Wednesday, August 13, 2014

If you want to convince Arizonans to reform PSPRS, you don't go to New York

With thanks to a colleague who informed me of this article, Coaxing Fire and Police Staffs in Arizona to Cut Own Pensions, by Ken Belson in the August 11, 2014 New York Times, I was hopeful that there was going to be some new ideas from Professional Fire Fighters of Arizona (PFFA) President Bryan Jeffries, who recently took over for Tim Hill.  Unfortunately, the article was a disappointment.

The article details Mr. Jeffries' attempt to sell the PFFA reform plan, discussed in several recent posts, as a noble concession by Arizona's current firefighters to help PSPRS, and by extension, taxpayers and future firefighters.  The article has errors*, and the writer does not seem to be very familiar with PSPRS or its recent travails.  I am not sure how the New York Times got involved in this or why they found it newsworthy, but the Arizona Republic, which has done excellent reporting on PSPRS, would have certainly been more accurate and probably given the claims of Mr. Jeffries and others quoted in the article a little more scrutiny.

For me the key passage in the article is this:
To put the plan into effect, Mr. Jeffries wants to change the Constitution to allow for this one-time fix. This would reassure workers that lawmakers could not make even more drastic changes later.
I do not know if the second sentence is a paraphrased quote from Mr. Jeffries or inferred from the desire to embed the PFFA reform plan in the Arizona Constitution.  Either way, this statement rather boldly declares that the PFFA strategy is basically an end run around the Arizona legislature when it comes to PSPRS.  It is arrogant enough for the PFFA to present a final reform plan to the legislature as if it was the perfect solution.  It is another thing to go to the New York Times, hardly an Arizona-friendly paper, portray your organization as a protector of Arizona's taxpayers, and give the impression that you plan to treat the Arizona legislature as a non-entity in PSPRS reform.

As I detailed in recent post the PFFA reform proposal is no good.  I do not know how involved the PFFA was in the drafting of SB 1609 three years ago, but their public position was that no reform was necessary at the time.  Now they are all-in for reform but think that the legislature should just rubber-stamp their proposal, even though it is no improvement over the Arizona legislature's own bill, SB 1609.  So what was Mr. Jeffries' goal in talking to the New York Times?  I do not know, but if he thought a write-up in an elitist east coast paper would help PFFA's case, I think he is badly mistaken.

*PSPRS only takes half of any returns over 9% and places them in the COLA fund, and only part of SB 1609 was overturned, not the entire law.

Monday, August 4, 2014

A modest proposal for PSPRS COLA reform

I have spent several posts criticizing the Professional Fire Fighters of Arizona (PFFA) pension reform proposal, and I have pointed out the fundamental flaws with both SB 1609 and the current excess earnings model in how they calculate COLA's, especially when we consider the possibility of inflation.  (And, once again, for consistency I will again use the acronym COLA throughout instead of the less familiar but more accurate term permanent benefit increase (PBI).)  So what would I propose to do about COLA's?

I think the solution is simple and does not involve any significant change to PSPRS.  It would simply be to eliminate COLA formulas and allow the PSPRS Board of Trustees ("the Board") to determine the next year's COLA based on input from its actuary.  This is such a basic idea that I find it hard to believe that I am the first to propose it, so if someone has already floated this idea in the past, I apologize.

The main opposition to this idea would be that the Board could not be trusted to award fair and appropriate COLA's.  The Board might favor employers (and taxpayers) over employees and retirees, or vice-versa.  In its current statutorily mandated makeup, the Board is made up of two employee representatives--one fire and one law enforcement, two employer representatives--one state and one local, an elected official or judge, and two citizen representative, all appointed by the governor.  As can be seen, the Board is constituted to have representation from all stakeholders in PSPRS: employees, employers, politicians or judges, and taxpayers.  This allows for a diversity of opinion and interests and forces some give-and-take from Board members.  Furthermore, the Board is already responsible for other more critical decisions, particularly how and where funds are invested, so entrusting them to decide COLA's seems reasonable.

