An impulse to help

Local reconstruction is not a primary mission of any pension fund

Can a pension fund serve two masters? New York City Teachers' Retirement System will try.

With its plan to invest $1 billion in Hurricane Sandy reconstruction, the retirement system seeks to embrace a dual mission for its pension fund.

One is financing retirement benefits; the other, local disaster reconstruction.

Both are critically needed missions. It is understandable, the retirement system's impulse to want to put some of its resources to work to help Sandy's victims, who are neighbors in distress and some of whom might be system participants. The teachers' system itself is operating with limited services because its building has been closed due to severe flooding from the storm.

But local reconstruction is not a primary mission of the system, or any pension fund. A retirement system has only one key mission: to fund retirement benefits. It is no easy feat to accomplish.

In announcing the commitment, New York City Comptroller John Liu said: “This innovative plan could help us rebuild the city, create jobs and yield solid returns on our pension funds ... Together we can produce great projects that are also sound investments.”

Bill Clinton, who was at the event and who has advocated using pension funds for economic development, called the pledge “a remarkable commitment” that would help by “putting us on the path to a sustainable future for New York City.”

The reconstruction investments could range from repairing bridges to rebuilding housing destroyed in the October storm, and come in the form of purchasing bonds issued by owners or part ownership of the projects.

The retirement system plans to evaluate all projects on the basis of their return and the pension fund's fiduciary standards, Mr. Liu said.

Return and risk, and the impact on meeting funding objectives, are the only ways to evaluate investments. Investments that fall short will mean pension contributions must be increased. Meeting that objective is essential to the sustainability of the retirement system.

Restoring the area will take a lot of capital, but the teachers' system isn't the only source. If the investment proposals are appealing, they will attract enough investors to finance the needs.

If they don't attract private investors, that would serve as an important market signal about potential flaws in the projects that might make them uneconomical and unsustainable. If that is the case, the retirement system should not become the financing source of last resort.

Some of the financing might come in the form of tax-exempt bonds, whose lower interest rate wouldn't ordinarily attract tax-exempt investors.

After the 9/11 terrorist attacks, H. Carl McCall, then-New York state comptroller and sole trustee of the New York State Common Retirement Fund, announced he would invest some of the fund's assets, now totaling $150.1 billion, in securities financing the rebuilding of lower Manhattan.

But ultimately there appeared little, if any, in the way of reconstruction financing opportunities for pension funds or other tax-exempt institutional investors in rebuilding the site.

On the occasion of the 10th anniversary of the attacks, officials at the New York State fund and the New York City Retirement Systems, which includes the teachers' fund, or other officials involved in the redevelopment, wouldn't comment on whether pension funds provided any capital. But the project got under way financed by other investors using tax-favored financing, and by 2011 every part of the World Trade Center complex of buildings was under construction.

The Sandy reconstruction commitment by the teachers' system amounts to more than 2% of its $44.98 billion assets. In fact, the New York City Retirement Systems, which comprise the city's five pension funds, already have invested annually about 2% of assets in aggregate through the city's economically targeted investment program, primarily for housing in low- and middle-income neighborhoods.

The ETI program seeks investment opportunities expected to deliver risk-adjusted market returns and also generate benefits to the city, according to the comptroller's website: “ETIs are designed to address market inefficiencies by providing capital or liquidity to underserved communities and populations citywide.”

But market inefficiencies often are the result of regulatory and political barriers on projects, rather than market failure.

The systems are dependent enough on the New York economy for their pension contributions. Further concentrating investments in the city adds to that non-diversified risk. It is like a corporate plan sponsor allocating pension assets to its own company stock, or 401(k) investors concentrating allocations to their employer stock. For defined benefit plans, ERISA allows up to a 10% allocation to sponsor-related investments, which is too high but satisfies political pressure from corporations. For defined contribution plans, there is no limit, although some companies have policies trying to restrict such allocations to promote better risk management through diversification.

The New York systems are well below that ERISA limit. Mr. Liu must ensure, as he said he would, that the Sandy commitments meet fiduciary standards on risk and return. Although there is no guarantee on return for even the soundest investments, he can help alleviate concerns through a transparent search, selection, and performance monitoring and benchmarking process, and opening the whole enterprise to public scrutiny.

The system, like all pension plans, must keep in mind its key target is funding as efficiently and effectively as possible, teachers' retirement benefits.

It is a sometimes unappreciated task, as seekers of capital see the enormous amounts of pension assets as a plum to bite without recognizing those assets already have a mission to fund enormous obligations and often fall short.

The aggregate funding ratio of the largest 100 U.S. corporate pension plans was 74% as of Oct. 31, according to Milliman Inc. For the largest U.S. public retirement systems, the aggregate funded level was 75.8% in fiscal year 2011, according to the Public Fund Survey sponsored by the National Association of State Retirement Administrators and the National Council on Teacher Retirement. The teachers' system was 64.1% funded as of June 30, 2011, according to its latest annual report.

Securing pension liabilities largely though investment return is often an underappreciated and unmet challenge. Fulfilling that mission serves a high social purpose few institutions can match, not only benefiting participants by providing retirement income, but benefiting taxpayers who would otherwise have to bear the cost of helping to provide for those who don't have a secure income in retirement.

This article originally appeared in the December 24, 2012 print issue as, "An impulse to help".