Monday, December 30, 2013

More Haze Over Long Island City

In September I wrote about the adoption of the NYCERS budget for FY-2014 at the March 14, 2013 NYCERS Board of Trustees meeting. I pointed out the scant reference to the issues surrounding the disaster recovery site at Long Island City (L.I.C.) in the executive director's written presentation on the budget. In a terse sentence she implied that the L.I.C. disaster recovery project was now functioning after an seven year delay.

I was curious whether any of the trustees had any questions at the meeting about this fiasco. So I made a FOIL request of the public minutes of the board meeting where the $52.2M budget was approved. This is the relevant exert form the minutes of the March 14, 2013 NYCERS Board of Trustees regular meeting:

All in favor?
(A chorus of "Ayes.")
Any opposed?
Motion carries.
Item 2 on the agenda is a report by the budget committee, of which I am chair, so I will report on that.

I think NYCERS really did an incredible job presenting their budget to us. There was beautiful and substantively informative PowerPoint presentation. All of the really knowledgeable staff was there to answer any questions we had. For me, I think everything was in order.

I don't know if anybody on the budget committee or anybody else has any questions?

A comment to echo your comments, Carolyn. I think Diane and staff did an excellent job of keeping the focus on member services, and also moving the institution forward in terms of technology and making progress in that regard. So I thank the executive director and staff for their efforts.

With that, a motion to approve the budget?

MS. D"ALESSANDRO(executive director):
...Then we move into the actual proposed budget for fiscal 2014 which is 2B(i) in your packet, and essentially it is the administrative budget for fiscal 2014 with $26,620,635 for PS expenses; $17,951,822 for other than personal expenses; qnd a total budget of $44,575,457 for fiscal 2014. (there is an additional $7.6M in fringe costs)

Any questions on this resolution?
Is there a motion to approve?


MS. STRYKER(Local 237, Teamsters):

All in favor?
(A chorus of "Ayes.")
Any opposed?
Motion carries.

As you can see from the quoted text above, that there was no substantive discussion about this major expenditure. The text is devoid of any concrete information other than the fact that the regular NYCERS admin budget for FY-2014 will be $44.5M. (actually $52.2M)

One thing that caught my attention was the comment about the "beautiful and substantively informative PowerPoint presentation". I thought that it would be wonderful to read the presentation given to the budget committee. So I made a follow up FOIL request for it. That was on October 18, 2013. I made a second request on November 11, 2013 and on December 3, 2013 I received the following response from NYCERS.

Please be advised that your request under the Freedom of Information Law for NYCERS PowerPoint presentation outlining the FY-2014 administrative budget given to the Trustees budget committee is being denied.

The information you are seeking is considered inter-agency or intra-agency materials. Said materials were not presented to the Board of Trustees or listed as an Agenda Item at any NYCERS Regular/Investment meeting.

If you wish to appeal this denial, please contact Diane D’Alessandro, (Executive Director) of NYCERS.

It is clear to me that this reason for denial is evasive and incorrect. Listed below is the exact wording from the state web site about this specific reason for denying a FOIL request:

(g) are inter-agency or intra-agency communications, except to the extent that such materials consist of:
i. statistical or factual tabulations or data;
ii. instructions to staff that affect the public;
iii. final agency policy or determinations; or
iv. external audits, including but not limited to audits performed by the comptroller and the federal government;
As per the meeting minutes, the Chairperson points to the PowerPoint presentation as the basis of the budget committee's recommendation for approval of the proposed budget.I think it is safe to say the document was the basis of a final agency policy or determination, the adoption of the agency's $52.2M FY-2014 administrative budget.

In addition, I suspect that the Budget Committee falls under the N.Y.S. Open Meetings Law. That means material provided to the committee is public record. I don't think the committee had any reason to conduct its meeting in executive session.

Needless to say, while I will never see this PowerPoint presentation, I am sure that the N.Y.S. Department of Financial Services auditors will demand to see this presentation. They should also demand a physical inspection of the L.I.C. site and observe actual full disaster drill, not some empty "trust me" claim.

You would think that NYCERS management would have been anxious to provide the public a clear picture of the status of the Long Island City disaster recovery site. Now, because of this failure to disclose, it seems reasonable to conclude that the PowerPoint presentation is inaccurate and a poor basis for adopting the FY-2014 budget. Besides the mess at Long Island City what other disasters are the NYCERS management hiding.

Tuesday, December 24, 2013

The IRS, Section 415(b) Benefit Limits and the NYCERS Excess Benefits Plan

As of October 1, 1987 the IRS imposed dollar limits (IRC S.415(b)) on pension benefits paid by tax exempt pension plans which included NYCERS.