The Board would also be required to take input from its actuary, whom they already rely on for the other critical decisions they make.  The actuary does the number-crunching, simulations, and projections that determine funding ratios and annual required contributions.  Within a certain range based on the actuarial calculations, the Board could be restricted in how large or small a COLA could be awarded, and this is where the give-and-take among the Board members could take place and would not allow them to award COLA's based on unrealistic assessments or personal bias.

If we take a historical perspective, this method would have worked fine in the past.  When PSPRS was overfunded and returns were high, COLA's would have been more generous (even exceeding the rate of inflation) and allowed the benefits of excess earnings to be distributed equitably among retirees, current employees, and employers.  However, as PSPRS became more and more underfunded and returns over time were not sufficient to recoup past losses, COLA's could have been reduced or eliminated.  Looking ahead, if PSPRS begins to recover and inflation becomes a problem, COLA's could surpass the 4% or 2% thresholds in place or proposed.

This method of awarding COLA's would avoid the long-term mistakes engendered by hard formulas put into law or, even worse, into the Arizona Constitution.  COLA's would be based on the current financial condition, not from when times were better or worse.  Unions that negotiate for employees have a vested interest in having wages and benefits determined by hard formulas.  These hard formulas create certainty and stability in their contracts that do not allow the negotiated terms to be changed arbitrarily by elected officials.  This works fine with a collective bargaining agreement (CBA) that may last only one or two years, but the use of hard formulas becomes a problem when you are talking 20 or 30 years.  Inflation and returns fluctuate over time and setting in stone a COLA formula based on only your most recent experiences is short-sighted and dangerous.  Would unions accept a 20-year CBA based on the economic conditions that exist now?  Of course not, so why would they think that locking down a permanent, unchangeable COLA formula is a good idea?

The PFFA proposal is bad, and I am thankful that the Governor did not call a special session to consider it.  It is a shame that PSPRS wasted money on an actuarial analysis of such an absurd proposal.  I know that there are multiple labor organizations representing Arizona law enforcement, and I was not sure their feeling about this proposal.  However, a letter copied in Tucson City Council Member Steve Kozachik's Ward 6  June 18, 2014 newsletter indicates support for the proposal from at least one law enforcement organization, the Arizona Lodge of the Fraternal Order of Police (FOP).  The letter says, "Those of us who have worked on the issue believe the Firefighter's proposal has merit and may protect our members from more draconian measures.  This proactive effort represents the best chance for public safety to protect important benefits, our employers, our pension fund, our retirees, our actives, and our future members."  It is disheartening to know they were on board with the PFFA proposal.

While the PFFA pension reform proposal looks dead for now, it was important to analyze it closely to show its flaws.  Even if it never rises again, the PFFA proposal served a useful purpose in exposing the chronic myopia that afflicts the PFFA leadership and, possibly, law enforcement union leadership as well, when it comes to PSPRS.  For someone who is already in the DROP or close to retiring, dedicating 4% of your future career earnings to retirees may not seem like a sacrifice.  If you have many years left to retire or are just starting your public safety career, it will greatly affect the financial well-being of you and your family.  For someone who is expecting a six-figure DROP payout, committing to 2% COLA's in the future may not seem like a hardship.  For someone who retired before the DROP went into effect, a 2% COLA could mean your retirement benefit could get eaten away by inflation.  Looking at pension reform only from the perspective of someone with 20-30 years of time in PSPRS and access to the DROP is not only financially perilous, it is grossly unfair.  Unless the PFFA leadership can start looking at the cost and benefits of reform from the perspective of all affected constituencies, no reform effort proposed by them should ever be taken seriously.

Saturday, August 2, 2014

PSPRS and its broken COLA system may be worse than you think

In recent posts I discussed the Professional Fire Fighters of Arizona (PFFA) reform plan to PSPRS.  If you have read those posts, it is clear that the PFFA plan is a non-starter which provides zero improvement over the reforms implemented by SB 1609.  However, the cost of living allowance (COLA) reforms of SB 1609 have been reversed for retirees and are virtually certain to be reversed for all PSPRS members hired before 2012.  This leaves us with an unsustainable COLA system that will remain in place for decades.  So what is to be done about COLA's?

