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Why the Pension Crisis
in New Jersey
Will Not Be Fixed

Edward J. McManimon, III
By Edward J. McManimon, III
League Associate Counsel,
McManimon & Scotland, LLC
Man holding piggy bank

A changeover to 401(k) type system for public employees would certainly fix the long term problem, but it would also remove the annual “contributions” from employees as well as contributions from the state and local governments to the pension systems. This change would significantly affect the cash flow to the state from investments and highlight the significant and rising deficit from underfunding the pension system.

Government pensions are basically like social security. So long as the amount in the system from previous contributions, current contributions and investments is greater than the annual withdrawal for the retirees, then it remains solvent and is a reliable source of income for those for whom it is intended.

For years now the view has been that the state and local government pension systems are significantly underfunded and may become insolvent as soon as within the next five to 10 years. Certainly it seems to be a serious drain on the state Treasury as the state struggled to meet even a modicum of its obligations. Meanwhile the state has imposed strict payment obligations on the local governments to pay their obligations to such funds in full.

  Pension fund payments have been a drain on the treasuries of most local governments. At least on the surface, it appears that these government pension systems need a serious fix. Rhode Island recently revised its pension system by switching a portion of its obligations for current and future employees from a defined benefits pension obligation to a 401(k) system. The move dramatically reduced its actuarial obligation to the system and created a more sustainable, affordable system for the future. Rhode Island is now in the process of providing similar changes to the pension systems of its 39 municipalities.

  Such a program provides employees with a retirement plan that is similar to that of most private companies. Virtually every private company came to this conclusion and made similar changes years ago. Few private pension systems still exist. The simple reason is that they are too expensive.

  So I figured somebody in New Jersey would be seriously considering what Rhone Island is doing for a start. (Increasing employee contributions is not a real solution.) It seems like an obvious solution, considering the significant underfunding by the state and the ever increasing obligations of a defined benefits system. At least that is what I thought until I read a recent article prepared by Lou Neely, the long time Chief Financial Officer for East Brunswick Township, for the New Jersey Tax Collectors and Treasurers. The article raised the issue of whether the New Jersey public employee pension “crisis” had any chance of being resolved. What that article and a subsequent conversation with him left me asking was whether there was any incentive for the state to even consider fixing the current system.

Why is the obvious solution not even being considered? To understand it, see the chart prepared by Lou Neely on the current status of the state and local pension systems for the past seven years. As of June 30, 2011, the overall value of the assets was $74.7 billion. More recently it was down to about $67 billion. Approximately 62 percent of that value is attributable to local government employees and 38 percent to state employees. I have not verified these amounts or the percentages and they are presented for perspective only. However, they reflect a state workforce of 95,000 employees and a local government workforce of 214,000 employees.

The chart shows is that the recommended actuarial contribution over the seven year period was $24,925,600,000 while the actual contribution for both state and local systems was only $10,450,200,000. Even more obvious is that most of this shortfall is at the state level.

Neely also notes, however, that there is some good news financially for property taxpayers in that more than 29,000 state and local employees have retired in the last 22 months. These retirements have resulted in a smaller work force and lower payrolls.

What Neely’s article does not point out, but was made clear in a conversation with him, is that the current cash flow from the investment of the overall pot of money when combined with the reduction in the workforce results in the amount of funds currently available being sufficient to keep the system solvent for now with a solvent projection forward. This is in spite of the numbers and the rising and unsustainable deficit. (The current system has enjoyed recent investment returns in excess of 18 percent which is divided between the State and Local Funds.)

This income and new staffing level, of course, masks the real long term problems and allows the state to continue deferring further consideration of real solutions. Obviously, these levels of investment returns are not sustainable and could just as easily go the other way in future years. Those investing such funds with these results should be complimented, but with caution if the expectations are that it will continue indefinitely and serve as a substitute for prudent decision making. The current returns remove the pressure to actually fix the system or adopt a full or partial 401(k) system.

A changeover to 401(k) type system for all or some portion of the system (like Rhode Island’s) would certainly fix the long term problem, but it would also remove the annual “contributions” from employees as well as contributions from the state and local governments to the pension systems. Instead, those amounts would go to a separate 401(k) type trustee. This change would significantly affect the cash flow to the state from investments and highlight the significant and rising deficit from its underfunding.

So, while the system begs for a substantive change, the push for state leaders to consider it is offset by the benefit of the current cash flow. The situation has temporarily masked the long term problem. When that consideration is coupled with the obvious desire of the public employees and unions to keep the current system, it seems quite clear that no change is imminent.

 

First Published in New Jersey Municipalities, Volume 90, Number 3, March 2013

 

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