Tuesday, April 15, 2014

PSPRS Members: What is the Windfall Elimination Provision (WEP) and how will it affect your Social Security benefits?

This post is not specifically about PSPRS, but it may be relevant to many of you.  (It is also April 15th so a tax-related topic is probably a fitting topic for today.)  If you worked for a while in other jobs prior to entering public safety or currently work a side or post-retirement job into which you pay into Social Security, there are two Social Security policies you should be familiar with: the Windfall Elimination Provision and the Government Pension Offset.  These can both affect your retirement income after you become eligible to draw Social Security, but in this post we will focus on the Windfall Elimination Provision.

You become eligible for Social Security when you have worked 40 quarters.  It is called a quarter because you can only earn a maximum of four quarters in a year.  However, it only takes $1,200 to earn one Social Security quarter in 2014, so you only need to earn $4,800 in Social Security-taxable earnings in 2014 to earn the maximum four quarters.  Any amount over this will not earn anymore quarters nor carry over into future years.  The amount necessary to earn a quarter was set at $250 in 1978 and has grown with wage inflation to its current  amount.  What it comes down to is that if you have worked for at least 10 years in jobs where you paid into Social Security, you have probably earned enough quarters to draw some amount of Social Security.

The age when you can start drawing your full Social Security benefit is determined by your date of birth.  If you were born in 1960 or later, you can start drawing your full benefit at age 67.  If you were born between 1943 and 1959, you can start drawing your full benefit sometime after your 66th birthday; anyone born prior to 1943 could have started sometime after their 65th birthday.  Social Security allows you take a reduced benefit if you start drawing benefits before full retirement age, and an increased benefit if you delay drawing benefits after full retirement age.  Both reductions and increases are done on a sliding scale.  For someone born in 1960 or later, starting to draw at 62 will reduce your benefit by 30%; waiting until 70 will increase your benefit by 24%.  Your Social Security Administration (SSA) statement will give you an estimated monthly retirement benefit at 62, full retirement age, and 70.  These statements used to be mailed to everyone around their birthday. Now a single statement is a mailed at age 25 with annual mailed statements not resuming until a person turns 60.

The Windfall Elimination Provision (WEP) will affect almost all PSPRS members who are eligible to draw Social Security.  The name is a bit misleading (and a little insulting) when one considers how modest the benefits are, but a little background is necessary.   Social Security benefits are not calculated like a PSPRS retirement, which uses a straight percentage formula to determine your monthly retirement check.  The SSA uses a special formula based on your average monthly earnings (indexed to wage inflation) over 35 years to determine your monthly benefit.  For someone reaching full retirement age in 2014 the monthly benefit equals 90% of the first $816 of average monthly earnings plus 32% of the next $4,101 plus 15% of any amount over that.  For someone whose average monthly earnings were $3,000, the monthly benefit would be $1,786, while someone whose average monthly earnings were $8,886 would get a monthly benefit of $2,642, which is the maximum monthly Social Security benefit for 2014.  For a more complete explanation of the WEP, including certain exceptions, see this SSA document.

The SSA's formula produces only an $856 monthly gain for someone who averaged $106,632 or more per year versus someone who averaged $36,000 per year.  The obvious goal of this progressive formula is to replace a higher percentage of the pre-retirement earnings of the lower-earning worker.  This is where the "windfall" aspect comes into play for those like PSPRS members who participate in a government pensions and do not contribute to Social Security.  The WEP changes the progressive formula used by the SSA in only one way--instead of using 90% of the first $816, it uses only 40% of the first $816.  The other two calculations remain the same, but this change can still reduce someone's  Social Security benefit by up to $408 every month.  This is done because the SSA uses the average indexed monthly earnings (AIME) for the highest 35 years.  If a PSPRS member joined an Arizona public safety department after working 10, 15, or even 20 years in another job where he paid into Social Security, the next 25, 20, or 15 years he worked as a PSPRS member could show zero or very low income earned during his time working in public safety.  These zero or low income years would figure into his AIME, and since the SSA does not distinguish between someone who contributed to Social Security as a full-time worker for only a short time and someone who had low earnings for the entire 35 years, the PSPRS member will have his Social Security benefits calculated as if he were a low earner.  This was not the intent of the progressive formula.

