New Jersey Hits The Pension Brick Wall
New Jersey Governor Phil Murphy (D) and lawmakers have agreed on a plan to make the largest public pension contribution in the state’s history, moving to ensure the solvency of a chronically underfunded system at a time of great economic uncertainty.
Under the plan, the state will make a $4.7 billion payment before the next budget year ends June 30, 2021. Policymakers approved the pension contribution as part of the fiscal year 2021 budget adopted Sept. 24. Murphy signed the measure Sept. 29, just before the Oct. 1 start of the new fiscal year. New Jersey pushed out the end of fiscal 2020 from June 30 to Sept. 30 as it navigated the impact of revenue fluctuations caused by the COVID-19 pandemic.
New Jersey’s commitment to its worker retirement fund is unusual in a year in which the rapid spread of the novel coronavirus triggered a recession that has sharply reduced government revenues nationwide. In response, some states have delayed or reduced pension system contributions to help plug budget gaps.
Murphy said he will rely on a combination of spending cuts, tax increases, and borrowing to cover a $6 billion state budget shortfall—and will keep his pledge to boost pension payments.
Research by The Pew Charitable Trusts shows that New Jersey’s defined benefit pension system for government workers has long been among the worst funded in the country. Pew has also advocated for pension stress tests, which New Jersey has used in recent years to help assess how the system would perform under different economic scenarios.
The system’s underfunding issues had been building for years. Between 2000 and 2017 the state made less than 25% of its annual required contributions, falling short of system needs by over $30 billion over that time. To address the underfunding, lawmakers first enacted substantial reforms in 2011 and, after some setbacks, recommitted to working toward making the full actuarially recommended contribution starting in 2017. The 2021 planned payment represents the fifth consecutive increase since 2017 and is a significant jump from the $3.9 billion contributed in fiscal 2020.
Twenty years ago, New Jersey’s pension plans were more than 100% funded, and leaders decided to increase worker pension benefits while reducing state contributions. In 2005, New Jersey made only 5% of its required contribution, but the system was still close to 80% funded. By 2015, the funded ratio—the value of plan assets in proportion to pension liabilities—had fallen to 47%. The available assets would cover just eight years of benefits. As of 2018, New Jersey ranked last among states with only 38% of assets on hand to pay for promised benefits.
This year, revenue declines related to the pandemic created new spending pressures that made a big increase in pension contributions—as a share of a $40 billion state budget—especially challenging. But the governor and legislative leaders found the stress test data convincing and agreed to increase contributions despite a recession.
Stress testing uses a rigorous simulation technique that provides the comprehensive data and analysis needed to make such difficult decisions. This approach can help policymakers prepare for the effects of adverse conditions on pension balance sheets and government budgets. The findings also can be used to evaluate reform proposals and provide early warnings if more actions are needed.
New Jersey enacted its stress testing requirement in 2018 and is now one of 12 states with such a law. Policymakers in Trenton have worked to obtain the needed financial data to ensure they are better funding their plans. Although the state has lagged others in managing its pension system, it was among the first to adopt stress testing.
Pew published a stress test of 10 state pension systems, including New Jersey’s, in 2018. The analysis found that an economic crisis could deplete plan assets unless policymakers rigidly adhered to their updated funding policies. The testing showed that New Jersey was at a greater risk of insolvency than any other state and that hitting that point could increase costs by more than $4 billion annually.
This year, the state actuary produced timely projections that assessed the impact of COVID-19 on pension plan balance sheets. In addition, Pew provided an independent stress test analysis to Senate President Stephen Sweeney (D) and then to state policymakers. The results of that analysis, which included a new framework to account for the economic impact of the pandemic on state finances and pension investments, indicated the $4.7 billion payment was only slightly over the minimum contribution required to protect against fiscal distress. The full payment illustrates New Jersey’s fiscal discipline as well as leaders’ commitment to pensioners and stabilizing the state pension systems.
The stress test results had been clear. Despite the fiscal challenges, New Jersey could not postpone or reduce pension contributions without risking collapse of the retirement system. For other states facing unprecedented budget challenges in the year ahead, New Jersey’s approach demonstrates how policymakers can commit to maintaining fiscal discipline and rely on nonpartisan, data-driven analysis to point the way.
New Jersey's massive pension contribution doesn't come as a surprise to those of us who have been tracking the dismal state of many US state pensions.
