Somethings Never Change: the Actuary and the Assumed Interest Rate

In September, 2015 I wrote a posting about the new NYCERS actuay, Sherry Chan, who was appointed in May, 2015. She is currently being paid an annual salary of $279,000.

Specifically I wrote:

The assumed interest rate is the key component of the annual pension costs that the city and the other participating employers must pay to the pension funds each year. It will be interesting to see where Ms. Chan stands on the 7% net of fees rate. She will be required to make a recommendation this winter for a new five year rate effective July, 1, 2016 and Albany will have to enact enabling legislation by June 30, 2016.

I suspect she will punt and ask for a one year extension of the old rate. North did this all the time. It is a bad fiscal policy and contributes to the under-funding of the pension funds.

Sure enough on June 30, 2016, the governor signed Chapter 61 of the Laws of 2016 which was a one year extension of the 7% (net of fees) interest rate. Ms. Chan stated that she was to busy during her first year to recommend a new five year rate.

This year, on June 29, 2017, the governor signed Chapter 71 of the Laws of 2017 which was again a one year extension of the 7% (net of fees) interest rate. This time Ms Chan stated that she chose not to recommend a five year interest rate because she was waiting for the completion of the two year actuarial audit.

As a point of reference the previous two year actuarial audit was completed in 2016.

I could yell and scream but, what the hell, nothing is going to change.

Parting Gift from the Old NYCERS Actuary

Last year I wrote short note on the history of the investment fees paid by the five pension fund sponsored by New York City.

On January 30, 2013 the Governor signed Chapter 3 of the Laws of 2013 changing the assumed interest rate for the five pension funds from 8% gross of fees to 7% net of fees. the legislation was drafted the NYCERS actuary, Robert North. It did a lot of other things but that was the big item. One of those minor things, however, deals with how city repays to the five pension funds the investment expenses incurred by the pension funds in the previous fiscal year (see below: S.13-705, NYC Admin Code). These expenses include the subsidy that the pension funds pay to the Comptroller for his regular operating budget that is part of the total city budget adopted by the City Council.

Beginning in FY-1999 the original legislation required the city to pay in FY-2000 with 8% interest all investment expenses incurred in FY- 199. This meant that these expenses were treated as operating expenses and not long term capital expenses. This is a very sound accounting practice. This legislation was also drafted by the NYCERS actuary.

You can further see that that starting with FY-2005 the law was changed to allow the city to repay expenses two years later rather than one year, so that FY-2005 was paid back in FY-2007 rather that in FY-2006. Again with 8% interest. This amending legislation was also drafted by the actuary.

You can also see that the law was again changed starting with FY-2010. And again it was drafted by the actuary. This change allows the city to treat the repayment of investment expenses as a long term capital expense rather than an operating expense. The new change also dropped the interest rate charge, in effect making this a interest free loan. Needless to say this is not a sound accounting practice. It gave the current city administration a payment holiday now and dropped the costs on a future city administration. This is how a pension crisis is born.

The new statute is listed below. It is the last item at the end of thirty two sections amending the NYC Admin Code. The new language is underlined as is standard.

§ 32. Subdivision d of section 13-705 of the administrative code of the city of New York, as amended by chapter 152 of the laws of 2006, is amended to read as follows:

d. In each city fiscal year, beginning with investment expenses paid during the nineteen hundred ninety-eight--nineteen hundred ninety-nine fiscal year, whenever the income, interest or dividends derived from deposits or investments of the funds of a retirement system are used pursuant to subdivision b of this section to pay the expenses incurred by such retirement system in acquiring, managing or protecting invest- ments of its funds, the monies so paid shall be made a charge to be paid by each participating employer otherwise required to make contributions to such retirement system no later than the end of the fiscal year next succeeding the fiscal year during which such monies were drawn upon, provided,

however, that where such charge is for such investment expenses paid during fiscal year two thousand four--two thousand five or during any subsequent fiscal year, such charge shall be paid by each such participating employer no later than the end of the second fiscal year succeeding the fiscal year during which such monies were drawn upon

, provided further that the provisions of this subdivision shall not apply to investment expenses paid during the two thousand nine--two thousand ten fiscal year or during any subsequent fiscal year.

