Pension360

Every year, around this time, we get to experience one of summer’s finest, most deeply rooted traditions.

No, I’m not talking about Fourth of July. I’m talking about the end of New York’s legislative session, which typically gives us as many fireworks as any Independence Day celebration, and twice the drama.

This year is no exception. So when the state’s legislative session ends on June 19^th, get ready for a flurry of activity and, likely, the rushed passage of a few bills that have been subject to very little scrutiny or debate, if any at all.

One particular bill is taking center stage in the days leading up to the 19^th. It was introduced quietly, its sponsors have been relatively hush-hush, and now several watchdog groups are concerned the bill could slip into law without much fanfare.

It’s officially called A9594/S7326, but often goes by the more colloquial “NYPD Pension Bill”.

We’ll dive into the details of the bill, but first some back-story is necessary. Back in 2009, then-New York City mayor Bloomberg passed a measure altering pension benefits for police officers hired after July 1, 2009; officers hired after that date were placed into a category called “Tier III”, the details of which are outlined here:

Tier III requires members to work for 22 years, instead of 20, to collect full-service pensions. Disability benefits are 44 percent of the final average of the last three years’ salary with an offset for Social Security benefits, instead of 75 percent of the final year’s salary with no offset.

The measure was projected to save the City $31 billion over 30 years.

The new bill, A9594/S7326, attempts to undo these changes. And actually, the bill isn’t new at all. A bill with the same language was proposed in 2009 with the aim of doing away with “Tier III” altogether and restoring larger benefits for newer hires. That bill was vetoed by then-governor David Paterson.

But now it’s back. And, if passed, it would represent a major expense for the City. The cost:

With more than one-third of all police retirees, approximately 15,000 people, collecting disability pensions, the proposed changes would increase New York City’s costs by $35 million in fiscal year 2015. The actuarial value of contributions required by the City to fund the new benefit would be far greater: $266.4 million in fiscal year 2015, growing to $617.9 million in 2019.

Those aren’t particularly palatable numbers, which explains why many typically pro-union politicians are shying away from supporting the bill.

Among them is New York City Mayor Bill de Blasio, who avoided commenting on the bill for weeks before news broke this week that he won’t support it. As reported by Capital New York:

Mayor Bill de Blasio, generally a champion of unions, opposes a state Assembly bill that would boost disability pensions for New York City police officers because he believes it would put too big a dent in the city budget, Capital has learned.

In response to an inquiry, an administration official confirmed the mayor’s opposition to the legislation…The City Hall official, who would only speak on background, stressed that the mayor supports the NYPD but views the bill, as written, as cost-prohibitive.

A source in the Assembly confirmed to Capital that aides to the de Blasio phoned on Tuesday to state the mayor’s opposition.

“They’re not supportive of the bill at all. It’s based on the assumed cost of the legislation,” said one source within the State Assembly.

City Council Speaker Melissa Mark-Viverito, who typically votes pro-union, said she has not yet determined her position on the bill.

In fact, not even the bill’s sponsor, Marty Golden (R-Brooklyn) seems to want to discuss it.

“We are looking at it and trying to get it out,” Golden told the New York Post. “We’re discussing it, and I don’t want to go any further than that as to the purpose of the changes.”

Police disability pensions are an especially sensitive issue because of several recent events that have exposed disability fraud in New York City. In January, a state investigation revealed that as many as 1,000 public workers had been collecting fraudulent disability payments to the tune of $400 million.

The retired New York City police officers and firefighters showed up for their psychiatric exams disheveled and disoriented, most following a nearly identical script.

They had been coached on how to fail memory tests, feign panic attacks and, if they had worked during the Sept. 11, 2001, terrorist attacks, to talk about their fear of airplanes and entering skyscrapers, prosecutors said. And they were told to make it clear they could not leave the house, much less find a job.

But their Facebook pages told investigators a starkly different story, according to an indictment and other court papers.

Former police officers who had told government doctors they were too mentally scarred to leave home had posted photographs of themselves fishing, riding motorcycles, driving water scooters, flying helicopters and playing basketball.

