NY’s big, fat pension gimmick compromise, Part II

by E.J. McMahon |  | NY Torch

Requiring timely payment in full of every employer’s actuarially determined annual required contribution is among the hallmarks of pension fund probity, in both the public and private sectors. Unlike many of its counterparts in other states, the New York State Teachers’ Retirement System (NYSTRS) has always lived up to that high standard.

Until now.

Buckling to political pressure created by Governor Cuomo’s fiscally irresponsible pension “smoothing” proposal, NYSTRS has negotiated statutory language that would give school districts the option of deferring a chunk of their rising pension contributions over the next seven years. If most districts participate, the sum involved could easily amount to well over $1 billion.

The NYSTRS plan is more conservative, limited in scope and structurally contained than the alternative put forward for the separate New York State and Local Retirement System (NYSLRS) by state Comptroller Thomas DiNapoli.  The teachers’ pension alternative also does not present the same open-ended financial risk as Cuomo’s plan.

But in the final analysis, like both the DiNapoli alternative and Cuomo proposal, the NYSTRS plan is a pension funding gimmick developed in response to political pressures.  In this case, that pressure has been exacerbated by the influence of the 800-pound gorilla ever-present in the school finance room, New York State United Teachers (NYSUT). Like all too many other public employee unions elsewhere in the country, NYSUT has shown itself to be less concerned about the long-term health of the pension fund (which is, in any case, constitutionally guaranteed) than it is about relieving the short-term pressure on its locals to negotiate contract concessions in the face of rising pension bills. NYSUT drafted a bill two years ago that would have allowed districts to bond out a portion of their pension costs, which was ultimately vetoed by Cuomo.  And NYSUT recently endorsed Cuomo’s more reckless pension deferral proposal.

The teachers’ pension funding change in the new budget will not take effect until is approved by the NYSTRS board of trustees, which will meet to consider it on April 25.  Four of the nine trustees are current or retired teachers. DiNapoli, who has no direct managerial role in teacher pensions, also has a representative on the board, as do school boards.

So, what’s the problem here?

The NYSLRS and NYSTRS pension funding changes in the final 2013-14 budget will authorize a form of expansive new borrowing from pension funds, pushing the current cost of funding growing liability further into an uncertain future.

Experience in other states suggests that the habit of legislatively messing with required pension contributions is a hard one to break. New York is taking a big step down a slippery slope that has led to serious pension solvency problems elsewhere.

At a minimum, if lawmakers were determined to make such changes, they should also have required participating employers to be held to a much higher standard of financial disclosure and accountability, including a requirement for filing of long-term financial plans.  Needless to say, it’s not happening.

Details of the teacher pension funding changes

As things now stand, the NYSTRS pension contribution rate payable in the fall of 2014 is 16.25 percent of covered payrolls, up sharply from 11.84 percent payable this coming fall.  NYSTRS refuses to forecast any further out than that, but calculations developed for the Empire Center’s December 2010 pension study suggest that by 2016 it will peak at roughly 19 to 20 percent — the level already hit in the DiNapoli-run New York State Employee Retirement System (ERS).

Districts have one year, commencing July 1, to decide whether to opt into the alternative plan.  Although the budget bill including the change had yet to be filed as of noon March 22, draft language now circulating in the Capitol includes these key provisions:

 

  • Pension contribution rates for participating districts will be frozen at 14 percent of payroll for a minimum of two and a maximum of seven years, financial conditions and actuarial calculations permitting.  If NYSTRS realizes its exceptionally ambitious 8 percent average annual investment return target throughout the period, the new “graded” contribution rate will be a flat 14 percent for all seven years — i.e., until 2020.
  • If poor asset returns cause a deterioration of NYSTRS’ funded status, the contributions could be increased to 16 percent in the third year, and to 18 percent in the fifth year.  Thus, in the worst-case scenario, instead of rising to a probably 19 or 20 percent by 2016, the percentage pension rate in sequence, starting with the payment due in the fall of 2014, will be 14-14-16-16-18-18-18.  The maximum annual savings for a participating district will thus be five or six percent of covered payroll.
  • In the sixth year of the plan, districts must begin to repay a pro-rated share of the pension contributions deferred in years one through five, with interest calculated at the prevailing rate of a 10-year U.S. Treasury bill plus one percentage point, which would currently come to about 3 percent (but which could, of course, increase in the future). The amounts saved in the first five years must be repaid in five even chunks over the next five years.
  • In year eight of the plan, a participating employer must begin paying a pro-rated one-fifth share of pension costs deferred in years six and seven.  Those deferred amounts must be fully repaid by the twelfth year.
  • If the NYSTRS ever falls below an 80 percent funded ratio, all bets are off and fund managers can insist on immediate full payment of the annual required contribution by participating districts.

Practically speaking, the plan is designed to be close-ended — with all deferrals ceasing after seven years and repayments completed in 12 years, or by the end of plan year 2024-25 (for which contributions are payable in the fall of 2025). That contrasts with DiNapoli’s approach, which will allow participating employers to issue a rolling series of annual 12-year IOUs to cover deferred pension costs. The comptroller’s plan could leave participating employers with a deferral-repayment hangover lasting much longer, probably into the early 2030s at a minimum.

The problem, of course, is that if school districts find themselves fiscally stressed by the need to repay pension deferrals during the latter half of the NYSTRS program, they (and NYSUT) could pressure the Legislature to tinker further with the system.

Politicians and pension fund managers in New York may scoff at the notion that the Empire State will ever develop the kind of pension solvency problem that some other states are now experiencing.  But, until recently, changes like the ones the Legislature is about to adopt would have been simply unthinkable.

- E.J. McMahon is the President at the Empire Center for Public Policy.