Benefits in place at the time were grandfathered and were not subject to the limits. New NYCERS benefits legislated after 1987, however, were subject to the IRS limits. Failure to comply could have cost NYCERS its tax exempt status.

The limits did not become a real issue until the mid 1990's when members started to retire under post 1987 retirement plans (i.e. Chapter 96 Physically Taxing Age 50/25 Plan). Over time more and more members began having their benefits reduced.

In order to provide relief to governmental pension plans the IRS allows them to establish excess benefit plans (IRC S.415(m)) to pay out the difference between the full state statutory benefit and the reduced IRS benefit.

On October 19, 2004 the NYS legislature enacted Chapter 623 of the Laws of 2004 which created excess benefit plans (EBP) for the five New York City pension funds. This chapter also made the EBP's retroactive to July 1, 2000. See text below. As of that date, for all such reduced benefits, NYCERS was authorized to pay the difference via the EBP.

§ 7. This act shall take effect immediately and shall be deemed to have been in full force and effect on and after July 1, 2000, provided, however, that this act shall remain in effect only as long as the bene- fits provided therein are authorized by the Internal Revenue Code; provided that the state comptroller of the city of New York shall notify the legislative bill drafting commission upon the occurrence of the enactment of the legislation provided for in this act in order that the commission may maintain an accurate and timely effective data base of the official text of the laws of the state of New York in furtherance of effecting the provisions of section 44 of the legislative law and section 70-b of the public officers law.

This statute was enacted only five months before the trustees terminated me as executive director. So I am not sure how NYCERS put this benefit into place.

I suspect, however, the statute was not correctly implemented. At the very least. the reference to Chapter 623 in the old Tier 4 NYCERS SPD Update had a significant error in it.

It stated that the statute only applies to members who retire after July 1, 2000. You can see in statute below that there is no restriction based on retirement date, only based whether the retirement benefit has been reduced by IRC Section 415(b). See paragraph 4 of Section 13-196 below. The old Tier 4 SPD does not appear to be available on the NYCERS website anymore. There now appears to be only a Tier 4 62/5 Plan SPD which makes no mention of the excess benefit plan.

It is clear that in 2005 all retirees who had their benefits reduced because of IRC 415(b) limits should have received notification from NYCERS that they would be receiving benefits payable from the EBP and that the payment would be retroactive to July 1, 2000 if applicable. This is not large group but I suspect that notices were not sent out.

While it would have been very easy to just forget screening for the 415(b) limits going forward, it is not the way that Chapter 623 directed NYCERS to handle the EBP. It is clear that NYCERS needs to maintain separate accounting for benefits paid from the EBP as required by paragraph 3 of Section 13-196. It also appears that NYCERS is not following the law in this case since there is no reference the EBP in the FY-2012 NYCERS CAFR.

This is the NYCERS statute setting up the EBP.