The experts at The Pew Charitable Trusts are reminding us once again that US public pensions are in deep trouble and in this case, one of the most vulnerable ones is being thrown a lifeline.
It's not like New Jersey Governor Phil Murphy (D) doesn't have better use for that $4.7 billion, especially in the middle of a pandemic.
He obviously does but New Jersey lawmakers recognize just how precarious the situation is and decided to approve the pension contribution as part of the fiscal year 2021 budget adopted Sept. 24.
Murphy signed the measure Sept. 29, just before the Oct. 1 start of the new fiscal year. New Jersey pushed out the end of fiscal 2020 from June 30 to Sept. 30 as it navigated the impact of revenue fluctuations caused by the COVID-19 pandemic.
What prompted this massive pension contribution in the middle of pandemic? In short, years of neglect where one state government after another neglected to top up its pensions and the chickens have come home to roost:
Twenty years ago, New Jersey’s pension plans were more than 100% funded, and leaders decided to increase worker pension benefits while reducing state contributions. In 2005, New Jersey made only 5% of its required contribution, but the system was still close to 80% funded. By 2015, the funded ratio—the value of plan assets in proportion to pension liabilities—had fallen to 47%. The available assets would cover just eight years of benefits. As of 2018, New Jersey ranked last among states with only 38% of assets on hand to pay for promised benefits.
This year, revenue declines related to the pandemic created new spending pressures that made a big increase in pension contributions—as a share of a $40 billion state budget—especially challenging. But the governor and legislative leaders found the stress test data convincing and agreed to increase contributions despite a recession.
There comes a point where responsible lawmakers cannot ignore their pension liabilities. New Jersey has reached that point.
Remember, in the US, states are constitutionally bound to make their pension payments, if the retirement system goes bust, taxpayers are on the hook.
Even now, they will need to raise taxes in the midst of a pandemic to make this massive pension contribution. Not exactly a politically palatable move but it's either pay up now or pay a lot more in the future.
And it's not just New Jersey. As The Economist reported almost a year ago, America’s public-sector pension schemes are trillions of dollars short:
Perhaps it takes teachers to give politicians a lesson. Any official who wants to understand the terrible state of American public-sector pensions should read the financial report of the Illinois Teachers Pension Fund. Its funding ratio of 40.7% is one of the worst in America, according to the Centre for Retirement Research (CRR) in Boston (see table).
Since it was established in 1939, Illinois officials have not once set aside enough money to fund the pension promises made. As a result, three-quarters of the money the state (or rather the taxpayer) now pays in each year merely covers shortfalls from previous years. The situation is getting worse. In 2009 the schemes’ actuaries requested $2.1bn, but only $1.6bn was paid. By 2018 the state paid in $4.2bn, still well short of the $7.1bn the actuaries asked for. the trustees have warned the plan would be "unable to absorb any financial shocks created by a sustained downturn int he markets."
Got that last sentence? Fast forward to March 2020 when markets tanked and long bond rates plunged to new record lows.
Yes, stock markets have rebounded but interest rates remain at record lows and it's the drop in long bond yields which primarily drive pension deficits because the duration of liabilities is a lot bigger than the duration of assets.
And my fear is that long bond yields have yet to make their secular lows, it could get a lot worse for many US state pensions teetering on insolvency.
The folks at The Pew Charitable Trusts better start stress testing a whole pack of state pension plans because my gut is telling me a lot of them are hiding the catastrophic state of their funded status.
New Jersey enacted its stress testing requirement in 2018 and is now one of 12 states with such a law.
But there are plenty of other states that can't afford rising public pension debt who have yet to adopt such a law and are flirting with disaster.
Of course, this has been an ongoing issue for decades. The primary driver of state pension deficits is state governments failing to top up their pensions, but that's not the only problem.
In December 2013, I wrote a comment for the New York Times on the need for independent, qualified investment boards:
The main driver of public pension deficits isn't the financial crisis, it's decades of fiscal mismanagement. For years states willfully ignored their pension payments, borrowing money from public pension plans to create the illusion that they were balancing their budget every year.
To keep contributions down, stakeholders of public pension plans, including unions, deluded themselves into believing the pension rate-of-return fantasy -- a fantasy because it is based on the erroneous assumption that public pension funds will be able to attain their 8 percent investment bogey over a sustained period. With interest rates at historic lows, it's clear that discounting future liabilities using such rosy investment assumptions will only make matters worse.
