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PSPRS members: How to calculate what you paid in excess contributions to PSPRS

If you were wondering how much your refund from PSPRS was going to be, reader Rick Radinksy has discovered a relatively simple method of cal...

Sunday, December 30, 2012

The 2013 PSPRS plan: More Taxes

The following paragraph from PSPRS' 2012 Consolidated Annual Financial Report (CAFR) is included in the introductory letter by the Board of Trustees:
In the short term, and while awaiting final court decisions in the lawsuits challenging the changes made by the pension reform bill to the Plan's COLA and to member contribution rates, the Board of Trustees has directed the System's staff to urge the PSPRS constituent organizations and the employer groups to come forward with legislative proposals to add additional sources of revenue to supplement the revenue derived from contributions and investment return.  This seems to be the only means available in the short term to improve the Plan's funding status and diminish the upward trend of employer contribution rates.
In both its content and its presentation this passage verges on satire.  Filled with bureaucratic euphemisms, it attempts to disguise the Board's impotence and lack of ideas with a call to "constituent organizations and the employers groups to come forward with legislative proposals to add additional sources of revenue to supplement the revenue derived from contributions and investment return."

Translated into plain English, this means that the Board has no idea how to get PSPRS out of its financial crisis so they want retirees, employees (i.e. public safety unions), and local governments to pressure lawmakers to find new and creative ways to extract more tax money from Arizonans because PSPRS can not fund itself the way a defined benefit pension is supposed to.  This all comes from the group that is tasked with ensuring PSPRS is managed properly (Trustees were called Fund Managers up until 2009).

Of course, the problems with PSPRS are not fault of the current Trustees. All the current Trustees joined the Board after June 30, 2008, when most of the damage to PSPRS was already baked into the cake, and they are now presiding over a mess that was years in the making. However, this underwhelming statement of action can do nothing but disappoint PSPRS members and infuriate Arizona taxpayers.

Where the Board expects any "additional sources of revenue" will come from is a mystery.  Arizona taxpayers already pay a hidden tax in the form of fire insurance premium taxes that brought $12.2 million into PSPRS in FY 2012.  In November Arizonans  passed an initiative that limited property tax increases and refused to make permanent a one cent sales tax increase, so it is unlikely that there is a welcoming environment for anymore taxes, especially for a pension system that continues to lose money on its investments and takes more each year from employers and employees.  Furthermore, PSPRS' financial plight is unlikely to get much sympathy when taxpayers see PSPRS members so selfish that they are willing to drive PSPRS further into deficit so that they can continue to get annual raises.

2013 is not starting off very well for PSPRS.

Friday, December 21, 2012

PSPRS Members: Spend a few minutes reading PSPRS' 2012 Financial Report

The Arizona Public Safety Personnel Retirement System (PSPRS) Consolidated Annual Financial Report (CAFR) for the fiscal year ended June 30, 2012 is now available online.  Readers who are interested can find the report at the referenced link.  There will be more commentary on the report in future posts, but if you read only part of it, read the introductory letters by both the board of trustees and the system administrator starting on page nine of the CAFR.  They give a good idea of the legal and financial challenges facing PSPRS.

Friday, December 14, 2012

Working hard and retiring smart

I always cringe when articles like this one by Bloomberg, $822,000 Worker Shows California Leads U.S. Pay Giveaway, appear.  They decry the large overtime and sick leave payments and, invariably, highlight a few unfortunate individuals for exposure.  For better or worse, the salaries of public employees in Arizona are public record, and there are several searchable online databases that contain this information.

I can not speak to all government employees, but there is some additional explanation necessary for overtime and sick leave when it comes to public safety.  Due to the nature of their work, public safety departments try to  maintain constant staffing, which means they make every attempt to fill positions vacant due to sickness, injury, or vacation, so that the minimal level of service can be provide 365 days of the year.  This avoids brownouts or other service gaps that compromise public safety.  In order to do this, overtime becomes unavoidable and sick leave use is discouraged in order to keep those very same overtime costs down.

While there are no doubt plenty of abusers of overtime and sick leave policies, many of these costs are unavoidable.  If employees were not compensated for unused sick leave (usually at 50% of final hourly wage), they would simply use it.  We can debate the ethics of using sick leave when one is not sick, but the economically smart decision would be to use a benefit rather than lose it.  As for overtime, there are some employees that are more willing to work it.  Whether it is for financial reasons or sheer love of the work, some people are going to work more overtime while others may work none.  It is just another aspect of human nature that must be acknowledged and dealt with.

The real problem with overtime and sick leave sellback is how they are used to calculate pensions.  Since pensions, like PSPRS, are calculated on either an individual's high three-year or high five-year salary, the wise financial decision is to work overtime and sell back sick leave during those high salary periods.  This practice, often referred to as "pension spiking," creates an artificially higher pension that does not reflect what the individual paid into the pension over his total years of employment.  Pensions are supposed to use long-term compounding to achieve returns to pay future benefits, but pension spiking negates this advantage.

Employees should have overtime and sick leave sold back recognized in their pension, but there should be a formula where overtime worked and sick sold back over the employee's entire career is used to calculate a final pension, not just the a high years' period.  This would make more actuarial sense and protect the long-term health of the pension.

As a final note, the attempt to demonize individual employee's is not fair as one should always do what is best for oneself and one's family.  If an employee fairly utilized the rules in place to maximize his pension, the employee is not a villain.  The problem with the article referenced in the first paragraph is that egregious individual cases are the main takeaway.  This is a systemic problem, not a problem with individual greed.

Thursday, December 13, 2012

San Bernardino vs. CalPERS: Bust-out or betrayal

The ongoing battle between the city of San Bernardino and the California Public Employees Retirement System (CalPERS) was briefly dealt with in the post "What if?," but for a more detailed explanation of what happened in San Bernardino, readers should check out this article, (From suburb to basket case: How California city traveled the road to ruin).

San Bernardino may be the current poster child for out-of-control pensions, but it may go down in history for a more important reason.  It may become the city that changes how pension debts are treated in bankruptcy (CalPERS triggers legal fight with bankrupt San Bernardino over pension debt).  If San Bernardino can have its debt to CalPERS treated similarly to other liabilities, this would become a precedent that would alter the landscape for all public pensions.  If bankrupt government entities are only required to repay some portion of their pension debt, public pensions will be left with no way to recoup those lost funds to pay current and future retirees.  Even more important is the moral hazard that other cities, counties, etc. will feel less compelled to manage their finances as judiciously if they can vacate debts to their largest and historically untouchable creditor in bankruptcy court.  If San Bernardino succeeds, who else might consider a bankruptcy to get out from under their pension debt?

On the flipside, what other choice does San Bernardino have?  They can not pay their debt to CalPERS and remain a functioning city.  The debt is so large that it seems unlikely that San Bernardino could ever repay it, and attempting to do so would turn the city into just a transfer agent of taxes to CalPERS.  CalPERS seems to have the same bureaucratic indifference towards San Bernardino's plight that a large bank does toward a down-on-his-luck homeowner in foreclosure.  If CalPERS has to bust out San Bernardino to get its money, so be it.

Most everyone can guess how this will end because the little guy usually gets it in the end.  It just depends on which little guy gets the worst of it: the taxpayer or the employees and retirees.  If CalPERS wins, San Bernardino will continue its slow death as services are cut and residents and businesses relocate as the city spends its dwindling tax revenue on debt service.  If San Bernadino wins, it becomes more interesting.  If San Bernardino has its debt reduced, does CalPERS make up the shortfall so that San Bernardino's pensions will still be paid as promised to both retirees and current workers?  Or will retirees and current workers see their pensions reduced in a manner that corresponds to the shortfall?   I would bet on the latter since CalPERS has no realistic option to obtain additional funds, and CalPERS would soon find itself insolvent as well if it had to make up every shortfall caused by a bankruptcy.  Needless to say, the taxpayer is going to suffer under either scenario, but less so under the second one.