If we take a hypothetical PSPRS member who earned $300,000 over 15 years in jobs where he paid Social Security tax then worked another 20 years in public safety, his career earnings over the 40 years of work would appear in the SSA's system as $300,000.  While he actually earned an average of $20,000 during his first 15 years of work plus his much-higher public safety salary over the next 20 years, the SSA would record his annual earnings as only $8,571 over the high 35 years.  At this $8,571 annual earnings, his AIME would appear to be only $714, even though his true AIME is much higher.  The intent of Social Security is to replace a higher proportion of lower earnings and taper off as a worker's earnings increase.  Since the situation with our hypothetical PSPRS member incorrectly makes him appear to have low career earnings when he actually earned much more, the WEP is necessary to bring fairness back to the calculations.

Many public sector employees and their unions are up in arms about the WEP, thinking it is an unfair reduction of an already small Social Security benefit.  It is true that public employees will often have a small Social Security benefit, and the WEP appears to disproportionately hit the small benefit payments hard.  However, this fails to take into account the aforementioned methodology and purpose of Social Security.  It also looks at the wrong dollar figure.  While it is easy for these public employees to focus on the amount they feel they are being unfairly denied, it is more appropriate for them to consider the amount they are getting.  By comparing their final Social Security benefit to what they paid in taxes in their lifetime, I think that most would probably find that their benefit is fair.

For PSPRS members interested in getting an estimate of their Social Security benefit, you will need a copy of your Social Security statement.  If you do not have a paper copy, you can obtain one online from the SSA here.  With that statement you can use the WEP calculator to see how much your Social Security benefit will be reduced by the WEP.

Tuesday, March 4, 2014

Why PSPRS is underfunded and Warren Buffet is rich

They do not call Warren Buffett "The Oracle of Omaha" for nothing.  In 1975 Mr. Buffett sent the letter posted below to Katharine Graham, the CEO and Chairman of the Washington Post.
While most of the letter details his ideas on how to invest the Post's pension assets, it is in the first five pages (which I highly recommend) of the letter where Mr. Buffett makes his most important points.  The most amazing thing about the nearly 40-year-old letter is how prescient it was, anticipating many of the problems we have today with defined benefit pensions.  I especially appreciate the straightforward and understandable manner in which Mr. Buffett writes to Ms. Graham, herself a legendary businesswoman.  Too often we trust supposed experts, whether politicians, union representatives, or investment professionals, who can not clearly explain what they do to those of us they are supposed to serve.  Here you have an obvious expert in finance, actuarial science, and human nature with a 50+ year track record of success giving clear, common sense advice to an accomplished CEO, and he does it without even a hint of condescension.
Among the important points made by Mr. Buffett are the lack of understanding of actuarial science by otherwise knowledgeable business people, the permanence of pension benefits, and the fallibility of actuaries' assumptions.  Mr. Buffett's oracular genius can be summed up in one passage:
There is probably more managerial ignorance on pension costs than any other cost item of remotely similar magnitude.  And, as will become so expensively clear to citizens in future decades, there has been even greater electorate ignorance of governmental pension costs.  Actuarial thinking is simply not intuitive to most minds.  The lexicon is arcane, the numbers seem unreal, and making promises never quite triggers the visceral response evoked by writing a check.
Remember this was written in 1975!

However the most crucial point made by Mr. Buffett is that a pension "promise" is nothing more than a cost that needs to be accountable, calculable, and payable.  If it can not be accounted for, calculated, or paid, you should be very careful when committing yourself to it.  Mr. Buffett contrasts a pension which promises to pay $500 per month for life versus one that promises to pay 1,000 hamburgers a month for life, assuming a present hamburger price of $0.50.  Mr. Buffett calculates the actuarial value of the $500/month annuity at $65,000, but writes:
You won't find an insurance company willing to take the 1,000-hamburgers-a-month obligation for $65,000 - or even $130,000.  While hamburgers equate to $0.50 now, the promise to pay hamburgers in the future does not equate to the promise to pay fifty-cent pieces in the future.
Donald Rumsfeld would probably call the future price of a hamburger a known unknown.  These known unknowns need to be controlled for to the greatest extent possible, and unknown unknowns, say a new disease that wipes out the world's beef supply, need to be eliminated completely.

