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Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?

In this blog I and multiple commenters have broached the subject of the suspect constitutionality of PSPRS' replacement of the old perma...

Thursday, April 26, 2018

PSPRS investment returns through February 2018 with a recommendation to the Arizona Legislature on how to better oversee PSPRS

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through February 2018, the eighth month of the current fiscal year (FY), with the past four FY end returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%





7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%
10/31/2017 0.64% 3.38% 2.18% 6.85%
11/30/2017 1.28% 4.70% 3.04% 10.10%
12/31/2017 0.66% 5.39% 1.00% 11.20%
1/31/2018 2.35% 7.86% 5.27% 17.06%
2/28/2018 -1.37% 6.38% -3.69% 12.74%

There is usually about a two-month lag in PSPRS reporting its investment returns.

We finally have data from February 2018, which was an extremely volatile month for the markets with the Russell 3000 losing 3.69%, versus a loss of 1.37% for PSPRS.  This means PSPRS suffered only 37.13% of the monthly loss of the Russell 3000.  On the other hand, PSPRS only captured 44.60% of the gain in January 2018.  In the latest information provided by the Arizona State Retirement System (ASRS), ASRS' fiscal YTD return through April 17, 2018 is about 9.0%.  PSPRS' Cancer Insurance Plan (CIP) has earned 6.42%, net of fees, fiscal YTD.  The Russell 3000 had another loss of about 2.5% for the month of March 2018, and as of April 25, 2018, the Russell 3000 is up about 1% for the month of April with two trading days left.  It will be a close call whether PSPRS achieves its assumed rate of return (ARR) of 7.4% by the end of June.

For the fiscal YTD, PSPRS has captured almost exactly 50% of the gains of the Russell 3000.  This once again fits PSPRS' pattern of returning 50-60% of the Russell 3000.  At this capture rate, the Russell 3000 must earn between 12.33% and 14.80% in order for PSPRS to earn 7.4%.  PSPRS' actuaries are recommending that PSPRS lower this rate to 7.3% based on an experience study from last year.  Tier 3 members have an ARR of 7.0%.  Any decrease in the ARR will increase current liabilities as investment earnings going forward will be lower, which means contribution rates for Tier 1 and Tier 2 members will have to increase.  This will cause an increase in employer contributions as Tier 1 and Tier 2 members' contribution rates are fixed at 7.65% and 11.65%, respectively.

There was a bill that was attempting to tie PSPRS' ARR to the 3-year rolling average of the 20-year treasury constant maturity rate.  The bill would have forced PSPRS to adopt an ARR that was not more than 2% higher than this rate.  PSPRS would have been forced to drop the ARR 0.25% every year until that target was reached.  Fortunately, this bill was amended, and the language was changed to limit PSPRS from raising its ARR unless PSPRS was at least 80% funded.  This original bill was foolish, as it would have forced PSPRS to drop its ARR down to somewhere around 5%, which would have devastated every employer in the state and hit Tier 3 employees in the defined benefit pension especially hard.  These Tier 3 employees are required to split normal costs and unfunded liabilities 50/50 with employers, and once the ARR dropped below 7%, they would see increases in their pension contributions.  There is no way that this could have worked.

If the Arizona Legislature wants to impose more control over  PSPRS, it should start by giving another state agency, such as the Office of the State Treasurer or the Auditor General, the authority to select PSPRS' actuaries, pension consultants, and accountants.  We know that PSPRS' Board of Trustees and senior management cannot be trusted.  See this passage from The League of Arizona Cities and Towns PSPRS Task Force Report from August 2015:
It is also important to point that prior to FY 2015-16, the cost of the PBI (permanent benefit increase) was not included in the employer contribution rate. Excluding the PBI from the calculation effectively underestimated the normal cost of the pension plan, causing it to manifest itself in the unfunded liability. This issue was identified by PSPRS actuaries several years ago, but the PSPRS Board did not take action to address it. (boldface mine)
Despite this, the PSPRS Board of Trustees is still allowed to contract for these services.  It would be far better if the actuaries, consultants, and accountants were reliant on another state agency to award these contracts.  Their work would be more independent and not influenced by concerns over continued business with PSPRS, if they shined a negative light on the Board or senior management. Their reports and recommendations would also circulate outside of PSPRS for review and analysis.  The PSPRS Board and senior management would then be under pressure to adopt the recommendations of these independent companies or justify to the Arizona Legislature why they cannot.  If PSPRS repeatedly ignored the recommendations without justification, the Legislature or Governor could make personnel changes at PSPRS or pass legislation to force good policies.  This would be a good first step in holding PSPRS accountable.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.

Wednesday, April 11, 2018

Let's get ready to rumble! Will we see Round 3 of Fields v. EORP, and how would it affect PSPRS members?