There is no good solution to the situation in San Bernardino, and even bankruptcy experts are not sure how it will end.  The one sure thing is that some people are going to get shafted.

Tuesday, December 11, 2012

PSPRS Members: Will a COLA be paid next year?

PSPRS' most recent actuarial report for the fiscal year ending June 30, 2012 shows that PSPRS has a funding ratio of 58.6% and had a -0.8% return for the year.  These numbers are important for retirees because they are used to determine whether PSPRS will pay a cost of living allowance (COLA) during the next fiscal year.  PSPRS must have a minimum funding ratio of 60% and earn at least a 10.5% return for the previous fiscal year in order for a COLA to be paid.  Neither of these conditions were met, but PSPRS retirees received a COLA for the current fiscal year because funds remained in the Reserve for Future Benefit Increases that existed under the old COLA system.

However, this should be the last COLA awarded under the old system as the Reserve for Future Benefit Increases will soon be exhausted.  The elimination of this old system, which virtually ensured COLA's would be paid every year, was a key part of the pension reform included in SB 1069.  With PSPRS' funding ratio below 60% and likely to continue dropping, the prospects of COLA's in the next few fiscal years are very dim.

Yet there is still a good chance that the old COLA system may return.  The previous post, (Have a COLA and a smile), detailed how some retirees in the Elected Officials' Retirement Plan (EORP) were able to successfully challenge a similar change to their COLA system.  This case is currently under appeal, and other cases, by both active and retired EORP and PSPRS members, are also challenging the changes to COLA's as a breach of a binding contract and a violation of the Arizona Constitution.

This may sound like good news, but if any or all of these cases are successful, they will eliminate one of the key reforms to PSPRS, slow PSPRS' return to financial health, and continue to reward retirees at the expense of current employees and taxpayers.


PSPRS members: Assumed rates of return can make an ass out of you and me

While the Khan Academy is a good starting point for understanding the public pension crisis, those desiring a more detailed explanation should read Andrew Biggs' paper Public Sector Pensions: How Well Funded Are They, Really?

Mr. Biggs' paper concerns how public pensions set their assumed rates of return (ARR).  Also called the expected rate of return, the ARR is probably the most important factor in determining the funding status of a pension.  The ARR is the rate a pension expects to earn on its investment portfolio, so the ARR determines the contribution amounts made by employees and employers.  The higher the ARR the more the pension can expect to earn through its investments.  A higher ARR also means lower contribution rates for employees and employers.  The danger is that if the ARR is too high, the earnings of the pension going forward will be insufficient to meet its future financial obligations..

Mr. Biggs' critical point is that public pensions have erroneously based their ARR's, currently averaging around 8%, on historic market returns.  While this may seem like a sound strategy for long-term investing, it ignores the tradeoff between risk and return.  Mr. Biggs writes that pension obligations are guaranteed obligations, and the expectation that they will be paid is virtually certain.  This means that a pension should invest in as risk-free a portfolio as possible.  This would mean investing in U.S. Treasury securities, or minimally, in high-grade corporate bonds at rates in the 3-5% range.  In order to get an 8% return, a pension has to make riskier investments.  If those higher-risk investments lose money, the pension will not be able to meet its future obligations.  This is where many public pensions are today.

PSPRS maintained an ARR of 9% for 20 years between 1984 and 2004, but the ARR has been incrementally lowered since 2004 and will be at 7.85% for the next fiscal year.  For PSPRS the past dozen years have shown the dangers of having an overly optimistic ARR, along with two market crashes.  I can remember being told, back in 2000 when I came on the job, about the investing genius of PSPRS' then-administrator.  It was true that Jack Cross, the administrator from 1986 to 2004, had produced impressive gains for most of that time, but the end of his tenure was marred by large losses caused by the dot.com bubble bursting.  After Mr. Cross' retirement PSPRS took actions to diversify its holdings more widely and not concentrate so heavily in stocks.

While some have attempted to point the finger at Mr. Cross for PSPRS'current underfunding (Risky investments, poor oversight lead to $1.6B taxpayer bailout of police and fire pension fund), he seems to be just a convenient scapegoat for what appears to be standard practice among the vast majority of public pensions.  Though he was never the investment master that he was made out to be, he was not doing anything out of the ordinary for either public pensions or other knowlegeable investors, both amateur and professional.  This also conveniently ignores the fact that Mr. Cross was long gone when the housing bubble burst, after diversification was supposed to limit the impact of another market crash.  The simple truth is that anyone can be a genius in a bull market, and anyone can be made a fool during a market crash.

This gets us back to Mr. Biggs' central argument.  Government employers and employees like high ARR's because they mean lower contribution rates, and everything had worked fine until reality intruded.  Public pensions simply can not invest like other investment pools because the cost of losses greatly outweighs the potential gains of more risky investments.  If a public pension lowers its ARR to match a risk-free rate, its underfunded liabilities will increase, and employees and employers will need to contribute more to get the pension to fully funded status.  As it stands right now, most public pensions can not and will not use a risk-free ARR and can only hope that the market, which already burned them twice since 2000, will pull them out of this crisis.

Thursday, November 29, 2012

The Khan Academy

If you do not have the Khan Academy as one of your favorites in you browser, you will do yourself a real service by checking it out and adding it.  Founded by a Salman Khan, a former hedge fund analyst, the Khan Academy is a non-profit online school dedicated to providing free education to anyone in the world.  Mr. Khan and his team provide thousands of teaching videos and exercises to test knowledge.  They have also developed tools that allow both teachers and students to learn smarter and get immediate feedback in order to track their progress through their coursework.  The Khan Academy is accessible to all ages, levels of education, and areas of interest.

I mention the Khan Academy now because there are now available videos about American civics that cover topics such as taxes, Medicare, debts and deficits, etc.  Included under the American civics tab are two videos about government pensions that many readers may find interesting.  Hopefully, they will continue to add more and get into more advanced topics of pension accounting and actuarial science.

Wednesday, November 28, 2012

Arizona Public Safety Personnel Retirement System (PSPRS) FY 2012 actuarial report

While wine enthusiasts eagerly anticipate the arrival of the beaujolais nouveau at this time of the year, others await the release of PSPRS' actuarial and consolidated annual financial reports.  The actuarial report for the fiscal year ending June 30, 2012 (FY 2012) was released to PSPRS' trustees on October 12, 2012 and recently became accessible online.  The actuarial report is compiled to allow PSPRS to calculate the employer contribution rates for the fiscal year starting on July 1, 2013 (FY 2014).

As a layman, I find many parts of the actuarial report difficult to understand, though the authors, to their credit, have done their best to make it user-friendly.  While a better analysis of PSPRS' current financial state will have to wait until the annual report is released to the public in the next few weeks, here are some of the key numbers included in the FY 2012 actuarial report:

  1. The funding ratio of PSPRS dropped from 61.9% to 58.6%.
  2. The employer contribution rate will increase from 27.18% to 30.44%.
  3. PSPRS had a market return on investments of -0.8%.  Under the 7-year smoothing that PSPRS uses to calculate yield, PSPRS produced a 3.2% return.  The smoothing technique is utilized to prevent large fluctuations in employer contribution rates from year to year.
  4. The smoothed 58.6% funding ratio would drop to 49% if the current market value of assets were used to calculate the funding ratio.
  5. The average annual retirement increased from $47,739 to $49,480.
  6. The average salary of active employees increased from $71,110 to $72,767.
  7. There are 18,542 active employees, 9,802 retirees and beneficiaries, and 1,496 employees in the Deferred Retirement Option Plan (DROP).  This means that 18,542 are paying into PSPRS, while 11,298 are not (note: some DROP participants continue to pay into PSPRS but will be refunded their contributions with interest when they retire).  This is a ratio of 1.64 active contributing employee to each retired or DROPped non-contributing indivicual.
There is little good news in this report, and the writers state that the funding ratio can be expected to continue to drop and the employer contribution rate to increase over the next few years.  For those interested in how their own employers stand, use the following link: PSPRS 2012 Actuarial Reports (By Employer).  The most important information given by these employer reports is an estimate of  how much the employer will have to contribute to PSPRS next fiscal year. 