These ridiculous investment targets have led to an even bigger problem, excessive risk taking among U.S. public pension funds that have allocated a large portion of their assets into alternative investments like private equity, real estate and hedge funds. In some cases, this approach is warranted and successful but in most cases, U.S. public pension funds are wasting billions in fees praying for an alternatives miracle that will never happen.
The legislative response to public pension deficits is predictable and shortsighted. Some reforms, like raising the retirement age and using career average earnings for determining pension benefits, are necessary as people are living longer.
Other reforms, however, are silly and promote long held myths on public pensions. In particular, shifting public sector workers into defined-contribution plans shifts retirement risk entirely onto workers, ensuring more pension poverty down the road.
Legislators need to understand that defined-benefit plans are superior to defined-contribution plans, and they must take measures to maintain public pensions and expand defined-benefit coverage to private sector workers. This will actually help reduce fiscal debt in the long-run as retirees earning predictable benefits will spend more money and pay higher taxes.
But there is a caveat to all this. U.S. pension reforms need to incorporate the shared risk model that has worked so well in the Netherlands. This way workers, retirees and plan sponsors will share the risk of the pension plan. Moreover, U.S. pension funds need to incorporate the same governance model that has allowed Canadian public pension funds to flourish. This means adopting independent investment boards that operate at arms-length from the government and compensating public pension fund managers more in line with what private sector fund managers receive.
Until U.S. public plans get the governance right by implementing independent and qualified investment boards and compensating their public pension fund managers properly, all other reforms are cosmetic and do nothing to slay the pension dragon.
It's funny (more like sad), I wrote that comment seven years and nothing has significantly changed. US public pensions are still taking significant risks, they're still clinging to the 8% 7% rate-of-return fantasy, and they still haven't adopted the Canadian governance model to manage more assets internally and a shared risk model to make sure the risk of their plans is equally shared among retired and active members.
This is why earlier this year, I warned my readers that here come US pension bailouts, stating this:
Illinois has mismanaged its public pensions for years and it's beyond outrageous, and quite disgusting actually, that they are using this pandemic as a justification to bail these pensions out.
The sad part of it is pension bailouts are coming. It might not be right away, but it's only a matter of time because many chronically underfunded US public pensions getting slammed hard from coronavirus are one step closer to insolvency.
And remember what I keep telling you, pension bailouts are all about bailing out Wall Street which includes big banks and their big private equity and hedge fund clients that need perpetual funding.
It has nothing to do with bailing out pensioners but politicians will make it look that way.
Again, it may not be right away, but mark my words, Congress will eventually bail out many chronically underfunded pensions and the Fed and Treasury will just monetize this debt.
The problem? Just like keeping zombie companies alive, they will keep zombie pensions alive to make sure the elite on Wall Street are able to keep tapping them in perpetuity for their next fund.
And then we wonder why after every major crisis, inequality keeps soaring to unprecedented levels.
George Carlin was right: "It's a big club, and you ain't in it. You and I are not part of the big club."
We certainly aren't part of the big club. Ray Dalio is but even he doesn't understand what truly ails capitalism (or he does and doesn't want to rock the boat).
Here's some more food for thought for all of you on capitalism. The Fed increases its balance sheet by $3 trillion in response to the pandemic, Congress approves trillions in fiscal aid, and you really think they're going to let public pensions go belly up?
Come on folks, you all need to read C. Wright Mills' classic, The Power Elite.
The game is rigged. The power elite making all the decisions in the background are run by billionaires who have too many vested interests in state pensions, they’re their perpetual funding machines.
Alright, better wrap it up, I'm sounding too damn cynical even for my own liking.
Below, Steve Adubato goes on-location to the 2019 NJEA Convention in Atlantic City to talk to Steve Swetsky, Executive Director, New Jersey Education Association, to discuss his vision for the future of NJEA and the state of public pensions (February).
And New Jersey residents earning more than $1 million a year will face higher income taxes, and about 800,000 lower- and middle-income families will get a tax rebate of up to $500 under a deal Gov. Phil Murphy and legislative leaders recently announced.
Lastly, a conversation I had with Ed Harrison of Real Vision earlier this year on the fate of underfunded US state pensions. Not my best interview, COVID haircut and all, but I think I got the main points across.
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