As some of you may have noticed, posts are getting less frequent here.  There simply isn't as much going on now that the Fields and Hall cases have been settled, or at least, as it relates to issues that concern most PSPRS members.  Understandably, most PSPRS members want information about things that will affect their own finances, particularly anything that might change current wages or monthly retirement checks.  So just as I was starting to consider closing up shop, PSPRS sent this out:
Referendum headed to ballot
Arizona voters will be asked to reform the permanent benefit increase formula for retired members of the Elected Officials Retirement Plan and the Corrections Officers Retirement Plan. This question will be wrapped into one referendum appearing on the November 2018 ballot.

The reforms to pension increases for CORP and EORP largely mirror those included in Prop 124, which voters passed in May 2016 to replace the permanent benefit increase (PBI) for public safety retirees with a cost-of-living-adjustment model.

The PBI reform to CORP was included in Senate Bill 1442, which was signed into law last year and created additional benefit reforms. The legislation impacting EORP, House Bill 2545, was signed into law this week by Governor Doug Ducey.

As was the case with Prop 124, the changes to CORP and EORP require subsequent voter approval to amend the state constitution to adjust the retiree benefit structure. 

The replacement of the permanent benefit increase (PBI) for CORP and EORP retirees is supported by the PSPRS Board of Trustees due to the urgency to bring stability and sustainability to PSPRS-managed retirement plans. Reform related legislation passed through the state Legislature with unanimous votes or overwhelmingly majorities.

Employers and those interested are strongly encouraged to read all reform legislation related to PSPRS-managed retirement plans. This email is not intended to provide details on all pending or proposed reforms.
The Arizona Legislature is going to try and change how the Elected Officials' Retirement Plan (EORP) and Corrections Officers Retirement Plans (CORP) pay post-retirement benefit increases via a voter referendum in the 2018 general election.  EORP and CORP still use a permanent benefit increase (PBI) system similar to what PSPRS had for Tier 1 members prior to the passage of Proposition 124 in May 2016, which replaced PSPRS' old PBI formula with a capped 2% cost of living allowance (COLA) that is based on the inflation rate in the Phoenix-Mesa area.  PSPRS' COLA applies to ALL PSPRS members, regardless of tier, though Tier 3 members have additional restricions on the payment of their COLA's.

For Tier 1 CORP members (retired before July 1, 2011), half of any annual investment earnings over 9% go into a reserve fund that is used exclusively to pay PBI's of up to 4% of the average normal benefit.  For Tier 2 CORP members (retired July 1, 2011 or later, a sliding scale is used to pay the PBI.  The scale is based on the funded ratio of CORP.  Tier 2 members can get a PBI from 2-4% based on the funded ratio between 60-80%.  You can read more about the PBI's in the CORP Member Handbook.  For EORP members, the PBI rules are the virtually the same.  EORP members are not designated by tiers (tiers are for the little people, apparently) but are broken into in two groups with the same cutoff date as CORP members.  The only major difference I see in the EORP Member Handbook is that the EORP PBI's are based on a member's individual benefit, not the average normal benefit. which makes sense since there is wide range in salaries among EORP members.

On March 23, 2018 the Arizona Republic published this editorial by PSPRS Board of Trustees Chairman Brian Tobin about the dire state of EORP.  While I do not want to get into what Mr. Tobin had to say in his editorial, we should note the complete cluelessness and utter lack of credibility of a public servant who will walk away with nearly $1 million in his first year of retirement telling taxpayers that they need to pony up more money to pay for a broken pension system.

It might be tempting for PSPRS members to say what is good for the goose is good for the gander, especially when it involves the benefits of "elected officials."  However, the 2017 consolidated annual financial report (CAFR) shows the average annual PSPRS service pension is higher than the average annual EORP service pension ($56,232 vs $54,860), while CORP's average annual service pension is only $28,977.  So even if you have no sympathy for retired politicians and judges, many of whom had other sources of income during their working lives and shorter careers in public service, we should not forget that CORP members will be especially hard hit by a change in their PBI's.  No CORP member is getting rich off PBI's, and in fact, the average active CORP member's salary is lower than the average benefit of PSPRS and EORP retirees. This might be something PSPRS members should  keep in mind when it comes to fill out our ballots in November.  The PSPRS press release states that both CORP and EORP will be covered under a single referendum, rather than separately, cynically assuming that voters will want to punish "elected officials" more than they want to help retired corrections officers.

