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.

Tier 6 - Cost Relief for City and the 8% Assumed Interest Rate

With the new Tier 6 pension benefit provisions in place it's time to check in on the long running circus called the "assumed interest rate". Since the spring of 2009 the NYCERS actuary has been delaying making a permanent recommendation on what is a reasonable expected rate of return for the assets of the city pension funds. Each year he has recommended one year extensions of the the current 8% rate.

The actuary has not yet reported on what the cost savings will be for the new Tier 6 pension benefits. But the tie in with the interest rate is critical.

With the current 8% interest rate the estimated annual cost to the city for the average city worker covered by Tier 6 will be about 1% of payroll. If the interest rate is 7% the cost goes up to 2.12% of payroll. If you want to be even more conservative with a 6% interest rate, then the annual cost goes up to 3.6% of payroll.

The following are estimated total dollar costs with different interest rates for a Tier 6 worker who starts at a $25,000 per year salary and retires with a $45,200 pension 42 years later:

1. 8%: city = $18,210 worker = $60,127
2. 7%: city = $38,605 worker = $60,127
3. 6%: city = $65,556 worker = $60,127

You can easily see how important the assumed interest rate is.

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.

Slow Motion - Another Year at 8%

Bob North, the NYCERS actuary, is kicking the can down the road for another year. For the second year in a row, North has failed to recommended a new 5 year expected rate of return for the five city pension funds. That means another one year extension of the irresponsible 8% interest rate.

In plain English, this means the city & the other participating employers can continue to uderfund the pension plans for another year. Of course, things could be worse. New Jersey use 8.25% but then again, New Jersey doesn't make any pension contributions at all.

See the write up on this pending bill.

North has known for years that he needed to recommend a new interest rate in FY-2009, the last year of the last five year period. I know Bob moves slowly but this is glacial. No one wants to amputate a leg but if you don't, the gangrene will kill you.

A prudent rate would be 6%. But the city is between a rock and hard place. Because the city uses fairly accurate accounting, it has budgeted $7.49B in payments to the five pension funds for FY-2011. This is a huge number in spite of the inflated 8% assumption. A 6% rate could easily add $3B more to the cost for FY-2011.

The biggest threat to any pension plan is underfunding, followed by lousy investment decisions. What ever the benefits are, rich or poor, the driving force is funding. The city delayed paying its full pension costs and now time is running out.

One positive note. Compared to other public pension systems, the city is a saint.

Bob North and the 8% Dilemma

This spring Bob North, the NYCERS and NYCTRS actuary, must make a very important decision. He must recommend a new assumed actuarial rate of return for the city pension systems. This recommendation has to be enacted into law and is usually effective for the next 5 years. Last year the old 8% rate expired (2004-2009). Bob chose to kick the can down the road and recommended that the old rate be renewed for one more year (C.211/L.2009, see:NYS Laws).

This sounds like a very obscure issue but it is not. This rate of return has a huge impact on the city pension costs over the next 5 years. Any reduction in the rate will greatly increase the city’s cost. Over the last ten years the pension systems have only had a 2.17% rate of return, significantly short of their 8% target. This is a big part of the pension crisis in the city.

It is bad enough that the 8% assumption leads to underfunding of the pension systems but it is creates a rationale for risky investment decisions hoping for high returns to compensate for the underfunding. You can see what a vicious cycle this is.

Because of the budget crisis there will be intense pressure on Bob North not to reduce the actuarial rate. He most likely will buckle under the pressure. This is not responsible but at least, it is understandable. The trustees, however, must abandon their current risky policies and adopt a prudent investment strategy that recognizes a lower, more realistic rate of return. The trustees must not make the situation worse.

City workers have skin in this game. Over the last ten years NYCERS members have contributed $3.3B to NYCERS from their own paychecks. In that same time period the city and the other participating employers have contributed $8B. Most of that amount was paid in the last 4 years ($6.5B: 2006 – 2009).

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Background

In 1990, NYCERS and NYCTRS appointed Bob North as the actuary for the two pension funds. BY statute, this also made him the actuary for the police, fire, and Board of Ed. pension funds. At the same time the city created a new stand alone agency for the actuary. Previously the actuary’s operations were part of NYCERS. There was no legal basis for creating this agency but the Law Department can be counted on to be creative when asked.

This was done partly to make Bob feel good about running his own agency. This really didn’t matter much until 1996. In that year however, Albany granted NYCERS and NYCTRS their own independent budgets. The law was changed for several reasons, one of which was that the city was slowly strangling the budgets of both retirement systems.

Prudently, both retirement systems should have pulled the actuary’s operations back into their agencies in order to exercise proper control of their appointed actuary. The trustees did not do this and left the actuary under the budgetary control of the mayor. Since 1990 the mayor has controlled the actuary’s salary and he still does.

Of course, the NYC Law Department never advised the retirement system trustees that as of July, 1996 they should, as fiduciaries, place the actuary within the boards’ budgetary control. The Law Department has never given the trustees comprehensive advice about their fiduciary responsibilities. That potential advice would have had to include a clear warning about the on-going conflicts of interest that exists whenever the mayor’s lawyer is giving advice to the NYCERS Board of Trustees.

On January 28, 2010 the mayor proposed cutting the actuary’s budget for FY-2011 by $222K ($4.9M down from $5.1M) and his headcount by 5 (32 down from 37). In addition, if the state goes forward with the governor’s budget recommendations, the mayor has proposed cutting another 5 positions from the actuary’s headcount and an additional $406k from the actuary’s budget.

This is a clear reason why the actuary’s operations should be directly funded by the retirement systems. In addition, the actuary should be totally transparent with respect to any work that he does for any outside agencies. He should be more active with investment issues. He should also be more responsive to 1) the operational needs of the pension systems and 2) requests for fiscal notes of proposed legislation from all responsible parties, not just the city.

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FYI: This is the most current estimates of the city’s ongoing pension costs. The chart below does not include the Transit Authority, the Housing Authority, HHC, and other participating employers. These figures are based on the 8% assumption. Even with 8%, you can see that the situation is deteriorating. If the rate of return is reduced, the amounts will increase even further.

Year	As of June 2009	As of Jan. 2010
FY-2010	$6.7B	$6.8B
FY-2011	$7.0B	$7.3B
FY-2012	$7.4B	$7.7B
FY-2013	$7.6B	$7.8B
FY-2014	NR	$7.9B