In the event that such retirement system has more than one participating employer, the actuary shall calculate and allocate to each such partic- ipating employer its share of such charge.

All charges to be paid pursu- ant to this subdivision shall be paid at the regular rate of interest utilized by the actuary in determining employer contributions to the retirement system pursuant to the provisions of paragraph two of subdi- vision b of section 13-638.2 of this title.

The New NYCERS Actuary

I just came across the announcement of the new NYCERS actuary (see quote below). It is from the NYC web site dated back in May. I had been looking for it for awhile but I only found it when a friend sent me a link to the city web site. The reason I had not seen it before was that the announcement does not actually say that NYCERS had appointed a new actuary. The former NYCERS actuary, Bob North, resigned in the Fall of 2014.

May 29, 2015 NEW YORK—Mayor Bill de Blasio today announced Sherry Chan as the City’s new Chief Actuary. In this role, Chan will serve the City’s retirement funds and oversee actuarial calculations for post-employments benefits for City employees.

Legally the City does not have a Chief Actuary. NYCERS and TRS have actuaries (see quote below from NYC Admin Code). The two retirement funds usually appoint the same person as their actuary. That appears to be a very practical policy but in reality it is not financially sound. They are two very different pension funds with different liabilities. As background, by statute the NYCERS actuary is also the actuary for the Police and Fire pension funds and the TRS actuary is also the actuary for BERS (Board of Ed. Retirement System).

Ms. Chan is a ASA of the Society of Actuaries, not a FSA. I guess that is not a big deal unless it was because NYCERS could not attract a full Fellow of the Society of Actuaries. Once upon a time actuaries needed to be highly skilled mathematical technicians. Now they need to fearless messengers of painfully news.

The assumed interest rate is the key component of the annual pension costs that the city and the other participating employers must pay to the pension funds each year. It will be interesting to see where Ms. Chan stands on the 7% net of fees rate. She will be required to make a recommendation this winter for a new five year rate effective July, 1, 2016 and Albany will have to enact enabling legislation by June 30, 2016.

I suspect she will punt and ask for a one year extension of the old rate. North did this all the time. It is a bad fiscal policy and contributes to the under-funding of the pension funds.

Her most recent job was the actuary for the Ohio State PERS which began in January, 2014 and ran through May, 2015. It was interesting to watch the NYCERS chair introduce Ms. Chan to the Board of Trustees at the June Board of Trustees meeting. I guess they had never met her before that.

§ 13-121 Retirement system; adoption of tables and certification of rates.

The actuary appointed by the board shall be the technical advisor on all matters regarding the operation of the funds provided for by this chapter and shall perform such other duties as are required of him or her.

The actuary shall keep in convenient form such data as shall be necessary for the actuarial valuation of such funds.

Every five years, he or she shall make an actuarial investigation into the mortality, service and compensation experience of the members and beneficiaries as defined by this chapter and he or she shall make a valuation, as of June thirtieth of each year, of the assets and liabilities of the various funds provided for by this chapter.

Upon the basis of such investigation such board shall: 1. Adopt for the retirement system such mortality, service and other tables as shall be deemed necessary; and 2. Certify the rates of deduction from compensation computed to be necessary to pay the annuities authorized under the provisions of this chapter.

As part of the May 29th announcement, the mayor's office described Ms. Chan's work load as follows:

As Chief Actuary, Chan will work for the five major actuarially-funded New York City Retirement Systems, including the New York City Employees’ Retirement System (NYCERS), the Teachers’ Retirement System (TRS), the Board of Education Retirement System (BERS), the New York City Police Pension Fund, and the New York Fire Department Pension Fund.

The Chief Actuary also serves as the legally-designated technical advisor to the Board of Trustees of the New York City Retirement Systems (NYCRS).

The Office of the Actuary is responsible for determining employer contributions and funded status for NYCRS, preparing employer contributions for use in the development of budget and financial plans, certifying benefits for retiring employees, and preparing financial reports and accounting information on the New York City Health Benefits Program.

TRS - Permanent Handicap - TDA Transfer

Last year I wrote about a persistent negative cash flow at the NYC Teachers Retirement System (TRS).