If I had to predict, the referendum changing EORP and CORP's post-retirement increases from a PBI to a COLA will pass.  I cannot see any organized opposition from EORP members (There are just not enough of them.), and I have never seen CORP members (Are they even unionized?) flexing any financial or political muscle in Arizona.  I do not expect much to happen between now and November 6, 2018, but if the referendum passes, that's when I suspect things will really start to heat up because standing on the sidelines is EORP's arch-nemesis, retired Maricopa County Superior Court Judge Kenneth Fields.  His successful challenge to SB 1609 in 2011 was over the very issue of alteration of the PBI formula.  He also won another case against EORP in 2017 over how much employers were required to pay in contributions.  EORP currently has a fixed employer contribution rate that is grossly inadequate to fund the pension.

The curious thing about this is that EORP must be funded.  It makes no sense for Legislature could not set a fixed employer contribution rate and deliberately starve it of funding.  The obligation to retirees would not disappear because the state refused to make employers pay the necessary contributions.  EORP's defined benefit pension will have to be funded until the last member or survivor dies, and for some perspective, see this story.  So what was the purpose of setting a fixed employer contribution rate that is only half or one-fourth of what is needed?  I do not like conspiracy theories, but what else could it be but to force EORP into such a financial crisis that a radical change would be required.  For instance, maybe something like changing EORP's PBI to a capped COLA like PSPRS?  The Legislature tried to change the PBI's less radically in 2011, and Judge Fields beat them in court.  He beat them again last year.  If we can all see how this was set up, an experienced attorney and retired judge surely can, and I am sure that Judge Fields knew all along what the Legislature was trying to do.

Will we see round three in Kenneth Fields v. EORP?  I suspect so.  This is a man who has won a case against Maricopa County over retaliation by former Sheriff Joe Arpaio and the former County Attorney.  He also attempted to force former PSPRS Administrator James Hacking to attend remedial classes in the role of a public fiduciary.  We have previously discussed the constitutionality of changing PSPRS' PBI formula, and if you are not familiar with the issues, you can see this post, "Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?"  Long story short is that changing the PBI unilaterally, even if by voter referendum, appears to violate the contract clauses of both the Arizona and US Constitution, assuming the contract clauses trump Article 29 of the Arizona Constitution.

I would suspect that this is the legal argument Judge Fields would take to overturn any changes to EORP's PBI made via referendum.  He will have a tougher audience this time around, since Governor Doug Ducey has appointed three new justices to the Arizona Supreme Court since his first lawsuit agains SB 1609, though I do not know how may would recuse themselves from the case due to a personal stake in the outcome.   However, this is a case that seems tailor-made for the US Supreme Court since it would affect every public pension system in the country.  I suspect that no matter who wins, the loser would appeal to the highest court in the land.

While I believe that the PBI is horrible financial policy and should be eliminated, based on my layman's understanding of contracts, the electorate simply cannot vote to unilaterally alter a contract except in very extraordinary circumstances, like bankruptcy or fraud, and you certainly cannot initiate a Sopranos-like bust out of a pension in order to create extraordinary circumstances.  Suppose we have another financial crisis, not even one as bad as in 2008-09, could the legislature or special interest group place a measure on the ballot that implemented across the board cuts to existing pensions or raise contribution rates 5% or 10%?  How would those be different than Proposition 124?  It appears that the Arizona Legislature has gotten a taste for legislating via referendum.

So possibly standing in the way of all this is one man.  Judge Fields seems to be a disappearing breed, a man willing to fight on principle.  Does anyone really believe that he cares about the financial losses he might suffer over changes to the PBI?  You have to already be a successful attorney to get a judgeship in the first place, and it appears he is still quite active in the legal field.  So his lawsuits have been fought strictly to hold the government accountable.  Most of us expect promises to be kept, especially financial ones to those who are no longer working, but there are not that many that are willing to fight so hard to make sure they are.  So CORP members can take a little heart, they could have a white knight coming to their rescue, but they will have to wait until after the election to see.

What does this mean for PSPRS members?  If the EORP referendum passes and Judge Fields or some other EORP member (EORP has a lot of lawyers among its membership) sues to overturn it, I have not doubt that a CORP member will also file his or her own lawsuit the same way PSPRS members piggy-backed onto the EORP lawsuits by Judge Fields and Judge Hall.  However, PSPRS member unions started all this referendum nonsense in the first place, and it will be two and a half years since Proposition 124 was passed with no challenge made to it constitutionality.  Is there a timely filing requirement or other legality that would prohibit a PSPRS member from again piggy-backing onto an EORP lawsuit?  I guess like CORP members we will have to wait and see.  If this does happen, we will have a very interesting few years ahead of us.

