New actuarial calculations for New Jersey’s beleaguered public-employee pension system show an unfunded liability of near $50 billion, a staggering number for a retirement plan that’s been set up to cover roughly 780,000 current and retired government workers.
But many financial experts believe the pension system’s funding problem is potentially much worse, because the state has for decades been using optimistic assumptions when it comes to projecting annual investment returns.
The $72 billion pension system’s assumed rate of return, or discount rate, for the past few years has been 7.9 percent, which is higher than the average returns of just over 7 percent that the pension system has realized over the past 20 years. Gov. Chris Christie, a Republican who has stressed pension reform during his two terms in office, announced last week that the rate will be lowered to a more realistic 7.65 percent.
While the difference seems subtle, pension experts say the downward adjustment is good for the retirement system’s overall long-term health because it will generate a more realistic assessment of the unfunded liability, and that in turn will require the state to make more robust annual contributions in the ongoing effort to maintain the fund’s solvency.
Christie’s efforts — the reduction is just the latest to occur during his tenure — also line up with calls for more realistic accounting that have come from Senate President Stephen Sweeney (D-Gloucester), the Legislature’s leading Democrat on issues related to pension funding and employee benefits.
Other states in same shape
New Jersey is not alone in seeking more modest financial projections as leaders in several other states have been lowering pension-system assumptions in recent years to better align investment projections with expected market conditions. Under Democratic Gov. Jerry Brown, the California Public Employees Retirement System is reducing its assumed rate of return from 7.5 percent to 7 percent in phases over the next few years. Other states, including Michigan and Connecticut, are making similar changes.
Tom Healey, a financial analyst and former U.S. Treasury official under President Ronald Reagan who led a benefits-review commission impaneled by Christie in 2014, said in an interview that New Jersey has been working under a higher discount than most other states.
“At 7.9 percent, New Jersey was towards the top end of all states,” Healey said.
A report published last year 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. For New Jersey, using a lower discount rate in actuarial calculations will increase the size of the unfunded liability, causing a slight elevation of the annual contribution the state is required to make to keep the pension system solvent.
“The way the math works, it increases the amount of the actuarial required contribution,” Healey said.
New Jersey at one point nearly three decades ago used a much more conservative 7 percent discount rate, but it was elevated to 8.75 percent in 1992, a move that allowed politicians at the time to significantly lower how much the state needed to put into the pension system that year to keep it solvent. The rate was eventually moved down to 8.25 percent in 2004. Under Christie, the rate was lowered twice to land at 7.9 percent.
Last year, the pension system, which is professionally managed by the state Division of Investment, enjoyed returns of just over 7 percent. That marked an improvement over the 2015 returns, which didn’t crack 1 percent. Over the past 20 years, returns have averaged 7.03 percent, according to Department of Treasury records.
Willem Rijksen, a spokesman for state Treasurer Ford Scudder, said the recommendation to lower the assumed rate of return to 7.65 percent was formally approved by state pension officials late last month.
“Moving it downward is consistent with what other states have done and is based upon our analysis of the marketplace and past returns,” Rijksen said.
Christie, speaking during his annual budget address last week, said the discount-rate reductions that have occurred during his tenure mean the state is “stopping the gimmickry” of using inflated assumptions to make the unfunded liability look less severe.
“When we have too high an assumed rate of return, we are not telling the public the truth,” Christie said.
“While this concerted effort has contributed to increases in the annual required contribution into the pension system, those payments are crucial in ensuring the long-term viability of the pension system,” said Christie, who also enacted legislation in 2011 that forced employees to contribute more toward their pensions.
Do the right thing
“This has not been easy for us to do, but the right thing rarely is easy,” he said. “We have obviously not done this to get credit — good thing because we haven’t gotten any — we’ve done it for our state’s pensioners and our state’s fiscal health.”
Sweeney, the Democratic legislative leader, said Christie’s efforts to reduce the assumed rate of return put the governor in line with his own advocacy on pension issues. But Sweeney, who is also a private-sector labor official, said making the full state pension contribution, and making that payment in quarterly installments under a new law that will go into effect on July 1, must also be priorities for the state.
“I have long advocated for a more realistic assumed rate of return for the pension system, and my plan to make quarterly payments and insistence on making the full actuarially required pension payment, as scheduled, are crucial to sustaining the long-term financial health of the system so it is there for hard-working public employees,” Sweeney said.
But throughout Christie’s tenure, his administration has never fully funded the state’s obligation even though the governor worked with lawmakers to enact a 2010 law that called for full funding of the state contribution by the 2018 fiscal year, which begins July 1. Instead, Christie’s $35.5 billion budget proposal for the 2018 fiscal year includes a $2.5 billion contribution, which is about half the total that actuaries say is needed. Christie’s spending plan will be reviewed by state lawmakers over the next several months as part of the formal budget process leading up to a June 30 deadline.
Phil Murphy, a Goldman Sachs veteran and Democratic candidate in this year’s gubernatorial election, led a blue-ribbon task force set up by then-Gov. Richard J. Codey in 2005 to review state employee-benefits funding issues. The panel’s loudest warning was a call for “no more pension holidays” for state and local governments, but the authors also called for an end to “valuation gimmicks.”
Asked to comment on the change from a 7.9 percent assumed rate of return to 7.65 percent, Murphy’s campaign sent a statement that instead focused on the size of the state’s annual pension contributions, and fee-driven hedge-fund investments that have been pursued during Christie’s tenure.
“First principle, the state must make its payment, and if the state is having trouble meeting its targets, then it should jettison the high-cost, money-losing hedge funds that only pad the profits of Wall Street while dragging down the pension funds’ performance,” Murphy’s statement said.