Recession) has averaged 6.09%. At Council’s meeting Tuesday, Lahanas provided a handout from MERS showing “A Track Record of Success.” In that, MERS shows data from 1983-2017 providing an “annualized 35-year rate of return for MERS Defined Benefit: 9.26%,” although this is “gross of fees,” meaning it does not reflect fees paid to MERS. (MERS’ chosen look-back period of 1983-2017 includes the Great Recession and bull markets before and after. It does not include the recession of 1981-82.)

In the discussion at Council, Director of Human Resources Shelli Neumann explained that buying service credits does not allow employees to be vested in the retirement system sooner, nor does it allow them to retire earlier than the City’s retirement rules allow. (When a City employee can retire involves a formula based on job, number of years worked, and age.)

Neumann did not address the issue of the cost to the City if the presumed financial benefits of the service credit purchases mean an employee who can retire decides to retire sooner than she or he otherwise would. If that person were entitled to retirement benefits like pension and a retiree health plan paid by the City, the number of years the City pays those benefits would be extended over the life of the individual.

The City would enjoy the cost savings of no longer employing that individual, but if the employee had to be replaced, the City would then be paying the replacement’s salary and benefits along with paying post-retirement benefits for the retiree. ELi asked Lahanas repeatedly about this possible financial downside before out February report, with copies of those emails going to City Council, but no response on this particular issue was ever received from Lahanas or anyone else.

The focus at Council this week was limited to discussing costs related to the pension system itself, which Council members noted, where service credit purchases are concerned, is miniscule compared to the overall cost of the pensions in East Lansing. Right now, the City owes about $180 million in pension obligations and has about $91 million saved to meet those obligations.

At the meeting, Altmann said he wants Council to consider passing a “blanket” approval that would mean automatic approval of any service credit request without them having to come individually to Council for approval. He added, “I think this is a benefit the bargaining units have gotten and the real scandal would be if we denied one of these requests. There’s no real basis for it. They have negotiated for it. I don’t want to signal we are not going to honor it.”

But Lahanas responded by saying the contracts say employees have the right to ask permission to purchase service credits, not that Council must approve the requests. Neumann agreed, saying, “We purposely wrote it that way.”

Meadows did not favor a blanket approval, saying, “I would resist delegating our authority” to staff on this issue. He said he thought it was good to continue to examine pension obligations, and favored more discussion of them.

Lahanas said more service credits purchase requests would be coming to Council next week, so he wanted to address the issue before that.

Stephens suggested Lahanas use the e-Dialog newsletter of the City to explain the issue to the public. Stephens said it was “important to be just as transparent as possible” and that “it is the responsibility of a responsive and transparent government to make sure when an issue is raised, we address it.” Meadows agreed it would be a good use of the e-Dialog.

Lahanas responded that “it might be obscure to them, but we could make a stab at it.” Councilmember Shanna Draheim said she hoped the City website would more generally make financial information more accessible to the public. She also indicated her own support for the pension service credit purchase approvals.