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 public pension fund.
Unfortunately, for reasons explained below, he is blowing an opportunity to go further in the right direction.
The comptroller today confirmed what he’s signaled for months (going back to before stock prices began sinking): he will be reducing, to 7 percent from 7.5 percent, his return rate of return for the fund that feeds 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—except DiNapoli is also approving other changes to actuarial assumptions that will produce the biggest drop in ERS contribution rates in more than 25 years.
This decrease in ERS employer costs will be greeted as good news for local governments and taxpayers in the short run—but it’s still being achieved by needlessly shifting financial risks into the future.
New York’s Common Retirement Fund (the pool financing the ERS and PFRS, valued at $185 million as of March 31) will become one of only eight public systems in the nation, out of a total of 126, that assume annual returns of 7 percent or less. New York City’s funds began moving to a 7 percent level a few years ago. Less than one-third of all pension systems—including, notably, the New York State Teachers’ Retirement System (NYSTRS)—are stubbornly sticking with a more optimistic long-term return assumption of 8 percent, which was the norm before the market crash of 2007-09. The TRS is in the process of seriously underfunding itself, based on CRF standards.
Unfortunately, for reasons made clear in the comptroller’s own actuarial report, this latest drop in the discount rate does not go far enough. According to the pension system actuary, Michael R. Dutcher, the “expected” return on the CRF investment portfolio is not 7 percent but 6.58 percent (see page 8). In 150,000 simulations of actual market returns, Dutcher’s report said, the state’s own model suggests that a portfolio will return at least 7 percent only 42 percent of the time.
In other words, there is a less than 50-50 chance that the CRF will meet even the lower goal of 7 percent.
Dutcher wrote that he did not recommend lowering the return assumption to the statistically more likely 6.6 percent level because “we have a funding objective of smooth employer contribution rates and I am concerned that such a precipitous reduction leans in the direction of being rash.”
But based on other data in the actuarial report, it also appears that employer costs could, in fact, have been kept “smooth” even if the discount rate and return assumption had been set at less than 7 percent. That’s because Dutcher and his actuarial advisory committee agreed to make several other adjustments that will have the impact of reducing the amount that must be set aside to pay future pensions.
Most important of these changes: the assumed average salary increases for state and local employees will be significantly reduced—to 3.8 percent from 4.8 for ERS members, and to 4.5 percent from 5.4 percent for PFRS members. Compounded over time, that can make a very big difference in pension obligations, which are based on final average salaries.
“The current economic climate and disposition towards civil service wages does not portend a reversal of the pattern of low wage growth, and I think the salary scales can be dramatically reduced,” Dutcher explained.
However, if future public employee raises return to the levels more common before the Great Recession, pension funding will prove inadequate and the assumptions will have to be changed.
Other changes that will reduce pension costs include the incorporation of two stronger investment return years “smoothed” into the base—even though the fund actually underperformed, at 7.1 percent last year; and a further adjustment to a new “mortality table” based on the actual lifespans of retirees, along with administrative and billing changes.
Result: the rate of taxpayer-funded employer contributions will decrease from 18.2 percent in 2016 to 15.5 percent in 2017, the biggest single-year drop since 1989, after peaking at nearly 21 percent this year. The PFRS contribution rate will decrease less in the same period, from 24.7 percent to 24.3 percent. Rates will continue to rise for local governments that opted into DiNapoli’s “stabilization programs,” which allowed them to defer some of their pension bills by effectively borrowing from the pension fund for up to 10 years.
Meanwhile … the S&P 500 has lost 5.3 percent of its value since CRF closed its last fiscal year on March 31. To hit its expectation in what’s left of this year, stock prices as measured by the S&P index would have to rise by 13 percent in the next seven months. That’s not completely unprecedented—the same index rose by more 10 percent between last October and the end of March—but in the current climate, it would appear to be highly unlikely. (For example, if the domestic and international stock market recover sufficiently to gain 4 percent on the year, and if all other asset classes perform in line with expectations, the pension fund in fiscal 2016 will earn around 5 percent.)