For years, New York City has been dutifully pumping more and more money into its giant pension system for retired city workers.
Next
year alone, the city will set aside for pensions more than $8 billion,
or 11 percent of the budget. That is an increase of more than 12 times
from the city’s outlay in 2000, when the payments accounted for less
than 2 percent of the budget.
But
instead of getting smaller, the city’s pension hole just keeps getting
bigger, forcing progressively more significant cutbacks in municipal
programs and services every year.
Like
pension systems everywhere, New York City’s has been strained by a
growing retiree population that is living longer, global market
conditions and other factors.
But
a close examination of the system’s problems reveals a more glaring
issue: Its investment strategy has failed to keep up with its growing
costs, hampered by an antiquated and inefficient governing structure
that often permits politics to intrude on decisions. The $160 billion
system is spread across five separate funds, each with its own board of
trustees, all making decisions with further input from consultants and
even lawmakers in Albany.
The
city’s pension assets have fallen further and further behind its
obligations — the amount needed to cover future pension payouts — a
troubling trend that could eventually ripple across the entire city
budget, but which has so far received little attention under Mayor Bill de Blasio.
Whether
he can restore balance to the city’s pension system promises to be one
of his biggest challenges, one that will affect not just future
generations of workers, but all city residents and taxpayers.
Pension
analysts compare the worsening situation in New York to watching
someone try to fill a sink when the drain is open. “They’re never going
to catch up,” said Sean McShea, president of Ryan Labs, a New York-based
asset management firm that works for pension funds and other
institutions.
The
fallout can be seen in measures of the pension system’s financial
health. From 1999 to 2012, for example, the plan for general workers
fell to just 63 percent funded from 136 percent.
Last
year, Morningstar, the investment research firm, evaluated for the
first time the strength of state and local pension systems across the
country and rated New York City’s as poor. Only a few major cities’
pension systems garnered such a low rating, said Rachel Barkley, a
municipal credit analyst who wrote the report for Morningstar.
Mr.
de Blasio, who has appeared less engaged with the city’s pension
problems than his predecessor, Mayor Michael R. Bloomberg, is
confronting a legacy of costly and questionable decisions going back at
least to the years of Mayor Rudolph W. Giuliani, a review by The New
York Times found.
Like
many public systems, New York has promised irrevocable pension benefits
to city workers on the thinking that fund investments would grow enough
to cover the cost — but they have not. Its response so far has been to
take advantage of a recovering local economy and inject a lot more city
money into the pension system quickly — an option not available to
declining cities like Detroit, which filed for bankruptcy last year, or a
tax-averse state like New Jersey, which has been underfunding its
pension system for years.
At
the same time, New York has been aggressively chasing higher investment
returns, shifting more money into riskier assets, which come with
higher fees. Even as the system’s returns have lagged, pension officials
have resisted making changes in the oversight structure that many
experts believe could lead to improvements.
Complicating
matters for Mr. de Blasio, wages and benefits are likely to swell even
more in the near future, in line with a new teachers’ union deal that
sets a baseline for more than 100 other expired contracts.
All
of these factors have made the system acutely dependent on investment
income. Yet its investment strategy is subject to the whims of the
city’s electoral calendar, changing whenever a new comptroller is
elected.
Regulators are now paying closer attention, very aware of the financial crises that have gripped other cities.
Despite
state laws calling for regular audits of the city pension system, there
has not been one since 2003. Now Benjamin M. Lawsky, the state’s
financial services superintendent, appears to be making up for lost
time. In November, he subpoenaed about 20 companies that help pension trustees decide how to invest the billions under their control.
Increasing Investments, but Still Falling Behind
The city’s pension obligation has nearly doubled over the
last six years. This reflects the growing number of city retirees, very
low interest rates and other factors. Market returns have run well below
fund assumptions of 7 or 8 percent per year recently, requiring larger
contributions from taxpayers. But the funds are still behind what they
need. Here’s how one of the city’s five funds has fared.
BILLIONS
Benefits paid to retirees,
and other deductions
Investment income or loss
Contributions from employers and
employees, and other income
$100
95
90
85
New York City Employee
Retirement System
Total pension obligation
80
Estimated cost in today’s
dollars of paying all present
and future retirees
their benefits.
The New York City Employees Retirement
System, or Nycers, is the biggest of the city’s five pension funds.
There are also separate funds for police officers, firefighters,
teachers and other education employees.
75
70
65
In 2003, contributions were just $430 million.