We cannot end without remarking on the contrast between Judge Kenneth Fields and our "leaders" in Arizona.  We had the flaccid negotiating of the Professional Fire Fighters of Arizona (PFFA) and law enforcement unions against the Arizona Legislature and Reason Foundation.  These crack artists of the deal were willing to give away everyone else's benefits as long as they kept their deferred retirement option plan (DROP).  (Who cares about retirees keeping up with inflation or protecting Tier 3 members' paychecks from contribution increases?!  We are going to fight to the end to make sure Brian Tobin gets that $817,398 payment when he retires!)  Speaking of Mr. Tobin, this is someone who will not even stand up to PSPRS' management, the very group that he and the other trustees are supposed to oversee.  How can we expect him to call out the Arizona Legislature for manufacturing a crisis in order to bring about a "constitutional" change to diminish and impair retirees' benefits.  Can't Mr. Tobin at least stand up for CORP members now that a manufactured crisis for EORP is engulfing them, the lowest paid retirees of all?  He and the other Trustees represent CORP members as well.   How is that EORP members have one man fighting so effectively for them, while PSPRS members are stuck with such a group of spineless, selfish, and shortsighted leaders?  Too foolish to know that they were opening a Pandora's Box of pension chaos when they supported Proposition 124, they now want to open the lid again and see what other havoc they can let loose.

There is more to talk here on pension chaos and havoc, but that will have to wait for another post.

Thursday, March 1, 2018

Inflation, COLA's, the future of PSPRS, and investment returns through December 2017

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through December 2017, which is the midpoint of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%





7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%
10/31/2017 0.64% 3.38% 2.18% 6.85%
11/30/2017 1.28% 4.70% 3.04% 10.10%
12/31/2017 0.66% 5.39% 1.00% 11.20%

There is usually about a two-month lag in PSPRS reporting its investment returns.

Through the first half of the current fiscal year (FY), PSPRS is returning about 48% of the Russell 3000.  PSPRS has pretty consistently been capturing 50-60% of the Russell 3000 as this table shows:

Time Period Captured
FY 2014 54.80%
FY 2015 57.75%
FY 2016 49.53%
FY 2017 67.42%
Calendar Year 2017 53.90%
3-year Annualized 67.00%
5-year Annualized 53.72%
10-year Annualized 55.23%

The exceptions are FY 2017 and the 3-year annualized returns, but the 50-60% range seems to hold for long and short periods and for periods of high and low returns.  The only data missing is a year of longer period(s) of negative return(s).  It will be interesting to see what the month of February 2018 does to these numbers as the Russell 3000 lost 3.69%.  This loss is lower than mid-February when the Russell 3000 was down as much as 8%, but we will see what PSPRS' alternative investments do to counteract the losses in equities.  Unfortunately we will not get to see these numbers until April.  The Arizona State Retirement System (ASRS) had a Board of Trustees meeting on February 23, 2018, and its meeting packet included returns up through February 12, 2018.  I do not know why PSPRS cannot provide more up-to-date numbers in its meeting packets.  Between January 29, 2018 and February 12, 2018, ASRS' FY 2018 return dropped approximately 3% from about 11% to about 8%.  These ASRS numbers come from a graph on PDF page 29 of the meeting packet.

Through the end of December 2017, ASRS looks to have had a FY return of approximately 8.50%, over 3% more than PSPRS through the same time period.  PSPRS' Cancer Insurance Plan (CIP) has returned 6.82%, net of fees, through December 2017, also beating PSPRS by about 2%, when we subtract a half percent in fees from PSPRS' returns.  If this 50-60% capture range remains consistent, the Russell 3000 would need annualized returns of 12.33% to 14.80% in order for PSPRS to achieve its assumed rate of return of 7.40%.

The meeting minutes from January 2018 show that the Board of Trustees unanimously approved the use of the calendar year Phoenix-Mesa CPI-U to determine the cost of living allowance (COLA) for retirees.  The first of the new COLA's will be paid in FY 2019.  More detail about this is in this post from earlier this month.  The relevant statutory language about COLA's is:
A retired member or a survivor of a retired member shall receive annually a cost-of-living adjustment in the base benefit based on the average annual percentage change in the metropolitan Phoenix-Mesa consumer price index published by the United States department of labor, bureau of labor statistics, with the immediately preceding year as the base year for making the determination ....
The gist of this is that retirees will be getting a 2.0% COLA starting July 2018.  The average inflation rate in the 2017 calendar year was 2.5%, 2.2% in the first half of 2017 and 2.7% in the second half.  Starting this year, inflation numbers will be provided every two months, instead of just twice a year, which means average inflation calculation will be based on six rates, not just two.  The first of these two-month rates will come out in about two weeks.  The meeting materials from January 2018 showed the average inflation rates for Phoenix-Mesa from 2004 to 2017.  For a PSPRS member who retired in 2003 with a $3,000 monthly benefit, this is the difference between actual average inflation and the new COLA benefit:

               Average               Actual                   New
Year       Inflation               Cost       COLA     Benefit
2004       1.8%                     $3,054   1.8%      $3,054
2005       2.9%                     $3,143   2.0%      $3,115
2006       3.0%                     $3,237   2.0%      $3,177
2007       3.4%                     $3,347   2.0%      $3,241
2008       3.5%                     $3,464   2.0%      $3,306
2009       -1.4%                    $3,416   0.0%      $3,306
2010       0.6%                     $3,436   0.6%      $3,326
2011       2.8%                     $3,532   2.0%      $3,392
2012       2.2%                     $3,610   2.0%      $3,460
2013       1.3%                     $3,657   1.3%      $3,505
2014       1.6%                     $3,715   1.6%      $3,561
2015       0.2%                     $3,723   0.2%      $3,568
2016       1.6%                     $3,782   1.6%      $3,625
2017       2.5%                     $3,877   2.0%      $3,698

Over the 14 years since the member's retirement, the monthly loss of purchasing power would have been $179 or $2,148 annually.  This retiree would only be able to purchase about 96% of what he could in 2003.  This is not insignificant, especially if one is living on a fixed income.  If we eliminate the one year of deflation in 2009 and replace it with 0% inflation, the monthly loss goes up $55 to $234 and the annual total to $2,811, leaving the retiree only able to buy 94.5% of what he could in 2003.  In the 14 years, we have seven years with inflation under 2%, including one year of deflation, and seven years of inflation over 2%.  Outside of deflation or perpetual 2% inflation, retirees will always end up losing purchasing power over time.

If we project out another six years for this hypothetical PSPRS retiree using the current 2.5% annual inflation for 2018 through 2023, after 20 years in retirement the retiree will have lost about 7.5% of the value of his retirement.  If inflation is 3% over that same six-year period, the loss will be 10%.  Your guess is as good as mine as to what extent the recent market volatility has been driven by fears of higher inflation, but the prospect of higher inflation is certainly concerning if you are already retired.

This is again a reminder to those still working to fund another source of retirement income and not rely solely on your PSPRS pension.  If inflation does take off, it only benefits debtors like PSPRS, which can pay retirees benefits that will decrease in value over time, while it takes advantage of the rising rates of less risky investments like US Treasury and high-grade corporate bonds.  As recently as 2000, anyone could invest in a six-month certificate of deposit (CD) earning 5% a year at a time when the US inflation rate was 3.4%.  With inflation at this level, a PSPRS benefit would lose value every year, and it is critical to have some other retirement savings that can benefit from risk-free instruments like CD's to maintain a lifestyle.

As for current retirees, what options do they have?  Unlike the ASRS Board of Trustees, where one of the seven seats is held by a retiree representative, they have no representation on the PSPRS Board of Trustees, where four of the nine seats are filled by active PSPRS members.  The cost of the new COLA system is also included in the annual contribution rate that is split 50/50 between employers and Tier 3 employees (those hired in FY 2018 or later).  These Tier 3 employees (whose COLA will be determined on a sliding scale, based on PSPRS' funded level) are already getting a less generous, more restrictive COLA than Tier 1 and 2 members.  Why would they push for higher COLA's for current retirees when this will eat into their wages, especially after the previous generation shafted them?  They are more likely to push for more non-PSPRS retirement enhancements like matching contributions to their deferred contribution accounts.  Tier 3 members will likely become the majority of active members within 10-12 years.

This situation was brought to us by the blue falcons in the leadership of the Professional Fire Fighters of Arizona (PFFA) and, to a lesser extent, the state law enforcement unions, who played Sancho Panza to the PFFA in this matter.  Not content with just selling out existing retirees and future public safety workers, they set the precedent of altering contractually-bound pension benefits via referendum through their support of Proposition 124.  This will come back to haunt all PSPRS members if there is another pension crisis in Arizona, especially when we have been "led" by people like PFFA President Bryan Jeffries who told the New York Times, public safety members "should volunteer to cut their own pension benefits" during a financial crisis.  However, the final deal he and others brokered with the Arizona Legislature did clarify that he didn't mean his generation of public safety members should sacrifice any benefits, just those that came before and after him.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.

Thursday, February 8, 2018

PSPRS to members: Keep calm and don't think about annualized returns

As we discussed in the last post, we will not know for about another two months if PSPRS' investment strategy will show the success of its more conservative approach.  (The Russell 3000 dropped about 3.65% today and is down 8.33% for the month of February 2018.)  However, PSPRS will not wait that long to see evidence.  They came out with a press release on February 6, 2018 which boasts that "the current PSPRS portfolio is 72 percent less volatile than the Standard & Poor (S & P) 500 Index."  This kind of public relations is what you buy with the $95,000 a year taxpayers shell out to PSPRS spokesman Christian Palmer and the $72,000 paid to an outside consultant.