Using the Tucson Fire Department (TFD) as an example, we can see that TFD is only 48.7% funded with about $416 million in liabilities and only about $203 million in assets.  The contribution rate for TFD will increase from 42.6% to 46.77%.  The following table shows TFD's annual contributions:

    Fiscal Year ended June 30       Annual Required Contribution

                  2003                                         $   1,724,572
                  2004                                         $   2,653,025
                  2005                                         $   4,621,390
                  2006                                         $   5,100,332
                  2007                                         $   7,260,919
                  2008                                         $   9,981,531
                  2009                                         $ 12,625,922
                  2010                                         $ 10,905,280
                  2011                                         $ 11,200,199 (est.)
                  2012                                         $ 12,271,596 (est.)
                  2013                                         $ 14,011,673 (est.)
                  2014                                         $ 16,962,862 (est.)

If the FY 2014 estimate is accurate, the city of Tucson will need to find another $3 million in order to pay just TFD's increased annual required contribution.  This extra money does nothing to enhance services, decrease call loads, or replace aging equipment, so it does not benefit Tucson residents in any way.  If revenue projections are not sufficient to make up this $3 million and the additional $5 million increase to the Tucson Police Department's annual required contribution to PSPRS, it is easy to figure out of which departments' budgets these costs will be paid.

If the 2012 annual report is anything like the actuarial report, it will be interesting reading.




Tuesday, November 27, 2012

Quinnie, the Pension Pollyanna

The previous post (A lesson for PSPRS members from Illinois' teachers) documented the perilous state of Illinois' pension system.  However, judging from this website, operated by the Illinois Office of the Governor, one might think the state's pension crisis merits the seriousness of a Sesame Street skit.

In a short video starring Illinois Governor Pat Quinn, the same man who floated the absurd idea of a federal bailout of his state's pensions, the viewer is treated to a lighthearted explanation of the pension crisis and its consequences for Illinois' citizens.  It even includes Squeezy, a cartoon python who squeezes the budgets for public safety, education, and healthcare.

While Governor Quinn's video is somewhat condescending to the citizens of Illinois, the rest of the website does include more serious facts and figures, so its goofball presentation might be forgiven if it was more honest about the sacrifices that will be required to solve the pension crisis and why the fight for reform will be so tough.  So far, all Governor Quinn is telling his citizens to do is "get involved," as if all that has been lacking so far is citizen engagement.  He needs to tell them that only a combination of tax increases, diminished government services, and retiree benefit reductions will solve the problem and that everyone must pay to clean up the mess.  He needs to identify who has traditionally fought against reform and who will fight against it this time around.  Finally, he needs to be frank about the ultimate consequences of putting off true reform: pensions defaults and bankruptcies of cities, counties, school districts, and other government entities.  If he refuses to level with his state's citizens about the stark choices ahead of them , Governor Quinn, not Squeezy the Pension Python, will turn out to be the real cartoon character.

Friday, November 16, 2012

Killing the Hostess

Arthur Scargill, the former leader of Great Britain's National Union of Mineworkers, was once asked under what conditions was it acceptable to shut down a coal mine.  His reply was that a mine could only be shut down when every last ton of coal was removed from the mine.  If it cost $100 to mine $10 worth of coal, that did not matter; or if keeping an unprofitable mine open cost the country millions of pounds, that did not matter either.  The mine existed to employ and provide income to mineworkers, all other considerations be damned.

Mr. Scargill would likely approve of the actions of the Bakery, Confectionery, Tobacco Workers and Grain Millers International Union (BCTGM) in its conflict with Hostess Brands.  After the BCTGM refused to abide by contract terms forced on them by a bankruptcy court and chose to strike, the bankrupt company decided to liquidate and layoff its entire workforce, including other non-BCTGM union workers.

The BCTGM has tried to make a case that the greed of owners and poor management are responsible for company's problems and that workers are being made to pay for their mistakes.  However, the Teamsters Union negotiated an acceptable package of pay and benefit cuts that it could present to its members, 53% of whom approved it.  Hostess Brands' offer included a 25% equity stake for workers and two seats on its eight-person board of directors.  The Teamsters, while acknowledging the problems with Hostess' owners and management, accepted the reality that cuts were necessary for the company to stay in business.  The Teamsters urged the BCTGM leadership to allow its members to vote on whether to accept the contract terms imposed by the bankruptcy court, but if a vote was done, the results were never revealed. 

The BCTGM accomplished a successful murder-suicide against Hostess Brands, but this Pyrrhic victory provides a fascinating look into a union completely divorced from reality.  The fundamental purpose of a union is to achieve more for its members collectively than its members can achieve individually.  If Frank Hurt, the aptly-named BCTGM president, has some higher vision in which the loss of 18,000 jobs (more than 11,000 of those jobs belonging to non-BCTGM members) collectively benefits BCTGM members, it is not readily discernible.  From the outside, it appears that individual BCTGM members would have been much better off if they had ignored their union representatives and returned to work.

In the end, the only collective benefit that BCTGM provided its members was anger, not leadership, not solutions, not hope, not jobs.  If members stay riled up about executive salaries and bonuses and how it is all management's fault, they will be insulted by a 25% equity stake and a quarter of the seats on the board of directors.  Keep members angry, and the changing American appetite and bad economy are just excuses to attack labor, not an imperative for a less contentious relationship between management and labor.  If nothing else, the BCTGM showed America what its fired up members can do to any struggling company that tries to mess with them.

The sudden demise of Hostess is a stark reminder that math always wins out.  At the bitter end, you can rage all you want, but the numbers will not change to appease you. 

Thursday, November 15, 2012

A line in the Michigan sand

Voters in Michigan, who voted for President Obama 54% to 45% over Mitt Romney, did something that might surprise many people.  They defeated state Proposition 2, the so-called "Protect Our Jobs," initiative by a margin of 58% to 42%.

Proposition 2 would have amended the Michigan State Constitution to make collective bargaining a right for both private and public sector unions.  Proposition 2 would have preempted Michigan legislators from passing the same type of law limiting collective bargaining by public employees that neighboring Wisconsin did.  Wisconsin unions responded to the law, known as Act 10, championed by Wisconsin Governor Scott Walker by initiating recall efforts against state legislators and the governor himself.  These recall efforts failed and Act 10 remains on the books, though it is being challenged in court.  A previous court challenge to Act 10 on different grounds was previously rejected by the Wisconsin Supreme Court.

For Michigan, a state that is home to the United Auto Worker, this is a remarkable rejection of a union-sponsored initiative.  Michigan voters will not give carte blanche to unions, nor will they tie the hands of their elected representatives in dealing with public sector unions.  The overwhelming rejection of Proposition 2 shows that voters in Michigan did not view the fight in Wisconsin as an attack on unions, and there is a limit to voters' tolerance of labor demands, even in a traditionally labor-friendly state like Michigan.

Wednesday, November 14, 2012

PSPRS members: How I learned to stop worrrying and love my pension

The previous post showed how much it would cost to purchase a lifetime annuity that paid the same benefits as a PSPRS member who retires after 25 years with an average high three-year annual salary of $67,000.  In this post we will see how much a PSPRS member pays to achieve his benefits.

There are several assumptions necessary to make these calculations, but for simplicity we will assume the member earns $67,000 annual salary over his entire career.  We will use the high member contribution rate of 11.65% that will begin July 1, 2013.  The member contribution rate is currently 9.55%.   Over a 25 year career, this member will have paid a total of $195,138 ($67,000 X 25 years X 0.1165) or about $300 biweekly ($7,805 per year) into PSPRS in order to receive a benefit of $41,875 per year.  In order to receive the same benefit from a lifetime annuity it would cost a male PSPRS member $801,000.

