Where the City's Pension Money Goes - FY-2012

For FY-2012, the city has budgeted the following amounts for the five pension funds. As of June 30, 2009, the very efficient NYCERS actuary reported the number of members and retirees of the the five pension which I have also included.

System	City Amounts	All Members	All Retiree
TRS:	$2,658.6M	129,308	70,825
Police:	$2,203.7M	38,449	44,285
NYCERS:	$1,423.0M	216,664	131,031
Fire:	$948.7M	11,524	17,263
BERS:	$161.7M	27,295	13,641
Never Never Land:	$950.9M	***	***

Never Never Land is my nick name for a contingency fund which the city claims it might need. That is in contrast to teachers, and fire houses. Last year $603M was budgeted for Never Never Land and never used.

Note: Only 55%, approximately, of the NYCERS members & retirees are city workers.

Private Equity Underwater

Recently, I have been trying to get NYCERS to turn over the detail quarterly reports of the performance of the NYCERS private equity and real estate investments.

Note: These investments are generally limited partnerships where NYCERS pays two percent annual fees and 20% of the profits to the general partner in return for 2 to 3% above the S&P 500 index. The trustees, however, never see the actual contracts with these investment managers and they really don’t know what the details are. NYCERS has been investing in limited partnerships since FY-2000. Hevesi was the NYC Comptroller and the NYCERS designated investment manager at that time. Hevesi was instrumental in moving the real control of the investment contracts from the trustees to the Comptroller’s office.

NYCERS gets these reports from the Comptroller’s office. The reports are written by investment consultants that are under contract to NYCERS. NYCERS refuses to make these reports public. My opinion is that the data in the reports are extremely embarrassing and that, while some investments are doing well, others are a disaster, for example: Shamrock Capital.

As of June 30, 2010, the alleged value of these investments, aka “fair market” value, was $3.4B according to the Comptroller’s general quarterly report. Since there are no independent market values for these assets, any stated value is just a guess. The Comptroller stopped putting the general quarterly reports on his web site in 2005. The last one posted was for the March 31, 2005 quarter.

NYCERS, however, must file annual NY State Insurance Department Reports (SIR) as of June 30 of every year on March 1 of the following year. Interestingly the SIR requires that NYCERS list all private equity investments along with their actual costs and their fair values.

The NYCERS SIR for June 30, 2010 states that the actual cost of private equity investments was $4.48B and their fair value is $4.12B. After investing for 11 years, NYCERS is underwater with a -8.0% loss on its private equity investments. NYCERS Russell 3000 index performance for the last 10 years is -0.9%. The good news is the 10 year loss for private equity as of June 30, 2009 was -15%.

What is truly insulting about this comparison is that NYCERS paid the private equity managers $108.1M in FY-2010 and only $535,817 to it two Russell 3000 index managers who managed $8.56B.

As a postscript, I have very little confidence in the accuracy of these figures because of the lack of internal control of the accounting of investment activity at NYCERS.

Where Did the $603M Go?

Last year as part of the the city's pension budget of $7.481B, there was a contigency reserve of $603M. It was supposed to cover modifications to actuarial assumptions that were to be enacted into law. It now appears that $603M is not going to be paid to the pension funds. The city's pension cost for FY-2011 is now only $6.883B. I suspect the legislation was delayed. So where did that money go? Did city just save it or did they use it somewhere else?

The pension contigency for FY-2012 is $951M. Is it really needed? Will the legislation be again delayed? This whole issue of public pensions has drifted into Never Never Land. The truth has vanished and all we have left is delusions.

Actual returns vs 8% returns

This is just a quick note inspired by the Comptroller's recent pension report. I will post a full analysis later.

The amount of employer contributions to the 5 city pension funds from 2000 to 2010 is $42.9B. If the funds made 8% each year in this period, the pension assets would be $168.9B, instead of $89.9B.

If the employers had contributed a flat line 4.5% of budget, the contributions would have been $28.1B. With this amount an 8% return would have raised the pension assets to $151.6B.

The Comptroller's 8% estimate assume an employer contribution of $11B over the 11 years producing a pension asset value of $139B. I actually estimated the asset value at $129.7B with this contribution assumption.

The Cost of Bad Investment Decisions

For quite awhile I have been criticizing the NYCERS investment strategy as being overly risky and expensive. I have pointed out the radical growth in fees over the last eight years. I have not, however, given any specifics about how this risky strategy actually produces lower profits than a more conservative, less expensive strategy. So I recently ran a simulation of the NYCERS portfolio for the period from 2005 to 2010 using a conservative strategy.