Just recently someone pointed out to me the impact of something I vaguely knew about but not really. Every year TRS pulls money out of the pension fund and transfers it to the TDA plan that it runs separately from the pension plan. The TDA plan is a defined contribution plan, a 403(b) plan in IRS speak. Information about this transfer is buried in the TRS annual CAFR. The city, however, has never identified the transfer in its annual CAFR. That is until FY-2014.

This is why TRS has had a negative cash flow for the last 15 years. In the last eight years (2007-2014) TRS has paid $33.3B in benefits but $6.8B went to the TDA plan and not pension benefits. The employers' contributions for the 2007-2014 period were only $19.2B. This is a big problem. It is never discussed publicly. I have no idea how Bob North, the TRS actuary, values this liability for the TRS pension fund. This is a huge leak in the funding pipeline for the TRS pension plan.

If you look at the table below it appears that North is reporting a funding level for TRS based only on the liability based on the pension benefits paid and ignores the TDA transfer.

Funding Status for TRS and NYCERS for FY-2013

System	Actuarial Assets	Actuarial Liabilities	Funding Level	Members	Pensioners	Pension Benefits Paid	TDA Transfer
NYCERS	$42.4B	$65.3B	65.0%	212,347	137,987	$3.9B	$0.0B
TRS	$33.6B	$57.7B	58.2%	132,017	76,539	$3.6B	$1.1B

TRS Benefit Payout Since 2007

Fiscal Year	Employer Contributionds	All Benefits Paid	Pensions Paid	TDA Skim	Other Benefits Paid	Pension Paid %	TDA Skim %	Other Benefits %
2005	$1.23B	$3.13B	*	*	*	*	*	*
2006	$1.32B	$3.34B	*	*	*	*	*	*
2007	$1.60B	$3.58B	$2.89B	$0.55B	$0.14B	80.7%	15.4%	4.0%
2008	$1.92B	$3.78B	$3.02B	$0.65B	$0.11B	79.9%	17.2%	3.0%
2009	$2.22B	$3.78B	$2.92B	$0.77B	$0.10B	77.2%	20.4%	2.6%
2010	$2.48B	$4.12B	$3.20B	$0.82B	$0.10B	77.7%	19.9%	2.4%
2011	$2.47B	$4.33B	$3.38B	$0.85B	$0.10B	78.1%	19.6%	2.2%
2012	$2.67B	$4.49B	$3.44B	$0.95B	$0.10B	76.6%	21.2%	2.3%
2013	$2.86B	$4.67B	$3.54B	$1.05B	$0.08B	75.8%	22.5%	1.7%
2014	$3.00B	$4.58B	$3.82B	$1.15B	nr	76.9%	23.1%	*
2007-2014	$19.22B	$33.72B	$26.21B	$6.78B	$0.73B	*	*	*

Reality Comes to NYCERS -- Funding Status 2007 - 2013

Below is the NYCERS funded ratio for the last seven years. It charts out a serious problem for NYCERS and in turn for the members, retirees, and the taxpayers of New York City.

This problem is in large part due to the failure of the NYCERS trustees to properly invest the assets of the fund over the last 14 years. See NYCERS income statement history .

Over the last 14 years NYCERS has earned an annual rate of return of 2.11%. From my calculations the index/core strategy would have enabled NYCES to achieve a 3.59% return over the same period. Both of which are significantly short of the 8%/7% actuarial interest rate (AIR) that NYCERS has been using for the last 14 years.

This is a classic "Catch 22" situation. The 8%/7% allowed the city to contribute less to NYCERS in the short term but motivated the NYCERS trustees to adopt an irresponsible investment strategy which allegedly would achieve the 8%/7% target. The end result was under-funding, underperformance, and ironically causing the city to pay more to NYCERS over the long run.

I do not have any concrete evidence of corruption but at some point incompetence rises to the level of criminal.

As of FY-2000, NYCERS had 71% of its assets in a index/core strategy. In 2013, NYCERS had only 39% in a index/core strategy and another 16% in illiquid assets which create uncertainty about the real value of the assets.

