New York's pension 'smoothing' may short-change retirement fund

New Yorkers who rely on the state pension fund for their retirement may be short-changed about $735 million over the next 10 years as a result of Governor Andrew Cuomo's policy of permitting local authorities to defer fund payments so they can fill budget gaps and pay for services such as schools, street lights and police.

Cuomo has been trying to rid New York of its reputation as a high-tax state and has put limits on tax increases by local governments, reducing their ability to meet their often rising obligations. The smoothing policy is intended to make it easier for them to raise money without raising taxes.

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At stake is whether the $176 billion state pension fund will be able to fully meet its obligations, or instead be used as a piggy bank for municipalities who haven't budgeted or raised money well enough to meet their present obligations. Though New York's pension system is 87 percent funded, one of the best in the country, the smoothing program may undermine its future health, critics said.

New York Gov. Andrew Cuomo
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"New York has traditionally been a good state as far as funding policy goes but they have in recent years shown that they are willing to take steps backwards," said Josh McGee, a pension expert at the Laura and John Arnold Foundation, a policy group that's expressed concern about the fiscal dangers presented by pension plans for public employees. "Giving deferrals in the short run just means you have to come up with more money in the long run."

Under the policy, introduced in 2010 and called "smoothing," local and state authorities that need money are permitted to either defer making pension payments for as long as 12 years, or borrow directly from the pension fund. So far about $3.3 billion in pension payments has been deferred, including $1.4 billion in 2013.

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The state charges local authorities interest of about 3.7 percent on the payments they defer. Because the fund's assumed rate of return is 7.5 percent, the difference between what it expects to earn and the money it's actually earning from the deferred payments is 3.8 percentage points.

At that rate, the fund stands to have about $735 million less in its coffers in 2024 based on the $3.3 billion that's already been deferred, an amount that will rise in coming years as the program goes on.

Pension funds & return reality
Pension funds & return reality

The $735 million figure is an estimate that was calculated with the aid of Noor Rajah, who runs the actuarial science program at Columbia University's School of Continuing Education in New York.

Fund integrity

The low rate is more about giving municipalities the ability to borrow cheaply than ensuring the integrity of the pension fund, McGee said. It also means the fund is taking on greater risk because it's allowing low or unrated municipalities to defer their pension payments, he said.

The state says it's justified in charging 3.7 percent interest because it considers the outstanding balances as a part of its fixed-income portfolio, which has a lower expected rate of return than the fund's equity portfolio.

However, the fund's annual report accounts for the deferred payments and the interest on them as a receivable and doesn't include the money in the fixed-income part of its portfolio. That matters because of the fund's asset allocation mix, which as of March 31 devoted 54.5 percent to equities and 27.2 percent to fixed-income securities, with the rest divided between real estate, private equity and other investments.

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If the deferred payments were included with fixed-income, the fund would have to adjust its equities holdings higher so as to maintain its targeted allocation mix.

Elizabeth Wiley, an actuary at consulting firm Cheiron in McLean, Virginia, said the deferred balances won't hinder the fund's performance "if they are actually considering the deferred balances when they set the asset allocations."

State comptroller Thomas P. DiNapoli's office, which administers the pension plan, counters that not including the deferred balance in the overall asset allocation isn't a drag on the fund.

The program "is fiscally sound, transparent and adequately funds the Retirement System," a spokeswoman for DiNapoli said. "It provides an option for state and local employers to manage the budgetary impact of rising contribution rates in the aftermath of the global financial crisis."

Pension fund boom
Pension fund boom

DiNapoli's office didn't comment on the $735 million estimated shortfall.

The fund's blended fixed income portfolio, divided between "core fixed income" and Treasury Inflation Protected Securities, fell about 1.5 percent last year as TIPS slipped 6.5 percent. Its blended equities gained about 20.3 percent, led by its U.S. stock holdings. The Standard & Poor's 500 Index rose 30 percent in 2013.

Cheaper money

Some local authorities that use the smoothing program said they could get money cheaper if the state allowed them to sell pension bonds.

"We are forced to borrow at a higher rate than we would if we could go to the market," said Westchester County Executive Rob Astorino, who is the Republican nominee for state governor in this year's election. "We were borrowing at twice the market rate from the pension system which is more wasted money."

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Westchester County estimates it will defer $104 million in total and would save $10 million over 13 years if it could issue bonds instead of using the state's plan, even though bonds covering pension costs are usually taxable.

Still, being able to defer more than $40 million in pension contributions last year allowed the county to avoid laying off 420 employees or raising property taxes by 6 percent, Astorino said.

"To have paid it in full we would either have had to have a very big tax increase, and we drew the line in the sand that we were not doing that, or massive layoffs and program cuts, which were not palatable, especially to the legislature, or reluctantly go into this, which we did," he said.

By Reuters