In a new Manhattan Institute report, authors Ed McMahon and Josh McGee recount the troubled history of the five funds collectively referred to as the New York City Pension System. New York City’s history of pension underfunding, unrealistic assumptions, benefit enhancements, and general complacency during boom-years mirrors that of many pension systems across the country. The particulars of New York’s pension crisis provide an interesting case study for how a plan can go from underfunded to fully funded and back again because of bad funding and accounting policies, leading McMahon and McGee to focus their reform proposals not on changing plan design or benefits, but instead on improving the plans’ governance and funding policies.
During the mid-1970s, New York City was on the brink of bankruptcy. After the city failed to receive relief from the federal government, New York turned to the city’s pension funds. Together, the system purchased $3.5 billion in Municipal Assistance Corporation bonds, in addition to general obligation bonds.
This play injected much-needed cash into the city’s coffers, and the city’s pension plans were relying on the bet to pay off. In 1978, the plans were only 50% funded with a plan to pay off the $10 billion ($37 billion today) of pension debt over 40 years. The system wound up being fully funded by 2000, 18 years ahead of schedule, thanks to the boom during the 1980s and ‘90s.
These investment returns dramatically shrank the cost of the required contributions the city needed to make to fund its plans. Between 1982 and 2000, investment returns averaged 12.9%. This shrank required pension contributions from 21% of payroll in 1980 to 12% in 1990, and then to 7% in 1999.
At the turn of the millennium, after complacency set in due to decades of high investment returns, the market turned around and took with it the health of New York’s pensions. Investment underperformance between 2000 and 2002 led to a dip in funding which has yet to be paid off. Though investment returns improved during the housing bubble, the financial crisis and low returns during 2014 and 2015 meant the City’s investments have underperformed relative to its 7% rate of return (lowered from 8% in 2012).
Benefit increases made by legislators during the systems’ boom times have also added billions to the pension debt. In 1984, the New York State legislature repealed pension reforms implemented in the 1970s designed to limit new benefits. This pattern continued through the end of the 20th century.
Piling on to the “sweeteners” of the previous decade, in 2000, then-Gov. George Pataki and the legislature approved further benefit enhancements (over the objections from then-Mayor Rudy Giuliani) that have added $13 billion to pension cost increases from their enactment to 2010.
Beyond these fiscal policy failures, McMahon and McGee offer an in-depth analysis of the city’s actuarial practices.
Until recently, New York used actuarial practices that under-valued its liability by using a discount rate that was well above market values or what would be used by pension plans in the private sector. Beginning in 2003, the city’s actuaries started to use alternative measures of the plan’s funded status, namely the market value of assets over the cumulated benefit obligation (called the market value accumulated benefit obligation, or MVABO).
The most notable part of this calculation was its use of used a discount rate equal to US Treasury spot yields, rather than just the assumed rate of return—common practice in the public sector. Using the MVABO more accurately describes New York’s financial situation. In 2012, for example, the City’s official measure showed an average funded ratio of 61%, while the MVABO indicated it was closer to 36% funded.
What can be done to save the Big Apple? The authors recommend accelerating debt repayment by shortening the amortization schedule from 15 years to 10 years, along with reducing the assumed rate of return and discount rate. Reducing the discount rate from the current 7% to either 6% or the market rate of 3.61% would cost the city $3.7 billion and $7 billion more per year, respectively.
These proposals are bold and would require major budgetary tradeoffs, but realistic accounting that accurately prices the costs of the city’s pension plans is the best way to prevent an unplanned pension crisis from wrecking New York’s finances. And, while the particulars vary from jurisdiction to jurisdiction, it would be wise for policymakers across the country to consider McMahon and McGee’s proposals for their own struggling pension systems.
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