Fiscal Year	Actuarial Assets	Accrued Liability	Unfunded Liability	Funded Ratio	Covered Pyrl	Unfunded as % of Pyrl
2013	$42.41B	$65.27B	$22.86B	65.0%	$12.23B	186.9%
2012	$40.33B	$62.94B	$22.50B	64.2%	$12.10B	185.9%
2011	$41.71B	$53.05B	$11.34B	78.6%	$11.88B	95.5%
2010	$40.72B	$51.11B	$10.39B	79.7%	$11.31B	91.9%
2009	$38.93B	$49.25B	$10.33B	79.0%	$10.76B	96.0%
2008	$38.37B	$46.60B	$8.23B	82.3%	$10.13B	81.3%
2007	$39.69B	$39.80B	$0.10B	99.7%	$9.67B	1.1%
....	....	....	....	....	....	....
2000	$42.39B	$42.42B	$0.03B	99.9%	$7.87B	0.3%

As of July 1, 2011 NYCERS changed actuarial valuation methods going from "frozen initial liability" to "entry age". In simple English, NYCERS started using a real actuarial method as opposed to a delusional one. And I mean "deluuusional" in the way Lewis Black uses it in his comedy routines. NYCERS also switched actuarial interest rates from 8% gross of expenses to 7% net of expenses.

You can clearly see how the NYCERS pension liabilities jumped from $53.1B to $62.9B in 2012 because of the switch from 8% to 7%. You can just imagine what the accrued pension liabilities would be if the actuary used the real rate of return of 2.11%. A straight linear projection would produce an added $50.0B. That is the cost of bad investment decisions.

In 2008, the NYCERS actuary started providing the "entry age" numbers as supplementary information in the CAFR in order to supply the public with better disclosure on NYCERS funding status. That is why my chart changes dramatically from 2007 to 2008. Page 127 in the FY-2013 NYC CAFR shows the the change occurring in 2012 instead of 2008. Everyone tries to delay bad news.

Any funded ratio below 80% is a sign of trouble. The other four city pension funds, unfortunately, have much lower funded ratios than NYCERS.

NY Times - Pensions - Detroit

On July 20, 2013 Mary Williams Walsh wrote the following highlighted article in the NY Times concerning the newly discovered deficit in the two Detroit municipal pension plans and the city's pending bankruptcy action. Ms. Walsh has written many pension articles in the past. Like most commentators on public pension plan issues, however, she never addresses the whole picture. Not that what she reports is necessarily incorrect but that it is incomplete.

For the record, the one issue I never hear reported is the miserable investment performance of public pension plans and how much this contributes to pension underfunding. There are also many questionable investment decisions that the NY Times never reports. It's a great newspaper but it's not always on the cutting edge.

In this article Ms. Walsh points out a sudden increase in Detroit's reported pension underfunding and lays a large amount of blame at the door of widespread actuarial practices which have lead to long term shortfalls on employers' contributions to most public pension systems around the country.

This is a valid and accurate statement but it is not a secret. Everyone in the public pension community knows that the plan actuaries have not been providing good numbers for a long time. Their chief sin has been the use of investment targets that are far to high. This has systematically lead to underfunding of the plans. It has also lead to reckless investment strategies adopted by plan trustees trying to hit the unrealistic targets. It also created the excuse to hire investment firms with outrageous fee structures.

Generally actuaries are very bright mathematicians but like all of us they are usually short on courage. No one wants to lose his/her job. That is what would happen if an actuary came in with the real numbers. So, they do what most of us would do. They bend and twist to keep the parties with power happy.

Below is an extract from Ms. Walsh's article that describes this problem. Towards the end of the extract Ms. Walsh mentions a "Blue Ribbon Panel" set up by the Society of Actuaries which was formed to look into how to address the reputational risks that "bad" numbers were creating. One of the panel members that she idnetifies is Robert North, the NYCERS and NYCTRS actuary. North has a questionable history on his own interest rate assumptions for the city pension funds. I listed below the interest rate changes he has recommended while working for NYCERS. Walsh doesn't seem to be aware of the inconsistency in having North on this panel.

