So, in the end, the state’s pension guardian caved, after all.

To his credit, Comptroller Thomas DiNapoli did not embrace Governor Cuomo’s dubious proposal to allow localities to massively underpay pension contributions to the New York State and Local Retirement System (NYSLRS), trading short-term savings for potentially open-ended long-term liabilities.

However, NYSLRS’ sole trustee did the next-worst thing: unnecessarily offering an “alternative” revision to an existing pension cost deferral program, enacted with his support three years ago.

(Click here for subsequent post on separate teacher pension funding changes.)

Since 2010, both the state and its local governments have had the option under the comptroller’sContribution Stabilization Plan of choosing to pay a special discount “graded rate” instead of the “normal annual contribution” established by the system’s actuaries.  For 2013, the average normal rates — i.e., what employers should be paying –are 18.9 percent for the Employee Retirement System (ERS) and 25.8 percent for the Police and Fire Retirement System (PFRS). The graded rates are just 11.5 percent and 19.5 percent, respectively.  The difference between the two is deferred – effectively converted into a loan by the pension fund to the employer, repayable over a 10-year period at  a rate of interest pegged to taxable municipal bond rate, which equates to about 3 percent.

The annual change in the graded rate is limited to one percentage point a year, meaning they can’t go up or down any faster than one percentage point. Each succeeding a year, the difference between what a participating employer pays and what it actually owes is converted into a new IOU, repayable over a 10-year period.

Under these terms, over the past three years, the state and local governments opting into DiNapoli’s Contribution Stabilization Plan have deferred a total of $2.2 billion in pension contributions. As of fiscal 2012, a smaller number of local governments around the state also owed the fund a total of $325 million for 2004-07 contributions they were allowed to amortize for up to 10 years under a 2004 deferral law.

DiNapoli’s “New Alternative Contribution Stabilization Plan,” to be included in the 2013-14 state budget, differs from the current plan in these respects:

• the maximum annual change in pension contributions is half as much – i.e., 0.5 percentage points, so the increases and decreases will be at a slower pace;
• the repayment period is 12 years;
• the interest rate on deferred payments is linked to the rate on Treasury bills, plus one percentage point, which also currently equates to roughly 3 percent, and
• the state government is not eligible to participate, but all local governments, public hospital corporations in several counties, and Boards of Cooperative Educational Services (BOCES) will be eligible.

The new law will open a one-year window for opting into the new plan at graded rates of 12 percent for ERS and 20 percent for PFRS (Cuomo’s starting point was also 12 percent for ERS, but 18.5 percent for PFRS) compared to normal rates of 20.5 and 28.9 percent, respectively, for 2013-14.

Once checked into the plan, participating employers will not be allowed to exit from it. They may elect not to defer a portion of their contributions in any given year, but their savings when rates decline (whenever that happens) remain limited to a half-percentage point, even if the decline in normal rates is faster.

DiNapoli’s original plan was objectionable because it constituted a form of borrowing from the pension fund. It allowed participating employers to push costs further into a murky future, at which point the fund could be holding a big pile of IOUs from financially distressed governments.

The new, decidedly unimproved alternative plan allows for more borrowing, for a longer period of time. This risk is that this will generate a bigger stack of IOUs from New York’s shakiest local governments, giving rise to more political pressure to defer even more if the future brings more economic and fiscal hard times.

But, for all that, the comptroller’s alternative is  less financially risky and objectionable than Cuomo’s plan, which would have messed with the actuarial mechanics of the state pension fund to purportedly create a “stable” rate for 25 years. The underlying assumption was that the normal rate will decline fairly steadily and steeply as new employees are hired under the Tier 6 pension plan, which has a lower “normal” cost to employers.

But what if the fiscal weather turned foul and the pension fund needs more to keep its head above water? The governor’s plan gave the comptroller the ability to raise the rate by no more than two percentage points after five years, and then again after 10.  So in the worst case, the maximum rate paid by participating employers (again, excluding the state) would have been 16 percent — even if the pension fund required, say, 20 percent.  Beyond that, if the pension fund were falling further behind in what it needed to raise to cover future liabilities, the comptroller’s only recourse would be to extend the repayment period beyond the 25 years. Out to infinity, conceivably.

DiNapoli’s compromise plan at least requires a payback schedule of no more than 12 years – albeit 12 years starting in the last year a participating employer defers a portion of its required contribution, which will be years from now.  Participants have the flexibility to defer a portion of each year’s bill – meaning they could voluntarily pay more, or benefit to at least a limited extent from any sharp drop in pension rates, rather than being locked into the governor’s “stable” rate for a longer period.  Compared to Cuomo’s proposal, DiNapoli’s plan will allow localities to defer smaller amounts over a shorter period of time.

The New York State Teachers’ Retirement System (NYSTRS) has not previously offered any pension deferral plan, but a draft of something similar (but not identical) to DiNapoli’s plan is circulating and is likely to be in the same budget bill, whenever it appears. More on that in this space soon.

The basic problem with all these pension deferral approaches is that they represent a step further down a slippery slope that could very easily lead to more serious abuse and underfunding of the pension systems in the future — especially if the future brings more economic and fiscal stress for local governments. If experience in other states teaches us anything, it’s that the bad habit of underpaying pension contributions is easy to develop and difficult to shake – until it’s too late.