Wednesday, June 26, 2013

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.

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