A Reasonable Proposal: Sharing More of the Cost of Public Sector Pensions with Employees

Feb 16, 2012
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The pension reform proposal that Governor Andrew Cuomo submitted with the Executive Budget, known as Tier VI,  would increase contributions from new employees to the pension funds of New York’s state and local governments, including New York City. The new basic employee contribution rate would range from 4 percent to 6 percent of wages, depending on pay level, with higher or lower percentages possible depending on the market performance of pension assets and other cost drivers. The proposal has two advantages: 1) it brings New York’s expected employee contributions more in line with national public sector norms; and 2) it distributes downside risk more fairly, shifting some of the burden from taxpayers to the employee.

Currently new members of the State Employee Retirement System (ERS) and Police and Fire Retirement System (PFRS) and Metropolitan Transportation Authority (MTA) employees in the New York City Employee Retirement System (NYCERS) contribute 3 percent of salary to their pensions for their entire length of service. For teachers in the New York State Teachers Retirement System (NYSTRS), the rate is 3.5 percent for their length of service, and for teachers in the New York City Teachers Retirement System (NYCTRS) the rate is 4.85 percent for the first 27 years and 1.85 percent thereafter. For municipal employees in the NYCERS the rate is 4.85 percent for the first ten years and 1.85 percent for the next 20 years.  New workers in the New York City Police and Fire funds have the most generous arrangement; they pay 3 percent for up to 25 years.

These contribution rates are low compared to what is required in public sector retirement systems nationally. In 2009 fully 78 percent of state and local pension plans required employee contributions greater than 3.9 percent (See Figure 1.) The Tier VI requirement would be an increase for public sector employees in New York, but the new arrangement would not be onerous by comparative standards. For example, for members of ERS with wages below $32,000 the basic contribution rate would increase from 3 to 4 percent; for employees with wages above $32,000 up to $63,000 the rate would increase to 5 percent, and for those with wages above $63,000 the rate would increase to 6 percent.[1] The average contribution under the sliding scale would place New York among plans with rates ranging from 4 to 5.9 percent. Fully 55 percent of public plans require contributions of 6 percent or greater, a fact that makes the Governor’s proposal very reasonable by comparison.

 

 

New York’s relatively low requirements for employee pension contributions are also reflected in the nationwide employer and employee contribution rates for state-run systems shown in Table 1. In 2010 total employer and employee contributions to state-run public pension funds were $97.7 billion. On average employers contributed 66 percent or two-thirds of the total, and employees 33 percent or one-third; the employer-to-employee ratio is 2:1. In contrast, New York State and its local government entities that participate in New York’s state-run systems (ERS, PFRS and NYSTRS) made 89 percent of total contributions and employees just 11 percent, a ratio of approximately 8:1. This is not only higher than the nationwide average, but also gives New York State the second highest contribution ratio among the ten largest state-run pension systems, and the sixth highest contribution ratio among all states.[2] Aside from Florida, where the state is responsible for almost all pension contributions, the next highest ranked large pension plan is Michigan, with an employer to employee contribution ratio of 4:1.  Most of the largest state pension systems have a ratio of 2:1 or less.

 

Table 1: Ratio of Employer to Employee Contributions, Ten Largest State-Run Pension Systems, Fiscal Year 2010

 

Among pension plans run solely by local governments New York’s are unusual in scale because of New York City’s five plans. In 2009, the most recent year for which there is comparative data, employer and employee contributions to local public pension funds in the U.S. totaled $27.6 billion. (See Table 2.) The amount contributed to New York’s local pension plans – almost all of it to New York City’s plans - was $8.3 billion, nearly one-third of the national total.[3] Of that total fully $7.2 billion, or 87 percent, came from local taxpayers and just over $1 billion, or 13 percent, came from employee contributions. Among the 41 states that have separate local systems New York ranks sixth for its share of the total contributions paid by employers.[4] Among the 10 largest local systems New York ranks second; only the 89 percent of total contributions collected from Colorado employers is higher. New York’s ratio of employer to employee contributions is 7:1, compared to a national average for local systems of 4:1.

 

Table 2: Ratio of Employer to Employee Contributions, Ten Largest Local Pension Systems by State, Fiscal Year 2009

 

In addition to raising the employee contribution rate, the Governor’s Tier VI proposal includes an unusual feature that would “share-out” the downside risk and the upside potential of the market performance of pension assets and other cost drivers.[5] If the employer contribution rate as a share of payroll rises above 7 percent, then half of the added amount would be contributed by employees. On the other hand, if employer contributions fall below 4 percent of payroll, then half of the saved amount would be used to lower employee contributions.[6]

One of the significant disadvantages of the relatively low employee contribution rates in New York State is that almost all of the downside risk from market downturns and the Legislature’s tendency to “sweeten” pension benefits is borne by employers and ultimately taxpayers. New York State pension funds currently assume a 7.5 percent annual rate of return, and New York City systems assume 8 percent (although it soon is likely to be revised downward to 7 percent). To the extent that the market underperforms these assumptions or the Legislature increases the cost of the benefit plans, the required employer funding amounts will increase. The innovative “risk-reward” approach contained in the Governor’s proposal should be considered because it shares this risk with employees.

Increasing the employee contribution rate for public pensions in New York State is not unreasonable. Comparisons with nationwide norms for employee contributions show the basic proposal to increase employee contribution rates to a range of 4 to 6 percent would move New York toward the middle of the pack among states while providing much-needed relief to local government leaders and taxpayers.

 

 

By Elizabeth Lynam and Melinda White


[1] Members of other pension plans have different thresholds for the contribution increase that are tailored to the typical salary scales of titles covered by the plan. For members of PFRS, for example, the thresholds are up to $63,000 for the increase to 4 percent, $63,001 to $126,000 for the increase to 5 percent, and $126,001  and over for the increase to 6 percent.

[2] The states that collected less than New York from employees in 2010 are Florida (shown in the table), Virginia, Oregon, Utah, and Nevada, in ranked order from 1 to 5.

[3] Almost the entire $8.3 total is for New York City’s plans.  All of New York’s other local governments participate in the major state-run plans, ERS, PFRS, and NYSTRS. However, some localities continue to maintain small legacy systems for a few dozen aging retirees who became eligible for benefits prior to the centralization of the pension systems in the Office of the State Comptroller.

[4] Local systems in states ranked above New York are in Oregon, Utah, Indiana, Kentucky, South Carolina, Arkansas, and Colorado (shown in the Table 2.).

[5] Few public sector pension plans have fluctuating cost sharing arrangements; one is the plan adopted in Utah in 2011. For new civilian employees, the employer contribution to the defined benefit component of the plan is 10 percent of wages; the employee is responsible for 100 percent of any actuarially required contributions above that. For uniformed employees the threshold is 12 percent. (The plan also contains a defined contribution component; plans that combine defined contribution and defined benefit aspects are generally referred to as hybrid plans).

[6] For New York City plans the threshold rates would be set by the New York City Budget Director with the approval of the New York State Budget Director.

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