New York City Administrative Code(NEW)
§ 13-196 Excess benefit plan.
As used in this section, the following words and phrases shall have the following meanings, unless a different meaning is plainly required by the context:
(a) "Retirement benefits" shall mean benefits payable to a beneficiary by the retirement system or a variable supplements fund established pursuant to this chapter which are subject to the limitations imposed by section 415(b) of the Internal Revenue Code.
(b) "Beneficiary" shall mean a person who is receiving retirement benefits from the retirement system.
(c) "Excess benefit plan" shall mean the excess benefit plan established by this section for the sole purpose of paying benefits as permitted under section 415(m) of the Internal Revenue Code.
(d) "Eligible participant" shall mean a beneficiary who is entitled to replacement benefits from the excess benefit plan for a plan year in accordance with subdivisions four and five of this section.
(e) "Replacement benefits" shall mean the benefits payable by the excess benefit plan to an eligible participant as determined pursuant to subdivision five of this section.
(f) "Internal Revenue Code" shall mean the Federal Internal Revenue Code of 1986, as amended.
(g) "Plan year" shall mean the limitation year of the retirement system as provided in section six hundred twenty of the retirement and social security law.
There is hereby established an excess benefit plan, the sole purpose of which shall be to provide replacement benefits, as permitted by section 415(m) of the Internal Revenue Code, to beneficiaries whose annual retirement benefits have been reduced because such benefits exceed the limitations imposed by section 415(b) of the Internal Revenue Code. The excess benefit plan shall be administered by the board of trustees of the retirement system.
There is hereby established a fund to be known as the excess benefit fund which shall be maintained for the sole purpose of providing replacement benefits to eligible participants in the excess benefit plan established by this section, as permitted under section 415(m) of the Internal Revenue Code. Such fund shall consist of such employer contributions as shall be made thereto pursuant to subdivision six of this section. Such contributions to the excess benefit fund shall be held separate and apart from the assets held by the other funds of the retirement system, provided, however, that the assets of the excess benefit fund may be invested with the other retirement system assets, but such excess benefit fund assets shall be accounted for separately from the other retirement system assets.
All beneficiaries of the retirement system whose retirement benefits for a plan year are being reduced because of section 415(b) of the Internal Revenue Code shall be eligible participants in the excess benefit plan for that plan year. Participation in the excess benefit plan shall be determined for each plan year. No beneficiary of the retirement system shall be an eligible participant in the excess benefit plan for any plan year for which his or her retirement benefits are not reduced because of section 415(b) of the Internal Revenue Code.
(a) For each plan year in which a beneficiary is an eligible participant in the excess benefit plan, such eligible participant shall receive replacement benefits from the excess benefit plan equal to the difference between the full amount of the retirement benefits otherwise payable to the eligible participant for that plan year prior to any reduction because of section 415(b) of the Internal Revenue Code, and the retirement benefits payable to the eligible participant for that plan year as reduced because of section 415(b) of the Internal Revenue Code. No replacement benefits for any plan year shall be paid pursuant to this subdivision to any beneficiary who is not receiving retirement benefits from the retirement system for that plan year.
(b) Replacement benefits pursuant to this section shall be paid at the same time and in the same manner as the retirement benefits which are being replaced. At no time shall an eligible participant be permitted directly or indirectly to defer compensation under the excess benefit plan.
(a) The required employer contributions to the excess benefit fund for each plan year shall be an amount, as determined by the actuary, which is necessary to pay the total amount of replacement benefits that are payable pursuant to this section to eligible participants for that plan year.
(b) Such required employer contributions shall be paid into the excess benefit fund from an allocation of the employer contribution amounts paid by the city and other public employers pursuant to sections 13-127, 13-130 and 13-131 of this chapter and other applicable provisions of law. Such allocation of employer contribution amounts shall be paid into the excess benefit fund at such times and in such amounts as determined by the actuary.
(c) The benefit liabilities of the excess benefit plan shall be funded on a plan year to plan year basis, provided, however, that any employer contributions to the excess benefit fund, including any investment earnings on such contributions, which are not used to pay replacement benefits for the current plan year shall be used to pay replacement benefits for future plan years.
The right of an eligible participant to receive replacement benefits pursuant to this section, and the replacement benefits received pursuant to this section, shall be exempt from any state or municipal tax, and shall not be subject to execution, garnishment, attachment or any other process whatsoever, and shall be unassignable, except as otherwise specifically provided for benefits payable by the retirement system.
Nothing contained in this section shall be construed to mean or imply that variable supplements payments from a variable supplements fund established pursuant to this chapter constitute pension or retirement allowance payments, or that any such variable supplements fund constitutes a pension or retirement system or fund.
Nothing contained in this section shall be construed as affecting in any way the eligibility of any person for variable supplements pursuant to applicable provisions of this chapter.

Friday, December 20, 2013

de Blasio, Taxes, Pension Investments, and Universal Pre-K

In the first budget that Mayor de Blasio will have to submit, FY-2015, he will have to include an amount of $541.0M that represents the repayment of $472.5M in pension investment fees incurred in FY-2013 along with two years of 7% interest charges, $68.5M. Actually it will be little less because the public authorities will have to pick up $82.5M of the $472.5M cost.

In addition the FY-2015 pension costs will include $2.2B in missed investment earnings that the pension trustees failed to capture.

At the same time in order to fund universal pre-K Mayor de Blasio is trying to get Albany to raise the city income tax rate from 3.87% to 4.41% for income over $500,000.

Maybe it's time to clean house before traveling to Albany.

Monday, December 16, 2013

What the Comptroller Won't Tell You

The chart below is a report card for the investment performance of the NYCERS trustees over the last 14 years. The Comptroller has never presented this type of report. The trustees have never demanded this type of analysis. It is "crystal" clear why neither party does.

The avgerage actual annual rate of return over the last 14 years is 2.11%. No one wants to have to explain this long term sub par performance. It has been a rough 14 years for pension fund investing.

