Just in time for Wall Street’s latest bout of bearish volatility, state Comptroller Thomas DiNapoli is taking an important step to fortify New York’s largest pension fund.
Too bad he also passed up a golden opportunity to go further in the right direction.
The comptroller is reducing, to 7 percent from 7.5 percent, the annual rate of return that he assumes the state Common Retirement Fund will earn on its investments. DiNapoli, the pension fund’s sole trustee, began strongly hinting at this move before the stock market’s plunge in August.
Assuming a 7 percent return puts New York’s largest public-pension fund on the leading edge of a nationwide trend also joined by New York City’s pension systems, which began moving toward assuming a 7 percent return a few years ago.
The comptroller’s action leaves the separate New York State Teachers’ Retirement System — which covers public-school educators outside New York City — in a shrinking minority of funds still optimistically assuming they’ll earn 8 percent.
The rate of return matters because it’s a key determinant of the amount taxpayers must fork over every year to ensure that pensions are adequately funded in the future.
Normally, the less the pension system assumes it will earn on investments, the more taxpayers have to pay in the form of current contributions, which are calculated as a share of current payrolls. Based on DiNapoli’s recent signals, New York’s state and local governments had reason to expect their pension costs would stay at their current high levels for years to come.
But DiNapoli coupled his rate reduction with changes in other calculations that will shrink current pension-funding costs. Most notable among them: the assumption that future pay hikes for state and local workers will remain lower than they were before the recession. That should translate into lower pensions — assuming, of course, state and local officials actually hold the line on salaries.
So, even assuming lower investment gains, DiNapoli projects that state and local government pension bills for 2016 will decrease by $800 million, reflecting New York’s biggest one-year drop since 1989 in pension contributions as a share of employee salaries.
But today’s savings will likely translate into tomorrow’s higher costs. In a world of ultra-low interest rates on the safest fixed-income investments, such as bonds, the pension fund can only hope to earn 7 percent by continuing to invest heavily in stocks and other riskier, more volatile assets.
There’s still another problem here, common to all public pension systems: unlike private pension-fund managers, DiNapoli is allowed to “discount” future pension liabilities based on what he assumes he’ll earn, rather than using the much lower “market” interest rate determined by low-risk bonds.
In fact, as noted in DiNapoli’s own actuarial study, there’s a less than 50-50 chance New York state’s pension investments will make 7 percent annually over the next 30 years. The expected long-term return on the state’s current investments is 6.6 percent, the study said.
Re-setting the return assumption to 6.6 percent would have would have moved at least a bit closer to reflecting the true cost of generous public-pension benefits, which are guaranteed by the state Constitution. And it would’ve done more to limit pension-fund shortfalls after the next prolonged market dive — which, for all we know, could be just around the corner.
The Common Retirement Fund earned an average of 5.9 percent between 2001 and the end of its 2015 fiscal year on March 31 — and since then, the S&P 500 has dropped by more than 5 percent. Assuming DiNapoli’s stock investments roughly track the S&P, they’ll have to gain at least 13 percent over the next seven months to hit the new return target. That’s not completely unprecedented — but would appear to be highly unlikely.
It’s quite possible that New York state’s pension investments will live up to their assumptions in the future. Or . . . not. With employee-pension contributions limited, the retirement fund is gambling mainly with someone else’s money — yours.
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