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Commentary By E. J. McMahon

NY's Pension Peril

Cities, Cities, Governance, Economics New York City, Tax & Budget

NEW York state’s pension system lost 26 percent on its investments and shrunk by a net $45 billion in fiscal 2008-09, Comptroller Thomas DiNapoli disclosed last week. Those losses will have to be made up by much higher pension contributions from taxpayers starting in 2011, he acknowledged.

But the situation isn’t as bad as it sounds. It’s actually worse -- when you realize that New York, like most other government employers across the country, systematically understates the true value of its long-term pension promises.

Under government-accounting standards, the pension systems of both the state and New York City were at or near “fully funded” status before the market meltdown of 2008. However, New York City’s actuary estimated in 2006 that the city’s retirement plans alone were $45 billion short of the funding levels needed to meet liabilities valued by private-sector financial standards. A similar calculation for New York state would no doubt have yielded an even larger shortfall at the end of the last fiscal year.

In fact, recent studies have estimated that public-pension plans across the country would be up to $3 trillion in the hole if their liabilities were “discounted” on a basis that reflected the true risk/reward tradeoff between taxpayers and government retirees.

Because public pensions are guaranteed by the state constitution, they are a risk-free proposition for the employees who collect them. But these pensions are financed by investments that expose taxpayers to substantial financial risk -- as was illustrated vividly by the two sharp downturns in this decade.

As recently as 1984, two-thirds of New York’s pension funds were invested in less-risky fixed-income investments -- bonds, commercial mortgages and cash. By 2008, the proportions had more than reversed.

As the meltdown began, nearly 72 percent of the state’s pension-fund assets were in equities, including stocks, private equity and hedge-fund holdings. This was typical of the investment mix in public-pension systems across the country -- which is why they’re all about to dump bigger bills on taxpayers.

To stop the bleeding, the obvious alternative is a defined-contribution model, such as 401(k) plans.

With a DC system, taxpayers would no longer bear all the financial risks associated with providing guaranteed pension benefits. The tax-funded share of retirement benefits would become both predictable and easily understandable, and the real costs of proposed benefit increases would be transparent.

If Albany had made such a switch in the wake of the last market meltdown, its outlook would now be less dire. State workers hired since 2003 -- a full 41 percent of the workforce -- would have individual DC accounts like those offered in the popular State University and City University optional-retirement programs.

Those programs require an employer contribution of up to 10 percent of salary, which remains level no matter what’s happening in the markets. Contribution rates in the traditional system are likely to go much higher than that over the next few years.

As long as the traditional system is perpetuated -- even with the sort of modest reduction in benefits proposed by Gov. Paterson -- New York runs the risk of sinking under the massive weight of its accumulating pension promises. Even if the current pension plan is closed to new entrants, its legacy cost will be a gigantic headache for decades.

Unfortunately, DiNapoli’s announcement raised as many questions as it answered. For example, it implicitly compared the pension fund’s performance to various stock-market indices, without detailing the fund’s returns by asset class.

This much seems clear: DiNapoli’s investment strategy for the future will be more of the same.

“In today’s economic environment, the temptation for some investors may be to run and hide,” he said. “But we have the liquidity and the right investment programs in place to take advantage of attractive opportunities.”

Sounds like he’s ready to double-down on some potentially losing bets. Terrific.

While the comptroller avoided specifics on the likely increase in pension costs over the next few years, the state’s own financial plan forecasts a 50 percent hike in contributions by 2012-13. That would equate to a combined increase of well more than $1 billion for the state and for counties, towns, villages and cities outside New York City -- which itself faces a $1 billion increase in pension contributions over the next four years. School teachers outside the city are in a separate system confronted by the same trends.

To help “mitigate” rising costs, DiNapoli is proposing legislation allowing local governments to “amortize a portion of the added costs over time.” In other words, more costs would be shifted to the future.

But as taxpayers get squeezed harder, there’s increasing reason to wonder whether there will be enough New Yorkers left to pay the bill.

This piece originally appeared in New York Post

This piece originally appeared in New York Post