This does not mean, of course, that politicians and others with a financial stake in a pension would not blithely guarantee a pension paid in future hamburgers.  After all, future costs are an abstraction, and there will always be tax revenue coming in to pay any "unexpected costs."  This is how we end up with things like immutable COLA formulas, the DROP, and unlimited pension spiking.  If these drain PSPRS, those who made the promises can honestly claim ignorance since they probably never carefully quantified in dollars the promises they made.

And I am sure they never read Warren Buffett's letter.  In case you were wondering, at the time Jeff Bezos purchased the Washington Post newspaper from the Washington Post Company last year, its pension had a $1 billion surplus.

Monday, March 3, 2014

PSPRS lawsuits and unintended consequences: Will another victory be our undoing?

I know that most people do not have much interest in reading court decisions, but many of you may find the Fields v. EORP opinion informative.  It is a 15-page PDF document that gives a history of pension legislation up to and including the implementation of SB 1609, as well as the reasoning behind the Arizona Supreme Court's decision to decide in favor of retirees and against EORP and PSPRS.

The Fields case is settled, but it is only the first of two pairs of lawsuits against EORP and PSPRS.  The still-pending lawsuits by active members of EORP and PSPRS could have even more dire financial consequences if they are decided in favor of the plaintiffs.  The Hall and Parker cases against EORP and PSPRS, respectively, seek to not only restore the old COLA formula for active members, but more importantly, they seek to reduce the employee contribution rate back to where it was before SB 1609 became law.  For PSPRS members hired before SB 1609 went into effect, this would return the employee contribution rate to 7.65% (PSPRS' current fiscal year 2014 rate is 10.35%)  and force PSPRS to refund the excess contributions over 7.65%.

Figuring for the current fiscal year, an active PSPRS member, who had $70,000 in pensionable income, will pay PSPRS 10.35% or $7,245 in contributions between 7/1/2013 and 6/30/2014.  If PSPRS was forced to refund 2.7% in excess contributions for the current fiscal year (FY), PSPRS would have to return $1,890 to that active member.  Smaller increases in the employee contribution rate in FY's 2012 (1% or $700) and 2013 (1.9% or $1,330) would bring a total refund due of $3,920.  Multiply this amount by the thousands of active PSPRS members, and you have a huge outflow of PSPRS' assets.  Based on numbers from the FY 2013 annual report, I estimate that at least $65 million in refunds would be due.  Worst of all for employers is that these higher employee contribution rates are figured into PSPRS' current amortization of its unfunded actuarial accrued liability.  If the employee contributions rates are reduced, the funding ratio will immediately drop, and employers (i.e. taxpayers) and new hires (i.e. union brothers and sisters) will have to make up the difference.  This is why the Hall and Parker cases are so important.