More recently, a Journal News investigation revealed that 25 retired cops and firefighters in the Lower Hudson Valley were collecting disability pensions of over $100,000. Some of those retirees claimed disability stemming from incidents years before they retired, and were healthy enough to put in a large amount of overtime hours their last year on the job. That group of 25 retirees will collect $3.17 million in combined pension payments in 2014.

Photo by Giacomo Barbaro via Flickr CC License

On March 5, 2013 the Dow Jones closed at over 14,000—a then-record high for the major index. One month later, it pushed the mark further and closed at 15,000; by late November, the Dow had eclipsed 16,000 for the first time in history. Now, in June 2014, the index sits just a few points away from 17,000.

The S&P 500 has come along for the ride, closing with record highs 19 times in 2014 alone.

You’d be forgiven for assuming that the nation’s public pension funds—all of whose health are intimately tied to equity markets—are enjoying the spoils of this market expansion more than anyone. But the numbers tell a different story.

Between 2009 and 2013, while the S&P 500 saw 188 percent gains after reaching an all-time low, public pension funds across the country saw their average funded ratios decrease—from an average of 79 percent in 2009 to 72 percent in 2013.

You don’t need to be a statistician to see the problem here: equity values have skyrocketed in the last 5 years. But pension funds, at least on the surface, have not benefited. In fact, they’ve become less healthy on the whole.

Are the numbers lying? No, according to a new report from the Center for Retirement Research. But the numbers aren’t telling the whole story either, and there are a few explanations for this pension paradox.

First, it’s important to note some significant changes recently adopted by one of the world’s largest funds, the California Public Employees Retirement System (CalPERS). In 2012, on the recommendation of its actuaries, the fund lowered its discount rate to 7.5 percent from 7.75 percent. More recently, the fund began assuming larger benefit packages for a segment of its participants and longer life spans for all of them.

Those changes brought CalPERS’ funded ratio down from 83 percent in 2012 to 69 percent in 2013. But it doesn’t explain the lack of funding status improvement across the country.

For a real explanation, we turn to an accounting technique called asset smoothing, which takes annual fluctuations in the stock market and averages them over a period of (typically) 5 years.

The purpose of the policy is to keep funds focused on the long-term and to negate the panic and short-term thinking that comes with major negative fluctuations in the market.

But the flipside is the phenomena we’re witnessing now, where today’s strong returns are weighted down by bear markets of the recent past. So, despite large market gains in the last 4 years, the “smoothed” value of pension plan assets only rose 2 percent in 2013.

As the CRR report notes, 2014 is a big year for pension funds. The 2009 market losses will rotate out of the smoothing calculations, and that alone could increase the aggregate funding status of US public plans to 75 percent, according to CRR estimates.

New GASB standards have also begun kicking in, meaning many funds will begin reporting the market value of their assets rather than the smoothed values. That could bring plans’ funded ratios to around 80 percent on average, says the CRR.

If that happens, the burden will be on state and local governments to pay their annual required contributions (ARC), in full, into their systems. All too often, they shirk this responsibility during the “good” times. Unfortunately, we’re seeing a bit of that mentality surface again.

The trend is clear: during market contractions (the tech bubble in 2001 and the financial crisis in 2008) governments scramble to cover funding shortfalls and are willing to pay nearly their entire ARC. But when the market rights itself, they are content to watch their required contributions taper off and let market gains cover the ensuing shortfall.

Since the financial crisis, governments have slipped back into old habits. Still, we have to give credit where credit is due: governments paid more of their ARC’s in 2013 than they did in 2012. But you know the old saying: one time is an accident, two is a trend. Hopefully, 2013 wasn’t an accident. Whether it’s the start of a trend, however, remains to be seen.

This article is based on data presented in a June 10, 2014 report by the Center for Retirement Research. Read the full report here.

Photo by Andreas Poike via Flickr CC License

In 2009, the Kentucky Retirement System (KRS) made two bold investments. The first: a $100 million investment in a newly formed hedge fund called Arrowhawk Durable Alpha.

Next, the System placed $24 million in another, more established hedge fund—Camelot Group.

