No ITHP for Tier 3 and So What!

The ITHP

The ITHP has a strong fan base throughout the FDNY and with good reason. Over time participants have invested their capital and earned a strong rate of return with zero volatility. Zero volatility is the key attraction especially for risk-averse investors. Zero volatility cannot exist in publicly traded securities that price throughout the day, but it does exist for ITHP investors. It is difficult to gauge risk on investments that are not subject to mark-to-market pricing, but do note that the investment is not riskless. The rate of return on the ITHP has changed over time. For simplicity, this article assumes it is 8.25%.

No ITHP For Tier 3

The ITHP is not available for Tier 3 members. Many Tier 2 and Tier 3 members feel that the newer Tier 3 members have been deprived of a strong wealth building option that was previously available to members in Tier 2. This article will attempt to reconcile this story with the numbers and will have some interesting takeaways for Tier 3 members.

Comparing the ITHP to Stocks

Tier 3 members earn full benefits after twenty-five years of service. Consistent with this time period we will present investment performance periods of twenty-five years, on a rolling basis, comparing the compounded return (CAGR) earned in the ITHP Vs. the CAGR earned investing in the S&P 500 index (a proxy for US stocks) with dividends reinvested (SPXT Index). Here is how it works. At end of each year we will consider that a firefighter finishing twenty-five years retires. For the year ended 2022, we assume a firefighter was hired at the end of 1997 and retired at the end of 2022. This method allows us to compare stock market returns Vs. ITHP returns. For simplicity in comparing the investments, we assume $100,000 was invested on the hire date and no further investments were made. The playing field is equal.

The Historical Returns

The first row on the following chart illustrates that a firefighter hired at the end of 1997 and retired at the end of 2022 would have earned 7.64% in stocks and 8.25% in the ITHP with a difference of 0.6% in favor of the ITHP. Note that this was the only period of the sixteen total periods that the ITHP had a superior return. Stocks dominated the remainder of the twenty-five year periods:

(Source: Brave Eagle estimates)

The stock market investor earned higher returns in fifteen of the 16 periods. There are summary statistics at the bottom of the table that offer some important information. The median and average stock market returns are in the high 9's, 9.7-9.8%. The minimum twenty-five year return in stocks happened from 1997 through 2022 and was 7.64%. This is low considering that there wasn't even one other period with a 7% or 8% return handle, all were above 9%, The maximum stock market return was 12.73% from 1982-2007 and resulted in massively higher returns of 4.5% per-year against the ITHP. Note that in no other periods was the difference as high as 3 or 4%.

The following chart illustrates the above data. The years on the X-axis are retirement years after 25-year periods. The returns are on the Y axis. The blue line is the S&P 500 Index with dividends reinvested and the orange line is the ITHP. The grey line at the bottom simply highlights the difference between the two other lines (stocks - ITHP):

(Source: Brave Eagle estimates)

The Difference in $

In most of the time periods stocks earned around 1-2% higher than the ITHP. However, over long periods what seems like small differences in compound rates of return can result in enormous differences in actual money. The following data table translates percentages into dollars to illustrate the ending money balance at retirement for the two investment options, and the difference in dollars on the original $100,000 investment:

The first-row highlights that the slight under performance of stocks vs the ITHP in that one twenty-five year period resulted in 96k less money, i.e., 629k for the SPXT investor Vs. 725k for the ITHP investor. At the other end of the return spectrum, we see that for the period ending in 2007 (1982-2007) the stock market investor ended with almost $1.3M more. This is astonishing, and highlights just how large the difference is between 12.73% and 8.25%. This investor would have finished with $2M from an initial $100,000 investment. This one result also appears to be an outlier and we find the summary statistics to be more useful. The median and average suggest the stock market investor usually ended up with about $1M, with a minimum of 629k and a maximum of $2M. The ITHP investor always ended with 726K. The median and average also suggest that most times the stock investor was about 300k better off than the ITHP investor, although it ranged from -$96K worse off all the way to $1.3M better off.

The Difference in Risk

Stocks appear to earn higher returns the vast majority of the time, but how do we account for risk? There really isn't a good way to do it. On the one hand we have publicly traded stocks, that are incredibly volatile in any give year, but seem to earn strong returns over time. This is not surprising since stocks should be priced to have positive expected returns, and we can see that during our time period sample this did play out with no negative return periods. On the other hand, we have an investment that doesn't trade publicly, and doesn't get marked-to-market. It just goes up with no volatility. In our opinion the risk to the ITHP investment is more fixed income like than equity like, and on a look-through basis is a NYC credit risk. To say the ITHP  investment is guaranteed, or riskless, is wrong.

Nevertheless, if you view risk as volatility than the ITHP is clearly superior in terms of riskiness. However, if your view of risk is more nuanced, and you incorporate the risk of ending with less money (less real wealth), you might have a different opinion.

There isn't really a good way to compare, or scale, these two different investments in terms of risk.

What is the Point

There is no ITHP for Tier 3 and so what. We do not think that should hold Tier 3 members back from saving/investing. The overwhelming majority of the recent time periods that we analyzed stocks have outperformed the return that was available on the ITHP, and it is not even close. Of course, stock investors had to deal with volatility that the ITHP investor did not. Nevertheless, Tier 3 members should consider taking advantage of the resources that are available to them through the job. e.g., the NYC Deferred Compensation Plan and the Union Annuity Plans, to educate themselves on basic investing, or go further and hire a qualified professional to help them build a retirement plan. The data we presented here are historical artifacts and the results are not guaranteed to repeat themselves. Investors should be concerned with forward-looking expected returns rather than historical artifacts. Tier 3 members that do a good job saving and building portfolios with high expected returns may just do better than their Tier 2 counterparts that had the ITHP as an option.