While I am not an attorney nor an expert in pension law, I still wanted to see if anything in the Fields decision might give some idea how the Hall and Parker cases might be decided.  The following paragraphs give some tantalizing clues as to how those cases may be decided.  I have put in boldface several passages which I think are relevant.
¶27 Our interpretation of the Pension Clause is consistent with prior cases. In Yeazell v. Copins, this Court held that an employee was entitled to have his retirement benefits calculated based upon the formula existing when he began employment, rather than a less-favorable formula subsequently adopted during his employment. 98 Ariz. 109, 115, 402 P.2d 541, 545 (1965). The Court explained that the employee “had the right to rely on the terms of the legislative enactment of the Police Pension Act of 1937 as it existed at the time he entered the service of the City of Tucson and that the subsequent legislation may not be arbitrarily applied retroactively to impair the contract.” Id. at 117, 402 P.2d at 549. As in Yeazell, Fields has a right in the existing formula by which his benefits are calculated as of the time he began employment and any beneficial modifications made during the course of his employment. Thurston v. Judges’ Ret. Plan, 179 Ariz. 49, 51, 876 P.2d 545, 574 (1994) (recognizing that “when the amendment [to retirement benefits] is beneficial to the employee or survivors, it automatically becomes part of the contract by reason of the presumption of acceptance”).
¶28 This definition of “benefit” also comports with the use of the term in other states that have similar constitutional provisions protecting public pension benefits. For example, construing a similar definition of “benefit,” New York and Illinois have also determined that benefit calculation formulas are entitled to constitutional protection.5 See Kleinfeldt v. New York City Emps.’ Ret. Sys., 324 N.E.2d 865, 868–69 (N.Y. 1975) (including the formula utilized in calculating an annual retirement allowance under the Pension Clause); Miller v. Ret. Bd. of Policemen’s Annuity, 771 N.E.2d 431, 444 (Ill. App. 2001) (holding benefit increases to be constitutionally protected). Additionally, unlike narrower protections found in other states’ constitutions, the protection afforded by the Arizona Pension Clause extends broadly and unqualifiedly to “public retirement system benefits,” not merely benefits that have “accrued” or been “earned” or “paid.” See, e.g., Alaska Const. art. 7, § 7; Haw. Const. art. 16, § 2; Mich. Const. art. 9, § 24.
 ¶32 EORP relies on Smith v. City of Phoenix, 175 Ariz. 509, 858 P.2d 654 (App. 1992), to argue that Fields had only a contingent right. In Smith, a city ordinance set the salaries of city judges at 95% of the salaries of superior court judges. Before a statutory increase in superior court salaries took effect, the city revised its ordinance to preserve the salaries for city judges at the then-existing amount. Id. at 514, 858 P.2d at 659. The court of appeals held that Smith had no vested contractual right to continued salary increases under the city ordinance, observing that his “contract of employment” did not express “that the method of calculating his salary would remain fixed throughout his term,” and “[i]ndeed, the fact that both parties knew his salary was established by a city ordinance, which was naturally subject to change by the city council, suggests just the opposite.” Id.
¶33 Smith is inapposite. Assuming the case was correctly decided, we note that it reflects the general principle that statutory provisions do not create contractual rights. See Proksa v. Ariz. State Sch. for the Deaf & the Blind, 205 Ariz. 627, 629 ¶¶11–12, 74 P.3d 939, 941 (2003). But statutorily established retirement benefits are an exception to this rule. Id. at 631 ¶21, 74 P.3d at 943. Under Yeazell, the right to a public pension on the terms promised vests upon acceptance of employment, 98 Ariz. at 115, 402 P.2d at 545, and “the State may not impair or abrogate that contract without offering consideration and obtaining consent of the employee,” Proksa, 205 Ariz. at 630 ¶ 16, 74 P.3d at 942; cf. Thurston, 179 Ariz. at 52, 876 P.2d at 575 (recognizing that a detrimental modification to retirement benefits “may not be applied absent the employee’s express acceptance of the modification because it interferes with the employee’s contractual rights”).
Paragraphs 27 and 28 would seem to indicate that the COLA formula that was in place when one was hired is considered a benefit protected by the Pension Protection Clause of the Arizona Constitution for active employees as well as retirees.  It can not be reduced without the consent of the affected employees, and any change beneficial to the employee is assumed to be accepted by the employee and also protected.  If I were betting on this, I would bet that Hall and Parker will almost certainly win this part of their cases.

The more interesting and speculative situation regards the employee contribution increases. Paragraphs 32 and 33 seem to indicate that an employee's pay is subject to change through legislative channels.  While the Court rejected EORP's use of this precedence in the Fields case, it still seems germane to the Hall and Parker cases.  I would consider a change in employee contribution rates a matter of pay and not pension benefits, and therefore, not subject to the Pension Protection Clause.  The employee contribution rate to PSPRS would seem to be no different than what an employee pays for medical insurance, and since it only affects the employee's current pay and not his end pension benefit, the contribution rate in place when an employee was hired does not appear to be protected.

The justices include a rather curious qualifier to the Smith case with the inclusion of the statement, "assuming the case was correctly decided," which they do not do for any other precedent cited.  Does this mean they think this case was decided incorrectly and should not be cited as precedent in future cases?  I do not know.  Also, the Fields case skirts the Contract Clause of the Arizona and U.S. Constitutions and really only deals with the Pension Protection Clause.  In the end, I think the Court would be very reluctant to consider employee contributions rates as a pension "benefit."  If they cited the Contract Clause to say employee contribution rates were set when employees were hired and could not be changed by the legislature, they would be opening a Pandora's Box of lawsuits over every benefit change that adversely affected an employee.

