Change in Assumption Rate Will Increase Pension Contributions
Just when it appeared that the funding picture of the state retirement systems was brightening, a move by the outgoing administration of Governor Chris Christie to reduce the assumed rate of return for pension asset growth (7.65% to 7%) has cast a gloom over the pension landscape and will result in higher than anticipated annual employer contributions to the systems in 2018 and future years. The move by the governor, who left office on January 16, will impact on the first budget of the new governor, Phil Murphy.
Assumed rate of return in defined benefit retirement plans is one of the key factors used by the actuaries of plans in determining the annual size of the contributions that must be made by the employer each year to keep the plan solvent. Reducing the assumed rate of return increases the size of the employer contribution that must be made to reach the actual dollar amount required to meet obligations. As an example, if the funding requirement for a plan in 2018 is $1 million, a decrease in the assumed rate of growth from 7.65% to 7%, means the employer must increase the pension contribution by .65% to have the same $1 million at the end of the year. On the other hand, if the employer does not increase the contribution by the .65% reduction, the plan will have a smaller asset base at the end of the year and a smaller asset base means potential trouble.
To avoid this problem, employers make regular contributions to the plans each year. Some years the contribution is smaller than the previous year because the asset base has grown faster and larger than anticipated. Some years the contribution is larger because the asset base has grown slower. However, for long-range assumptions, the actuaries choose a number that is based upon past and current interest factors and appears to be reachable, and that becomes the assumed rate of growth. If their projections prove incorrect for a period of time, they make an adjustment and change the assumption rate. This change causes larger or smaller contributions by the employer.
The action just taken by the Christie administration follows this course of action. As retirement systems that provide pensions to thousands of public employees, the Teachers’ Pension and Annuity system, the Public Employees’ Retirement System and the myriad of smaller systems receive their contributions from both the State of New Jersey and hundreds of local employers. They will have to increase their annual contributions because the asset base has not grown or is not expected to grow at the rate that had been predicted by the plan’s actuaries. That increase will be felt by all employers and will have a negative impact on the budget of the new governor.