In 1866, Surrogate Gideon J. Tucker wrote that "[n]o man's life, liberty or property are safe while the Legislature is in session." Over a hundred years later, the New Jersey Legislature is doing its very best to keep Surrogate Tucker’s warning pertinent by once again advancing special-interest legislation that reaches for a new low in bad public policy and stunning indifference to taxpayers.
The issue at hand is the state Senate’s recent unanimous approval of, a bipartisan bill to transfer “management” of the $26 billion Police and Firemen’s Retirement System (PFRS) from the Department of the Treasury’s Division of Investment and the State Investment Council to a union-controlled board of trustees. The stated rationale includes giving PFRS’s beneficiaries more control over the investment of their retirement savings and insulating pension-asset investment decisions from nefarious political influence. That sounds benign, even reasonable. As the bill’s prime sponsor stated: “It's a matter of enlightened self-interest for people who have skin in the game."
“Self-interest”? Certainly. “Enlightened”? Not so much.
Here are only a few of the many reasons why this bill is a very, very bad idea:
Although it’s possible to make a straight-faced argument for giving PFRS and other pension-fund beneficiaries a greater role in making investment decisions, it makes absolutely no sense for government employers to turn over investment management while retaining all investment risk. And it’s demonstrably insane to give public employees unqualified power to set their own benefit levels and require that government employers (and taxpayers) pay the tab. Yet that’s exactly what this bill does.
Headlines aside, S-3040 is about much more than giving PFRS beneficiaries “skin in the game.” Specifically, the bill grants the new PFRS board the power to enhance benefits and restore cost of living adjustments (COLAs) that were suspended pursuant to 2011 reform legislation pending the fund’s return to fiscal health. The board would also have the authority to review retirement applications, modify member contribution rates, and adjust important rules for calculating pension benefits.
Actuaries calculate required employer contributions based, in part, on projected member contributions, investment returns, and benefit levels. Since there is nothing in the bill that conditions benefit enhancements on an increase in member contributions, the PFRS board will in effect have the unilateral power to enhance benefits and make other costly changes without assuming any responsibility for funding them with member contributions. Similarly, the board will bear none of the risk that its investment performance might fall short of expectations. In both instances, employers — meaning local taxpayers — will be on the hook.
As a final nail in the taxpayers’ coffin, the bill uses the threat of an offset against state aid to force local government employers to pay their required contribution to PFRS. Query whether this and the lack of local government control over the proposed PFRS board would trigger a “state mandate, state pay” issue that would force the state (and state taxpayers) to assume any additional burden.
Under the practice of “pattern bargaining,” labor unions and employers will attempt to use one favorable settlement as leverage to demand the same benefits or concessions elsewhere. Even though S-3040 is mostly focused on local government employees and does not immediately impact the various state-funded pension funds, the public-sector unions would be derelict in their duties to their members if they did not use it to establish a bargaining pattern against the state. Predicting how events will unfold is easy: When PFRS uses S-3040 to reestablish a COLA for retired police and firefighters, there will be unrelenting political pressure to extend the same benefit to state retirees. The state will cave. And it won’t stop there. Beware quiet, below-the-radar gambits with respect to qualifying for tax-free disability pensions, calculations of final compensation, and the cap on creditable compensation. Who will foot the bill? You guessed it: state taxpayers.
In investing, as in buying diapers, it’s cheaper to buy in bulk. Setting aside supporters’ dubious claim that PFRS would benefit by pulling money from hedge funds and other “alternative” investments that impose what they believe are outrageously high performance incentives, the fact is that the majority of New Jersey public-pension fund assets are invested in traditional asset classes (e.g., stocks and bonds) and managed at very low cost by division employees. For those assets not managed in-house, fee structures are tied to the amount under management, with larger amounts subject to a discount. Though still a multibillion-dollar operation, PFRS on its own will inevitably face a choice: It can maintain the division’s current broad mix of investments but at a higher marginal-fee cost since the amount available to be managed by any one manager will be reduced. Or it can consolidate its investments across fewer managers and retain current fee discounts. The problem with the latter approach is that it would reduce diversification and thus increase investment risk. In sum, PFRS under the S-3040 structure will both lose the benefit of significant economies of scale and take on additional risk.