As PSPRS is wont to do, they only present half the picture.  While controlling volatility is part of the picture, PSPRS still has to balance this with maximizing returns.  The time frame PSPRS used to graph its volatility ran from May 2008 to November 2017.  This period starts with the market crash in 2008 and runs to the latest investment returns PSPRS reported.  I wanted to compare PSPRS' returns with those of the PSPRS Cancer Insurance Plan (CIP), Arizona State Retirement System (ASRS), the Standard & Poor (S&P) 500 Index, and a Vanguard 3 Fund Portfolio that Ben Carlson uses to measure endowment performance at his blog, A Wealth of Common Sense.  This Vanguard 3 Fund Portfolio is a  mix of 53% US stocks, 27% foreign stocks, and 20% bonds.  The time period for the following table is for the period ending June 30, 2017, which is necessary for consistency purposes.  Here are the annualized rates of return for the various portfolios over one, three, five, and 10 years:
 

1-year 3-year 5-year 10-year
PSPRS 11.85% 5.27% 7.95% 3.98%
CIP 10.12% 4.34% 7.64% 5.36%
ASRS 13.90% 5.70% 9.60% 5.60%
S&P 500 16.80% 7.72% 12.96% 4.86%
Vanguard 14.90% 7.00% 8.30% 6.50%

PSPRS' annualized returns over the 10-year period is lower than all the other funds.  It might be fairer to look at the 5-year returns since PSPRS had not fully implemented its strategy ten years ago.  During the 5-year period, PSPRS still lags all but its own CIP, a fund that consists of 50% US and foreign stocks, 45% bonds, and 5% commodities.  ASRS bested PSPRS by 1.65% over the five year period, and the S&P 500 bested PSPRS by 5%.  A 5% annual return on a $9 billion portfolio would earn nearly $2.5 billion over five years, so while the S&P 500 was more volatile, it also earned a significantly higher return for that added risk.

If we include reinvested dividends in the 5-year period that ended June 30, 2017, the S&P 500 earned 15.28%.  This extra annualized return of 7.33% would have earned PSPRS an additional $3.82 billion.  We all know that there is a correlation between risk and reward, but it is deceptive of PSPRS to point only to the volatility of the S&P 500 without acknowledging that the S&P 500 had nearly double the return of PSPRS' portfolio.  Even the less impressive additional 0.88% annualized return over ten years would have earned PSPRS an additional $824 million.  With reinvested dividends, the S&P 500 had an annualized 10-year rate of 7.10%.  This additional 3.12% per year would have earned PSPRS an additional $3.24 billion over ten years.  Unfortunately, there are no volatility numbers for the other portfolio.  Regardless, it is clear that the volatility/return tradeoff has been favorable for the S&P 500, but PSPRS does not want members to see this full, honest picture

While PSPRS likes to make absurdist claims on incomplete and cherry-picked information, we should not do that as well.  It is not realistic to solely compare PSPRS against the S&P 500, as no pension or endowment would ever be 100% invested in a single market index, or even the Vanguard 3 fund portfolio.  A fairer comparison would be against another pension fund like ASRS that deals with the same risk/reward conundrum.  Over the five and ten year periods, ASRS has bested PSPRS by 1.65% and 1.62%, respectively.  The extra 1.65% would have earned PSPRS an additional $767 million over five years; the extra 1.62% would have earned an additional $1.57 billion over ten years.

Despite the whining and excuses of PSPRS Board of Trustees Chairman Brian Tobin and PSPRS Chief Investment Officer (CIO) Ryan Parham, ASRS has consistently outperformed PSPRS while operating in the same market conditions.  Yet Mr. Parham, who was paid $268,000 in 2016, is the second highest paid in employee in the Arizona state government (Note: this does not include Arizona university system employees).  Who was the highest paid Arizona state government employee?  Why it was Paul Matson, the Director of ASRS, who made $285,230 in 2016.  For some perspective, Karl Polen, the CIO of ASRS, made $201,420 in 2016, while Jared Smout, PSPRS Administrator, made $210,000 in 2016.

So Mr. Matson, who has successfully run ASRS for 15 years, makes only $17,230 more than Mr. Parham.  Even more perplexing is how Mr. Parham is paid $57,000 more per year than ASRS' CIO.  The combined salary of Mr. Matson and Mr. Polen is $486,650.  The combined salary of Mr. Smout and Mr. Parham is $478,000.  Looking at the millions and billions in higher ASRS earnings, I think that the $8,650 more paid to Mr. Matson and Mr. Polen is the bargain of the century.

