A Threat to Pension Solvency

by E.J. McMahon |  | Albany Times Union

The state’s largest public union is right. Gov. Andrew Cuomo’s proposal to “smooth” pensions for local governments and school districts is “a bait-and-switch scheme … that will allow public employers to underfund their pension obligations,” as the Civil Service Employees Association described it last week.

In lieu of fundamental mandate relief, Cuomo wants to give counties, municipalities and school districts the ability to immediately reduce pension contributions by up to 43 percent, and “lock in” a “stable” pension contribution rates for a 25-year period.

This would be accomplished by significantly underfunding the pension systems over the next few years, based on the expectation that the cheaper benefits offered to newly hired workers under Cuomo’s Tier VI pension plan will ultimately yield more than enough savings to make up the difference later in the 25-year period.

There are three problems with the idea:

Even under ideal economic and financial market conditions, it’s likely to be a losing bet for employers — saving them less in the short-term than it would cost them in the long run.

It weakens and increases the financial vulnerability of the pension funds at a time when they have yet to fully recover from their massive losses during the recession, and in the long-term poses greater financial risks for both the funds’ beneficiaries and the funds’ ultimate underwriters, New York’s taxpayers.

It may violate the state constitution’s prohibition on impairment of public retirement benefits.

Fortunately, Cuomo’s plan cannot be implemented without the approval and cooperation of state Comptroller Thomas DiNapoli, who is sole trustee of the New York State and Local Retirement System, and the board of trustees of the separately administered New York State Teachers’ Retirement System.

It’s hard to see how DiNapoli or the teachers’ fund trustees could find this proposal consistent with their fiduciary responsibilities.

The comptroller already has pushed the envelope by allowing local employers to borrow a portion of their pension increase from the pension fund itself, to be repaid in annual installments over 10 years. Less than two years ago, Cuomo himself vetoed a bill that would have allowed school districts to bond out a portion of their pension increases. The governor said it would “breach the trust placed in me by the people of this state” and create debt without voter approval.

The pension problem is a real one. After the historic boom of the 1990s, pension fund investment returns turned especially volatile in the past decade, culminating in massive losses between 2007 and 2009. Because employee contributions are both minimal and fixed, taxpayer-funded contribution rates have had to make up the difference, rising from a low of just above zero in 2000 to the projected 2013-14 levels of up to 16.5 percent for teachers, 28.9 percent for police and firefighters and 28.9 percent for other municipal workers. Localities and school districts have been hit with massive pension increases when they can least afford it.

The governor’s proposal purports to tame this volatility by slashing contribution rates to a flat, predictable levels starting as low as 12 percent, or roughly double the expected level of long-term pension contributions once the workforce consists mainly of Tier 6 members. Expected is the key word here, since the plan assumes that Tier 6 benefits will never be sweetened (defying all historical precedent) and that the pension funds will reap higher investment returns than investment gurus like Warren Buffett feel comfortable predicting.

The last time New York attempted to make this big a change in public pension calculation calculations was 1990, when Gov. Mario M. Cuomo and the Legislature passed a law directing the comptroller to switch from the relatively conservative “aggregate cost” method to the “projected unit credit” or PUC method, which would have permitted lower employer contributions.

Three years later, ruling on a lawsuit brought by the CSEA, the state Court of Appeals struck down the law as an unconstitutional impairment of retirement benefits. The court said that then-Comptroller Edward Regan had been improperly “divested of his autonomous judgment” on whether the switch to PUC was prudent. But the decision also contained strong hints that the funding change would have been overturned as an unconstitutional impairment even if Regan had gone along with it.

Andrew Cuomo’s new pension gimmick poses at least as big a threat to pension solvency as PUC ever did. The CSEA should be prepared to call its lawyers again.