$60
By 2013, contributions were up to $3.5 billion
55
50
Asset balance
45
40
35
Beginning
asset balance
($32.8 billion)
30
In 2009, the fund lost $7 billion in the market.
25
25
2013
obligation
not yet
available
20
15
10
5
0
’03
’04
’05
’06
’07
’08
’09
’10
’11
’12
’13
Total pension obligation is a calculation of
the “market value of accumulated benefit obligations,” one of the ways
the city auditor calculates the size of the city’s promises that
minimizes the risk that New York’s workers and retirees won’t be paid.
Regulators
from his office have also been sifting through documents at New York’s
pension office, Diane d’Alessandro, executive director of the general
workers’ fund, said at a recent meeting of trustees.
Letters
accompanying the subpoenas said that “the recent financial difficulties
in Detroit serve as a stern wake-up call, demonstrating why strong
oversight of New York’s public pension funds is so important.”
Clashing Voices
Many
cities have one pension plan, or two, separating general workers and
uniformed personnel. But New York City has five, covering general
workers, the police, firefighters, teachers and other school personnel.
Each
fund has its own trustees. The exact makeup for each fund differs, but
the mayor, the comptroller and organized labor each have their
representatives, and their interests are frequently diametrically
opposed.
The
boards are fond of personally vetting investment firms — something
experts in model boardrooms say they should not be doing. Politics can
often intrude. The teachers’ union, for example, keeps a list of
investment firms it sees as unacceptable because of their connections to
groups that, say, favor charter schools.
Ranji
Nagaswami, who served as Mr. Bloomberg’s first chief investment
adviser, said that changes in the governing structure — consolidating,
professionalizing and depoliticizing the pension boards — could result
in “vastly improving outcomes.”
In
the existing environment, important questions about cost and
sustainability can be broached only with great diplomacy. In 2010,
Blackstone Advisory Partners, a private equity firm, found out what can
happen otherwise. On a conference call with investors, a company
official answered a fiscal question by saying retirement benefits for
public workers across the country were excessive. When New York City’s
trustees got wind of the comment, they called for Blackstone’s chairman
to apologize in person. A few months later, he did, and when that proved
insufficient, Blackstone issued a statement saying it opposed
“scapegoating public employees.”
When the dust finally settled, Blackstone survived as one of the system’s biggest investors.
New
York’s pension system is also the only major governmental system in the
country to outsource virtually all of its investment decisions to
outside money managers, pension experts said. That inevitably leads to
higher investment fees. In 1997, the city’s biggest fund, the New York
City Employees’ Retirement System, known as Nycers, spent $17.3 million
in investment fees for a $31.7 billion portfolio. By 2010, it was
spending $175 million for a $35.4 billion portfolio.
Some
have argued the pension system would perform better if it hired its own
professionals to manage the money in-house. Fees would drop, and the
overall strategy would be more coherent, they contend.
For
years, pension officials saw little reason to alter investment
strategies or governing, in part because the stock boom of the 1990s
made it seem as if they had a winning strategy. Even after the tech
crash beginning in 2000, the city’s pension reports relied on an unusual calculation
that made the system appear 99 percent funded. When that calculation
was disallowed in 2006, Nycers’s reported funding level tumbled to 64
percent. Even then, some economists said the city was still
underestimating its total obligation.
As
it turns out, Robert C. North Jr., the system’s actuary, had been
preparing his own stark projections, buried in annual reports. They are
based on fair-market values and reflect what an insurer would charge for
annuities designed exactly like the pensions. He estimated last year
that Nycers was only 40 percent funded, a figure normally associated
with funds in severe distress.
Expectations and Reality
In
the complex world of pension math, one number looms larger than the
rest: the expected rate of return on investments over the long term.
The higher the assumed rate, the less money the city will be asked to inject in the pension system each year.
In
New York, this all-important number is chosen by the State Legislature,
with input from the pension boards’ many trustees and the system’s
actuary. The temptation is to be overly optimistic, because that makes
the whole pension plan look more affordable and, therefore, more
politically palatable. The more money the city needs to contribute, the
more it becomes a problem for the city budget and the greater the
likelihood the costs breed resentment against public employee unions.
But
excessive optimism can lead to financial disaster, because regular
shortfalls could ultimately leave the city unable to fulfill its
required payouts. For years, the investment return expectation was set
at 8 percent. In reality, the system’s returns have often fallen well
short of that, earning just 2 percent on average from 1999 to 2009, for
instance. (The returns have ticked up as the market has risen.)