The difference in performance and management between ASRS and PSPRS is stark, and while ASRS continues along its steady path of stronger earnings, PSPRS has to blow smoke.  Until PSPRS has some evidence to show us that their strategy is working, they might do something useful for members, like getting their software working properly so members can get retirement estimates.  I think seven months is enough time for members to wait for this to be fixed.

Tuesday, February 6, 2018

PSPRS investment earnings through November 2017 (with some discussion about COLA's)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through November 2017, which is the fifth month of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%





7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%
10/31/2017 0.64% 3.38% 2.18% 6.85%
11/30/2017 1.28% 4.70% 3.04% 10.10%

There is usually about a two-month lag in PSPRS reporting its investment returns.

PSPRS' Board of Trustees published its January 2018 meeting materials last week, but in light of the market conditions over the past several days, it is nice to discuss them now, rather than earlier.  The Russell 3000 is down 6.00% for the month of February 2018 as of February 5, 2018, so this will possibly be the first real test of PSPRS' investment strategy.  I say "possibly" because we are only five days into February with quite a bit of time for the market to recoup its loss or even end with a gain.  Regardless, we will have to wait two months to find out the end-of-month (EOM) results for February 2018.

In the meantime, the November 2017 EOM results provide us with a picture of the market since the election.  For the current FY, PSPRS has earned 46.50% of the Russell 3000 (4.70% vs. 10.10%, respectively).  From December 1, 2016 through November 30, 2017, PSPRS' did a little better, earning 53.40% of the Russell 3000 (10.66% vs. 19.93%, respectively).  This tracks with what has been PSPRS' usual pattern, earning 50-60% of the Russell 3000, with last fiscal year being an exception. 

For some perspective, PSPRS' Cancer Insurance Plan (CIP) has earned 5.85% FY-to-date and 15.03% over the preceding 12 months.  These earnings were net of fees as opposed to PSPRS', which are gross of fees, making the CIP's earnings even more impressive compared to PSPRS'.  The Arizona State Retirement System (ASRS) has earned 3.5%, net of fees, through September 30, 2017, which is the latest number available on ASRS' website.  This handily beats PSPRS' return, gross of fees, through the same period.  Whether PSPRS' conservative strategy pays off remains to be seen, but through November 2017, PSPRS has lagged both the CIP and ASRS.

There was one other interesting bit of information in the meeting materials which will be especially pertinent to retirees. This is what it says about calculating the new cost of living allowance (COLA), which will be paid for the first time next fiscal year:
QUESTION: WHICH YEAR SHOULD WE USE AS THE BASE YEAR?
Since 2001, the Phoenix-Mesa CPI has been updated by the Bureau of Labor Statistics every 6 months.  Beginning later this year, the Phoenix-Mesa CPI will be updated every 2 months after each even month  (February, April, June, etc.). The results are typically available about two weeks after the end of the  month. For instance, the June, 2018 results will be available July 12, 2018. There are advantages and disadvantages of using the fiscal year vs. the calendar year as the basis for determining the COLA that
will be granted to benefit recipients each July 1st.
The biggest advantage of using the fiscal year as the base year (in other words, measure CPI from June 30 to June 30) is that the COLA is granted closer to the period of time the price of goods is being measured.  For instance, if the price of oil increases during the January to June timeframe, the COLA granted on July 1st will better reflect that increase.
The biggest advantage of using the calendar year is that staff would have enough time to calculate, communicate and process COLAs by July 1, as is required by statute. Any delays in the Department of Labor calculating and publishing the CPI would not have an effect on getting the COLAs processed timely. While we can’t comment on the intent of the legislature, it is important to note that typically when the statute refers to a fiscal year, it specifically states “fiscal year.” In the two sections of statute that refer to how the new COLA is calculated (§38-856.05 and §38-856.06), the statute does not specify “fiscal year” but rather states “year.” That may be an indication that the legislature intended us to measure the CPI on a calendar year basis. 
Recommendation: Staff recommends that we use the calendar year that precedes July 1 as the base year when calculating the amount of the COLA.
QUESTION: WHICH CPI SHOULD WE USE?
The Bureau of Labor Statistics publishes two measures of the Consumer Price Index—the CPI-U and the CPI-W. The CPI-U is the Consumer Price Index for all urban consumers. Approximately 89% of the population in the Phoenix metro area is included in this measurement. The CPI-W is the Consumer Price Index for a subset of the CPI-U population. It includes wage earners and clerical workers only, and represents approximately 29% of the population. Retirees who are not earning a “wage” are included in the CPI-U, but not in the CPI-W. Likewise, unemployed people are included in the CPI-U, but not in the CPI-W. In general, the CPI-W is more volatile because it uses a smaller sample population. According to the Bureau of Labor Statistics, in most cases across the country the CPI-W increases more than the CPI-U. In looking at the increases over the past 14 years in Phoenix, however, the CPI-U has outpaced the
CPI-W in 9 of those years. Because the CPI-U population coverage is more comprehensive, it is typically the measurement used in most escalation agreements.
Recommendation: Staff recommends that we use the CPI-U as the measurement when calculating COLAs since retirees are included in that population and it is less volatile over time.
Remember that the new COLA will be the lower of either the Phoenix-Mesa CPI or 2%.  The staff recommendations would have to be approved by the Board of Trustees, and they will almost certainly go along with their own staff's recommendations.  For retirees, the main issue is the rate of inflation.  The Phoenix-Mesa CPI-U annual average rate for the 2017 calendar year was 2.5%; for the FY that ended June 30, 2017, it was 2.25%.  Under either base year rate, retirees would be limited to the 2.0% COLA.  Historical rates for the Phoenix-Mesa CPI-U can be found on PDF page 212 of the meeting materials. 

