New Jersey is not able to pay enough into its state pension plans to pay public workers what they were promised when they signed on the bottom line. New Jersey workers currently receive a defined benefits plan, which Governor Christie would like to convert into a defined contribution one instead. A New York Times Dealbook column describes the situation.
Gov. Chris Christie of New Jersey delivered the latest blow on Tuesday, when he proposed to freeze that state’s public pension plans and move workers into new ones intended not to overwhelm future budgets or impose open-ended demands on taxpayers.
Govorner Christie is endeavoring to make this switch in order to manage risk going forward in New Jersey’s state budgets. He ran on a platform of keeping New Jersey from going broke and unlike many who practice the dark arts of politics, Gov. Christie is attempting to honor his campaign promises in the face of unpleasant reality. This is unpleasant reality that will cause people to get hurt, Governor Christie’s popularity to go down and the State of New Jersey to wind up in front of a judge somewhere.
You see, a defined benefit pension promises to pay workers $X per period of time regardless of what happens in the outside world*. The state hires investment professionals who figure out what yield they are required to achieve year over year to get the amount of money needed to pay as promised. As available yields get lower, the state has to take greater financial risk in order to get the required funds. The Federal Reserve has followed what is colloquially been referred to as a “ZIRP” policy. This causes bonds to underperform so that states with defined contribution pension plans are forced to invest in riskier propositions to get their pensions funded.
What Christie needs New Jersey to switch to is a defined contribution plan. This involves the state and the employee putting aside a given amount of money each month to go into something similar to the standard 401K. An investment manager then offers several plans that correspond to different levels of risk that vary directly with potential return on investment. The state is obligated to match a certain percentage of employee contributions, but isn’t on the hook for what happens to the pension on the investment market.
While Christie still remains tied to defined benefit plans, he attempts to freeze the levels of contribution into an already underfunded system. Here is the problem Governor Christie now faces.
New Jersey underfunded its public pension system more than any other U.S. state for more than a decade, according to a study to be released later on Wednesday. From fiscal year 2001 through 2013, the Garden State paid on average just 38 percent of what it was supposed to have contributed annually into its system, according to the report by the National Association of State Retirement Administrators.
To generate the pension that New Jersey State Employees were promised, the funds invested from 2001 to 2013 now have to get 2.63 the rate of return on investment that they would have had to have achieved had New Jersey funded it to the hilt. The only way to ramp this return up to Warp Six, Mr. Zulu, is to take a much greater investment risk with people’s retirement money than most investment professionals would recommend.
As New Jersey sold a lot of bonds in 1997 to finance the shortfalls in their state pension system, their debt service fee grows higher. As Louie The Loan Shark would tell ya’, “you gotta’ pay the juice!” The New Jersey State Vig is slated to get worse until at least 2020. While this particular nasty twist isn’t Gov. Christie’s fault, it is Governor Christie’s problem.
So Governor Christie’s challenge is to change how people view their relationship with government. The State of New Jersey, like 49 states I could name, is in no financial position to be guaranteeing anyone’s retirement checks. It can afford to manage the risk of contributing money to these retirements that can then be invested at individual risk in the market. This would mean redefining the role of government from guarantor to assistant. It’s tough when necessity dictates that you break somebody else’s unrealistic promises.
*-An employment lawyer well versed in The ERISA statutes would argue that there are exceptions to this statement. See my earlier prediction that Gov. Christie and New Jersey would wind up in court.