A Little Backstory

Obviously, this is a difficult question to answer, so the best place to probably start would be at the beginning.  I have mentioned this several times before, but we have to remember that what we are discussing are not really cost of living allowances.  PSPRS confuses the issue by interchanging the term COLA and permanent benefit increase (PBI) in its documentation.  PSPRS does not increase retiree benefits based on any measure of inflation like the consumer price index (CPI), which tracks the prices of a basket of goods, to raise Social Security benefits annually.  The PBI awarded by PSPRS is based strictly on a highly flawed excess earnings model, and recent PBI's have been much more generous than Social Security.  This can be seen in the post here that looks at PBI's since 2000.  Another way that PSPRS differs from Social Security is that PSPRS awards a flat monthly dollar amount not a percentage of the existing benefit.  This helps those with lower retirement benefits as it represents a higher percentage increase than those with larger benefits.  As a final note, the Arizona Revised Statutes also do not mention the term COLA and uses the term "permanent increase in the base benefit."

The flawed excess earnings PBI model was based on an even more flawed and misguided notions. The excess earnings model could only have been designed and advocated by those who believed that PSPRS could never become underfunded, that it could never suffer large investments losses, or that the bill for systemic underfunding of benefits through bad policies and programs would never come due.  I suppose these notions came about from an extended bull market from the early 1980's until about 2000, a textbook case of financial short-sightedness.  This was all capped off with the passage of Proposition 100, which added a "pension protection clause" to the Arizona Constitution, in 1998, and the flawed excess earnings model became permanent.

What we have seen over the past 13 years is an erosion of PSPRS' aggregate funding ratio from a high of 126.9% in fiscal year 2000-01 to 57.1% in fiscal year 2012-2013.  This erosion has been steady and unrelenting yet, except for the brief interlude after SB 1609's passage and the resolution of the Fields case, PBI's continued to be paid, and with the Fields decision, retroactive PBI's have recently been paid out.  The most powerful and most expedient way for PSPRS to increase its funding ratio is through the compounding of market returns.  Legend has it that no less than Albert Einstein said that compound interest is the most powerful force in the universe.

Let's see exactly how powerful this would be with some calculations done with the compound interest calculator available here.  We will use two annual excess earnings of  $100 million and $200 million to show the difference to the balance in PSPRS' underlying fund under scenarios where half ($100 million) of the amount over 9% goes to the PBI fund (as in the current excess earnings model) fund versus all ($200 million) earnings remaining in PSPRS' underlying fund (as in the SB 1609 model with PSPRS under 60% funded).  $200 million compounded monthly for five years at the current ERR of 7.85% would earn the PSPRS' underlying fund about $48 million more than $100 million compounded at the same rate.  This $48 million is in addition to the $100 million that was never placed in PSPRS' underlying fund in the first place, so instead of having an additional $296 million in it, the underlying fund has only an additional $148 million, with the remaining $148 million in the PBI fund.  Of course, PSPRS is not actually losing the $148 million total since it exists in a different account that PSPRS controls, but funds in that PBI account do not count toward PSPRS' funded ratio since those funds can only be used to pay PBI's.

While this is a simplistic scenario it illustrates how destructive the current excess earnings PBI model is.  The millions not going into PSPRS' underlying fund mean higher contribution rates for employers, and consequently, lower pay and benefits for current employees and diminished services for citizens.  Keep in mind that the current excess earnings PBI model is even worse than it appears at first glance because excess earnings are paid into the PBI fund regardless of PSPRS' past performance.  Using the previous examples, PSPRS could suffer a cumulative loss during the five year period but still pay excess earnings into the PBI fund because some individual years may have exceeded a 9% return.  In this case, not only does PSPRS lose an opportunity to help clear its unfunded liability, it actually increases its unfunded liability.  We do not need a compound interest calculator to know that this is not a sustainable method of paying PBI's. 

