Tier 6: Benefits vs Costs

I've created a spreadsheet modeling the pension benefit for a typical long term city worker under Tier 6. Comments about problems with public pension plans rarely go into specific details relating benefits with costs. It is always helpful to examine the details to get a true picture of problem.

Let us assume a city employee starts working for the city (and joins NYCERS) at age 22 with a salary of $25,000. If the member gets on average a 2.5% pay increase each year (probably too optimistic) and works to age 55 or age 63, his/her annual pension benefit under Tier 6 will be:

• Age 63: $51,768 based on a five year avg. salary of $65,527, 42 years of service, and $60,127 required employee contributions.
• Age 55: $17,619 based on a five year avg. salary of $53,782, 34 years of service, and $42,428 required employee contributions.

What is very interesting about these benefits is how the city's cost for theses benefits fluctuate based on what NYCERS actually earns on its investments.

Currently NYCERS is using a 7% assumed interest rate (AIR) for its assets. (See Chapter 3 of the Laws of 2013 .) This is the rate of return that NYCERS projects that it will earn each year on its assets. NYCERS also currently uses 7% annuity factors to calculate the present value of pension benefits at the point of retirement. Again, this is a rate of return assumption over the lifetime of the retiree.

The city's costs for these two benefits under the 7% assumption are:

• The age 63 benefit has a present value of $495,566 which requires the city to contribute $52,809 over 42 years or 2.9% of salary each year. This amount along with the $60,127 contributed by the member will generate a sum equal to $496,983 at retirement.
• The age 55 benefit has a present value of $193,213 which requires the city to contribute $17,099 over 34 years or 1.3% of salary each year. This amount along with the $42,428 contributed by the member will generate a sum equal to $193,966 at retirement.

If, however, NYCERS earns on average only 5% on its assets, the cost to the city changes significantly. This would also require NYCERS to use a 5% annuity factor at retirement to calculate the benefit's present value. As a historical note NYCERS used 4% annuity factors up until the late 1980's when it switched to 7% factors to blunt the cost of eliminating gender discrimination ordered by federal courts. The change in costs for a 5% rate of return are listed below:

• The age 63 benefit has a present value of $587,356 which requires the city to contribute $152,964 over 42 years or 8.4% of salary each year. This amount along with the $60,127 contributed by the member will generate a sum equal to $586,272 at retirement.
• The age 55 benefit has a present value of $235,984 which requires the city to contribute $61,820 over 34 years or 4.7% of salary each year. This amount along with the $42,428 contributed by the member will generate a sum equal to $235,870 at retirement.

It is incredibly clear from these figures ($52,809 vs $152,964) that the NYCERS trustees must be consistently successful with their investment decisions. There needs to be a hard and open review each year on whether the trustees made the 7% target or failed to get the job done. It can not be hidden in executive sessions behind closed doors. There must be a public record of investment failures. You only have to look at Detroit. It is the workers and retirees who are at risk of being destroyed. The trustees are long gone working for hedge & private equity funds.

At the very least, the NYS Department of Financial Services should be critiquing the investment performance of all seven public pension funds in New York State. The last report only covers up to 2002, which is over 11 years ago. It is strange that DFS will be starting a new audit at NYCERS in FY-2014 and they still haven't produced any report since 2002.

Finally the Actuary Gets 7% "Net of Expenses"

On January 30, 2013, the governor signed the law changing the assumed interest rate for the five city pension funds from 8% gross of expenses to 7% net of expenses. This new rate is effective as of July 1, 2011. The rate should have gone into effect on July 1, 2009 when the five year term of the old 8% rate ended. That is two years of underfunding for all of the city pension funds. That does not mean that the new rate is an appropriate rate, just better.

I love Bob's little twist on the new rate, "net of expenses". In plain English this means the new rate is actually higher than 7% when compared to the old 8%.

The expenses in FY-2012 were $486.7M($370.3M investments and ($116.4M administrative). The assets as of June 30, 2011 were $111B. A 7% return is $7.777B, add on the $486M and you have $8.263B. That is a 7.4% rate needed to cover the 7% "net of expenses". The bottom line is that the target rate for 2012 was 7.4% gross of expenses.

Unfortunately, for FY-2012 the five city pension funds fell short of their target by $5.963B. Over the last 13 years the shortfall is $38.375B. Either the trustees are going to have to ramp up their investment skills or the taxpayers are going to have to continue to cover their losses.

7%: in limbo

I recently commented on the actuary's recommendation and proposed legislation dealing with a new interest rate assumption .