So my inexpert legal prediction would be that Hall and Parker win over the COLA changes and lose over the employee contribution rate increases.  What causes me to lose sleep at night is that if this prediction is correct, it means that employee contribution rates can be raised to whatever the legislature deems necessary.  As it stands now, the employer contribution rate can not exceed 11.65% nor can total employee contributions exceed more than one-third of the aggregate employer/employee contributions, whichever is lower.  Employers must pick up at least two-thirds of the aggregate.  For comparison, the Arizona State Retirement System (ASRS), which covers most public employees in Arizona, has a 50/50 split between employees and employers.  If the legislature had constitutional cover to raise employee contribution rates into PSPRS, could they raise them to make it an even split?  I do not see why not, especially when employees asked for this decision.  Going from a 33% share to a 50% share of aggregate contributions would increase employee contribution rates by 50%.  Our aforementioned hypothetical employee would pay an additional $3,255 to PSPRS this fiscal year if the employee contribution rate went from 10.35% to 15%.  Last FY employees paid only about 26% of the aggregate employer/employee contributions, so the potential increases are even worse than they now seem.

This is just one scenario based on a layman's reading of the Fields decision, but it is very possible that any victory by the plaintiffs in the Hall and Parker cases is a pyrrhic one.  As before, we will have to wait and see how the Arizona Supreme Court rules, and how the legislature reacts.  Stay tuned.

Monday, February 24, 2014

You take the good, you take the bad, you take them both, and there you have . . . "The Facts About DROP"?

PSPRS Administrator Jim Hacking posted this memorandum about the Deferred Retirement Option Plan (DROP), dated February 12, 2014, on PSPRS' homepage.  As document links like this can disappear, I have posted the memorandum verbatim (with the exception of a few format changes to make it fit):
The Facts About DROP
DROP was a mechanism initiated in 2000 to enable System employers to retain highly-experienced personnel who, prior to DROP’s implementation, tended to retire after completion of the 20 years of credited service required for retirement. Concerned about losing a significant portion of their senior workforce, the System’s employers designed DROP to entice senior employees otherwise eligible to retire to continue working for up to an additional 5 years. Under DROP, the retirement benefits that would otherwise be paid a retirement-eligible employee would be paid into a separate account (a “DROP Account”) which would bear interest at a specified rate.* The employee would continue working for up to 5 years, and after the employee actually terminated employment, he/she would be paid the deferred retirement benefits accumulated in the DROP Account, plus accrued interest. 
DROP’s benefits to the employer were two-fold: during the period the employee was enrolled in the DROP program, the employer would not have to make employer contributions toward the employee’s retirement, since the employee’s retirement benefits were already being remitted to his DROP Account.  These contribution savings were significant, and in some cases, equaled more than 25% of each employee’s pay during the DROP period. Second, the employer retained highly-skilled staff which it otherwise would lose and at great expense, have to replace with less experienced workers. 
DROP’s benefits to the employee were also two-fold: while the employee would not receive the benefit of his already accrued retirement benefits until such time as his DROP period expired, he would nevertheless continue working during his DROP period and receive a paycheck. Further, the employee would have a “guaranteed” return on his DROP Account and not have to worry that his retirement benefits would be dissipated in the securities markets.
While the media has made much of the fact that some participants in the DROP program are receiving significant lump sum payments upon expiration of their DROP periods, the fact remains that the amounts paid DROP participants are simply the money they otherwise would have been paid had they retired before participating in the DROP program, plus interest.
The employers actually incur less payroll expense for DROP employees, because they often save more than 25% in payroll expense for each DROP recipient. And while the DROP program has been terminated for new hires effective January 1, 2012, the program definitely achieved its purpose while in effect. During the past 13 years, the System’s employers were able to retain a great many of their senior level employees for 5 years beyond their 20 year normal retirement date,** and we expect these numbers to fall precipitously as fewer employees qualify to participate in DROP over the ensuing years. The result will be that as time progresses, more employees will retire upon their normal retirement date, employers will have to bear greater employment expense for new hires, and employee turnover will be heightened.
          ____________________________
* DROP Accounts of employees with at least 20 years of service before January 1, 2012 are credited with interest at the System’s assumed earnings rate (currently, 7.85%). DROP Accounts of employees participating in the System before January 1, 2012 but with less than 20 years of service before that date (and who elect to participate in DROP thereafter) accrue interest at a rate equal to the System’s average annual return on the market value of its assets over 7 years (currently, is 3.2%).
** This is evident by data reflecting that, four years after implementation of the DROP program, only 280 employees retired in contrast to the following year, wherein 648 employees retired upon expiration of the maximum 5 year DROP period. This means that DROP increased by 200% the number of retirees who elected to continue working beyond
their 20 year normal retirement date.  4841-9854-1592.1

