New York’s pliable pension actuaries have been subject to severe criticism on this blog, and by actuaries that now write for publications and no longer need to be “team players” with politicians and unions in order to earn a living. After years of pension enhancements, pension funding cuts, and inflated estimated investment returns, we need to figure out what our situation actually is, and our future actually holds. So in the “do it yourself” spirit of an era in which there are few people and institutions left worthy of trust, I’ve decided to take a shot at it myself, with the simplified model in the attached Excel file. This post will describe the model, and attempt to estimate how much the public employee pensions promised (back when they were hired) to those approaching retirement would have cost (without any subsequent deals for pension enhancements in exchange for campaign contributions and political support), and how much should have been set aside to pay for them. The information discussed will be in the worksheet in the “promised” tab. A second post will try to estimate how much pensions have been underfunded due primarily to inflated estimated future investment returns, as noted in the “underfunding” tab. A third post will attempt to estimate the impact of some of the major pension deals I have been aware of over the years, among the hundreds passed and thousands proposed.
I find that for a typical New York government employee now approaching retirement (or recently retired early under some deal), a pension was promised that would have cost 11.8% of total pay during their careers, with 3.0% paid by the employee and 8.8% by the taxpayer, plus retiree health insurance for three years before Medicare carries most of the burden after age 65. For those in “physically taxing” jobs like sanitation workers, the promised pension would have cost 16.2% of their pay, with 13.2% from the government, and 10 years of pre-Medicare retiree health care. And for police/fire, it would have cost 29.6% of their pay, with almost all paid by the taxpayer and perhaps 21 years of pre-Medicare health care. But future taxpayers and service recipients (if there are any more services) will face a drastically greater burden. .
Accounting for pensions is complicated, because there are so many variables and variations depending on an individual’s salary and work history. The tables in the three worksheets provide a simple model of a single employee who works the number of years required for a full pension, retires at the earliest allowable year, and then lives to age 80, a reasonable average for those retiring today or (if they are male) their spouse.
Some workers end up working longer and/or later, allowing more time to contribute to the pensions and fewer years of payouts, so the percent of their pay that must be deposited into pension funds may be smaller. But they also are entitled to higher payouts. At the minimum age for full retirement, most New York government workers are entitled to 50% of what they earned at the end of their careers, but that would have gone up 1.5% per year for additional years worked under the rules when they were hired. Someone working 50 years would have been entitled to a pension worth 80.0% of their pay. So that may balance out, making the cost as a percent of pay similar to those presented here.
Other workers only work for the government a few years and leave, leaving most of the money set aside for their pensions (ie. the share provided by taxpayers) behind. So the extent to which pensions need to be funded depends on an estimate of how many workers will be ripped off in this way. Although looking at pensions from a single-employee perspective ignores the “savings” from turnover, frankly I wouldn’t be counting on too much of it going forward given the state of the private economy. And in many cases, participation in the pension system can be avoided by those who believe themselves most likely to leave.
A reasonable expected investment return, based on history, is 4.0% more than inflation if starting at fair (not inflated) asset prices, with somewhat more for stocks and somewhat less for bonds. This is what is used in the model, although current bond yields are lower and I believe stock prices remain inflated, particularly given that today’s earnings require more and more debt to allow a big difference between what most people earn on the job and what they buy as consumers. I expect additional years of very low returns, and many financial experts do likewise. This is an optimistic model.
The action in the spreadsheet concerns two variables and one key number. The first variable is the inflation rate, which the user can set. I used 1.8%, the recent spread between regular 10-year U.S. Treasuries and TIPS, which indicates the market inflation estimate for the next ten years. But the actual inflation rate is zero, with some economists fearing deflation, others believing the Fed won’t be able to stop it. Inflation at zero means bond yields down at 3.0% or less rather than 5.0% or more; inflation below zero is worse. If deflation occurs, let’s move directly to a discussion of state and local government bankruptcy.
The inflation rate is used not only to set the rate of return, but also to deflate the past salaries of public employees retiring today into their 2010 dollar equivalents. The actual average annual inflation rate for the 20-year period from 1990 to 2009 was 2.8% rather than 1.8%, but the first spreadsheet is a model of promised pensions rather than actual salary histories, so expected inflation is a reasonable shorthand. Adjustment were supposed to be made if conditions turned out to be significantly differently. While this doesn’t affect the “promised,” worksheet, where pensions have an inflation adjustment, the inflation rate is also used to inflate the pension paid in later years. More or less, as will be discussed in the third blog post.