The investments were supposed to produce big returns and lift some weight off the shoulders of Kentucky’s woefully underfunded retirement system. But the reality was quite the opposite.

Less than three years after KRS’ initial investment, Arrowhawk Durable Alpha Fund failed and closed.

Around the same time, the founder and then-head of Camelot Group, Lawrence E. Penn III, was indicted on 32 counts of various fraud charges—he’d allegedly stolen more than $9 million of his investors’ money, according to prosecutors.

The KRS was eventually able to recover the $100 million it had invested in ArrowHawk. But when it came to Camelot Group, they weren’t so lucky.

That’s because the SEC froze Camelot’s assets in January, making it became impossible for KRS to withdraw its money.

Not that it mattered: predictably, Camelot hadn’t managed its investor’s money very well.

According to KRS documents, its initial investment of over $23 million was valued at a mere $12 million as of March—a 48 percent loss.

This string of poor investment decisions by KRS hasn’t gone unnoticed. Last week, the City of Fort Wright filed a class-action lawsuit against the Kentucky Retirement System, seeking restitution for the increased contributions required from the city due to investment losses associated with the ArrowHawk and Camelot funds, among others:

In its lawsuit, filed in Kenton Circuit Court, the city of Fort Wright said KRS violates the law with risky investments in hedge funds, venture capital funds, private equity funds, leveraged buyout funds and other “alternative investments” that have produced small returns and excessive management fees, possibly in excess of $50 million over the last five years.

KRS, which is publicly funded, is legally required to stick with relatively safe common stock and bond investments, at least with the local government pension and retiree health care money that it manages through its County Employees Retirement System, the city said.

“Some of the alternative asset investments selected by the board were start-up funds with virtually no track record,” attorneys for the city wrote in the suit.

Fort Wright wants a court order keeping its money out of alternative investments; an accounting of where its money has gone so far, including the disclosure of all investment management contracts; and restitution in excess of $50 million, to compensate it for allegedly improperly paid fees.

KRS manages investments for the two largest state-level and local-level pension systems: the Kentucky Employee Retirement System (KERS) for state employees, and the County Employees Retirement System (CERS), for local employees.
One of Fort Wright’s goals in filing the suit is to force KRS to separate its investments into two pools: one for KERS investments, and the other for CERS investments. According to Fort Wright attorneys, the CERS pool would involve less risky investments.

You only need to glance at the numbers to see the motivation for the proposed separation: KERS is dangerously underfunded (23 percent funded ratio), while CERS remains healthier by comparison (60 percent funded ratio).

That’s a direct result of local governments making their required contributions, in full, into the system. The state government, on the other hand, has consistently skimped out on such payments. This chart from Ballotpedia tell the whole story:

The dire health of KERS means money is more likely to be allocated toward riskier investments with promises of higher returns. When those returns don’t materialize as expected, however, the loss must be offset somehow. That burden unfairly falls on the cities and counties of Kentucky, argues Fort Wright’s lawsuit.

Indeed, ballooning pension costs were the scapegoat when the town of Covington laid off 22 employees in 2011. From the Cincinnati Enquirer:

The city’s pension costs accounted for $6.2 million out of its $47 million budget this year, Covington City Manager Larry Klein said. That’s double what it was 10 years ago, he said. Health care cost the city an additional $6 million.

“Imagine a private business having 25 percent of its revenue spent on pension and health care, not paychecks,” Klein said. “That is a drag on the budget. It means less of everything, less reinvestment, less infrastructure and less services.”

Fort Wright, and by extension CERS, want no part of that game.

“It’s a sinking ship over there,” said [Jerry] Miller, [a Louisville Councilman]. “My argument is, let’s cut our losses and separate CERS from the rest of the system and let CERS be managed more prudently, using plain-vanilla investment techniques instead of these risky equity funds that have enormous fees.

Attorneys for Fort Wright said they filed the lawsuit on behalf of all cities and counties in the state, but it remains to be seen whether others will take up arms.

Picture courtesy of PurpleSlog via Flickr Creative Commons License