Police and fire union leaders who support S-3040 note that PFRS, at about 70 percent funded, is comparatively much better off than its state-funded counterparts and should not be subject to the same 2011 reform-law restrictions, such as the continued suspension of COLAs. They also publicly express fears that any future benefits reform might raid PFRS to benefit the other systems. The former assertion is wrong on the merits — the 2011 COLA suspension is a major reason PFRS is anywhere near financial solvency — and the latter is not a credible legal risk under either state or federal constitutional law. Then we must ask: Why single out PFRS for special consideration? Why would the state Senate approve S-3040 by unanimous vote? The answer is simple and classic New Jersey: next to teachers, police and firefighters are the best organized, most powerful political force in local politics. And better yet, they spread political favor and mete out political pain to Republicans and Democrats alike.
One particularly irresponsible excuse I’ve heard from Republicans inside the State House is that S-3040 is OK because it simply advances a recommendation made by Gov. Chris Christie’s New Jersey Pension and Health Benefit Study Commission in 2015. That is just not true. Yes, the commission proposed transferring the assets of the existing pension plans to willing employee entities, but only as part of a comprehensive reform plan that also included transferring full responsibility for the plans’ liabilities going forward. In other words, under the commission’s plan, public employees must assume the “risk of managing the plans to ensure that the available funds are sufficient to pay for” existing benefits and full responsibility for funding any benefit enhancements. If the police and fire unions are still willing to go forward with the commission’s full recommendations, I’d say “go for it”. Somehow, I think they’d prefer the right to manage $26 billion without any troublesome additional investment risk.
The mechanics of transferring PFRS to a new board would be exceptionally complex. For example, it’s simply not possible to take a figurative knife and slice a $72 billion pension fund into two or more chunks without encountering a host of practical, administrative, and legal issues. How would you divide portfolio investments that are themselves indivisible, by law or contract? How would you handle the execution of existing multiyear funding commitments? Would the division be obliged to liquidate investments to raise cash necessary to facilitate the PFRS transfer? If so, how would it apportion any early withdrawal penalties? How would the division apportion the cost of administrative support, during the transition and after? Would the board be empowered to pay its staff incentive compensation and salaries that exceed the current $200,000 statutory salary cap for the director of the Division of Investment (an amount that is laughably low for experienced asset-management professionals)? Would PFRS on its own still qualify as a “governmental” pension plan under federal law, a status that qualifies it for exemption from funding and other requirements that it could not otherwise meet? Would the state retain some form of contingent legal or moral liability if local governments could not meet their obligations to PFRS?
This only scratches the surface of possible issues. Could they be resolved? Probably, but only at considerable cost, both in upfront legal, accounting, actuarial, and other professional services and in foregone investment returns as the uncertainty and mechanics of separation and transition will likely force the division to maintain higher levels of cash and cash equivalents.
Currently, Treasury’s Division of Investment manages the assets of the state’s seven active pension funds on a combined basis under investment policies established by the State Investment Council (SIC), an independent oversight body comprising state, local government, and union representatives. The division director and the SIC share fiduciary responsibility to the funds and operate under extensive and exacting requirements with respect to transparency, public bidding, and conflicts of interest. It is, in both law and fact, a highly professionalized operation that is subject to public scrutiny and well-insulated from political influence.
The bill would segregate and transfer investment responsibilities for PFRS to a new union-majority board, which would in turn hire an executive director, chief investment officer, and other staff. S-3040 includes references to currently applicable ethics requirements, so in theory we should expect professional, high-functioning, and ethical pension administration.
But let’s get real. $26 billion is one heck of a lot of money. The depressingof public-pension fund scandals suggests the need for constant vigilance. Unchecked by the need to coordinate its daily functions with the Division of Investment, a separated PFRS will enjoy greater autonomy with less constructive scrutiny from the press and public. Moreover, it’s not at all clear what procedural, procurement, and anti-conflicts standards will apply to certain PFRS board functions, such as the selection of fund managers and providers of professional services. Forgive me, but I can’t help worrying.
In sum, S-3040 is a shameless special-interest power grab at taxpayer expense. The state Assembly will soon consider a companion bill. Out of respect for itself, if not the voters and taxpayers of this state, the Assembly should quietly deep-six this embarrassment.