So how does this compare to an employee with a defined contribution retirement plan like a 401(k), 403(b), or 457(b)?  Among the assumptions we will make is that this employee earns the same salary and works the same number of years as the PSPRS member.  With no matching by an employer and a 5% annual interest rate, compounded monthly, the employee would need to contribute about $16,100 per year or $619 biweekly for 25 years to be able to purchase the $801,00 annuity.  Using the PSPRS assumed rate of return of 7.85%, compounded monthly, the employee would need to contribute about $10,300 annually or $397 biweekly to achieve the same annuity amount.  If the employer was especially generous and matched contributions up to 10% of an employee's salary, the amounts would drop.  In this case, a 10% matching would mean that the employer would match the employee contribution up to a maximum of $6,700 (10% of the $67,000 annual salary).  At the 5% rate, the member would only have to contribute $9,400 annually or about $362 biweekly.  At 7.85%, the member would only have to contribute $5,150 annually or about $198 biweekly.

This would make it seem that the private sector employee's potential retirement savings match up well with the PSPRS member.  However, this is illusory for one simple reason: the PSPRS member's contributions have no bearing on his ultimate retirement benefits.  The $195,138 paid by the PSPRS member guarantees him a $41,875 per year retirement benefit, regardless of the return his contributions earn.  The retirement benefit is also based on the average of his high three-years salary, so the PSPRS member will not pay the $195,138, yet receive benefits as if he did.  If he increases his high three years with overtime and sick leave sellback, this will further distort the cost-benefit discrepancy.  The difference will, of course, have to be made up by taxpayers when the required rates of return are not achieved. 

Compared to our less fortunate private sector employee, his contributions have everything to do with his retirement benefits.  He must start contributions early and at a very high level to take advantage of compounding over his working life.  He will bear all the market risk of his investments and must invest in such a way as to achieve above average returns.  The ability to save $800,000 over a 25-year career at a $67,000 annual salary would require a monastic frugality and/or incredible investing acumen.

The preceding examples were unrealistic because no employee earns the same salary his whole working life.  Futhermore, we utilized the most optimistic conditions for the private sector employee and the most pessimistic conditions for the PSPRS member.  Changing the conditions for either will only further show how much better the PSPRS member fares versus the private sector employee.  The PSPRS member ostensibly has a worry-free situation where he pays his contributions and need not concern himself with how that money performs.  The private sector employee will not only have to contribute more during his working life but also worry about his money until the day he dies.


Note: Bankrate.com Compound Savings Calculator was used to calculate returns.

Thursday, November 1, 2012

My pension will beat up your pension

For anyone interested in comparing how his or her Arizona PSPRS pension compares to those in other states, go to this link: (Calculate Your Public Pension).  I can not vouch for other states, but I checked the accuracy of its calculations against PSPRS' own pension estimator and found it to be right on.  I calculated a firefighter pension for an individual who began working in 2000 and retired with 25 years of service in 2025 at the age of 55 with an average salary of $67,000 for his high three years.  Here is how this pension stacks up against the other states' pensions available for comparison:

StateMonthlyAnnual Male  Female
Arizona$3,490$41,875  $800,986   $859,309
California$3,490$41,875 $800,986  $859,309
Connecticut$1,578$18,936 $479,327  $522,594
Florida$4,188$50,250 $961,184  $1,031,171
Illinois$3,490$41,875 $1,111,790  $1,214,942
Louisiana$4,653$55,833 $1,067,982  $1,145,745
Maine$1,619$19,430 $371,658  $398,719
Montana$3,490$41,875 $1,111,790  $1,214,942
New Jersey$3,629$43,550 $952,846  $1,031,423
New York$2,038$24,455 $521,216  $562,984
North Carolina$1,905$22,864 $437,339  $469,183
Oklahoma$1,675$20,100 $384,474  $412,468
Washington$2,792$33,500 $723,670  $782,283

The large figures under the male and female headers are the cost to purchase a guaranteed lifetime annuity, beginning at age 55, that paid the same monthly income provided by the corresponding state pension.  The variation in annuity cost between states with the same monthly payment is caused by variations in how COLA's are calculated for each state. The longer life expectancy of women accounts for the higher annuity cost for a female retiree.  These annuity figures give a good indication of the true value of someone's pension, especially in comparison to other retirement vehicles like 401(k)s and Social Security.

The current annual contribution limit for deferred compensation accounts like 401(k)s, 403(b)s, and 457(b)s is $17,000 per year with a $5,500 per year catch-up amount for those over 50.  These amounts may be increased each year based on inflation.  In order to reach the same $800,000 amount to purchase the equivalent annuity for an Arizona PSPRS retiree, an individual would have to put away about $862 per month ($10,344/year) for 25 years at a monthly compounded rate of 7.85%.  This assumes that someone could save this amount for all 25 years and earn PSPRS' assumed rate of return of 7.85%.  If we drop the monthly compounded rate to a more conservative 5.0%, the amount saved each month would increase to $1,345 ($16,140/year). For an individual in Maine, it would be necessary to put $624 per month away at a monthly compounded rate of 5% (or $400 per month at 7.85%) in deferred compensation to achieve the same monthly benefit as a Maine firefighter.  All of these contribution amounts could be reduced by any matching contributions made by an employer. 

As can be seen by the calculations in the last paragraph, the real takeaway here is not how Arizona's public safety pensions compare to other states' pensions, but how they compare to defined contribution pensions where most of the responsibility for saving falls on the worker, not the employer. It shows how difficult it is to save for retirement, even if one socks away the annual maximum into a deferred compensation retirement account.  It also shows how generous public safety pensions are.  In the next post, we will crunch some more numbers to examine how much a PSPRS member's total career contributions to PSPRS compare to his total retirement benefits.



Tuesday, October 30, 2012

A lesson for PSPRS members from Illinois' teachers

The following are current interest rates from several popular online bankers:

              Discover Online Savings Account             0.80% (APY)
              ING Orange Savings Account                    0.75% (APY)
              Ally Online Savings Account                     0.95% (APY)
              CIT Bank Online Savings Account            0.90% (APY)

These rates are not being given to advertise online banks but for some perspective. The State of Illinois Teachers' Retirement System (TRS), the pension for many of the states' teachers, announced that its 2012 fiscal year (FY) return was 0.73% (TRS earned less than one percent on its investments last year).  This rate was earned on a fund that has an assumed rate of return of 8.25% and during a year in which the stock market had positive returns (per the article, the S&P 500 grew 7.39% in FY 2012).  It would be interesting to know how much TRS paid in fees to its investment advisors and fund managers to get a rate of return that underperformed risk-free savings accounts.   If those fees are not already included in the 0.73% rate, TRS almost certainly lost money in FY 2012 once those fees are figured in. 

Illinois probably has the worst funded pension systems in the United States.  Illinois governor Pat Quinn has even brought up the idea that the federal government could bail them out by guaranteeing state bonds sold to cover current pension deficits.  This audaciously selfish plan would be a hard sell in the best of times and will never happen while trillion dollar annual deficits are being run up by the federal government.  However, this is a perfect window into the standard method of problem-solving used by politicians.

Governor Quinn seems to believe that Illinois can fall back on the "solution" that politicians have always used in the past: deferral and diffusion of current costs.  In this case, he believes he can defer TRS' liabilities even further into the future by selling bonds and diffuse the costs over an even greater number of taxpayers by using the federal government as the bonds' ultimate guarantors.  While this has always worked in the past, he now wants to push the problem up to the next level of government.   The problem is that the cavalry he is counting on to ride to the rescue of his state can not and will not help him.

An underfunded pension system that promises too much, saves too little, and can not even competently invest its meager funds to achieve risk-free returns has only two options: finding greater sources of funding or bankruptcy.  Illinois already has the largest budget deficit in the country, despite raising personal and corporate income tax rates in 2011, so we can see which option is more likely.  The reckoning due TRS will be ugly, with the wailing and gnashing of teeth by teachers' unions and retirees, who will see that all their political influence is impotent against financial reality.  The situation in Greece is a powerful cautionary tale for all Americans, and the ultimate fate of TRS stands as a powerful one for PSPRS members.