Yet
the pension boards have been reluctant to ask Albany to lower its
investment-return assumption, out of concern that it would incite a
backlash toward unions and pensions.
Already,
the growing sums consumed by the pension funds have forced officials to
scrimp on certain programs or abandon them, said Marc La Vorgna, a
press secretary during Mr. Bloomberg’s administration. One casualty was
the Advantage program, which helped homeless people move out of shelters
and into apartments. It was eliminated in the Bloomberg administration.
Nicole
Gelinas, a fellow at the conservative Manhattan Institute, cited
infrastructure spending as another priority that has been affected.
Pension costs are “suffocating our ability to make long-term
investments,” she said.
In
2012, the pension trustees asked the State Legislature to lower the
system’s long-term investment expectation to 7 percent, at the prodding
of Mr. North. Many experts say
7 percent is still too high. But cutting the assumption to 7 percent
from 8, along with some other adjustments, was going to cost the city an
additional $2.8 billion in contributions in the first year. Mr. North
eventually lowered the contributions total to $600 million by spreading
the cost over 22 years.
The
additional cash will certainly help the pension system, but it will
still take years and luck in the markets for the city to close the gap
from the years it should have been contributing more.
It
is the pursuit of higher returns that has led the trustees, and
lawmakers in Albany, to authorize more aggressive, alternative
strategies, mirroring a national trend among public pension systems. The
approach carries the possibility of a greater upside but also brings
greater risks and costlier fees.
“There’s
nothing wrong with taking the risk,” Mr. North said. “The risk,
however, should be recognized and understood as it is mostly borne by
future generations,” people who were not consulted on these decisions.
In
New York, private equities — stocks that do not trade on any exchange
or have a published price — have become a favored asset class. Private
equity investments are typically done through partnerships with
specialized firms, which last for several years. Until they run their
course, the returns cannot be calculated accurately. The fees are high,
and it is not yet clear that the partnerships are delivering
consistently higher returns.
In
one example, John Murphy, a former executive director of Nycers, the
fund for general workers, said he noticed in 2011 that the Allegra
Capital Partners IV fund had just come to an end, making a final
accounting possible. After long delays, he received data showing that
Allegra had lost 8.24 percent per year, on average.
“Nycers
invested $24 million and got back $11.66 million,” Mr. Murphy said.
“This is clearly an imprudent strategy for a large pension fund.”
Mr.
Murphy said that Nycers had lost money in just five years out of the
last 30 — all in the 2000s, after the system adopted its private
equities program. Out of curiosity, he calculated what the returns might
have been if Nycers had continued its strategy of investing solely in
publicly traded stocks and high-rated bonds. The answer was: billions of
dollars ahead of where it is today.
Low Priorities
The
city’s decades-old structure for its pension system almost changed in
2011. Mr. Bloomberg and the comptroller at the time, John C. Liu, bitter
rivals, unveiled an ambitious plan to consolidate the five plans.
The
aims included hiring professional in-house investors and breaking the
link between the pension system and the political calendar. Most of the
ideas died, however. Some labor leaders felt that they had not been
consulted, and Mr. Liu became hobbled by a federal investigation into
his campaign finances.
Now,
of course, there is a new mayor and a new comptroller, both of whom
have been staunch labor allies. A new chief investment officer started
last month, and Mr. North, the system’s actuary for nearly 25 years, is
expected to retire this year.
It is unclear whether pensions will be a top priority.
Mr.
de Blasio, notably, did not mention the word “pension” during his
hourlong budget presentation in May. Mr. Bloomberg, by contrast, raised
the issue often and made his final formal speech a stemwinder on pension
costs.
In
May, Comptroller Scott M. Stringer announced he would try to commit $1
billion to smaller investment firms led by minorities and women, despite
research showing that initiatives geared toward emerging firms make it
harder to achieve top investment returns.
Mr.
North said that Mr. de Blasio’s recent deal with the teachers’ union —
and two subsequent deals with health care workers and nurses — would
necessitate bigger pension contributions from the city. But precisely
how much bigger remains unknown because the contracts are complex.
After
Mr. North leaves, it would be easy for New York to tweak key
assumptions and lowball its contributions. That would save the city
money, but it could wreak havoc on the future. He has urged the trustees
to be mindful of the city’s not-so-distant past.
“It’s less than 40 years since we were near bankruptcy,” he said.
No comments:
Post a Comment