New Jersey zigzags on pension fund discount rate
New Jersey Gov. Phil Murphy’s new administration is taking a zigzag approach to setting funding requirements for the state's troubled pension system.
Acting State Treasurer Elizabeth Maher Muoio announced late Thursday that she would increase the expected rate of investment returns for the pension system to 7.5% from 7%, then lower it again in phases. The administration of Murphy's predecessor, Chris Christie, cut the expected return rate in November to 7% from 7.65%.
The change eases short-term budget pressure on governments that contribute to the system while lowering the amount of funding the significantly underfunded system will get.
Current treasury officials say the 7% rate implemented by Christie's treasurer, Ford Scudder, would have required the state to fund pensions to the tune of an additional $238 million this year and cost local governments around $415 million.
“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 and the consequences this would have on their structural budget, reserves, and ultimately, their taxpayers,” said Muoio in a statement. “Moreover, 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.”
Muoio, a former state assemblywoman who was appointed to the treasurer post by Murphy in December, said she plans to start moving the investment rate of return down for the state’s five retirement systems over time. The rate will drop to 7.3% from 7.5% for the 2021 and 2022 fiscal years before returning to 7% in 2023, Muoio said.
New Jersey officials compared the decision to gradually reduce pension return expectations to a recent move by the California Public Employees’ Retirement System, which voted in late 2016 to drop its discount rate down over a three-year period to 7% in 2020 from 7.5%. Other states have also opted to lower their expected pension return rates in response to years of poor investment performance.
“We are moving in a direction that is consistent with not only the advice of actuarial experts, but also the nationwide trend among states,” said Muoio, who is still awaiting state Senate confirmation on her appointment. “The path we’ve laid out takes into account the alarms that were sounded late last year when the state took the widely unprecedented step of lowering the rate so precipitously.”
Howard Cure, director of municipal bond credit research at Evercore Wealth Management, said that while raising the rate of return this year will decrease pension contributions New Jersey badly needs, the Muoio plan may prove beneficial in the long run. He said gradually lowering the assumption rate is recognition of the financial burden many local governments would face from a more drastic drop such as the one implemented under Christie in November.
“You want the assumed rate to reflect reality with the higher rate giving the illusion of a smaller liability.” said Cure. “I think, at this point, most analysts and the rating agencies go beyond the stated assumptions and use other proxies to adjust the pension liabilities.”
An April 2017 report released by Pew Charitable Trusts said New Jersey has the worst pension funding level of the 50 U.S. states at only 37% for the 2015 fiscal year. Scudder previously lowered New Jersey’s assumed rate of return on pension assets in February 2017 to 7.65% from 7.9% in an effort to boost contribution levels.
State Sen. Anthony R. Bucco, R-Boonton Township, blasted Muoio's pension change, noting that the Christie administration’s moves to lower the assumed rate of return to 7% in steps from a high of 8.25% was praised by actuaries and ratings agencies. He said “rosier assumptions” would result in lower required payments into the pension funds.
“Our pension funds got into bad shape by making overly optimistic projections on the rate of return that we could expect,” said Bucco in a statement. “We need to stay the course and keep making the biggest pension payments that we can.”
A heavy pension burden has weighed heavily on New Jersey, playing a major role in 11 rating downgrades from 2010 to 2017. The Garden State has general obligation bond ratings of A3 from Moody’s Investors Service, A-minus from S&P Global Ratings and A from Fitch Ratings and Kroll Bond Rating Agency.
Moody's analyst Tom Aaron said that the revised assumptions are a "a relative credit negative" for New Jersey because they are higher than other large public pension funds. Aaron said Moody's generally views the lowering of pension fund investment return assumptions as a credit positive for the sponsoring government.
"Lower return assumptions tend to force more contributions by governments, and sooner," said Aaron. "While initially more expensive, front-loaded contributions mean less long-term risk that unaffordable unfunded liabilities will accumulate."