Over the years NYCERS has had a general asset allocation of 70% in stocks and 30% in bonds. With that allocation and using a US stock index fund and a core bond strategy the market would have given NYCERS an average annual rate of return of 3.59% over the last 14 years. This is not anything to write home about but it would have produced an extra $11B over the $47B closing balance that NYCERS had at the end of 2013.

On a side issue, you can see how dangerous the actuary's 8%/7% interest rate assumption is.

The 2000 closing balance, $42.9B, was 99.9% based on market values. In contrast, the 2013 closing balance, $47.2B, is only 85% market based due to the illiquid non-market based components of the current portfolio. The $47.2B includes a $7.2B estimate for private equity, real estate, and hedge fund assets. This estimate is always open to question and raises the very real possibility that the $11B shortfall is even larger.

In conjunction with this rise in illiquid assets NYCERS has shifted out of the the index/core strategy that it previously followed. In 2000, the NYCERS portfolio was 71% invested in an index/core strategy. By 2013 NYCERS had only a 39% position in the index/core strategy.

To be accurate the trustess outperformed the market four times (marked in column 4) over the last 14 years but it was not enough to make up for the damage incurred in the other 10 years.

The last column of the chart lists the investment fees incurred each year. You can see that from 2000 to 2004 these fees were in the range of 10 basis points. Since 2005, the trustees have lost control of these fees. I suspect that the trustees are most likely not aware of the actual fees being paid or the content of the investment contracts they have agreed to.

NYCERS - Actual Returns Versus Index/Core Returns 2000 to 2013

Fiscal Year Close Balance Net Cash Flow Actual Rate of Return Index/Core Return (70%/30%) S&P/Bond Returns Index/Core Close Balance Fees
1999 $41.9B $ % % % $ $
2000 $42.8B -$412M 3.14% 5.52% 6%/4.47% $43.8B $32.5M
2001 $38.1B -$558M -11.86% -7.58% -15.8%/11.65%% $40.0B $41.3M
2002 $32.8B -$1,028M -11.44% -10.82% -19.2%/8.65% $34.8B $37.6M
2003 $31.5B -$1,511M 0.62% 2.36% -1.5%/11.47% $34.0B $29.3M
2004 $34.2B -$1,202M 12.71% 12.08% 17.1%/0.43% $36.8B $35.1M
2005 $35.5B -$756M 6.30% 5.56% 4.4%/8.2% $38.1B $53.9M
2006 $37.3B -$711M 7.10% 4.23% 6.6%/-1.36% $39.0B $69.4M
2007 $42.5B $368M 13.03% 14.75% 18.46%/6.33% $45.2B $98.1M
2008 $39.7 $314M -7.32% -8.10% -14.9%/7.67% $41.9B $115.3M
2009 $31.9B $313M -20.46% -17.50% -28.2%/7.40% $35.0B $138.2M
2010 $35.4B $72M 10.68% 11.63% 12.1%10.49% $39.3B $175.3M
2011 $42.4B $164M 19.39% 20.94% 28.1%/4.15% $47.8B $145.1M
2012 $42.7B $728M -1.14% 5.01% 3.1%9.35% $51.0B $129.5M
2013 $47.2B $783M 8.81% 12.26% 17.9%/-0.95% $58.2B $183.3M

Wednesday, December 4, 2013

The Wolves at the Gate.

Yesterday in Detroit a federal judge drove a stake through the heart of public pension funds in the United States. If this decision is upheld on appeal, every public pension fund will have to reevaluate its funding and investment assumptions. From now on any shortage could easily fall on the backs of the public employees and retirees.

It is ironic that in the mid 1970's when New York City came close to bankruptcy, it was the city's pension funds that bailed out the city.

Previously, public employees and retirees reasonably felt that state constitutional provisions protected their pensions. That is no longer true.

Public employees and retirees must become totally aggressive so far as protecting their pensions. There is no legal protection for their pensions. It appears that bankruptcy will trump any legal protection you thought was there.

With this decision it is not clear what type of protection the individual pension trust may have. However, even if the trust is outside the reach of the bankruptcy court, the public employer will be able to walk away from any contractual obligation it has to the employees and retirees. The particular state constitution is null and void in federal bankruptcy court. Unlike bond holders who knew that there was a bankruptcy risk, employees and retirees were totally blindsided.

Ok, what needs to be done going forward. Employees and retirees need to force the public employers to properly fund the pension trust every year and the plan trustees to do a better job investing the assets of the fund. This is most acute for municipal pension funds. You don't see Michigan running into bankruptcy court.