A Closer Look at PBI's


For PSPRS retirees, the payment of PBI's has been a great deal.  The most recent PBI retroactive for fiscal year  (FY) 2014 (July 1, 2013 to June 30, 2014) was $121.19/month or $1,454/year.  The FY 2013 PBI was $159.13/month or $1,910/year.  For someone with a monthly retirement benefit of $4,000/month, the PBI would mean a percentage increase of 3.0% for FY 2014 and 4.0% in FY 2013.  The average PSPRS pension for FY 2013 was $49,571/year.  The following shows the COLA's paid by the Social Security Administration over the past 40 years:

7/1975: 8.0%     1/1985: 3.5%    1/1995: 2.8%     1/2005: 2.7%
7/1976: 6.4%     1/1986: 3.1%    1/1996: 2.6%     1/2006: 4.1%
7/1977: 5.9%     1/1987: 1.3%    1/1997: 2.9%     1/2007: 3.3%
7/1978: 6.5%     1/1988: 4.2%    1/1998: 2.1%     1/2008: 2.3%
7/1979: 9.9%     1/1989: 4.0%    1/1999: 1.3%     1/2009: 5.8%
7/1980: 14.3%   1/1990: 4.7%    1/2000: 2.5%     1/2010: 0.0%
7/1981: 11.2%   1/1991: 5.4%    1/2001: 3.5%     1/2011: 0.0%
7/1982: 7.4%     1/1992: 3.7%    1/2002: 2.6%     1/2012: 3.6%
           *               1/1993: 3.0%    1/2003: 1.4%     1/2013: 1.7%
 1/1984: 3.5%     1/1994: 2.6%    1/2004: 2.1%     1/2014: 1.5%

* Change from a fiscal to a calendar year

The following show PBI's paid by PSPRS and their percentage of the same $4,000/month retirement benefit:

2004: $111.90/2.7%    2008: $134.34/3.4%  2012: $153.06/3.8%
2005: $116.82/2.9%    2009: $138.60/3.5%  2013: $159.13/4.0%
2006: $121.76/3.0%    2010: $146.74/3.7%  2014: $121.19/3.0%
2007: $127.06/3.2%    2011: $152.84/3.8%  2015: TBD

Comparing the two charts shows that since 2004 PSPRS has exceeded the COLA percentage paid by the SSA in all but two years, and in two years when SSA paid nothing, PSPRS paid 3.5% and 3.7%.   Under the current excess earnings formula, retirees are eligible for a PBI of up to 4% of the average normal retirement benefit, so it is possible that PBI's could be less than the rate of inflation.  However, with inflation kept pretty tame over the past 30 years, PBI's have been a boon for retirees, especially when we note that the average annual pension in FY 2004 was only about $35,000/year versus $49,571 in FY 2013.   Someone with a $3,000/month pension in 2004 would have seen a 4.0% increase in his pension that year, and in 2014 would now be getting a monthly benefit of $4,484, a nearly 50% increase in his benefit check in just 11 years, which makes his annual pension $4,000 higher than the FY 2014 average.  Using the SSA's COLA percentages would give us a monthly, inflation-adjusted benefit of $3,915, $570 less than what PSPRS actually awarded

Inflation

I would hope that everyone would agree that robbing the underlying PSPRS fund to pay PBI's will hurt everyone, whether retired or not, even if it has been, up until now, a real good deal for retirees.  SB 1609 addressed some of the problems by tying PBI's to PSPRS' funded ratio and raising the threshold for paying PBI's.  Of course, this is now a moot point since that part of SB 1609 has been ruled unconstitutional.  So where does this leave retirees?

Let's start by taking a few steps back and looking a little closer at some economic issues, particularly inflation.  When one considers an investment, it is necessary to determine the real interest one is earning.  This is simply the nominal interest rate minus the inflation rate.  This is equally true when considering an increase in pay as someone getting a 2% pay raise in an economy with 3% inflation is actually poorer (but of course better off than if he had gotten no raise).  For a retiree, whose only source of income may be his retirement benefit, knowing the real interest rate is very important.

