Thursday, February 9, 2012

Endless Dance on 8%

Based on recent newspaper articles it appears that the NYCERS actuary, Bob North, has finally decided on a new five year interest rate assumption of 7% down from the current 8%.

Ever since the summer of 2002 North has known that the 8% interest rate assumption was too high. The only question was how far off the mark was it and what was the correction going to cost.

The current mayor came into office in 2002 with a budget crisis caused by the dot.com bubble and the 9/11 attack. The last thing he want to do was start paying higher pension bills. In fact he didn't even want to pay the 8% costs. He was able to get Albany to give him a three year discount on the full 8% pension costs. So from FY-2003 to FY-2005 the city underfunded the five pension funds.

In the spring of 2004 when NYCERS needed to adopt a new five year interest rate assumption, North recommended keeping the interest at 8% in spite of serious investment losses. Since 2009 when that five year period ended, North, for three years running, has put off making his recommendation on a new five year interest rate assumption.

It now seems he is ready to propose a change from 8% to 7% along with a creative scheme to lessen the cost impact of the change. Unfortunately, even 7% is overly aggressive especially with the Federal Reserve lending the banks money at an almost zero rate. Over the last eleven years the city pension funds have earned an annual rate of return of only 5.1% even with the great closing market figures of June 30, 2011. Of course, this also assumes you believe the fairy tale values that the pension funds report for their private equity and real estate holdings.

Four Problems, Not One

There are basically four pension worlds in NYC. They are the teachers fund, the police fund, the fire fund, and everyone else. "Everyone else" includes correction officers (8,900) and sanitation workers (7,500).

This year, FY-2012, the city (not including the other employers) is ponying up $2.66B for the teachers fund , $2.20B for the police fund , $0.96B for the fire fund, and $1.58B for everyone else. There are significantly different cost structures in each of these funds. It is not constructive to talk about them as if they were one system.

It also doesn't help to throw health insurance costs into the mix. That is a totally different issue with different problems and solutions. For instance, the city could choose to self insure but that would make EmblemHealth extremely unhappy.

Each pension fund has its own particular problems. Police and fire members retire at an early age. Fire fighters have a huge accident disability issue. Since 2009, new police officers and new fire fighters are trapped in the old 1976 Tier 3 benefit with significantly lower benefits than pre-2009 members. Teachers are paid significantly higher salaries than the average city worker and their union has enormous political power. As an example in the spring of 2008 the mayor agreed to give the teachers an improved pension plan with an age 55 & 25 year service requirement. The teachers in the fall of 2009, however, agreed to lower Tier 5 pension benefits for new teachers (Chapter 504/Laws of 2009).

The average city worker ("Everone else") catches a lot of heat over their pensions. But $1.56B for 112,000 workers is a lot cheaper than $2.2B for 35,000 police officers. In light of the Tier 5 structure now in place for new state workers Albany will have to extend that structure to new general city workers.

The primary source, however, of the current pension shortfall for all city pension funds is the miserable investment returns nationwide over the last eleven years. In addition the trustees of the city pension funds have made the situation worse by their overly aggressive investment decisions and their tolerance of run away investment fees.

Last year the trustees are on record as having paid out $395M in fees. Assuming that figure is correct, this significantly increases annual pension costs. The city and the other participating employers must pay back that $395M to the pension funds in FY-2013 along with 8% per year interest (maybe 7%) for the two year lag.

While benefit reform will take years to save money, investment reform will show significant savings immediately. It is obvious that even a 6.1% rate of return over the last eleven years would have saved the pension funds $11B and if the fees were kept at $100M a year, the assets would be an additional $1.2B higher.

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