It’s official: after a decade in which the New York State pension fund’s annual return on assets averaged less than half its target rate, the fund will need to jack up its taxpayer-funded contribution rates next year, Comptroller Thomas DiNapoli announced today. DiNapoli said the rate in 2011-12 would rise from 11.5 percent of salary to 16.3 percent for members of the Employee Retirement System (ERS) and from 18.2 to 21.6 percent for members of the police and Fire Retirement System, (PFRS).
This is no surprise. In fact, almost precisely the same rate of change in pension contributions was projected by Governor Paterson’s Division of the Budget (DOB) eight months ago, in the 2010-11 Five Year Financial Plan (see table on page 59).
And this is just the beginning of a steady climb in pension bills. Although the state comptroller avoids projecting contribution rates more than a year in advance, DOB estimates they will hit 23.5 percent for ERS and 31.4 percent for PFRS for by 2013-14. However, thanks to a newly enacted law first proposed by DiNapoli, the state intends to “cap” the increase in its annual payments to the fund at a percentage point a year. It will send the pension fund an IOU for anything over that amount, repayable in 10 annual installments with interest. Local governments can similarly kick the can down the road by opting into the same Cap-and-Owe gambit.
By 2015-16, the state alone will owe the pension fund about $2 billion, according to DOB estimates. This is prudent, the comptroller essentially argues, because sooner or later the fund will start earning hefty returns again, which will make it possible to reverse the rate run-up.
Speaking of returns, DiNapoli’s announcement today was actually a two-fer: in addition to disclosing new contribution rates, he announced the pension fund’s updated actuarial assumptions. Among the changes, also as expected, the fund will be reducing the assumed rate of return on its investments from 8 percent to 7.5 percent.
Like other state public pension funds, New York’s retirement system discounts its future liabilities based on its assumed returns, a practice that has come in for much criticism by independent financial economists and actuaries and other analysts. Private pension funds, covered by more stringent accounting rules, must discount based on a low-risk bond rate.
Any reduction in the assumed rate of return also means a slight increase in the estimated present value of future liabilities. However, it’s not clear whether the change in the discount rate announced by DiNapoli today played a major role in the announced increase in contribution rates, since other changes in actuarial assumptions may have offset that impact.
DiNapoli disclosed that the market value of the fund’s assets had decreased 4.38 percent in the April-June quarter of this year “due to market volatility.” But the financial markets weren’t just “volatile” in first quarter. They were down. And since June 30, equity values have basically moved sideways.
Will the economy and the financial markets snap back strongly enough for the pension fund to turn the first quarter’s 4.38 percent loss into a full-year gain of 7.5 percent between now and next March 31? No one can say, which is just part of thrill and excitement of constitutionally guaranteeing tens of billions of dollars in pension payouts based on risky investments and optimistic market assumptions. After all, Mr. and Ms. Taxpayer, we’ve always got you as a safety net!
DiNapoli also emphasized that New York’s assumed rate of return and discount rate will be among the lowest of any public pension fund. This won’t be true for long, though, as pension systems across the country are wrestling with the same issue. For example, the giant California Public Employees’ Retirement System (CalPERS) currently assumes a return of 7.75 percent and says it needs at least 7.6 percent to meet its obligations over the next 15 years. But CalPERS is also expected to reduce its return assumption after a year-long review in which its trustees have repeatedly been told to lower their sights. Here is what they heard from a top investor around this time last year:
“You’re not going to get a 7.6 percent return when the U.S. is seeing a subpar (economic) growth rate of 2 to 3 percent,” BlackRock Inc. chairman and CEO Laurence Fink told the CalPERS board. “You’ll be lucky to get 6 percent on your portfolios, maybe 5 percent.”
The New York State pension fund’s time-weighted annualized return has been 4.2 percent over the past five years and 3.7 percent over the past 10, according to today’s actuarial report. Nonetheless, the fund could easily meet its 7.5 percent target in the long run if asset returns retrace the path of the mostly booming 1980s and 1990s. It has happened before, and it could happen again. Or, then again, maybe not. If not — well, there’s always that safety net.
DiNapoli’s Republican opponent, Harry Wilson, today issued a report with a completely different take on pension funding.