While this memo is called "The Facts About DROP," it seems a bit short on information showing the cost versus benefit of the DROP.  Other than the second footnote, there is no statistical data about the DROP, and even this footnote is of limited value.  What was the value of those additional 368 statewide employees who worked one more year than those who retired the previous year?  Is there any quantifiable measure to show that employers got more arrests, less crime, less property damage, fewer injuries, or better medical outcomes of EMS patients because those 368 employees delayed their retirements one year?  Was there no other incentive that could have retained these employees ?  None of these questions are answered.

The real questions here are financial.  Did employers really save money as stated in the memo?  Without the DROP, what would employers' annual required contribution (ARC) rates now be if employers and employees had fully paid their contributions into PSPRS over the last 13 years?  What if PSPRS had not been paying interest on DROP benefits in excess of its annual returns, even in years when PSPRS had negative returns?  What would PSPRS' funding ratio be if there had never been a DROP?  As for the experience question, what is the average years of service at retirement before and after the DROP was implemented?  And again, what benefits are gained by the extra five years of service for an average employee and can it even be quantified in any measurable way?  PSPRS is the only one that has the data to answer these questions, which are the most important ones if you are trying to defend the DROP to the media, politicians, and citizens.

I have previously written about how the DROP is essentially an end-of-career windfall for employees that increases costs for employers without providing them with any of its purported benefits (see "The folly of the DROP," part one, part two, and part three).  I see nothing in this memo that would change that opinion.

Friday, February 21, 2014

How much will the Fields decision cost PSPRS?

The following press release was posted to PSPRS' website in response to the Arizona Supreme Court's decision in the Fields case:
PSPRS Board responds to consequences of Supreme Court Fields decision
Feb. 20, 2014. PHOENIX, AZ:
The Public Safety Personnel Retirement System’s (PSPRS) Board is disappointed by the Arizona Supreme Court’s decision to hold the Permanent Benefit Increase (PBI) changes made by Senate Bill 1609 unconstitutional. The ruling in this case undermines the legislature’s attempt to make PSPRS healthier and more financially stable for public safety personnel, judges, elected officials and correctional employees.
“We estimate that retroactive payments to beneficiaries of all three PSPRS Plans will total $40 million,” PSPRS administrator Jim Hacking said. “We also estimate that we will have to transfer $335.6 million to the reestablished Reserve Accounts of our three Plans.”
The upcoming asset transfers will further reduce the funding ratios of the three PSPRS Plans (PSPRS, CORP and EORP). Such an impact will force up employer contribution rates.
In 2011, the PSPRS Board supported the passage of SB 1609 in order to protect the long-term viability of the pension system. Prior to the passage of SB 1609 in 2011, during any year with an investment return in excess of nine percent, half of the excess was diverted to a reserve account used to fund fixed annual Permanent Benefit Increases (PBI).
“The funds set aside for PBIs could not be used to offset PSPRS’s liabilities,” said PSPRS Board Chairman Brian Tobin. “This proved costly to the fund during 2008 and 2009 when the country was in the midst of a crippling recession, adversely affecting investment returns. The State’s and its political subdivision’s heavy budget cuts left fewer people contributing to the fund. Even while the system was losing money, PSPRS was still forced to pay fixed PBIs to its retirees.”
The most important figure is the $335.6 million that will have to be transferred to the Reserve for Future Benefit Increases. According to the January 15, 2014 PSPRS Board of Trustees meeting minutes the total combined fund (the "fund"), which pools the assets of PSPRS, EORP, and CORP for investment purposes, was valued at $7.695 billion, as of November 30, 2013.  $335.6 million represents 4.36% of the fund's assets as of November 30,2013.  This $335.6 million will not be "lost" as it will remain in another account under control of PSPRS managers, but for the purposes of calculating PSPRS' funding ratio, its sequestration represents a loss of 4.36% of the fund's assets since it can only be used to pay COLA's*.  This is why PSPRS is saying employer contribution rates will increase.

