For the third time in nine years, state Comptroller Thomas DiNapoli is reducing his assumed rate of returns on state pension fund investments.
DiNapoli today announced he will drop—to 6.8 percent from 7 percent— the rate of return assumption used to calculate tax support for the New York State Employee Retirement System (ERS) and the Police and Fire Retirement System (PFRS), which cover roughly 1 million active and retired non-teachers outside New York City.
The return assumption also is used as the discount rate on projected future liabilities, which in turn is a crucial factor in determining tax-funded employer contributions as a share of payroll. Generally, a lower rate requires higher contributions. However, DiNapoli is projecting the ERS rate for 2020-21 will remain unchanged at 14.6 percent of base salaries, and the PFRS rate will tick up only slightly, to 24.4 percent from 23.5 percent.
According to the annual report of the retirement systems’ actuary, employer rates can be stabilized despite the lower discount rate because the systems also are adopting an updated “mortality improvement” table developed by the Society of Actuaries. The new table reflects a slight decrease in U.S. life expectancy stemming from higher mortality rates for Alzheimer’s, accidental deaths, and suicides, as explained here. The bad news of more early deaths equates to savings for defined-benefit pension plans.
Stepping in the right direction
The state ERS and PFRS discount rate was last reduced to 7 percent from 7.5 percent in 2015. It had been 8 percent as recently as 2010. In fiscal 2019, which ended March 31, the funds’ investments earned only 5.23 percent. One the past 20 years, its annual return has averaged 6.64 percent.
DiNapoli’s latest move is a good one. Mind you: the rate will still be much too high by private-sector standards, which require corporate plans to discount liabilities based on risk interest rates closer to the roughly 3 percent yield on AAA-rated corporate bonds. As explained in this space four years ago, the comptroller’s move to 7 percent in 2015 was a missed opportunity to go a notch lower without markedly increasing pension costs. DiNapoli’s own actuary estimates there is a slightly greater than 50-50 chance the system will actually earn less than 6.8 percent (see table on page 14 of his report).
However, once again, DiNapoli deserves credit for continuing to at least nudge this crucial key variable slightly further in the right direction—down.
The combined pensions system administered by New York’s state comptroller will now be among only 17 out of 129 public systems across the country with a discount rate below 7 percent. The national median for these plans as of February was 7.25 percent, according to the National Association of Retirement Administrators. If DiNapoli had kept the rate at 7.25 percent, he could hide in the middle of the pack—and take bows for much lower state and local pension costs. This is a rare instance of an elected official putting the taxpayers’ long-term interests ahead of his short-term gain.
DiNapoli is being far more prudent and responsible than the trustees of the New York State Teachers’ Retirement System (NYSTRS), who maintain the illusion that the rising cost of generous pensions can be funded at a lower cost by assuming their investments will earn 7.25 percent.
New York City has set a discount rate target goal of 7 percent—but it hasn’t gotten there yet. Unlike DiNapoli’s state systems, which have immediately adjusted funding requirements to meet each reduction in rates since 2020, the five city pension funds are “amortizing” (i.e., phasing in) their way towards eliminating current pension shortfalls based on a 7 percent discount rate as of 2032.
** NOTE: The following paragraph was corrected and clarified since the original was posted.
In 2015, the city’s actuarial consultant recommended
the rate for the five city funds be reduced to 6.75 percent. that the city “lower [its] return assumption.” The consultant did not recommend a specific figure, but used 6.75 “for illustrative purposes.” City Comptroller Scott Stringer has ignore d did not follow this recommendation, no doubt because it saves money in the short run to stick at 7 percent. (Again: the more you assume you’ll earn, the less you have to contribute to the system.) A 6.75 percent discount rate would add $655 million to the city’s annual tax-funded pension contributions, already at a record of roughly $10 billion in Mayor deBlasio’s current budget.
But the short-term savings from assuming a continuing phase in of a higher discount rate also creates a much bigger risk that, after the next (imminent?) recession and bear market, pension contributions will leap even higher, perhaps billions of dollars higher.
In the wake of DiNapoli’s latest move, both Comptroller Stringer and the NYSTRS trustees should feel more pressure to explain why they are not at least moving in the same direction.
PS — Financial markets have been increasingly volatile in the past decade and are expected to stay that way in the foreseeable future. In his report, the state actuary makes this point:
In a more mature fund with a high asset leverage ratio, investment volatility has a greater impact on the employer contribution rate. NYSLRS is now a mature plan with the associated significant exposure to investment volatility risk. [emphasis added]
An important point: The exact same thing can be said of NYSTRS and the New York City systems.