Return assumption cut for state pension fund a problem for Murphy
New Jersey's Republican state treasurer sharply reduced the New Jersey Pension Fund's assumed rate of return, producing a financial and political dilemma for Gov.-elect Phil Murphy, a Democrat, who will be sworn in later this month.
Last month, Treasurer Ford Scudder announced a cut in the assumed rate of return to 7% from 7.65% for the fiscal year that starts July 1, the second rate cut in 12 months. Last February, he reduced the rate to 7.65% from 7.9% for the current fiscal year.
The lower rate means cash-strapped municipalities and the state must raise more money to feed the severely underfunded New Jersey Pension Fund. Mr. Murphy will be hard-pressed to find politically palatable and sufficient additional revenue sources, even from a Democratic Party-controlled state Senate and Assembly.
As of July 1, the funding ratio was 59.3%, according to the state Treasury Department. This statutory funding status includes the estimated present value of the state lottery. Last year, Gov. Chris Christie signed a law making the lottery an asset of the pension fund, using the proceeds to cover part of the state's pension contribution.
Pension experts say the 7% assumed return figure represents a more realistic rate given forecasts for lower stock market gains and modest interest rate increases. They also said the size of the cuts within the time frame is unusual.
"It's pretty dramatic," said Richard Keevey, a lecturer at the Woodrow Wilson School, Princeton University, and a senior policy fellow at the Bloustein School of Public Planning and Policy at Rutgers University. "I would have been inclined to reduce it over time." Mr. Keevey is a former New Jersey state budget director and comptroller.
"It is significant, but we are getting realistic," said Thomas Brendan Byrne Jr., chairman of the State Investment Council, which develops policies for the Treasury Department's division of investment to manage the pension fund's investments. The Trenton-based fund has $76.6 billion in assets.
"Timing aside, the direction is clear," Mr. Byrne said. "Experts say stocks will return to single-digit gains and long-term interest rates will stay low. We can't bet the ranch on stocks."
The New Jersey Pension Fund produced a 13.07% return for the fiscal year ended June 30. The annualized return for the past three fiscal years was 5.25%; for five years, 8.75%; and for 10 years, 5.55%.
Some observers of New Jersey government said the rate reduction appears to have had some political overtones.
Marc Pfeiffer, assistant director, Bloustein Local Government Research Centers, Bloustein School of Planning and Public Policy, Rutgers University, New Brunswick, N.J., said the rate reduction can be seen "as a parting shot" by Mr. Christie toward his successor.
"Murphy has some very challenging decisions ahead in regard to pension funding," Mr. Pfeiffer said.
The governor-elect last month, through a spokesman, attacked the decision to lower the assumed rate of return. The spokesman, Dan Bryan, described the move as "playing politics" by "rushing this decision at the 11th hour."
In a prepared statement, Mr. Bryan said such a "significant change" should be phased in. "At a time when our taxpayers are already taking a hit, our focus should be on lessening the burden of property taxes, not increasing it," he said.
Mr. Bryan was referring to the impact on municipalities which, according to actuarial reports and the treasurer's office, must come up with an extra $422.5 million in pension fund contributions for the 2019 fiscal year under the 7% rate. By law, they must contribute 100% of their actuarially required contribution, and they don't have many choices for raising revenue.
"The change in the assumed rate of return has made budgeting more difficult at the state and local levels," said Lisa Washburn, a Summit, N.J.-based managing director for Municipal Market Analytics, a research firm.
In New Jersey, "the No. 1 anger point is local real estate taxes," said Thomas J. Healey, chairman of the New Jersey Pension and Health Benefit Study Commission, noting local governments have few revenue-raising choices. "There's not a lot of room or flexibility in the (state) budget."
The goal of the commission, created in 2014, was to make multiple changes in the management of state benefits including reducing health-care expenditures and making revisions to the pension system.
Major pension recommendations from the commission included freezing the New Jersey Pension Fund and creating a cash balance plan for current and future participants. The Legislature didn't act on these suggestions.
Of the seven systems in the New Jersey Pension Fund, two rely on contributions from the state and municipalities — the Public Employees' Retirement System and the Police and Fire Retirement System. These systems plus the Teachers' Pension and Annuity Fund, which relies solely on state contributions, account for about 97.5% of the New Jersey Pension Fund assets.
"After much analysis, the treasurer concluded that the assumed rate of return of 7.65% warranted further reduction," Will Rijksen, a spokesman for Mr. Scudder, wrote in an email on Jan. 2.
Mr. Scudder's decision was based on "Division of Investment internal return assumptions, feedback from the actuaries of the respective retirement systems (and) market return assumptions from external consultants," Mr. Rijksen wrote. The treasurer's analysis also included a "general understanding of market return expectations of external financial professionals and (discussions with) members of the state investment council."
Reducing the return assumption also means the state must contribute more for the next fiscal year. If it were contributing its full actuarially required amount, the extra cost would be $390 million. Because the state is scheduled to pay 60% of the required amount the next fiscal year, it will contribute an extra $234 million under the lower return assumption, Mr. Rijksen wrote.
The state legally doesn't have to make full payments each year — and it doesn't. Over the years, governors have ignored payments, made fractional contributions or cited fiscal crises for last-minute cuts in the state's annual contribution. For the current fiscal year, for example, the $2.5 billion state contribution represents 50% of the actuarially required contribution.
Securing more money to expand the state's contribution will prove tough for Mr. Murphy, who, during his gubernatorial campaign, advocated a tax on the state's wealthiest residents to help pay for improved pension system funding.
However, some legislators have cooled on this idea following the passage of federal tax reform. The federal law affects high-tax states, including New Jersey, because it limits the deduction from federal taxable income of state and local property taxes and sales and state income taxes to $10,000.
Seeking a new tax on wealthy residents losing many federal deductions of state and local taxes will be a tough sell for Mr. Murphy.
"This puts a lot of pressure on the 'millionaires' tax,'" said Mr. Healey.
A 'challenging' increase
The pressure on the state's finances was outlined recently in a report by Moody's Investors Service. If the state sticks to its schedule of raising its annual pension contribution 10 percentage points at a time, "the largest year-over-year increase will be in fiscal 2019 when the combined contribution from the state lottery and the general fund will increase to $3.4 billion," based on the 7% return assumption vs. $2.5 billion for the current fiscal year based on the 7.65% return assumption. The lottery is good for about $1 billion annually of the state's contribution.
"The state's ability to increase its pension contributions on schedule will be critical to reversing its pension cash flow deficit and maintaining a stable credit profile," the Moody's report said.
S&P Global Ratings has a glum view of New Jersey's prospects. "Putting off paying the 100% is putting themselves in a hole for future years," said David Hitchcock, senior director in the U.S. public finance-states group at S&P Global, referring to state payments below the actuarially determined contributions.
Although S&P rates New Jersey's general obligation bonds A minus with a stable outlook, a December report said the state's pension system "remains among the worst funded in the nation and a primary reason why our GO (general obligation) rating on New Jersey is the second lowest of all the states." S&P's analysis doubted the state could raise it contributions to reach full annual pension contributions within five fiscal years.
The size and speed of the New Jersey rate reduction was "unusual, but it's a move in the right direction," said Alicia Munnell, director of the Center for Retirement Research at Boston College, describing as "untenable" the state's pension predicament.
"The problem won't be solved by reducing the assumed rate of return," she added. "New Jersey needs to get everyone to the table, divvy up the pain and reach a solution."