If we look at the SSA chart again, we see a seven-year period between 1975 and 2002 where inflation was quite high, reaching 14.3% in 1980.  As stated before the current excess earnings model for PBI's allows for a maximum PBI of 4% of the average normal benefit.  Translated into actual dollars this could be more or less than 4% of an individual's benefit, depending on whether the individual's benefit was north or south of the average.  If we again use our $48,000/year pension and calculate a PBI benefit at the maximum 4% per year for four years, that annual pension would be $56,153 at the end of that four-year period.  It gets interesting if we begin to contemplate the possibility of inflation exceeding 4% per year.

If inflation is 6% per year, a retiree would find himself $10,597 poorer (with annual losses of $960, $2,016, $3,175, and $4,446) at the end of the four-year period based on his -2% real interest rate with a pension 7.3% lower than the first year (having only $56,153 available but needing $60,599 to keep up with the increased cost of goods).  At 8% inflation, he would be $21,613 poorer with a pension 14.0% lower than the first year.  At 10% inflation, he would be $33,061 poorer with a pension 20.1% lower than the first year.  We could go on with higher inflation rates or longer periods of time, but I think that the insidious effect of inflation is quite clear in these examples.

If you are a retiree, high inflation is your kryptonite.  Neither the current excess earnings model or SB 1609 allow for a PBI higher than 4%, and the PFFA proposal limits PBI's to 2%.  The danger here is the same one that has afflicted PSPRS for years: a sense of complacency that everything will continue on as it always has.  High returns will continue indefinitely--wrong.  Equities have always made us money--wrong.  Serious market crashes can be prevented--wrong.  Inflation can be controlled--right?  I don't know about the last one, but the track record has not been very good on the others. 

My final point on inflation deals with PSPRS itself.  It may seem like PSPRS would also suffer with inflation, but in fact under all the current PBI scenarios, inflation would be helpful in returning PSPRS to financial health.  Inflation benefits debtors who can pay off debts with cheaper dollars.  If inflation were to take off, PSPRS would most likely see an increase in market returns on its investments.  Wage inflation for employees and higher tax revenue coming to employers would bring in more contributions.  Higher market returns and greater contributions would go a long way to erasing PSPRS' unfunded liability, but retirees would be limited to the 4% or 2% PBI's. I have already expressed my disdain for the PFFA pension reform proposal as a current employee, but retirees should look askance at it as well when we consider the potential for harm to those on a fixed income.  The 2% limit on PBI's proposed by the PFFA were to be embedded in the Arizona Constitution making them nearly impossible to alter.

 Conclusion

So the past is no guide to the future.  In years of low inflation PSPRS was paying PBI's that exceeded inflation, yet PSPRS has no mechanism for dealing with extended periods of high inflation.  This is the legacy of treating PSPRS as some kind of magic money machine that only has to be programmed with the right formulas to keep paying out in perpetuity.  The next post will have some modest proposals to deal with this.

Sunday, July 13, 2014

A final word about the soon-to-be-former PSPRS Administrator Jim Hacking

In case you missed it, the Arizona Republic had this July 11, 2014 article by Michelle Ye Hee Lee: Pension fund chief placed on leave in wake of illegal raises. The violation of state law has forced the Board of Trustees to terminate Jim Hacking's contract.  I expect Hacking's forced retirement to be the first of several departures, either voluntarily or involuntarily, from PSPRS' upper-level staff.

I have written minimally on the turmoil in the PSPRS office because I do not think it is important.  Worse yet, it is a huge distraction from the bigger, existential issues that plague PSPRS.  I do not know Mr. Hacking or what it is like to work for or around him, and I do not agree with everything he says or does.  However, before he leaves I would like to reiterate a point I have made in the past.

PSPRS' financial problems have been long in the making and preceded Mr. Hacking's tenure.  Responsibility in varying degrees can be laid on past and/or current PSPRS staff, Boards of Trustees, politicians, and unions.  If his personnel management style has annoyed and angered some people, Mr. Hacking has still done, I believe, an admirable job of righting the PSPRS ship and placing it on a sustainable future course.  Ideally, it would be nice to see PSPRS run without any controversy, but paychecks and retirement checks are the only real concern of PSPRS members.  Mr. Hacking deserves, at the very least, some begrudging gratitude, though it is unlikely he will ever receive credit for the good things he has done for PSPRS.

