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 Basket Clause and the Real Pension Crisis

At the 3/26/2013 NYCERS investment meeting the trustees agreed to back the passage of legislation increasing the “basket clause” limit (Section 177 NYS RSSL)to 35% from 25%. The “basket clause” refers to the part of the investment portfolio that can be invested without any limitation. The limit was originally 5% but as the trustees have become more risk tolerant the limit has gone up to 25%. The trustees now want greater latitude in their decisions, hence the 35% limit.

This is a stupid and dangerous idea. Without a legitimate oversight of the trustees' investment decisions and performance the legislature in Albany should under no circumstance increase the trustees ability to make bad decisions. The trustees suffer no penalties for their mistakes, only the members, retirees, and the taxpayers of New York City get hit with the losses.

On their own public pension trustees are not capable of investing anything, period. You must always keep this in mind when evaluating the investment decisions that they make.

What the trustees are proposing is similar to a coach of basketball team that hits 10% of their 3-point shots and 50% of their 2-point shots trying to get his team to score more points. So he tells the team to shot more 3-point shots and less 2-point shots. Guess what. The coach gets fired because the team loses, but not the trustees. No one knows whether they are winning or losing.

To help them make their investment decisions, like hiring investment managers, the trustees hire investment consultants to provide objective advice. The consultants, however, get a significant amount of their profits from the investment managers. This arrangement is like a homeowner hiring a general contractor to do work on his house and allowing the subcontractors to pay the general contractor huge fees for being consider eligible to be awarded subcontracts. The homeowner winds up on the short end of the stick.

So how are the NYCERS trustees doing? Below is a score card for the last 13 years. For each year there are two closing balances using a 70/30 equity/fixed income allocation. One is the actual closing balance and the other is a simple S&P 500 index/ core bond index projection. You can click on Income Flow for a detailed spreadsheet. I suspected bad performance but I was amazed at how bad it really is.

In particular, why 2012 was so bad is a mystery to me. I have a bad feeling about it. The Comptroller is no longer providing investment meeting agendas on his web site.

NYCERS Investment Performance: 2000 - 2012

Year	Closing Balance	Closing Balance
****	NYCERS	Index/Core	Wins	Losses
2000	$42.8B	$44.20B	****	$1,382M
2001	$37.3B	$39.6B	****	$2,364M
2002	$32.8B	$34.1B	****	$1,261M
2003	$31.5B	$33.6B	****	$2,056M
2004	$34.1B	$39.1B	****	$4,881M
2005	$35.5B	$36.0B	****	$ 510M
2006	$37.3B	$37.0B	$291M	****
2007	$42.5B	$43.2B	****	$ 641M
2008	$39.7B	$39.4B	$332M	****
2009	$31.9B	$33.1B	****	$1,174M
2010	$35.4B	$35.7B	****	$ 301M
2011	$42.4B	$43.0B	****	$ 546M
2012	$42.7B	$45.3B	****	$2,605M

If NYCERS had followed the straight index/core strategy since 2000, the closing balance for June 30, 2012 would have been $55.5B.

It is significant that in FY-2012 the NYCERS actuary formally reported a realistic liability for NYCERS at $62.94B.

From 2000 to 2006 the city and the participating employers systematically underfunded NYCERS hoping that future market increases would make up for the shortfall. That did not happen. The early funding decision has lead to increased current funding requirements. This is on top of the effect of poor investment decisions.

As a way of getting a feel for what is lost when annual funding for the pension plan is not adequate, the straight index/core closing balance as of 2012, with a steady small net cash delta, would have been $63.2B. That is a $7.8B increase due to the change in the net cash history.

Who is the main culprit in the city's pension dilemma?

A word of caution, I have a certain level of skepticism about the NYCERS investment accounting figures. In 2000, NYCERS reported only $13M in illiquid assets. BY 2013, the amount had risen to $6.25B. That is over 15% of the portfolio. Illiquid assets have no market values and any quoted value is just a guess.

Another point of aggravation is the fact that annual investment fees went from $30M to $130M over the 13 years.