With the inflation rate set, the user also sets the percent of payroll that will be deposited into the pension plans. The goal is to set it to the rate that will allow enough money to be set aside when the employee is working that, given investment returns, all payouts can be covered until age 80. (Some will die sooner, producing a savings, and some later adding to costs, but this is expected to balance out.) Your shift the percent of payroll in back in forth until you hit the rate that gets the balance at age 80 as close to zero as possible. This is a brute force approach. A financial whiz could probably put in a macro to calculate the percent of payroll required for the balance to hit zero age 80 automatically. But then a financial whiz would probably need to know what outcome one wanted to show to justify whatever self-serving deal they were doing and work backward from that, and charge a good price for doing it. So we’ll stick with the horse and buggy.
The other field in the spreadsheet that is input data rather than a calculation is the salary earned each year. Although teachers have separate pension plans in New York State, and may thus have slightly different pension rules, I used the salary of New York City teachers as my input for general New York state and local government workers, since teachers account for the largest share of total public employees. It was a little complex, because NYC teachers are paid based on the number of post-graduate course credits they have as well as how many years they have worked, but I put in the data based on a hypothetical career in which credits are gradually accumulated. The information I was able to get was for teacher salaries was from 2008, but that isn’t that obsolete. After all, most people in the private sector aren’t making more, and are perhaps making less, now than they did that year.
The “promised” model does not include overtime, because no one promised that employees would be able to use overtime to pad their pensions. Just as the model does not include a “discount” for turnover, as discussed above. You’ll have to hire an actual actuary for these nuances, one of the few who might actually remember how to tell the truth.
The Tier IV pensions, as promised when those now approaching retirement were hired, allowed full retirement at age 62 after 30 years of work, paying out 50% of the average pay over the last three years worked, with no adjustment for inflation (a decline in the real value/cost of the payout over time). Assuming a 5.8% return on assets (4.0% real plus 1.8% inflation), $531,944 would have to have been accumulated by age 62 to meet that obligation to pay.
Given investment returns before retirement, and the $59,367 that the employees themselves would have contributed (based on the then-required 3.0% of pay contribution level), the government would have had to contributed $174,144 over the years, at a steady 8.8% of salary rate. (Yes I know that to make greater sense of the $59,367 and $174,144, they should be translated into current dollars, but there are enough columns in the spreadsheet as it is). The total percent of payroll required would have been 11.8%, with 8.8% for the taxpayer and 3.0% for the worker.
How about physically taxing titles, which allow full retirement at age 55 after 25 years of work under the rules then (and now) in effect? I would like to have used the wages of a New York City Transit worker hired as a conductor who switched to a train operator after five years as an example, but was unable to find information on what MTA workers get paid on the MTA or TWU website, so I went with a sanitation worker instead. The 25 years of pension payments from age 55 to 80 would have required a pension balance of $428,574 at the time of retirement given a 5.8% rate of return. (It is less than the requirement for teachers, despite the longer duration, because the final salary and pension payment for sanitation workers is lower than that for teachers, or so I believe based on the limited pay information I was able to get). And that would have required a steady contribution rate of 16.2% of pay over the 25 years of work, including 13.2% for the taxpayer and 3.0% for the worker.
And what about police officers and fire fighters, who get to retire after working for just 20 years at any age? Assuming they come on board at age 22 (it could be younger), they could be on their way to a life of leisure at age 42, with 38 years in retirement on average. Based on the police officer salary scale I could get off the NYPD website, that would require $686,247 to be socked away by the time of retirement, which would require 29.6% of payroll to be put away during a police officer’s career.
The share that the police officers are responsible for is a little funky according to the annual report of the police retirement fund. Evidently it starts at 8.65% of pay and gradually decreases. Except that under a 1963 deal, the city not only pays its share of required pension contribution, but also pays most of the employee share. This makes little sense, except that if the police officers earned 5.0% more, instead of having the city make a 5.0% of pay pension contribution on behalf of the officers, the officers might owe more in taxes but also receive higher pensions. Also, with more of their pay hidden in the form of additional pension contributions, perhaps the police officers get to whine more about their pay than is justified – like CEOs unionized public employees prefer pay that is unseen and uncounted. In any event, this is just another example of what a complicated mess the pension systems are after decades of deals.
Bottom line, the taxpayers promised to pay for just about all of the police pensions, and perhaps the fire pensions in NYC (not sure about the rest of the state). That puts the taxpayer contribution at about 28.7%.
So there you have a rough estimate of what was promised to different types of public employees in New York State when they were hired. Pensions costing the taxpayer 8.8% of pay for most workers, 13.2% of pay for those in physically taxing titles, and 28.7% of pay for police and fire.
As an aside, it appears that NYC teachers, with summers off, earn more than I do after 15 years of work. I am approaching 25 years of experience in the type of work I do. Police officers surpass my pay level after six years, not including overtime, and with more days off. Sanitation workers earn 83.8% of what I do after six years, without having had to attend college or graduate school. I have always been aware of this, and it doesn’t bother me for three reasons.
