Tier 6 Costs and the new 7% Interest Rate - June, 2012

Now that the final specifics of Tier 6 have been locked into place and the legislature is about to adopt a new reduced assumed rate of interest (7%), I wanted rework my previous cost estimates for an average Tier 6 benefit.

I just caught the story that North didn't put a fiscal note of his new 7% assumed interest rate recommendation. This is after delaying his recommendation for three years. This forced the governor to issue a message of necessity. He hates doing that especially for someone else. Of course, this allows North to avoid giving the plain English specifics of this proposed legislation.

For instance, this law will allow the the city to postpone replacing the pension investment expenses paid in FY-2010 and any years later. There was a $493M payment scheduled to be made in FY-2012 and a $453M payment to be made in FY-2013. They will be rolled into long term pension costs paid back over 22 years. This was quite a trick on North's part.

If a person starts working at age 21 for the city under Tier 6 with a salary of $25,000 and retires at age 63 with a final salary that went up 2.5% per year ($67,126), his/her pension would be $45,215 after 42 years of service with the city.

If NYCERS earns an annual rate of return of 7% on its investments and uses a 7% annuity factor, this benefit will only cost the city 2.15% of payroll, $39,151, over the 42 years. That is an average of $933 a year. The employee will have contributed $60,127 over the 42 years.

Even though 7% is better than 8%, it is still far from realistic. Unfortunately, a more prudent 5% interest rate would also be a more costly interest rate. The bottom line with 7% is that the city is still underfunding its pension costs, even the reduced Tier 6 benefit structure.

In contrast to the 7% assumption, if NYCERS uses a 5.5% target on its investments and uses a 5% annuity factor, the city's cost for the $45,215 benefit rises from 2.15% to 4.43% of payroll, $80,670, over 42 years. That is average of $1,921 per year.

I know these numbers just make peoples eyes glaze over but that is one of the reason poor decisions continue to be made. If done right, pension can have reasonable costs and reasonable benefits.

As I have said before, it is every clear how important it is to the city and the employee that the pension fund trustees are prudent about their investment decisions. High risk/high cost strategies do not work for pension funds.