If Mr. Hacking never receives any thanks, we should not allow the most unfair thing to occur, which is to allow the creation of a public perception that there is some linkage between his management and PSPRS' dire financial situation.  One has nothing to do with the other, and whoever takes over for Mr. Hacking will have to deal with the same financial short-sightedness, political machinations, and naked self-interest engendered in the policies and actions of state and local government and public safety employee unions. The outrage shown toward Mr. Hacking and other PSPRS staff members would be better directed at the politicians and union officials (past and current) who are truly responsible for PSPRS' financial problems.  Implying some type of causal relationship between Mr. Hacking's management and PSPRS' finances is not only an injustice to Mr. Hacking but allows other responsible parties to escape blame and continue the same destructive behavior.  For an example of this kind of implication see "Think VA is arrogant?  Check out Ariz. pension system" by the Editorial Board of the Arizona Republic.

I wish Mr. Hacking a happy retirement.  And best of luck to whoever takes over his job.

Friday, July 11, 2014

Beggar thy younger brothers and sisters: The Professional Fire Fighters of Arizona (PFFA)'s underwhelming and offensive PSPRS reform proposal

In the last post, we posed the question of why the changes proposed by the Professional Fire Fighters of Arizona (PFFA) are necessary when simply allowing SB 1069 to stand as originally passed by the Arizona Legislature would have the same results?  In this post we will focus mostly on how the cost of living allowance (COLA) will change under the PFFA proposal.  Following is the chart we referenced in the last post:


































Before SB 1609 became law COLA's were paid out of a Reserve for Future Benefit Increases ("the Reserve").  The Reserve was funded by half of any earnings over 9%, the expected rate of return (ERR) at that time, earned in any fiscal year.  This portion of excess earning went into the Reserve without any consideration of PSPRS' funded ratio or its past earnings.  For example, PSPRS could lose 20% one fiscal year, then earn 12% the next fiscal year, yet money would still flow into the Reserve that second year.  For a more complete explanation see the post Have a COLA and a smile.  This formula is not sustainable as the chart shows, but it was reinstated for those retired at the time SB 1609 went into effect.  The Fields decision by the Arizona Supreme Court deemed the changes to the COLA formulation in SB 1609 unconstitutional.

SB 1609 eliminated the Reserve and changed the COLA formulation as follows:
  • If the ratio of the actuarial value of assets to liabilities is 60-64% and the total return is more than 10.5% for the prior fiscal year, 2% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 65-69% and the total return is more than 10.5% for the prior fiscal year, 2.5% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 70-74% and the total return is more than 10.5% for the prior fiscal year, 3% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 75-79% and the total return is more than 10.5% for the prior fiscal year, 3.5% maximum increase to all eligible retirees and survivors.
  •  If the ratio of the actuarial value of assets to liabilities is 80% or more and the total return is more than 10.5% for the prior fiscal year, 4% maximum increase to all eligible retirees and survivors.
As can be seen, this new formulation takes into account PSPRS' funded ration and raises the ERR threshold to pay COLA's from 9% to 10.5%.  However, it also allows for a sliding scale of COLA's from 2-4% based on PSPRS' funded ratio.  This formulation was designed to allow PSPRS to slowly recover yet still pay some COLA's to retirees.  The chart shows that this change and others made by SB 1609 would steadily bring PSPRS back to full funding and drop employer contributions to a reasonable level.