Before SB 1609 was signed into law in April 2011, the fund placed half of any investment earnings over 9% in the Reserve for Future Benefit Increases (the "Reserve").  It was from this Reserve that COLA's were paid out.  No excess earnings have been paid into the Reserve in the three fiscal years (FY's) since SB 1609 was signed into law.  Investment rates of return in FY's 2011, 2012, and 2013 were 17.37%, -0.79%, and 10.64%, respectively, so the $335.6 million represents a portion of excess earnings in FY's 2011 and 2013.  Even though a loss was sandwiched between the two years with rates of return over 9%, the excess earnings of the two positive years will still be siphoned off into the Reserve, instead of being used to make up for that loss.  The FY 2012 loss of 0.79% is actually quite a bit worse for PSPRS because the fund has an expected rate of return (ERR) of 7.85%, and anything under that negatively affects PSPRS.  From just looking at this three-year period, we can see, in a nutshell, what the problem is with the old, now reinstated COLA formula.  An underfunded pension needs the excess earnings of the good years to make up for losses of the bad years.  There is also an inherent unfairness in some reaping the benefits of the good years while bearing none of the costs of the bad years.  PSPRS already needs many years of really, really good investment returns to get back into financial shape.  This decision just made that a whole lot more difficult.

*( A quick note about terminology is in order here.  PSPRS has recently taken pains to use the term Permanent Benefit Increases (PBI) instead of COLA, which stands for cost of living allowance and is a more familiar term.  PBI is the more appropriate term because increases are not indexed to any measure of inflation.  However, even PSPRS often uses the terms interchangeably, and I find it easier to use the term COLA.)

Thursday, February 20, 2014

******Breaking News: Arizona Supreme Court rules against EORP/PSPRS in Fields case******

That sound you heard this morning was the hole being blown in PSPRS' financial condition.  The Arizona Supreme Court issued its ruling today in Fields v. Elected Officials’ Retirement Plan (EORP) (CV 2011-01744).  See this story, Court's pension ruling could cost Arizona taxpayers millions, by Craig Harris in today's Arizona Republic for more detail.  This ruling means that those retired before SB 1609's reforms went into effect must have their COLA's calculated under the old formula.  This means that these retirees should expect some type of retroactive COLA's paid to them.  A more thorough explanation of the new and old COLA formulas can be found here.

This decision is hardly a surprise as the retirees had a rock-solid legal case, and I expect to see some interesting figures coming from PSPRS as to how this decision affects funding ratios and annual required contributions from employers.  Phoenix and Tucson have already projected budget deficits for the next fiscal year, so this is not good news for them or their law enforcement and fire/EMS personnel.

This is only going to get more interesting as the Hall v. Elected Officials’ Retirement Plan (EORP) (CV 2011-021234) and Parker v. Public Safety Personnel Retirement System (PSPRS) (CV 2012-000456) are decided.  (Whichever one is decided by the Court will set precedent for the other.)  These cases involve active employees who were employed before SB 1609's reforms went into effect.  They are suing not only to restore the old COLA formula when they retire but to also lower the employee contribution rate back to 7.65% and return any excess contributions paid since the rates were raised.  This will have even more dire financial consequences if they win their cases.

These two cases were basically postponed since a loss by retirees would have made the Hall and Parker cases moot.  Now that the retirees have won, this cases are the new, more critical battleground.  Definitely stay tuned.

Additional note: I should have made it clear that, in the same way that there are two cases involving active EORP members and active PSPRS members, there was second case, Rappleyea v. Public Safety Personnel Retirement System (PSPRS) (CV 2012-00040), by PSPRS retirees suing over the same constitutional question as Fields.  The Fields decision will carry over to those PSPRS members who retired before SB 1609 pension reforms went into effect.