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Upping Rate of Return on Pension Investments Buys Murphy Breathing Room

A 0.5 percent boost will ease state pension payments and give new governor more cash in his first budget to spend on priorities like education and mass transit

Elizabeth-Maher-Muoio
Credit: NJTV News Online
Elizabeth Maher Muoio

Gov. Phil Murphy will present his first state budget to lawmakers in a little over a week, but he's already eliminated some of the suspense on the issue of public-employee pension funding.

Murphy's administration announced late last week that it is changing how the state will estimate future returns earned by the pension system's investments, a deep in-the-weeds policy shift that will result in a slightly more aggressive assumed rate of return being used during the 2019 fiscal year.

Former Gov. Chris Christie had set a 7 percent assumed rate of return for pension-system investments in a surprise move made late last year during his final weeks in office. It represented a sharp downturn from the 7.65 percent rate that had previously been in place. But Murphy is now moving the rate to 7.5 percent for the next few fiscal years, though he plans to gradually bring it back to 7 percent.

Smaller pension contribution

The new policy will give Murphy the option of making a smaller state pension contribution in his first budget, while still sticking to a funding ramp-up schedule that was established by Christie. That will leave Murphy more cash to spend on his core priorities, like K-12 education and mass transit.

It will also provide some more breathing room for local governments across the state by rolling back, at least in the short term, the abrupt alteration enacted by Christie. That change, announced by Christie with no forewarning, has sent local officials scrambling this year to cover increased pension costs.

Acting state Treasurer Elizabeth Maher Muoio stressed that the Murphy administration's decision to change course will "help mitigate the undue stress" for local governments by phasing in Christie's change over the next years. It drew immediate praise from Hetty Rosenstein, the state director for the Communications Workers of America labor union. But the policy change was roundly criticized by Assemblyman Edward Thomson, an actuary and pension expert, as a reversal of promises that Murphy, a Democrat, has made about boosting overall pension funding.

"This is just political gamesmanship (and) there's no basis for this," said Thomson (R-Ocean).

Aggressive Rate of Return

For well over a decade, New Jersey's $77.5 billion pension system operated under an assumed rate of return for investments that equaled roughly 8 percent, which was considered to be an aggressive figure, especially for a retirement plan that is one the nation's worst-funded. But the higher figure was also cherished by governors and lawmakers from both parties because it allowed the state to assume more revenue could be generated from its investments than would be under a more conservative estimate, thereby lowering the employer pension payment required from the state in the annual budget.

Over the past five years, New Jersey pension system investment returns have averaged 8.74 percent under the management of the state Division of Investment, according to the DOI's most recent figures. But investment returns over the past 10 and 20 years have averaged 5.95 percent and 6.76 percent, respectively.

A report published in 2016 by the American Legislative Exchange Council determined the average assumed rate of return among some 280 state-level public-employee pension funds is 7.37 percent, and under Christie, a Republican who stressed fiscal reform, the state pension system's assumed rate of return was lowered several times during his two terms in office. The last reduction, announced in late December 2017, lowered the rate from 7.65 percent to 7 percent.

Easing concerns

For New Jersey's more than 560 municipal governments, the Murphy administration's new pension policy eases immediate concerns about cost increases that local officials were facing in the wake of Christie's last-minute announcement - and the changes to pension-funding math that it brought on. Unlike the state, which is allowed to skip its full employer contribution due to balanced-budget language in New Jersey's Constitution, the local governments are required by law to foot their full employer obligations.

Michael Cerra, assistant executive director of the New Jersey State League of Municipalities, said that Christie's late-December policy change left a lot of local officials with "sticker shock," and could have resulted in "significant service cuts" as they are trying right now to finalize calendar-year budgets for 2018. The total hit for municipalities was an estimated $400 million statewide.

"It was simply too significant a hit to absorb in any given year," Cerra said.

Spreading out the move to a lower assumed rate of return will ultimately help ease the burden on the taxpayers, Muoio said.

"A gradual path to a lower rate will help mitigate the undue stress that would otherwise have been placed on local governments to address the significantly increased contributions required of them," she said.

Christie only made partial state pension contributions throughout his eight years in office, a record Murphy has repeatedly criticized and promised to improve on. In fact, the current state budget that Murphy inherited from Christie sets aside $2.5 billion for the pension system, about half the payment that actuaries say the state should be making.

Ramp-up schedule

Under a pension-funding ramp-up schedule that Murphy is inheriting from Christie, the state contribution in the fiscal year 2019 budget was set to increase to about $3.4 billion, or by roughly $900 million. But the new policy announced by the Murphy administration will reset the assumed rate of return at 7.5 percent, meaning the contribution can total closer to $3.2 billion, while still sticking to the ramp-up schedule.

In her announcement last week, Muoio said the state would still get down to the more conservative 7 percent figure established by Christie, but not until the fiscal year 2023. The 7.5 percent rate will remain in place for the 2020 fiscal year, but it will be lowered to 7.3 percent for the 2021 and 2022 fiscal years.

"This move signals to ratings agencies that we are serious about bringing our assumptions in line with long-term expectations in a measured and sustainable way," she said.

Rosenstein, the CWA labor leader, said the union members are thankful to see that "Christie's wreckage to our state is finally beginning to be reversed."

"We agree that the interest-rate cut on pensions should be phased-in," she said.

But Thomson, the Republican assemblyman and actuary, labeled the move "hypocrisy" from the Murphy administration, given how much the new governor criticized Christie on the issue of pension funding during the 2017 gubernatorial campaign. He suggested the pension system's gross underfunding means the state should be setting policies that result in an increase in how much is being contributed by governments in New Jersey, not those that allow for a decrease.

"If anything, (the assumed rate of return) should be going down, not up," Thomson said. "It's the wrong thing to do."

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