screen-shot-2019-01-31-at-4-55-16-pm-150x150-6287798The board of the New York State Teacher Retirement System this week voted to reduce the pension plan’s assumed rate of return on investments from 7.25 percent to 7.10 percent, which is (a) a step in the right direction, and (b) still unrealistically high.

The new projected return assumption, used as the discount rate for calculating and funding long-term teacher pension liabilities, matches NYSTRS’ actual return on investments during the fiscal year ended June 30, which fell 0.15 percent short of the previous target.

As a result of the discount rate change, and of some other tweaks to actuarial assumptions, the board also was told that the employer contribution rate for the 2020-21 school year (payable in fall 2021) will range from 9.25 percent to 10.25 percent. This represents an increase over the 2019-20 school year rate of 8.66 percent. The dollar impact on school districts and other employers of NYSTRS members will be an increase of $100 million to $300 million, depending on where the needle lands, according to a presentation by the pension system’s actuary.

NYSTRS’ move is consistent with a slight, continuing downward trend in discount rates among public pension funds across the country, which belatedly have been tugging their assumed returns down from an average of 8 percent prior to the financial crisis and recession.

The discount rate matters because it is used to determine how much cash the system needs to collect from employers and (younger) employees every year to cover future pension benefit obligations, which are constitutionally guaranteed in New York.

The higher the rate, as supposedly justified by a higher investment return assumption, the less current cash you need to save to cover future obligations. But we are now living in the lowest interest rate environment in modern history, with U.S. Treasury bond rates hovering around 2 percent.

The broad consensus of actuaries and independent financial analysts—those employed outside the public sector, at least—is that assumed rates of return for public pension plans should be much lower, matched to the level of risk associated with the benefits promised. Private-sector corporate employer pension plans are required to discount pension liabilities based on low- or no-risk discount rates, now typically in low single digits. European and Canadian pension plans also use much lower discount rates; for example, the Ontario Teachers’ Plan manages to be fully funded while discounting its liabilities at a 4.8 percent rate.

State Comptroller Thomas DiNapoli announced two months ago that he would drop—to 6.8 percent from 7 percent—the rate of return assumption used to calculate tax support for the New York State and Local Retirement Systems (NYSLRS), encompassing the 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.

So why doesn’t NYSTRS drop its rate a little further, matching DiNapoli’s?  That question does not appear to have been addressed at the NYSTRS board meeting, but the probable answer is that the board did not want to cause a larger increase in contributions. That’s just another way of saying they’d rather leave taxpayers holding the bag for the substantial risk that returns will not, in fact, meet or exceed 7.1 percent—a level that requires the fund to continue investing heavily in corporate stocks and other riskier assets, as opposed to safer bonds.

Meanwhile, the five New York City pension plans collectively are discounted at a rate of 7 percent—and much less well funded than either NYSTRS or NYSLRS.

The following passages from the last NYSTRS-focused blog post in this space bears repeating:

While other states grapple with serious pension funding shortfalls, NYSTRS consistently ranks among the best-funded public pension plans in the country. However, like all defined-benefit plans, it still poses an open-ended financial risk to future taxpayers, who must stand behind a constitutional guarantee of pension benefits.

Given Wall Street trends since last summer, NYSTRS is highly unlikely to earn anything close to its assumed 7.25 percent rate of return on investments before its current fiscal year ends June 30 [asnoted above, it didn’t]. A prolonged bear market would inevitably push rates up again within the next few years.

The Tier 6 reforms have reduced the so-called “normal” cost by slightly reducing benefits, raising full retirement age, and requiring employee contributions to the pension fund. However, the Tier 6 savings have been offset in part by changes in actuarial assumptions.

Funding issues aside, the defined-benefit pension system is rigged to produce generous guaranteed retirement benefits for teachers who work at least 25 years, while short-changing a large number of teachers who leave before reaching the 10-year vesting period, or who suspend their careers for long periods to raise children.

About the Author

E.J. McMahon

Edmund J. McMahon is Empire Center's founder and a senior fellow.

Read more by E.J. McMahon

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