Simply stated NYCERS uses a 70% stock/30% bond strategy. In addition, NYCERS has multiple variations within both of these classes. If, in 2005, NYCERS had returned to its traditional 50% stock/50% bond allocation and used only indexed stock funds and core bond classes, the simulation showed that NYCERS would have had a closing balance of $43B in FY-2010 instead of $35B. Listed below are the results of the simulation along with with the actual results since 2005.

Year	70%/30%	***	50%/50%	***
*	Closing Balance	Profit/Loss	Closing Balance	Profit/Loss
2005	$35.526B	$2.132B1	$36.285B	$2.551B
2006	$37.288B	$2.471B	$38.357B	$2.393B
2007	$42.514B	$4.858B	$43.892B	$4.949B
2008	$39.717B	-$3.103B	$42.685B	-$1.911B
2009	$31.903B	-$8.165B	$38.223B	-$5.218B
2010	$35.384B	$3.412B	$42.790B	$4.096B

You will notice that the conservative strategy produced better results and smaller swings in the returns than the current aggressive approach. This is due to better profit/loss figures, higher dividend/interest payments, and lower investment fees. All of this creates a better operating environment for a mature pension plan that paid out $3.4B in benefits for FY-2010.

Another advantage of the conservative strategy is that it is totally liquid and based on published market values. The actual NYCERS closing balance for FY-2010 has a $3.5B component that is illiquid and not based on market values. This raises reliability issues about the actual value of this component.

To my knowledge the NYCERS investment advisor, Callan Associates, has never run this type of comparison simulation.

The fees for the conservative strategy would have been only $15M as opposed to the $175M that NYCERS actually paid in FY-2010. Of course there would have no lunches, dinners, golf outings, or campaign contributions with this strategy. There would also have been no temptation for possible bribes either.

The next time you hear someone attack public pension plans, point out to them that investment decisions by elected officials are the most immediate threat to the solvency of the pension plans.

Outstanding Loans at Retirement (also Deficits)

Tier 4 Outstanding Loans at Retirement (also Deficits)

Many Tier 4 NYCERS members retire with a pension loan outstanding. The member can choose to pay off the full outstanding loan or have his/her benefit reduced by the actuarial value of the outstanding loan.

The reduction is accomplished by dividing the amount of the outstanding loan by an annuity factor to produce the amount of the annual reduction of the full pension benefit. The annuity factor is a function of an interest rate and one of the two Tier 4 mortality tables (service & disability).

The loan statute specifies that the interest rate changes each year and is equal to the 30 year US Treasury bond rate on January 1 of that year. All retirements during that year are keyed to that interest rate. That means that the cost is dependent on the year you retire. The factors change every year.

I’ve listed below a small snapshot of the service annuity factors for Tier 3&4 loans over the last five years as well as Tier 1&2 loan factors which do not vhange each year. For some reason NYCERS does not list the full tables when discussing the pension benefit reduction for outstanding loans at retirement.

Loan reduction factors – Service Retirements

****	Tier 3&4	Tier 3&4	Tier 3&4	Tier 3&4	Tier 3&4	Tiers 1&2	Tiers 1&2
Year	2006	2007	2008	2009	2010	all years	all years
Interest rate	n/a	4.81%	4.45%	2.69%	4.63%	4%(F)	7%(U)
Age at Retirement
55	13.903	13.474	13.992	17.106	13.729	13.803	10.941
56	13.681	13.266	13.767	16.764	13.513	13.501	10.810
57	13.452	13.052	13.535	16.416	13.290	13.193	10.673
58	13.218	12.832	13.297	16.062	13.061	12.881	10.531
59	12.977	12.606	13.054	15.704	12.826	12.566	10.383
60	12.731	12.374	12.805	15.343	12.586	12.246	10.230
61	12.480	12.138	12.551	14.977	12.341	11.923	10.072
62	12.224	11.896	12.292	14.608	12.091	11.596	9.909

The Tier 4 loan annuity factors are different from the factors used for computing the reduction for optional pension benefits. At retirement, a retiree can pick these benefits in lieu of his/her full maximum pension benefit. Optional benefits provide payment to a beneficiary when the retiree dies, whereas the maximum benefits stops upon the death of the retiree. As of August 19, 1985 the interest rate for these annuity factors is 7% (see the Tier 1&2 factors in the table).

