The New York City Pension Plan manages over $195 billion in assets for close to one million current and future civil service retirees. New York City should be complimented for regularly funding the plan unlike some other state and local governments. Some of those delinquent governments (see New Jersey, Illinois) are facing huge shortfalls that threaten the ability to continue paying out the defined benefit to its members. A couple of municipalities have already reduced pensions and others are considering it. There is also increasing pressure to eliminate defined benefit pensions and replace them with an inadequate defined contribution schemes a la 401K plans in the private sector.
New York City allocated approximately $12 billion in its fiscal 2019 budget for contributions to its pension system—a sizable sum in an approximately $85 billion budget. The city’s commitment is only going to grow as retirees are living longer, and as baby boomers retire and begin collecting their pensions. Therefore, investment performance is more important than ever. The better the return, the less the city needs to contribute to meet its responsibility to its members, thus freeing up money for other needs, like debt service, a rainy day fund and so on.
Given the budgetary commitment, its impact on hundreds of thousands of current and past civil servants and city taxpayers, I pose the following question: Is the structure and governance of the pension plan designed to maximize its investment return?
I don’t believe so.
The New York City pension plan is funded by contributions from employees, the employer (New York City taxpayer) and from earnings on the invested assets of the system. It’s from this pool of money that the benefits of a defined pension plan are paid to retirees. A defined benefit is the amount that the retiree will receive annually for the rest of that worker’s life. The pension check is based on the number of years of service and final salary.
Earnings on the invested assets are critical to the plan’s ability to fund its present and future obligations. According to actuarial tables, the plan must earn at least 7 percent annually to keep pace with those commitments.
If returns fall below that number, that usually means the taxpayers have to contribute more money to the system than the city’s financial plan projected. If the assets perform better than 7 percent, the city saves money.
The city’s five plans are run by the Comptroller’s Office through its Bureau of Asset Management. Each of the plans hires a consultant to develop an investment strategy. Generally the funds (with some minor deviation among the plans) are invested predominantly in stocks and bonds, with additional allocations to private equity, real estate, infrastructure, and hedge funds.
The stock portion is mostly invested in passive strategies. “Passive” means that there is little or no skill involved in selecting companies to invest in. The firms the city hires merely invest in an index like the Standards & Poor’s 500 (which includes the largest 500 companies). The advantage of passive investing is that it’s significantly cheaper than the active style.
About 20 percent of the stock portfolio is invested “actively.” This more expensive approach depends on the skills of the portfolio team to produce superior performance. The pension system portfolio is predominantly managed by external investment managers.
An example up north
We don’t have to reinvent the wheel in New York City to significantly improve the performance of our pension plan.
I am big a fan of the $360 billion Canadian Pension Plan Investment Board model. The CPPIB’s five-year return was 12.3 percent vs approximately 8 percent for New York City. This difference in performance is not insignificant. We are talking about tens of billions of dollars in savings for New York City taxpayers.
Without delving into the weeds, the CPPIB is structured as an independent entity that hires and incentivizes top investment talent. They have produced excellent results. Part of the reason they have done so well is internal management of most of their assets. Consequently, they save a huge sum on management fees. CPPIB has the expertise to directly invest in alternatives such as private equity and infrastructure. They don’t have to hire a top-flight firm and pay them a king’s ransom. For example, last fiscal year the CPPIB allocated $20 billion dollars to infrastructure investment utilizing the talent of their in house team. The total cost in fees to the plan was $75 million. Had they hired an outside firm to invest in this asset class it would have cost between $800 million and $900 million.
The CPPIB model, which has been copied by other Canadian pension plans such the Ontario Teachers, was proposed 20 years ago. It was in response to an actuarial report in the 1990’s that predicted that the plan that many Canadians pay into would be unsustainable and go bankrupt. The political leadership realized it had to act.
They overhauled, professionalized and modernized the plan. They created an independent entity that would be governed and managed at arm’s-length from political interference. A board of directors that includes non-partisan, financially minded people oversee the plan. In the case of the Ontario Teachers and other Canadian civil service plans, the board includes union officials. Labor union representation should also be mandated for any independent entity created in New York City.
The executives are hired entirely by the board. These Canadian funds brought in top-flight talent at competitive private-sector salaries that include incentives based on performance. Twenty years later this approach is a success as performance has dramatically and consistently improved.
Charter revision opens a window for change
As a member of the 2019 Charter Commission, I will urge my fellow commissioners to consider other pension plan models that routinely outperform the New York City model. The city is the financial capital of the world. We should have the best performing scheme not a clunker.
I propose overhauling the plan by professionalizing, reorganizing and devolving it into an independent agency to manage the system.
I believe it will improve performance which will benefit the city and the active and retired members of the plan.
The managers would consist of the best and brightest investment professionals with the skill to manage most of the assets internally. This would save the plan a ton of money they are now paying to external managers, a drain on performance.
I also suggest that the five plans be collapsed into one, negating all the duplication and costs the separate plans incur.
The agency has to be a stand-alone entity and should not be part of the office of an elected official. Politics cannot play a role in selecting top-flight talent or weighing investment decisions. We have seen politics rear its head and impact investment choices. This is not a reflection on any elected official; it simply makes clear the importance of implementing a system that is totally aligned with the interests of the members of the pension system and the taxpayers.
The Canadian model is a success and we should emulate it. My proposal is to devolve pension management out of the New York City Comptroller’s Office and create a similar independent entity. I believe it will be a big win for all New Yorkers. Taxpayers and members of our pension plan deserve and should have the most professional and best managed plan in the world.
A lawyer and financial planner, Sal Albanese represented a Brooklyn district in the New York City Council from 1983 through 1998. He was a candidate for mayor in 1997, 2013 and 2017.