Friday, October 26, 2012

Pension Doomsday Scenarios I and II

The issues dealt with most often in this blog are financial issues, which can be complicated enough, though with a little analysis can be understood by anyone who is conversant in basic arithmetic.  Legal issues are another matter since the necessary background knowledge is quite extensive, as well the specialization necessary to understand any particular field of practice.

Included among the possible "doomsday scenario" for PSPRS are a major municipal bankruptcy or another financial crisis, but the most likely scenario that I can think of is a successful referendum to repeal the 1998 Arizona Proposition 100 (Arizona Public Retirement System Rules).  This proposition passed handily 61.4% to 38.6% and added to the Arizona Constitution this key statement, "Membership in a public retirement system is a contractual relationship that is subject to Article II, Section 25, and public retirement system benefits shall not be diminished or impaired."  The main reasoning behind Proposition 100 was to protect the state pensions from lawmakers that might misuse pension funds as had been done in other states and the private sector.

If Proposition 100 was repealed, it could allow the state to decrease benefits for retirees and the promised benefits of those currently working.  The language introduced into the Arizona Constitution is the basis for a successful court challenge to the cost of living allowance reforms that were part of SB 1609.  If Arizona taxpayers became sufficiently concerned about the financial burdens and service cuts being caused by the state's public employee pensions, Proposition 100 could be repealed. It would be a tough fight and any implementation of benefit cuts would assuredly be taken to court, but it remains very possible that it could be repealed.

The following piece by Nick Dranias (Taxpayer Backing? What Taxpayer Backing?) raises the possibility of another doomsday scenario.  The intriguing part of his piece is that it states that there exists no guarantee that state pensions like PSPRS will "perform as promised."  For a layperson like me this raises some intriguing questions.  As it stands right now, Arizona employers have always made good on the contributions demanded by PSPRS, even as they have grown enormously over the past decade to make up for PSPRS' underfunded status, but from this article it appears that employers' financial obligations are limited.

If PSPRS is a separate entity from employers, employers could argue that they are not responsible for the unfunded liabilities of PSPRS that were due either to poor investments or market downturns.  If an employer made matching contributions into an employee's 401(k) investment account and the account dropped because of bad investment choices, market volatility, or fraud, the employer would not be expected to make good on the losses in his investment account.  The employer fulfilled his obligation to the employee with the initial matching contribution and has no further liability.  The same could be said for an employer contributing to PSPRS.  An employer could legitimately argue that their obligation to PSPRS should not include any amounts related to investment losses that were solely the responsibility of PSPRS and its managers.  This would mean that an underfunded PSPRS would have to make up for its own losses and underfunded status.

This whole premise negates the protections of Proposition 100 because the only entity legally obligated to PSPRS members is PSPRS.  PSPRS can demand that employers pay more to make up for market declines or bad investment decisions, but employers seem to have the legal right to refuse to pay amounts related to investment losses.  They could argue that it is PSPRS' responsibility alone to manage and invest the funds it gets from employees and employers in such a way to ensure it has enough money to meet all its obligations .  The question is how do you split out the normal ongoing obligations from the investment losses lumped together in the employer contributions demanded by PSPRS.  Is it even possible to make this split, and has it ever been done before?  Could PSPRS successfully fight back by arguing that employers never provided adequate funding to begin with?

This doomsday scenario is scarier than the repeal of Proposition 100 since it would cut the generally assumed financial obligation employers have to PSPRS.  If a financially strapped or bankrupt employer successfully made this argument, so could all other employers.  PSPRS would then find it very difficult to recover from its underfunded status and would have to rely on the charity of employers to help it, and charity, like hope, is not a good plan for financial health.

Thursday, October 25, 2012

The incredible shrinking PSPRS

PSPRS' consolidated annual financial report for the fiscal year ending June 30, 2012 should be released in the next month or two.  PSPRS Administrator James Hacking has already hinted that this upcoming annual report will show that PSPRS' condition has worsened over the past fiscal year.  With an already inadequate funding ratio of 61.9% on June 30, 2011, PSPRS members should brace themselves for some bad news just in time for the holidays.

If we want to know how bad, we can look to this piece by Byron Schlomach of the Goldwater Institute (Government Pension Funds: In Worse Shape Than They Admit).  Mr Schlomach shows that PSPRS has a funding ratio of only 53.9%, a drop of 8% over the previous fiscal year.  He lists Arizona State Treasurer Doug Ducey as the source of this official funding ratio, though he does not say if this is the funding ratio that will be included in the upcoming annual report.

If a 53.9% funding ratio is not alarming enough, Mr. Schlomach shows that the funding ratio for PSPRS would only be 37.1% if PSPRS used a more conservative rate of return of 5%, instead of its current rate of 8.25%.  Remember that the Government Accounting Standards Board (GASB) will soon require public pensions to be more conservative about how they use rates of return to calculate pension liabilities (PSPRS members: A dozen more reasons to be concerned about your pension )

Rates of return necessarily rise with risks taken, so the trap PSPRS has fallen into is one where it is forced to seek a riskier 8.25% return in order to meet its financial obligations.   This sets up PSPRS for the same type of devastating losses it experienced following the dot.com bust and housing market collapse if there is another financial crisis (e.g. Eurozone problems, Middle East war, fiscal cliff, etc.).  The other alternative is to use a lower assumed rate of return on its investments and acknowledge that PSPRS is critically underfunded and not able to meet it future obligations without a major infusion of capital.  This could mean requiring PSPRS members and/or taxpayers to contribute more each year to PSPRS or cutting benefits to retirees.

PSPRS deserves credit for diversifying its holdings away from its stock-heavy portfolios of the past.  We can all hope that diversification combined with a sustained bull market and growing economy will lead PSPRS back to financial health.  However, it appears that hope is a losing strategy that PSPRS members should not rely on.

Friday, October 19, 2012

A little honesty goes a long way: another reason to vote NO on Proposition 121

As an addendum to this previous post (California Dreaming: Why Arizonans should vote NO of Proposition 121), another important reason Arizona voters should want to retain partisan primaries is that they are often the only arena where voters get a true sense of a candidates political views.

When candidates must compete with others in their own party, they are forced to distinguish themselves over various issues.  They can not simply agree with one another and say that they would all treat important issues the same.  This is especially important for general election voters since candidates will normally attempt to moderate their positions to attract those in the other major party as well as independents.

If Proposition 121 is approved, voters will lose this important forum.  Candidates will simply run as generic conservatives or liberals or will attempt to appear as moderates to appeal to independents.  Voters will never get a deeper insight into candidates' positions  Their choices may be limited to enigmas who feel the need to conceal their views to win over as many general election voters as possible.

Voters should expect candidates to be honest about issues, and unfortunately, partisan primaries are sometimes the only place where voters of all political persuasions may get to see behind a candidate's mask.  This is another strong reason to vote NO on Proposition 121 and keep partisan primaries as part of Arizona's elections.

Thursday, October 18, 2012

PSPRS members: Live long and prosper

One of the more compelling justifications for the generous benefits of public safety personnel pensions is that public safety personnel, particularly firefighters, have shorter life expectancy than those in other professions.  Point number three in this article by the Marin County Professional Firefighters (The Truth About Firefighter Retirement Benefits) is an example of the rationale for more generous pension benefits for firefighters. The article even states that including  longer-lived law enforcement personnel in the public safety pool skews the numbers to make firefighters look as if they live longer than they do.  They give no proof of this, and it seems a bit selfish and morbid for Marin County firefighters to criticize their law enforcement brothers and sisters for throwing off the average off by living normal lifespans.  Alas, these must be desperate times in Marin County.

