Dropout Nation

Last year, Dropout Nation detailed how New York City Mayor Michael Bloomberg’ penchant for using money to buy teachers’ unions acquiescence to his reforms left the Big Apple’s two defined-benefit pensions for teachers and other employees virtually insolvent to the tune of $31 billion — or $6 billion more than officially reported. Back then, your editor noted that whoever succeeded Bloomberg would have a pension crisis on their hands that would complicate their other goals.

This time around, DN got its hands on the latest comprehensive annual financial reports for both the Teachers Retirement System and the Board of Education Retirement System. The news for Bloomberg’s successor, Bill de Blasio, isn’t good at all. And given the lavish contract he has already given out to the American Federation of Teachers’ affiliate, the mayor has followed Bloomberg’s bad example.

Let’s start with TRS. It officially reports a pension shortfall of $25 billion (as of 2012, the latest year available). That is $800 million more than the pension officially reported in 2010. But as you already know, the official numbers don’t show the true extent of TRS’ insolvency. For one, it doesn’t include $3 billion in unrealized gains that have been left out as part of “smoothing” efforts by the city to avoid dealing with the shocks that come with financial market gains and losses. If accounted in the numbers as they should be on a market value basis, TRS’ virtual insolvency would stand at $22 billion, or $3 billion less than officially reported.

While states and districts defend smoothing as a way to keep their budgets from being racked, the problem with that actuarial trick is that it leads to inaccurate accounting of insolvencies. When pension investments are doing poorly, it leads districts and states to underfund pensions, while if the investments are doing well, then it paints the solvency of the pension in a poor light. This was made clear by New York State’s own smoothing out of actuarial gains, which makes its pension look less solvent than it really is.

Then there’s the fact that TRS assumes an investment rate of return of seven percent, which is far above the 5.2 percent five-year return rate experienced in the market, according to Wilshire Associates, and the pension’s own five-year return rate of 5.65 percent. As a result of this inflated rate of return, TRS (and ultimately, the Big Apple) understates what is likely the true level of insolvency that taxpayers will ultimately have to bear.

To figure out TRS’ true insolvency, Dropout Nation uses a version of a technique developed by Moody’s Investors Service, which assumes a more-realistic 5.5 percent rate of a return on investments. [Moody’s bases its rate of return on the performance of a bond index, which can range between four and six percent.] Based on the formula, using just TRS’ officially-reported number, Dropout Nation concludes that the pension is underfunded to the tune of $30 billion, or 20 percent more than it officially reports. Based on a 17-year amortization rate, taxpayers and teachers would have to contribute an additional $1.8 billion a year to whittle down the shortfall; that’s 57 percent more than the $3.1 billion contributed to the pension in 2013.

That number, of course, doesn’t include the unrealized gains. If you account for those gains, Dropout Nation concludes that TRS is underfunded to the tune of $26 billion, 20 percent more than the $22 billion insolvency level including unrealized gains. Based on a 17-year amortization, Big Apple taxpayers and teachers would have to contribute an additional $1.5 billion a year, or 51 percent more than the $3.1 billion put into the pension in 2013.

But let’s remember that TRS overstates the value of its assets. In fact, the actual market value of TRS’ assets are $1.1 billion lower than the $33 billion actuarial value. If you take away that number from the $59 billion in annuity payments owed to Big Apple teachers, TRS’ insolvency would stand at $26 billion. Based on a 17-year amortization rate, taxpayers and teachers would have to contribute an additional $1.5 billion a year, also 51 percent more than paid into the pension in 2013.

No matter how you look at it, de Blasio faces a real problem with addressing TRS’ woes.

de Blasio’s predecessor, Michael Bloomberg, left behind a mess, his successor will have to eventually address if he is to be successful.

Meanwhile there is still the Board of Education pension, which officially reports an underfunding of $1.4 billion as of 2011 (the latest year available). The good news is that this is $200 million less than the $1.6 billion underfunding reported for 2010. But just because it appears better doesn’t mean it is truly so. As with TRS, Board of Education assumes a seven percent rate of return on investments that is higher than what is possible to realize on the market. As a result, it is understating its level of insolvency.

Using the Moody’s formula — and assuming a more-realistic 5.5 percent rate of return — Dropout Nation concludes that Board of Education faces a virtual insolvency of $1.6 billion, or 20 percent more than Board of Education officially reports. Based on a 17-year amortization rate, taxpayers and employees will have to contribute an additional $96 million a year to shore up the pension; that is 40 percent more than the $235 million paid into the pension in 2013.

Altogether, the Big Apple must address $31.6 billion (rounded up to $32 billion) in virtual insolvencies for its two pensions for teachers and other school employees. And the insolvencies are increasing just as de Blasio has gone on an unnecessary spending spree to appease the AFT affiliate, the United Federation of Teachers, as well as to fulfill his promise to expand the city’s early childhood education programs.

Let’s be clear about this: de Blasio is inheriting a problem that Bloomberg, the AFT, and former city comptrollers Bill Thompson and John Liu (both of whom ran unsuccessfully against de Blasio to become mayor) left him. In the case of TRS, Bloomberg appointed three seats on its board as the AFT still does, while Thompson and Liu held the seventh seat and served as guardians of the pension’s investments during their respective tenures. For Board of Education, Bloomberg must assume far greater responsibility for its insolvency, since he appointed nine of the pension’s 16 board members (including the chancellor and eight members of the city’s Panel for Educational Policy), while the AFT affiliate and other unions hold only two seats (and indirectly — and tenuously — control another five through their influence over the Big Apple’s five borough presidents they help elect, whose PEP board members also serve on the pension).

The city failed to increase contributions at a fast enough clip for both pensions even as it became clear that pension assets would not grow at nearly the rate expected. Even amid the financial boom of the last decade, pensions asset didn’t grow much as fast as annuity benefits owed. On an actuarial basis, between 2003 and 2012, TRS’ investments grew by just two percent, while liabilities increased by 70 percent in that same period. The actuarial value of Board of Education’s investments did grow by a far-better 26 percent clip between 2003 and 2012; but liabilities doubled (from $1.8 billion to $3.8 billion) in that same period.

Meanwhile Bloomberg gave away the store to the AFT and other unions in order to buy support for his reform efforts. This was especially expensive because neither teachers nor other school workers contribute much to their own retirements. New York City teachers contributed just five cents of every dollar put into TRS in 2013, while other school employees put in 17 cents out of every dollar of TRS contributions. Such low levels of employee contributions are no longer sustainable.

Yet de Blasio declined to bring up increasing teacher contributions in his contract negotiations with the AFT. Instead, he gave the union and its rank-and-file even more lavish payouts. This includes an eight percent salary increase to those teachers who retired from the city’s employ by the end of last month (which led to 777 more teachers retiring at the end of June than in the previous period last year). Given that annuity payouts are based on an average of final year’s salary, the salary increase for the retiring teachers is essentially a form of the pension spiking that California has tried to cracked down on, and thus, will increase the level of TRS’ insolvency.

Now, more than ever, New York City needs a mayor who will exercise fiscal discipline, bring the city’s two pensions into solvency, and ultimately, overhaul retirement compensation so that it works better for younger teachers who are unlikely to reap the benefits of their work. Unfortunately for the Big Apple, de Blasio will likely be as bad as Bloomberg on pensions, while departing from the former mayor’s otherwise-stellar record on systemic reform.