The significant changes proposed by the PFFA that were used to produce the chart are:
  • COLA delayed until 7 years after commencement of benefits or age 60. 
  • Tier 2 members can retire at 25 years of service (no minimum age required).
  • Employee Self funded Inflation Protection Program (IPP) provided for all active generations.  Members can participate in a Non-contributory, Contributory or Reverse IPP (dependent on the date of hire).  
  • Pensionable income limited to $180,000 indexed with CPI. 
  • Eliminate the current excess earnings model for the COLA.  
  • Reduce employee contribution rate to 7.65% (eliminating the 4% maintenance of effort contribution). 
  • Create a new account funded by 4.0% employee contributions (plus actual investment income) which would fund an annual COLA payable after 3 full years of contributions. 
  • A COLA would be paid each year based on funds available.
As can be seen these COLA changes are quite radical when compared to the more modest changes made by SB 1609.  There are multiple issues here, but the most outrageous one is the penultimate bullet point regarding the funding of a new COLA fund.  Another reform that was part of SB 1609 raised the employee contribution rate from 7.65% to an annually increasing rate that tops out at 11.65% in the 2015-16 fiscal year.  The rate just increased from 10.35% to 11.05% on July 1, 2014.  The PFFA wants to take that additional 4% employees will ultimately be paying into the general PSPRS fund and place it into a COLA fund to pay retirees.  PFFA wants to go from the excess earnings model to one that pays COLA's from the paychecks of current employees.

Remember there are still two outstanding lawsuits by a PSPRS member and an EORP member who were active employees when SB 1609 went into effect.   These members are suing over both the COLA formula change and the increase in member contributions.  They are virtually certain to win their case over the changes to the COLA formulation based on the results of the Fields case, but the increase in employee contributions is a new issue for the courts.  The PFFA seems to believe that the SB 1609 increase in employee contribution rates will also be deemed unconstitutional and wants to lock down this money for another purpose before it is returned to current employees.

A quick word about the "excess earnings model for the COLA," which is made to look like the villain here.  There is nothing wrong with using excess earnings to pay COLA's.  PSPRS is not designed as a pay-as-you-go system, and in fact, COLA's should only be paid out of excess earnings.  What is wrong with the current excess earnings model is banking the excess earnings in good years but leaving PSPRS (and taxpayers and current employees) to suffer the losses during the bad years.  Earnings, particularly in fixed income investments, should track with inflation and produce excess earnings in the future if the cost of living should increase.

As I stated before, I find the COLA proposals by PFFA outrageous.  The idea that anyone, much less a union that is supposed to look out for all its members, would propose to fund COLA's on the backs of its working members is offensive.  I know the standard response will be that this may seem unfair now but others will pay it for you when you are retired.  First, I don't think anyone believes anymore in the permanence of PSPRS, much less any of its current policies.  Second, if I were that concerned about COLA's in the future, I would take the 4% and put it away in my own deferred compensation account.  Third, this isn't some sort of shared sacrifice since those who are already retired or close to retirement paid only some or none of the increased contribution rates that current, non-DROPped employees are paying now and will pay for the rest of their careers.  Fourth, we have to remember that this proposal is meant as an amendment to the Arizona Constitution, meaning that it will be the law of the land unless it is repealed through a cumbersome initiative/referendum process.  Employees could pay this extra 4% long after it is necessary.  Fifth, the bad math of this proposal takes 4% of current workers' wages for a promise to pay a maximum 2% COLA sometime in their future.  Finally, as a current employee I understand that more money needs to be paid by current employees, and that is just the way it is, but it needs to be used to bring PSPRS back to full financial health.  We all need to work to get this done, and I am willing to play my part.  I expect others to do the same.

So back to the question we started this post with: why would the PFFA propose these reforms when they produce no net gain over the SB 1609 reforms?  The simplest answer is that the PFFA is afraid that the Arizona Legislature or concerned citizens will attempt to repeal or modify Article 29 (the "pension protection clause") of the Arizona Constitution, which states that "public retirement system benefits shall not be diminished or impaired."  Some legislators have already proposed this, so the PFFA is attempting to offer an alternative, crafted by a labor organization, that ostensibly has the blessing of rank and file workers.

However, the PFFA proposal is overly complicated and will need to be amended to the Arizona Constitution, which is supposed to deal in general state and local governance and individual rights, not financial minutiae of specific legislation that more properly belongs in the Arizona Revised Statutes.  Legislating via constitutional amendment is foolish.  I see little chance that this would ever make it to the ballot, much less be approved by voters.  I suspect that the PFFA recognizes that the best solution to PSPRS' woes is to simply repeal or modify the pension protection clause and give the legislature constitutional cover to make the reforms they know are necessary, namely SB 1609, but being a labor organization, they can never admit to this.  They had to make a proposal once they became involved in the process, even though they appear to have nothing to offer that is better than SB 1609.  Opposition is their stock in trade, so even their own bad proposal must be presented and defended just to show they can confront the powers that be.  The leadership adage that even a bad action is better than inaction may be the working principle at play here.