PSPRS does not have a full breakdown of law enforcement and firefighters in either contributing members or retirees.  The closest they have is this data.  According to PSPRS's 2011 annual report, these are the top ten participating employers:

                                                     Employees         Percentage
    1. Phoenix Police         2,870                   15.40%
    2. Phoenix Fire             1,380                   7.40%
    3. DPS                           961                     5.16%
    4. Tucson Police           780                      4.18%
    5. Mesa Police              698                      3.75%
    6. Maricopa Sheriff      642                      3.44%
    7. Tucson Fire              500                       2.68%
    8. Pima Sheriff             494                       2.65%
    9. Glendale Police        397                       2.13%
    10. Scottsdale Police      387                       2.08%
                    Total Top Ten           9,109                   48.87%
                    All Others                9,529                    51.13%

As can be seen, two fire departments make up just a little over 20% of the top ten PSPRS contributing members.  I can only guess at the other 51%, but the top ten shows a ratio of 1 firefighter to every four law enforcement.  We can utilize this ratio for those like the Marin County firefighters who believe that law enforcement skew the longevity numbers, and the ratio shows that for every year longer that an average law enforcement officer lives would mean an average firefighter would have to live four years less to maintain the same average life expectancy for total public safety personnel.  If we use the current 78 year life expectancy of the average American male, the average law enforcement life expectancy would need to be 79 for the average firefighter life expectancy to be only 74 to maintain the total public safety average life expectancy at 78.

There is no evidence provided by the Marin County firefighters to support their contention that law enforcement skews the numbers.  Furthermore, the studies they cite about shorter life span do not address the issue of longevity.  They link to a Bureau of Labor Statistics study, but this study deals with on-the-job deaths, not longevity.  I have attempted to find data about life spans for professional firefighters and law enforcement through the Bureau of Labor Statistics and Census Bureau, but I do not find any.  It does not appear to be a statistical category that the government monitors.  As for the other link in the Marin County firefighters' article, it deals with the higher incidence of cancer among firefighters but does not quantify the risks.  This implies a shorter lifespan but gives no information about life expectancy.

For a verifiable source of data, we can go to the PSPRS annual report's actuarial section.  The actuarial assumptions are more grounded since they are used to determine PSPRS' liabilities.  The 2011 report lists the following life expectancies for the most likely age range of male retirees:


Age             Future Life Expectancy
50                          30.07 years
55                          25.86 years
60                          21.64 years

So for those who retire between 50 and 60, the expectation is that they will live to be between 80 and 81 years old.  This is 2-3 years longer than the average American male's life expectancy of 78 years.  If we apply the law enforcement-skewing hypothesis, this would mean that the average Arizona firefighter who retires in 2011 will only live to be between 66 and 70 years old.  If we use PSPRS' 1998 annual report, the average PSPRS male retiree could expect to live to between 77 and 79 years old; the average lifespan of an American male in 1998 was 74 years.  Under the law-enforcement skewing hypothesis, the average Arizona firefighter who retired in 1998 could only expect to live to be between 54 and 65 years.  When we extrapolate out some actual life expectancy numbers for firefighters, the notion that law enforcement are living longer and raising the average life span of public safety personnel that was put forward by the Marin County firefighters is shown to be self-serving nonsense.

The origin of the data used in the PSPRS reports is not referenced, but it is possibly propietary data gathered by insurance companies. Life expectancy may be different for different regions and cities, and FDNY personnel involved in rescue efforts after 9/11 would be an example of a notable exception of public safety workers who could be expected to have shorter life expectancy due to their exposure to hazardous conditions at Ground Zero.  However, the California Public Employees Retirement System (CalPERS) uses similar life expectancy numbers (CalPERS Debunks Myth of Shorter Life Expectancy for Safety Employees), so the numbers used by PSPRS do not appear to be out of line, at least for the southwest.

No one can deny that public safety is more dangerous than most other fields, but the average public safety worker reaching retirement can expect to live to the same age or longer than the average American.  Shorter life expectancy may have been the case for public safety personnel in the past, and this may explain the persistence of this notion.  However, without better data and analysis, the only conclusion that can be reached is that public safety personnel do not have a shorter life expectancy versus other professions.  Perpetuating this false claim not only misinforms the taxpayers but will negatively affect the financial sustainability of PSPRS and other public safety pensions.

Tuesday, October 16, 2012

A COLA comparison: PSPRS vs. Social Security

The Social Security Administration (SSA) announced that Social Security (SS) recipients will be receiving a 1.8% cost of living allowance (COLA) starting January 1, 2013.  SSA awards a COLA each year to keep recipient benefits even with inflation.  SSA calculates this COLA based on the Consumer Price Index for Urban Wage Earners and Clerical Workers, which the Bureau of Labor Statistics bases on the prices of a representative group of goods and services.

As has been detailed before here (Have a COLA and a smile), PSPRS has used a different method to calculate COLA's for its beneficiaries.  PSPRS places a portion of earnings in excess of its annual expected rate of return into a Reserve for Future Benefit Increases.  As long as funds remain in this reserve, an annual COLA is paid.  The recent pension reform legislation will eliminate this method, and once the Reserve for Future Benefit Increases is exhausted a new formula will be used to calculate COLA's in the future.

The following chart gives a comparison of how much a PSPRS member and a SS recipient would get with their respective COLA's.  The $1,433.00 monthly benefit used is based on the maximum Social Security monthly benefit in 2000.  PSPRS members are awarded a fixed COLA, regardless of their monthly benefit, while SS applies a COLA as a percentage of the recipients monthly benefit. The COLA amounts are what would be included in the next fiscal year's checks, so for PSPRS members, they would have begun receiving their 1986 COLA starting July 1, 1985, while SS recipients would have begun receiving their 1986 COLA starting January 1, 1986.

Year      PSPRS Member     COLA     SS Recipient    Rate/COLA
2000     $1.433.00                  $93.24     $1,433.00          3.5%/$50.16
2001     $1,526.24                  $98.17     $1,483.16          2.6%/$38.56
2002     $1,624.41                  $102.53   $1,521.72          1.4%/$21.30
2003     $1,726.94                  $111.90   $1,543.02           2.1%/$32.40
2004     $1,838.84                  $116.82   $1,575.42           2.7%/$42.54
2005     $1,955.66                  $121.76   $1,617.96           4.1%/$66.34
2006     $2,077.42                  $127.06   $1,684.30           3.3%/$55.58
2007     $2,204.48                  $134.34   $1,739.88           2.3%/$40.02
2008     $2,338.82                  $138.66   $1,779.90           5.8%/$103.23
2009     $2,477.48                  $146.74   $1,883.13           0.0%/$0.00
2010     $2,624.22                  $152.84   $1,883.13           0.0%/$0.00
2011     $2,777.06                  $153.58   $1,883.13           3.6%/$67.79
2012     $2,930.64                  $120.00* $1,950.92           1.7%/$33.17
2013     $3,050.64                      **        $1,984.09                    ?

Cumulative COLA's              $1,617.64                                $551.09

* This monthly benefit amount was approved for the July 2012 payment to PSPRS beneficiaries but may be changed after final investment results are calculated.
** No adjustment under the old method as the Reserve for Future Benefit Increases should be exhausted.  Any potential COLA will be based on funding ratio as well as the prior year's rate of return.  This change is being challenged in court.

After 13 years a PSPRS member will be earning over $1,000 per month more than someone receiving Social Security.  The starting $1,433 per month figure was used because it was the maximum monthly SS payment in 2000.  This meant that if you had worked from the age of 21 to 65, all while earning Social Security's taxable maximum, the most you could receive was $1,433 per month once you turned 65.  For a 55-year-old PSPRS member who retired with 20 years of service before fiscal year 2000, his high three-year average salary would have been only $34,392.  So for a PSPRS retiree, $1,433 per month amount  would seem to be an unusually low amount.

However, even if we used a more realistic $3,000 per month benefit, this member would still be making more than 50% more per month in FY 2013 than he did in FY 2000.  These annual increases in benefits certainly stretch the definition of cost of living allowances and could more accurately be termed raises.  COLA's are meant to prevent retirees from losing money as inflation raises prices.  Enriching retirees is not the purpose of COLA's.

