Many US states find themselves with surplus funds after significant support from ARPA legislation. Although direct DB pension plan support was not a permitted use of the ARPA proceeds, states with surpluses are looking for ways to prop up their underfunded systems. One state, Michigan is considering making available to its municipalities $1.15 billion in state grants to help pay down the unfunded pension liabilities.

“House Bill 5054 would make $900 million in grants available to municipalities with pension plans less than 60% funded and $250 million for those that are at or above the 60% mark if the governmental units agree to a series of conditions (my emphasis).” source: (The Bond Buyer)

The proposed legislation would also direct another $350 million to the state police retirement system. Local government groups are said to be in favor of this proposal as the state contemplates the allocation of $7 billion in surplus revenues.

Importantly, these grants would come with conditions that I believe are quite appropriate for plans that are as poorly funded as those that would be eligible to receive the payments. Pension systems that are <60% funded must make all actuarially determined contributions and hold the discount rate and the assumed rate of return (ROA) at current levels or lower. Furthermore, they must adopt the most recent mortality tables recommended by the Society of Actuaries and they must not enhance benefit payments for 10 years after accepting the grant or the local unit must repay the full value of the grant.

Future benefit increases can only be adopted if the system is 80% funded and the value of the new benefit is 100% funded. We, at Ryan ALM, are huge supporters of DB pension systems, but we believe that the current pension promise should absolutely be secured before benefits are enhanced. It makes little sense to us that pension systems jeopardize the plan’s overall funding in an attempt to elevate current payouts. The legislation limits Grants to a maximum of $100 million per system.

It is great to see legislators utilizing excess funds to sure up their pension systems. Poorly funded plans are hard-pressed to close the funding gaps through investment returns only. Remember that a 50% funded plan must beat the ROA by twice in order to maintain the funded status. Yes, a plan that is 50% funded and has a 7.5% ROA objective must generate at least a 14.5% annual return, or the funding gap grows in $ terms. How likely are we to see above-average returns from the capital markets given the extraordinary returns achieved in the markets since the Great Financial Crisis (GFC)? When investments fail to achieve the objective plans must contribute more. House Bill 5054, if passed, shows that the legislators are not waiting to see if Michigan plans fall short of their objectives. Good for them!