Tier 3&4 Members who retired in 2009 received a significant break on the benefit reduction for outstanding loans. This was tied into lower interest rates caused by the financial crisis that hit in late 2008. A $10,000 outstanding loan for 2009 retirement at age 55 caused a $584.59 (=$10,000/17.106) annual reduction. In 2008, the same $10,000 loan resulted in a $714.69 (=$10,000/13.992) annual reduction at age 55.

In Tier 1&2, the same annuity factors are used for both outstanding loans/deficits and optional benefits. They are based on a 4% (female mortality) or 7% (unisex mortality) interest rate depending on which produces the best benefit. The factors do not fluctuate from year to year. There is also a provision which allows Tier 1&2 members contribute excess contributions. This, in turn, allows for an additional annual annuity paid in retirement based on these additional member (not employer) contributions. Tier 4 makes no provision for excess benefits based on excess contributions.

Note: Prior to 1991, the start of the Tier 4 Loan program, deficits in contributions resulted in the loss of the service credit associated with the missing pension deductions. Since the loan program offered an actuarial reduction process, NYCERS extended this process to deficits. NYCERS then offered members, retiring with deficits, the opportunity to have the deficit treated as an outstanding loan. This allowed the member to take an actuarial benefit reduction rather than the loss of the service credit. Usually this would produce a lower benefit reduction.

Interestingly, from February 18, 2002 to February 8, 2006, the US Treasury did not offer 30 year bonds and therefore, there were no daily quotes for these securities during this period. It is not clear what interest rate the NYCERS actuary used for retirees between 2003 and 2006.

Warning on Pension Revisions

Recently NYCERS sent a retiree a pension revision letter dated October 21, 2010. The member had retired five years earlier in 2005.

NYCERS was notifying him that they were reducing his annual pension from $39,924 to $36,165 and that they were going to recover $18,915 in overpayments by further reducing his monthly pension check by $378 over the next 4 years.

The letter said that the reason for the reduction was that NYCERS had used the wrong required contribution percentages for the member when NYCERS was calculating his required contributions. NYCERS had originally used 4.45% effective as of the retiree's membership date in 1982 and 4.25% as of 6/30/97. NYCERS was now saying that it should have used 6.45% all the way back to 1982. This increased his required contributions from $42,979 to $77,325 and in turn reduced his pension benefit.

NYCERS gave no rationale for using any of these rates. NYCERS did not state a reason why NYCERS had reviewed the retiree’s case 5 years after retirement. NYCERS also did not provide the retiree with a copy of the new calculation of his required amount or the history of his pension contributions and the interest they earned.

The retiree called NYCERS on 10/29/10 asking for further explanation of this significant reduction. The call center agent told him that he would get a call back within 3 business days explaining the revision.

On November 9, 2010, after not receiving the promised call back, this retiree and I visited the NYCERS customer service center. The customer representative indicated that the inquiry had been misdirected and maybe that was why NYCERS had not returned the retiree's call.

During the meeting it became clear that NYCERS had not scanned the October 21, 2010 letter into the agency's imaging system until November 8, 2010, the day before our visit. This two and half week delay may have contributed to the failure to call back the retiree. For an agency that is as well funded as NYCERS, this delay is a sign of an operations failure.

From the specific rates quoted in the letter, I guessed that NYCERS was incorrectly applying the specific plan rate to the period from 1982 to 2002. The statute, however, specifically limited the plan rate to only service credited after 6/30/2004.

After we showed the applicable section of law to the NYCERS customer representative, he promised to get an answer from the officials upstairs and call the retiree the very next morning.

The member, however, did not receive a call the next morning. The member waited until 3:00 PM and called the NYCERS call center. He was eventually connected to the representative from the previous day who then told the retiree that the October 21, 2100 letter was in error. The representative also stated that NYCERS would send an explanatory letter and that NYCERS would cancel the scheduled changes to his November pension check.

Let’s hope that this story ends well. The retiree did receive a letter on November 19, 2010 confirming that the original letter was in error and that there would be no change to his pension check. There was, however, no explanation of the cause of the error. Everyone makes mistakes. It's how one handles the mistake that defines you.

I suspect that that without my help this retiree would have lost a lot of money. I have been trying for many years to get NYCERS to provide a rationale for their interpretation of the rates used in the pension plan that this member retired under. NYCERS has, however, refused to provide their rationale.