We also need to keep in mind that between 2000 and 2011 there were two major market downturns, and PSPRS went from being well over 100% funded to being only 61.9% funded.  Forgone pay raises, decreased promotions, furloughs, and higher contribution rates all have been experienced by those still working and paying into PSPRS.  With PSPRS in such dire financial straits, it is a bizarre system where retirees get raises and workers earn less.

Monday, October 15, 2012

California Nightmare: Why Arizonans should vote NO on Proposition 204

"I have seen the future, and it works"
                    Lincoln Steffens, after his 1919 visit to the Soviet Union

In addition to Proposition 121, the Professional Fire Fighters of Arizona (PFFA) has also endorsed Arizona Proposition 204, the Arizona Sales Tax Renewal Amendment.  Proposition 204 would make permanent the temporary one cent state sales tax increase that Arizona voters approved as Proposition 100 in May 2010.  Proposition 100's intent was to close a large budget shortfall and prevent cuts to education.  The sales tax will end on May 31, 2013 if Proposition 204 is not approved in November.

Proposition 204 mandates how revenue would be spent with the bulk going to education and smaller amounts designated for social programs and infrastructure.  Proposition 204 also puts several restrictions on the state legislature.  These include setting a minimum spending level on education and restricting how vehicle license tax and highway user funds can be used.

As with Proposition 121, we again see the influence of California politics in another ballot measure, but a little more history is in order in the case of Proposition 204. In 1988 California voters approved Proposition 98, the Classroom Instructional Improvement and Accountability Act, which amended the California Constitution to require that 40% of general fund revenue go to K-12 education and community colleges.  The rallying cry at the time was similar to that of supporters of Arizona's Proposition 204: legislators can not be trusted to fund education and a designated revenue stream is needed to bring the state's schools up to where they need to be.

Proposition 98 has done such a fantastic job solving California's education funding problems that, flashing forward to the present, Governor Jerry Brown is now pushing a new referendum.  Proposition 30, the Sales and Income Tax Increase (2012), will raise the state sales tax by a quarter of a cent from 7.25% to 7.50%, as well as income tax on those earning over $250,000 a year.  These new revenues would again be used to fund K-12 education and community colleges.  The income tax increase is listed as temporary and is supposed to expire seven years after enactment.

Financially pressed California voters are currently being treated to veiled threats of blackmail.  College students are being threatened with tuition hikes, parents are being warned about the harm to their children, and all citizens are being warned about dire conditions if they do not vote for Proposition 30.

This should make Arizona taxpayers feel like Ebenezer Scrooge when the Ghost of Christmas Future showed him what lay ahead if he did not change his ways.  Arizonans are being sold the same nonsense that Californians were in 1988.  The revenue designated for education in 1988 was never about quality education but was meant to lock up funds for those special interests involved in education, mainly school and college employees and their union representatives.

The citizens of Arizona did a noble and unselfish thing in 2010 by approving a temporary one cent sales tax to close a historic budget gap.  Now supporters of Proposition 204 are trying to flog them with their own kindness.  Voters should realize that no amount of funding will ever be deemed enough by those advocating Proposition 204.  Voters may be frustrated by their legislators, but there still exists some influence over them through the ballot box.  If Proposition 204 passes, voters will further lose control of how Arizona is governed, empower special interests, and push Arizona closer to California's dysfunctional nightmare.

As general guidance, voters would be wise to reject any idea that comes from California.  Vote NO on Proposition 204.

Sunday, October 14, 2012

California Dreaming: Why Arizonans should vote NO on Proposition 121

Yesterday I received the Professional Fire Fighters of Arizona (PFFA) endorsement guide.  PFFA President Tim Hill's introductory letter explains PFFA's rationale for its endorsements and urges members to vote in November.  In addition to this standard verbiage, he also takes the opportunity to give a pitch for Proposition 121, the Open Elections/Open Government Initiative (aka "Top Two" Initiative).

Proposition 121seeks to eliminate partisan primaries and allow all voters, regardless of party, to vote in a single primary.  The two candidates receiving the most votes would advance to the general election, even if they belonged to the same party.  Californians passed a similar referendum, Proposition 14, in 2010.

Ostensibly this would appear to be a good idea, which allowed all voters, including independents, to pick the two candidates they like best.  Ideally, candidates would be forced to appeal to the greatest number of voters along the political spectrum in order to push themselves into the top two slots.  However, elections do not work under ideal conditions.

California's Proposition 14 is currently in effect and has already produced a situation in which a heavily Democratic district will have two Republicans candidates on the general ballot because four Democratic candidates split the vote to the point that none of them got enough to be in the top two.  This would not appear to be the wishes of the voters in this district.  However, this will most certainly be the last time something like this happens in this California district because future primaries will have no more than two Democratic candidates on the ballot.

Therein lies the problem with California Proposition 14 and Arizona Proposition 121.  These types of referenda will end up limiting voter choices by forcing parties to coalesce around a single candidate in an evenly split district or a pair of candidates in a district dominated by one party.  If a party runs too many candidates, they risk the possibility of having none of them on the general election ballot.  Someone will have to pick the one or two candidates on the primary ballot, and it will be party leaders, not voters.  This is redolent of the proverbial smoke-filled rooms of politics past where party bigwigs hand-picked candidates for office.  Instead of reducing the power of political parties, it will actually enhance it. (Note: according to this October 9, 2012 Arizona Republic article, Proposition 121 would create a 'top 2' primary in Arizona, the Arizona Republican party is officially opposed to Proposition 121, while the Arizona Democratic party has not officially taken a position, but has expressed reservations about it.)

Furthermore, the ability to disrupt primaries through the entry of bogus candidates to split an opposing party's votes will further turn primaries into a farce.  The other beneficiary of Proposition 121 will be special interests, who will exert more influence in the selection of primary ballot candidates and see a reduced slate of viable candidates.

Mr. Hill writes that Proposition 121 "will do more to moderate our state than anything we have ever seen," but moderation is neither the goal nor the purpose of elections in Arizona or anywhere else.  Elections express the will of the people, a noble goal in and of itself.  Proposition 121 will limit the choices of voters and put more power in the hands of political parties and special interests.

Vote NO on Proposition 121.

PSPRS: broke or broken promise

For PSPRS members, calculating one's pension is easy: take the average of your high three (or five) years of salary and multiply it by a percentage between 50-80% based on your years of service.  This amount is the annual retirement you will receive for the rest of your life.  However, the simplicity of this calculation belies the more complex system inside PSPRS where actuaries use mathematical models to project costs into the future and financial professionals have to make critical decision about where to invest funds in order to meet those cost projections.

The danger for PSPRS members is to simply think of the promise that is implied in their retirement calculation and not the mathematical and financial reality behind it.  The attempts to reform PSPRS are often portrayed as a breach of faith by government, despite the fact that Arizona's public employers have fulfilled their obligations to PSPRS and all other state pensions.  Unlike some public employers in other states, Arizona has not delayed or withheld funding to PSPRS or tried to hide its obligations in pension bonds, so the breach of faith explanation does not hold water.

The financial problems of PSPRS and other public pension are often portrayed as a broken promise since this idea is easier to sell instead of the reality that PSPRS has to survive in the same world as IRA's, 457(b) accounts, Social Security, and every other investment account.  PSPRS does not exist separately in its own financial realm where the only problem is legislators reducing funding or benefits.  Amity Shlaes addresses this situation very starkly in her September 28, 2012 article (Election won't prevent pension crash).

If it was financial self-delusion to think that dot.com companies could enrich investors without earnings or that home prices could rise indefinitely, then it is equally dangerous for PSPRS members to think their pension is isolated from market forces, common sense, or arithmetic.  Anyone who tells members that PSPRS' financial problems are only about broken promises is setting them up for disaster.

Friday, October 12, 2012

The future is the past

The comparison between  defined benefit pensions and defined contribution pensions is often portrayed as a moral choice.  Defenders of defined benefit pensions believe that they are an obligation that caring employers owe to their employees, while the defined contribution pensions are viewed as a cold-hearted abandonment of employees to their own retirement fate.  This good vs. evil model sets up those who advocate for defined contribution pensions as the bad guys.