This made me do a little homework. I checked the Society of Actuaries web site and listed all the panel names below. One of the names that Walsh did not identify was Mike Musuraca. For many years Musuraca worked for DC-37, a municipal union with a recent history of corruption while he was working there. He represented DC-37 on the NYCERS Board of Trustees for investment issues. In 2009 he went work for a private equity firm, Blue Wolf Capital, but not before he voted to hire Blue Wolf as private equity firm for NYCERS. Here is a little more background on Blue Wolf Blue Wolf.

When someone like Walsh has these issues in front of her and she doesn't address them, you wonder whether she serious about the problem.

Extract from NY Times article, July 20, 2013

But that is not what happens. To calculate a city’s pension liabilities, an actuary instead projects all the contributions the city will probably have to make to the pension fund over time. Many assumptions go into this projection, including an assumption that returns on the investments made by the pension fund will cover most of the plan’s costs. The greater the average annual investment returns, the less the city will presumably have to contribute. Pension plan trustees set the rate of return, usually between 7 percent and 8 percent.

...

A few years ago, with the debate still raging and cities staggering through the recession, one top professional body, the Society of Actuaries, gathered expert opinion and realized that public pension plans had come to pose the single largest reputational risk to the profession. A Public Plans Reputational Risk Task Force was convened. It held some meetings, but last year, the matter was shifted to a new body, something called the Blue Ribbon Panel, which was composed not of actuaries but public policy figures from a number of disciplines. Panelists include Richard Ravitch, a former lieutenant governor of New York; Bradley Belt, a former executive director of the Pension Benefit Guaranty Corporation; and Robert North, the actuary who shepherds New York City’s five big public pension plans.

The commplete list of members of the Blue Ribbon Panel

Chair: Bob Stein, FSA, MAAA, Retired, Ernst & Young
Co-Vice Chair: Andrew Biggs, American Enterprise Institute
Co-Vice Chair: Douglas Elliott, Brookings Institution
Bradley Belt, Palisades Capital Management, former executive director of the Pension Benefit Guaranty Corporation
David Crane, Stanford University, former advisor to Gov. Arnold Schwarzenegger, CA
Malcolm Hamilton, FSA, FCIA, Retired, Mercer, senior Fellow, C. D. Howe Institute
Laurence Msall, The Civic Federation (Illinois)
Mike Musuraca, Blue Wolf Capital Partners, former trustee of the NYC Employees Retirement Systems-NYCERS and formerly of American Federation of State, County and Municipal Employees
Bob North, FSA, EA, MAAA, FCA, FSPA, New York City Office of the Actuary
Richard Ravitch, Co-chair, State Budget Crisis Task Force, formerly Lt. Governor of New York
Larry Zimpleman, FSA, MAAA, Principal Financial Group

Assumed Interest Rate History under Robert North (1990 to 2013)

1. 7/1/1995 9.0% to 8.75%
2. 7/1/1999 8.75% to 8.0%
3. 7/1/2011 8.0% to 7.0% (net of fees)

I don't have the documentation describing the origin of the 9% rate and my memory is a bit weak that far back. It is quite possible, however, that North also make the recommendation for 9%.

The Impact of the Drop in the Assumed Interest Rate to 7%

The NYCERS actuary, Bob North, has finally started using 7% as the assumed interest rate in the financial statements for the city pension funds. The new rate still requires authorization legislation from Albany. That by itself is a whole other story.

With the new rate the funding status of all five pension funds has dropped significantly in FY-2012 from the levels in FY-2011.

1. NYCERS 64.2% from 78.6%
2. TRS..... 58.9% from 64.1%
3. Police... 60.1% from 71.3%
4. Fire..... 48.2% from 56.8%
5. BERS.... 57.8% from 68.7%

While 7% is more realistic than 8%, the city funds have only earned 4.82% over the last 13 years since FY-2000. That is a great argument for a 5% assumed interest rate. The end result of this miscalculation on the interest rate has been a long term short fall on the necessary annual contributions to the pension funds.

The historical rate of return on stocks is 6.8% and for bonds it's 3.5%. Actuaries should not be playing with these rates. A standard prudent pension plan should operate within a 50/50 range of stocks and bonds depending on the level of annual benefit payments that the plan is required to make. A 5.15% interest rate should be almost a mandatory upper limit for interest rate assumptions.

It is always painful to see pension plans being damaged by bad behavior when it is so easy to to run a successful plan.

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.

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