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The Dangerous Posturing of New York's Fossil Fuel Pension Divestment

The real measure of future taxation is the projected level of government spending. That simple truth makes filling the funding gaps of public employee pension funds crucial for states’ and municipalities fiscal health—as well as for the well-being of taxpayers who rely on the public services their taxes are supposed to pay for. Every tax dollar diverted to cover a pension shortfall is a dollar diverted away from road maintenance or school construction.

Unfortunately, some state and local officials are pursuing policies that expose taxpayers’ exposure to the liability of pension shortfalls—while putting public employees’ retirement security at risk—to push some social or political agenda. Now the political leadership of the nation’s largest city is engaging in such reckless political posturing.

On January 10th, New York Mayor Bill de Blasio and Comptroller Scott Stringer announced that the city is divesting from fossil fuel energy firms, while suing some of the nation’s largest oil companies over their alleged “contribution” to global warming. New Yorkers, who are already highly taxed, should be wary.

Many public pension funds are defined benefit plans, which pay a fixed amount to retirees. In several states, courts treat pension obligations as ironclad contracts, rather than government benefits, and thus render them essentially non-negotiable; state and local governments must pick up whatever portion of pension payouts that investment returns don’t cover.

That means that any investment returns forgone because of de Blasio’s and Stringer’s climate crusade will fall squarely on the shoulders of Empire State taxpayers. The forgone gains are bound to be large, and New York can ill afford them.

A new report by the American Council for Capital Formation (ACCF) paints a grim picture:

  • The city’s five public employee pension funds—the New York City Employees’ Retirement System, Teachers’ Retirement System, Police Pension Fund, Fire Department Pension Fund, and Board of Education Retirement System—have an average funding ration of 62 percent, well below the national average of 72 percent.
  • The city’s annual contribution to the pension funds has increased from $1.4 billion in 2002 to $9.3 billion in fiscal year 2017.
  • Pension payouts are on track to soon overtake social services as the city’s second-largest spending category, taking up 80 cents of every dollar raised by the city’s personal income tax.
  • The five pension funds have consistently underperformed the market since Stinger assumed the comptroller’s office in 2014.

For a preview of what greater environmental activism would mean for the pension funds’ overall performance, the study’s author, Tim Doyle, vice president of policy and general counsel at ACCF, looked at the 12 percent of the New York City pension funds’ assets invested in what is known as a Developed Environmental asset class. He notes:

For each of the specific New York City Pension Funds invested in this Developed Environmental Activist asset class, the return on these investments has underperformed the overall fund return over the last three calendar years full data is available. Yet despite the underperformance of this asset class compared to the funds’ overall returns, New York City Pension Funds have increased their investments in its assets since 2015 (the oldest data available).

Clearly, no single policy solution will address a funding gap this large, but a good first step is for city officials to stop narrowing the pension funds’ investment opportunities as de Blasio and Stringer now propose.

Better management and weighing of risks is also needed. “Despite evidence of poor performance,” Doyle notes, “it took until 2012 for New York City to reduce its assumed annual rate of return from 8 percent to 7 percent.” That’s a step in the right direction, but it may still be too high to accurately reflect the true funding gap. Preferable would be a risk-free rate of below 4 percent, such as that of a 10- to 20-year Treasury bond.

Another constructive reform would be to appoint actuaries and professional managers to pension fund boards. Currently, as Doyle notes, the pension boards are “comprised of elected and appointed officials and union representatives,” who are likely to face incentives to downplay the funding gap, in order to avoid alarming taxpayers over the potential tax liability or union members over the soundness of their retirement.

For more on public pension reform, see here and here.