There are more cynical explanations, but I will leave it up to the reader to consider those explanations.   Sadly missing here is any perspective from law enforcement groups. I do not know if they agree or disagree with the PFFA or have their own proposal to offer.  Any perspective that law enforcement personnel can offer would be appreciated.  In the next post, we will do a little more analysis of the different COLA formulations.

Wednesday, July 9, 2014

Proposed reforms to PSPRS: new but are they an improvement?

Since the last post I have had a chance to go through the PSPRS Special Board of Trustees Meeting dated June 4, 2014.  I should preface this by saying that there will no reform measures appearing on the November 2014 ballot since there has not been a special session called by the Governor, and at this late date, it would be nearly impossible to work out a ballot measure in time.  The meeting materials begin with the multiple COLA scenario studies PSPRS had requested from its independent actuary, Gabriel Roeder Smith & Company (GRS), to show the effects different COLA scenarios will have on PSPRS' (and EORP's and CORP's)  funding ratio and employer contribution rates.  It ends with a "summary of proposed changes for PSPRS" and funding policy review that includes a comparison of the effects to PSPRS' funding ratio and employer contribution rates when compared to three scenarios where SB 1609 changes are maintained or reversed or a new set of reforms is implemented.  Sandwiched between these studies are  Powerpoint slides by  the Professional Fire Fighters of Arizona (PFFA) that shows their proposed change for "fixing the PSPRS pension fund."

The most important information can be found in the graph and figuress on page 55 of the PDF document below.  (You can type "55" in the page number box to go directly to that page.)  The graph and figures show the effects on the median funded ratio and median contribution rate of PSPRS based on three different scenarios.  The green line and bar represent the effects of the following proposed changes:
  • COLA delayed until 7 years after commencement of benefits or age 60. 
  • Tier 2 members can retire at 25 years of service (no minimum age required).
  • Employee Self funded Inflation Protection Program (IPP) provided for all active generations.  Members can participate in a Non-contributory, Contributory or Reverse IPP (dependent on the date of hire).  
  • Pensionable income limited to $180,000 indexed with CPI. 
  • Eliminate the current excess earnings model for the COLA.  
  • Reduce employee contribution rate to 7.65% (eliminating the 4% maintenance of effort contribution). 
  • Create a new account funded by 4.0% employee contributions (plus actual investment income) which would fund an annual COLA payable after 3 full years of contributions. 
  • A COLA would be paid each year based on funds available.
The blue line and bar represent the effects of the SB 1609 reforms already in place.  Some of these reforms have already been reversed, and others may also be reversed in the near future, but it shows the effects as if the reforms were to remain fully in place.  The red line and bar represent a full reversal of all SB 1609 changes.






The graph and figures show that a complete reversal of SB 1609, the red line, would be a disaster for PSPRS.  Median contribution rates would continue to increase until 2033, and the median funded ratio would not reach 60% until 2023.  We have to remember that these are median rates and ratios and specific rates and ratios for individual employers could be much worse.  When we look at the blue and green lines and bars, they are nearly identical.  The blue and green bars are of nearly equal height, and the blue and green lines converge to a point where they appear like one line.  These lines also maintain a level median contribution rate until 2033.  The blue and green bars also maintain higher funding ratios over time and reach 60% funding approximately five years prior to the red bar.

This now brings us to the big question.  Why do we need a new set of reforms to PSPRS when the reforms of SB 1609 already appear to be working, and the proposed reforms show no improvement over SB 1609?  It goes beyond certain parts of SB 1609 being declared unconstitutional since the SB 1609 reforms could just as easily be proposed as a constitutional amendment as the proposed reforms.  We'll go into this further in the next post.