When duty clashes with public policy

State and local public pensions are in the cross hairs. Collectively, they are underfunded by between $1 trillion and $3 trillion (depending on earnings rate assumptions) and are a major reason for the precarious fiscal condition of thousands of state and local governments. Headlines about credit-rating downgrades, investor reluctance to invest in municipal bonds and municipal defaults have added urgency to the inevitability of reform.

The methods available for governments to address public-pension reform include increasing taxes, cutting services, reducing employment, reducing benefits or increasing employee contributions. Which tools are used in a given circumstance are matters of public policy, political ideology and fiduciary accountability.

Almost all states have constitutional, statutory or common-law protections for public pensions. However, as state and local governments struggle, protections are being changed or tested through state-level legislative initiatives. Legislation introduced in Michigan is an interesting case study.

OUT OF PUBLIC’S HANDS

About 85% of the nearly 900 municipalities in the state are members of the Municipal Employees' Retirement System of Michigan. MERS is an independent, public nonprofit organization offering defined-benefit, defined-contribution or hybrid retirement plans. Under Michigan law, a municipality must have voter approval to withdraw from MERS.

Bills introduced in June in both houses of the Michigan Legislature would permit an exit from MERS with approval by a majority of the municipality's governing body rather than of voters. The governing body could revoke MERS participation for all members in a plan, or for any division, subset or collective-bargaining unit of the municipality.

The bills would give governing bodies other new powers, including the ability to change the benefit program and member contribution programs that apply to employees, including curtailing or eliminating a member's accrual of future benefits and setting eligibility criteria for employee participation in a defined-benefit plan. A municipality that leaves MERS would have to engage a qualified actuary to analyze its contribution requirements associated with revocation of participation or a change in coverage, and would be required to fund the requirements.

Proponents of the new bills argue that voters are unlikely to have the time, inclination or skill to evaluate plan options, make informed decisions about dismissing or engaging plan providers, and make other difficult choices about public-employee retirement plans. They also contend that making it easier for municipalities to exit MERS will foster competition among plan providers and help drive down costs.

Opponents counter that managing the retirement assets of public employees is a long-term process that entails considering commitments to plan participants and beneficiaries, and a municipality's future ability to hire employees. If governing bodies are the decision makers, foes say, long-term issues might be addressed in a short-term context and the process may be distorted by political agendas.

Opponents also argue that making it easier to depart MERS will undermine the efficiencies that come from managing assets in a large pool, rather than a number of separate plans, thereby raising costs instead of saving them.

COMPLEX ISSUES

Public officials generally are considered to have a fiduciary responsibility to serve citizens' best interests. By necessity, they have considerable latitude in determining what those interests are and how competing interests — such as those of public employees and of taxpayers — should be balanced. That flexibility tends to make it difficult to hold officials accountable for failing to adequately consider all the fiduciary ramifications of their decisions.

The fiduciary duties of the trustees of public retirement funds are well-defined in law and regulation, and the trustees are accountable for fulfillment of these responsibilities. Trustees owe a duty of loyalty to the participants and beneficiaries of the plan. They must avoid conflicts of interest, and exercise the skill and prudence required of those who manage others' money. Though trustees may be for or against proposed legislative or regulatory changes according to their views of whether such action would be in the best interests of participants and beneficiaries, they must in the end deal with whatever decisions are made.

Blaine F. Aikin is chief executive of fi360 Inc. and a member of the steering committee for The Committee for the Fiduciary Standard.