Strangely, the proposed bill was not passed by the legislature in Albany. There was a third bill introduced, S.7804, along with the original two, S.7646 and S.7693. They all seem to be in the rules committee.

I wonder what the budgetary impact will be due to the delay. The city had put aside $900M for this contingency in FY-2012.

The New 7% Law - Pension Costs for the City

The legislature is looking at two pieces of proposed legislation dealing with the assumed rate of interest for the five city pension funds. The two pieces of legislation both incorporate the NYCERS & TRS actuary's recommendation for a new five year assumed interest rate dropping it from the current 8% to 7%.

The recommendation is three years late. The actuary has not written a fiscal note for either of the two bills. I suspect the actuary doesn't want to be on record describing the details of his own recommendations. Both bills are the same except for language dealing withh the FDNY VSF funds and possible funding shortfalls in those funds.

The actuary is appointed by the NYCERS trustees and the NYCTRS trustees. He is, however, paid directly by the city or in other words by the mayor. His annual salary is $250,000.

In the table below is the budget impact of the interest change. There are many other changes being implemented at the same time which I will outline below.

System	City Amounts			All Members	All Retiree
	FY-2012 & 8%	FY-2012 & 7%	FY_2013 & 7%	June 30, 2010	June 30, 2010
TRS:	$2,564.4M	$2,656.4M	$2,755.0M	130,620	72,356
Police:	$2,203.7M	$2,432.7M	$2,441.0M	37,281	44,634
NYCERS:	$1,423.0M	$1,569.M	$1,618.5M	213,255	132,487
Fire:	$948.7M	$1,004.7M	$1,005.4M	11,136	17,140
BERS:	$161.7M	$213.7M	$204.5M	27,184	13,969
Contingency for 7%:	$950.9M	***	**	***	***
City Totals	$8,252.5M	$7,876.6M	$8,024.3M

Note: Only 55%, approximately, of the NYCERS members & retirees are city workers.

The impact of the interest rate change has obviously been blunted. But it is also clear from the chart that pension costs vary greatly over the work force. This in turn creates difficult management problems. I don't pretend to have solutions for them but they should not be hidden behind blanket characterizations.

As I previously noted, this legislation allows the city and the other participating employers to amortized investment expense costs rather than pay them two years later. This created a significant short term savings in pension costs starting in FY-2012, the year that the 7% rate becomes effective. Specifically, the savings for FY-2012 will be $493M and for FY-23 $453M.

In FY-1997 the pension funds started paying these investment expenses directly as opposed to the city paying them out of the Comptroller's operating budget. In 1999, legislation was passed requiring the city and the other employers to reimburse the pension funds the following year for these expenses plus one year's interest. This was done to separate long term liabilities from short term expenses. In 2006, legislation was passed to change the payment year from one to two years later plus interest.

The proposed legislation also has provisions to guarantee the VSF funds. Listed below is the wording for the Correction VSF at NYCERS. There comaparable sections for the two Police and the two Fire VSF funds. These provisions may or may not be necessary but they definitely have nothing to do with the assumed rate of interest for the pension funds.

§ 6. Subparagraph 3 of paragraph (e) of subdivision 4 of section 13-194 of the administrative code of the city of New York, as added by chapter 255 of the laws of 2000, is amended to read as follows:

(3) Except as otherwise provided in subdivision eleven of this section and in sections 13-195 and 13-195.1 of this chapter, nothing contained in this section shall create or impose any obligation on the part of the retirement system, or the funds or monies thereof, or authorize such funds or monies to be appropriated or used for any payment under this section or for any purpose thereof.

§ 7. Section 13-194 of the administrative code of the city of New York is amended by adding a new subdivision 11 to read as follows:

11. In the event that, for any calendar year covered by a payment guarantee, the assets of the variable supplements fund are not suffi- cient to pay benefits under this section for such year, an amount suffi- cient to pay such benefits shall be appropriated from the contingent reserve fund of the retirement system and transferred to the correction officers' variable supplements fund.

The mayor, in his FY-2013 budget presentation, stated the following recommendations from the actuary:

1. Seven percent actuarial interest rate assumption (legislation)
2. new life expectancy tables
3. new experince relating to rates of retirement and disability
4. a new funding method, Entry-Age Normal Cost Method (legislation)
5. implementation of a market value restart

There was no mention of the delay in paying investment expenses or the mandated funding for shortages in the VSF funds. In addition the market value restart (taking immediate credit for the current recovery in the market) provides funding relief but is not sound actuarial practice.

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.