If the Board of Trustees accept the staff recommendation on the base year, retirees will lag inflation by 0.5% in fiscal year 2019.  This may not seem like a lot, and for a retiree on a $50,000/year retirement, it would only amount to a "loss" of $250.  The "loss" is the amount of goods and services the retiree will no longer be able to afford in the second year.  However, the compounding effect over ten years of a 0.5% difference between the COLA and actual inflation will leave the retiree with only 95.7% of the purchasing power he had in the first year and a "loss" of  $2,689.  A 1.0% difference will leave the retiree with only 91.6% of purchasing power and a "loss" of $5,485 in the tenth year.  If one has another source of retirement income, such as a 457, Social Security, or an IRA, there will be some cushion against inflation.  This makes it all the more urgent that current workers utilize any and all retirement savings vehicles available to them.  I have bookmarked the Phoenix-Mesa CPI-U page at the US Bureau of Labor Statistics (BLS) for future reference.  

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.

Friday, December 1, 2017

PSPRS investment returns through September 2017 (with some information from PSPRS' FY 2017 actuarial report)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through September 2017, which ends the first quarter of the current fiscal year (FY), with the FY end 2014, 2015, 2016, and 2017 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%
6/30/2016 -0.32% 1.06% 0.21% 2.14%
6/30/2017 0.22% 12.48% 0.90% 18.51%





7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%

There is usually about a two-month lag in PSPRS reporting its investment returns.

Through the first quarter of FY 2018, PSPRS has reverted back to returning 50-60% of the Russell 3000, achieving 59.5%, gross of fees, of the return of the Russell 3000.  For FY 2017 PSPRS returned, net of fees, 64% of the Russell 3000, which was an improvement over the previous three fiscal years.  It will take several more fiscal years to see if FY 2017 was the start of a trend or just a blip, but 60% still seems to be the high end of the range for PSPRS in comparison to the Russell 3000.

PSPRS' November 2017 meeting materials also contained the draft of PSPRS' FY 2017 Actuarial Report.  Anyone interested can find that draft report starting on PDF page 298 in the meeting materials.  The aggregate employer contribution rate for Tiers 1 and 2 increased slightly to 51.93% from 51.84%, meaning that all the state's employers combined will contribute $51.93 for every $100 in pensionable wages for all the state's active Tier 1 and Tier 2 members.  Individual employer contribution rates for Tier 1 and Tier 2 employees vary widely and can be found on PDF pages 369-374.   If anyone wants to see if an employer's rate has increased or decreased from the previous FY, FY 2016' individual actuarial reports can be found here.  The employer contribution rate for my employer increased by almost 9%, creating more budget problems for my employer as several million more will have to be paid to PSPRS starting in July 1, 2018.

PSPRS' aggregate funded ratio decreased  to 45.30% from 46.00%.  Individual employer's funded ratios can be found on PDF pages 363-368.  These ratios run from a couple in the single digits to a few that are over 200% funded.  Once again, you can compare FY 2017 to FY 2016 by checking your individual employer report.  My employer's funded ratio dropped 0.10% but still remains under one-third funded.  Most of the major public safety employers, like DPS and those in the Phoenix Valley, appear to be 30-50% funded.

One last interesting tidbit in the meeting materials was the current breakdown of Tier 3 members who chose the defined benefit (DB) versus the defined contribution (DC) plan.  Out of 187 Tier 3 members, only twelve chose the DC plan, 6.4%.  As more Tier 3 members join the ranks and the DC plan becomes better established, it will be interesting to see if this percentage grows over time.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% in FY 2014, 3.68% in FY 2015, 0.63% in FY 2016, and 11.85% in FY 2017.