First, I could have been a teacher, police officer or sanitation worker, but would rather spend my days doing research and writing reports that dealing with a class of kids, some nice and some less nice, dealing with the worst New Yorkers on their worst days, or picking up garbage (though the working outside part is nice, and mail carrier is a good job).
Second, I am the lower earning spouse in a two-income family, and like many New Yorkers in similar situation I have the double whammy of a high federal, state and local income tax rate (due to my spouse’s salary) and having all my income subject to the federal (and now MTA) payroll tax. So the taxes I would have to pay on any additional money I might get is well over 50.0%, on the way to a likely 60.0% and a possible 6.7.0%, plus any sales tax I would have to pay on what was left if I actually decided to spend it. So getting more money is not a priority.
And third, working with economic data as much as I do, I am well aware of what other, equally hard working and not powerful people typically earn in the United States, and realize that I get paid plenty and ought to be grateful for it.
But I am also aware of what other people receive in retirement benefits. In 2006, according to the federal Bureau of Labor Statistics, just 51.0% of all private sector workers were participating in any retirement plan other than Social Security, which provides a very modest pension at age 67 for those born in 1960 or later – though this may be cut back. New York’s public employees also get Social Security (California’s local government employees do not, saving taxpayers 6.2% of payroll).
Only 20.0% of all private sector workers had defined benefit pensions, including a far smaller share of younger workers, and many of those are underfunded. If they go under, as many have since 2006, the government only pays pensions to those 65 or over, and only up to a maximum amount. State and local governments are expected to cover public employee pensions regardless of the consequences for everyone else, even those poorer, no matter how severe.
A total of 43.2% of private sector workers had defined contribution plans (401Ks). Obviously, since the defined benefit and defined contribution total to more than 51.0%, many private sector workers had both, but many government workers do as well. The difference is that in the government the unionized public employee is often given a guaranteed return far in excess of typical market returns, with the government making up the difference. As in the 8.0% return guaranteed for NYC teachers.
And for the now-prevalent 401K plans, how much does the employer contribute? When pensions were phased out, employers typically promised to pay in substantial amounts to 401Ks instead, to convince needed employees to come on board. But in each recession many firms either reduce or eliminate the employer share, leaving the employees to fund their entire retirement out of their salaries. I would say the typical employer share is zero; my employer kicks in 1.0%. The reason is that current and retired public employees have voted for most private sector workers to receive little or no additional retirement compensation in addition to their salaries. When did they cast that vote? Every time they went shopping, and sought a better deal, they were forcing those producing what they were buying to settle for less.
And how much in turn are taxpayers, who must pay off the top and have no choice of seeking a better deal, contributing to public employee pensions today as share of payroll? According to the NYC Budget Summary, as shown on page 44 of this document, in FY 2011 New York City’s pension contributions are estimated to cost 16.4% of payroll for most Tier IV workers, and 29.1% for those in the Department of Education. Not the 8.8% promised. For the Department of Sanitation, with its “physically taxing” jobs, the expected pension contribution is 31.0% of payroll, not the 13.2% promised. For the Police Department, it is 59.6% of payroll, not the 28.7% promised. And not the zero most private sector workers receive. And these contribution levels are likely to go much higher, because pension contribution levels will need to rise and payroll (ie. workers actually providing services) will need to fall to free up more money for retirement.
Pension contributions for the State of New York and local governments in the rest of the state have been much lower, but are expected to soar until they are much higher, perhaps as high as in New York City. So the state has just passed a law allowing local governments in the rest of the state to not pay the required amount, leading to an even more massive bill later. When those localities cannot or will not pay, it is fair to assume the entire state will pay instead, including New York City which is already paying more. It is also fair to assume that the rest of the state is facing the kind of exploding taxes and collapsing services that New York City faced in the 1970s due to rising debt and pension costs, as NYC goes for Round II.
So what happened? I had to be, and was, some combination of two things: past taxpayers putting in less than they should have, shifting a far greater cost to future taxpayers and service recipients (though service cuts), as will now be done formally in the rest of the state under the new state law. And public employees getting far more in pensions than they were promised when they were hired, and contributing far less to them.
How much each of the two factors is responsible for the onrushing pension disaster should be at the center of the upcoming debate as state and local governments face an institutional collapse. I’ll try to model some scenarios in the other two worksheets in the attachment. But two things are certain. Those who cut the deals lied about the consequences, with the cost of each and every deal (if the deals were revealed at all) announced as zero even as pension costs soared and soared. And younger generations, of taxpayers, public service recipients, and public employees, will bear most of those future consequences, while most of the past benefits have gone to Generation Greed. And Generation Greed, as represented by the New York State legislature, has no other answer to the coming crisis other than to dig the hole deeper to defer those consequences as long as possible – while continuing to cut even more deals to benefit itself.