What about here in New York City? Since 2000, New York City with the help of the NYCERS and TRS actuary has been underfunding the five city pension funds, not as bad as New Jersey or Illinois, but still not contributing enough. On top of the underfunding, which has a very natural motivation, the NYCERS trustees, and most likely the trustees at the other four pension funds, have made a mess of the investment performance over the last 14 years.

In the past employees and retirees were far too casual about these issues thinking that it was the city's problem if things went bad. No more. It is their problem, if things go bad. The city can now walk away.

The assets of the NYCERS pension fund belongs to the employees and the retirees, not the city. When it comes to money, you trust no one. I just posted a "to do" list for the new NYCERS chair. I need to add another item. Ask the actuary how does he propose to make up the shortfall that his interest rate assumptions have caused at NYCERS since 2000. Of course, the union representatives on the Board of Trustees should have been on top of this fiasco all along.

But just to get everyone focused on how these problems happen consider the following. From 1996 to 2009 Mike Musuraca sat for DC-37 at all the investment meetings of the NYCERS Board. From my experience as the NYCERS executive director, Musuraca was the most forceful trustee on investment issues. In mid 2008 the NYCERS Board voted to hire Blue Wolf as a private equity manager. On January 23, 2009, Musurarca left NYCERS to work for Blue Wolf. The members and retirees of NYCERS can not allow this type of shit to continue.

Sunday, December 1, 2013

The New Chair of the NYCERS Board of Trustees

Mayor de Blasio will soon be appointing a new commissioner for the Department of Finance. The position, unfortunately, has a tradition of being filled with political operatives as opposed to public finance/taxation professionals.

The commissioner is, ex officio, a trustee of both the city police and fire pension funds.

The mayor will also be appointing his representative on both the NYCERS and TRS Boards of Trustees. The Mayor can appoint anyone to these two unpaid positions. On the NYCERS board the mayor's representative is the statutory chair. At TRS the chair is elected by the trustees.

Because of the mayor's enormous political and budgetary power, the mayor's representative is the most important member of the NYCERS Board of Trustees.

Prior to 1990, the power structure of the NYCERS Board of Trustees, to a large extent, mirrored the Board of Estimate which was the original governing body of NYCERS up until 1968. With the destruction of the Board of Estimate in 1990 the mayor's power within the city increased radically. That was alos true at NYCERS.

While the mayor's representative has only one vote, it is the most important vote. Even a dissenting vote from the chair on an investment decision is a warning signal to the other trustees.

Mayor Bloomberg's appointees to the NYCERS and the TRS Boards have been a disaster. The mayor has constantly complained about the rising costs of pensions during his three terms but his representatives have failed to control investment costs or institute a sound investment strategy that earns a market rate of return.

Mayor de Blasio's appointee will have the challenge of bringing the annual investment costs for the five pension funds down from the $472.5M (FY-2013) to a rational annual amount of $100M (FY-2002) along with pushing to adopt an index/core strategy which has the potential to earn on average an additional $1.5B a year in asset value for the five city pension funds.

With respect to NYCERS here are some operational recommendations that I hope the mayor's new representative considers:

  1. Hire a totally independent investment consultant with no revenue connections to the investment management community.
  2. Make all investment contracts public record and provide every trustee with a copy of each contract. It is most likely that the trustees have never seen any of these contracts.
  3. Make the Board's investment meetings totally open for all items unless the Law Department gives written direction that a specific item must be dealt with in executive session.
  4. Put in place a tight accounting control of the invoice/payment process for all investment expenses and publicly report all payments to the trustees at each meeting and once a year provide the trustees with a copy of the final annual reconciliation of investment expenses for the year.
  5. Utilize the NYCERS web site to provide public disclosure of investment data and decisions. The Comptroller's attempt in this area has failed to deliver on the information it promised to provide.
  6. Make available to the trustees the full cash flow history of each private equity, real estate, and hedge fund contract on a real time basis. (NYCERS web site)
  7. Explore the feasbilty of dropping of all asset classes that do not fit within a index/core strategy.
  8. Set 10 basis points as the general limit on fees for all investment contracts. I suspect that this will be a very effective screen for unproductive investments.
  9. Almost certainly drop all emerging manager contracts unless their fees are brought under the 10 basis point limit.
  10. Review the quality of NYCERS's senior administrative management. This staff was put in place while Martha Stark was chair.
  11. On an annual basis provide the trustees with a copy of a complete reconciliation of administrative expenses, This report was dropped in FY-2010. (NYCERS web site)
  12. Radically upgrade the agency's monthly production report to include open and closing transaction balances along with incoming work, work completed during the month, and aging information on the outstanding work. (NYCERS web site)