This simplistic model is complicated by financial reality.  The principal justification for the defined contribution pension is that it allows the employer a way to predict costs.  By paying a known cost based on wages and salaries, the employer knows that there will be no future surprises that could affect their ability to operate.  In the private sector, this also benefits employees of a company that later liquidates by keeping their retirement funds in the control of the employee.  The public sector has an decided advantage over the private sector because public sector entities, though they can and do go bankrupt, will never cease to exist or lose the ability to bring in revenue.

However, the public sector still has to budget and predict future costs, and the inability to do this is what caused the public sector pension crisis.  At the time most public sector pensions were established the honest belief was that defined benefit pensions could be managed and funded in perpetuity, but unfortunately, political and financial reality intruded.  Now public employees will go into the future with uncertainty about their retirement benefits hanging over their heads.

This leaves the good vs. evil model a tired argument, but it is still being sold to citizens and public employees.  The real test is if a defined contribution pension can allow governments to plan for costs (and avoid bankruptcy) and provide a fair and adequate retirement for their employees.  The following articles show that it can be done:
(How three Contra Costa cities avoided the doomsday of pension plans)
(Social Security by Choice: The Experience of Three Texas Counties)
It is amazing that the three California cities were able to resist the siren song of CalPERS and public employee unions when they were peddling financial snake oil.  The city officials who resisted these appeals had an unusual grasp of finance and a rare concern for their citizens and workers.  The Texas counties are similarly remarkable for rescuing their employees from the losing proposition of Social Security.  These long-retired officials in California and Texas are exemplars, not only for their ability to design retirement plans that were mutually beneficial to taxpayers and employees, but also for their sober and realistic attitude about future costs and benefits.  Regardless of what eventually happens to public sector employee pensions, this same attitude should be the standard mindset going forward.

Friday, October 5, 2012

The usual suspects, part 6

This series of posts on the usual suspects concludes on a rather depressing note.  The public sector pension crisis is an unfortunate manifestation of several groups all doing what is best for themselves.  Some might also include public pension actuaries in this stew, but while they may be guilty of overly rosy expectations, they are bound by the laws politicians enact and must invest in a volatile and unpredictable market.  Neither politicians, Wall Street, nor public sector employee unions intended to create the public sector pension crisis, and the reader can make a judgment as to who has the most responsibility.  However, blaming any or all of them is pointless.

The previous five posts were meant neither as a defense nor an indictment of politicians, Wall Street, or public sector employee unions.  Instead, it was to show how each group acts in the best way it knows to maximize benefits for itself.  The more suspicious readers may believe that this is part of a conspiracy in which politicians, public sector employee unions, and Wall Street all collaborate to fleece the taxpayer.  Politicians promise public employee unions generous pay and benefits without the revenue to pay for them.  These promises eventually become unsustainable, so underfunded pensions are forced to invest in riskier and riskier Wall Street products in a losing game to bring pensions back to full funding.  Wall Street reaps large fees that they can also channel back to politicians in a neverending cycle.  Each group then points the finger at the others to confuse the taxpayer about the shared culpability.

The truth is much simpler and sadder.  There was simply no one who would stand up to the absurd and dangerous groupthink that afflicted politicians, Wall Street, and public sector employee unions.  The politicians in Stockton already had adequate evidence of the harm done by passing unsustainable pension costs into the future, yet when Lehman Brothers told them they could again push costs further into the future, they went for it.  They did this despite their own skepticism and professed ignorance of the bond market.  This never addressed the fundamental problem that got them into the mess in the first place--promising more than they could ever pay for--and kept right on with their standard behavior.

As for public sector employee unions, it is possible to see the dangerous groupthink here in Arizona.  The reforms to PSPRS are slowly being chipped away.  The public employee unions never really accepted the changes made to PSPRS, and they are fighting them out of sight of the public in the courts and legislature.  The notion that a benefit could be taken away is anathema to unions, and the cost, sustainability or fairness of a benefit is not a consideration, even if its existence affects the long-term health of PSPRS.

There is not a lot to say about Wall Street.  Pensions must work with Wall Street to earn the returns they need to pay retired members what they were promised, but pensions are under no obligation to buy or utilize defective products.  Wall Street is just as prone to groupthink as the others and will follow any trend that makes them money.  They will have no qualms about selling a popular or profitable product, even if there is a potential for poor returns or default.  Pensions should not count on Wall Street to help them earn enough to make up for bad political and financial decisions .

If this is the way the system continues to work, the public employee pension crisis can only end with the bankruptcy of defined benefit pensions and their replacement with defined contribution pensions.  Simple arithmetic tells us that costs can not be deferred infinitely to the future and that benefits can not accumulate infinitely without a way to finance them.  The only salvation will be if politicians and public sector unions begin to accept reality and honestly deal with the crisis before courts and angry taxpayers do.

Monday, October 1, 2012

The usual suspects, part 5

According to the Bureau of Labor Statistics' 2011 data, the rate of union membership in the private sector is 7.2 million workers, representing 6.9% of the private sector workforce.  Union membership in the public sector is 7.6 million members, representing 37.0% of the public sector workforce.   This 37% of public sector union membership is greater than the 35% all-time high of private sector union membership achieved in the mid-1950's.

The high level of public sector unionization is in addition to civil service systems that provides many job protections to public sector workers not available in the private sector.  So what accounts for this seeming  incongruity of the data?  Do public sector workers do more dangerous work, work longer hours, or have a more contentious relationship with management than private sector workers do?  The answer, of course, is no, so another explanation is necessary.

As was detailed in the prior post, public sector unions inherited the DNA of private sector unions.  They understand the importance of politics and politicians because that is where their power ultimately derives.  They also embrace the concept that benefits approved are benefits earned, and these benefits should never be given up without a fight.  However, these values are complicated by the different labor-management relationship in the public sector.

The most militant union member in the private sector knows that there is a limit to his demands.  If a business is driven into bankruptcy or liquidation, all previous agreements become subject to a court's discretion, and the court can diminish or eliminate benefits previously awarded.  The public sector unions have no concerns about a government entity ceasing to exist and municipal bankruptcy courts have so far protected promised benefits.  Public sector unions also have the unique ability to influence the choice of their ultimate bosses, politicians, through elections.  In the private sector, unions can not replace owners, and boards of directors choose CEO's of corporations.  Finally, the notion of a fair share of revenue that private sector unions can legitimately negotiate with management over does not exist in the public sector as their wages are paid with taxes.

This combination of private sector union values in conflict with public sector attributes makes for an interesting  battleground.  The battles in Wisconsin over the past 18 months show how ingrained the values of private sector unions are in public sector unions.  The elected government of Wisconsin fulfilled the promises they made to voters and acted within their legal authority to change the law in Wisconsin.  This is how politicians, as representatives of taxpayers, are supposed to act.  Public sector unions responded with a series of recalls, legal challenges, and mass protests.  The rhetoric used by public sector unions attempted to frame this conflict as a regression to a mythical dark time in the history of  public sector labor, rather than the governor and legislators doing what they thought was best for taxpayers, workers, and public school students.

The situation in Wisconsin brought to the surface the private sector tendencies of public sector unions by a clear and open challenge to their power and benefits.  The usual modus operandi is to influence politics behind the scenes in order to increase benefits whenever possible and fight any changes in benefits.  This has been a very effective strategy over the years and explains why union membership is so high in the public sector.

Sunday, September 30, 2012

The usual suspects, part 4

The last post showed how private sector labor unions achieved success, not through direct confrontation with management, but through politics.  The ability to influence politicians was critical for labor to get necessary legislation and government support to fight management on more equitable terms.  There is nothing wrong with this, as this is how all special interest groups, attempt to create favorable conditions for themselves.

Once the fights over issues like work hours, overtime, workplace safety, and collective bargaining were won after many years of struggle and sacrifice, unions had already internalized the idea that they had won their battles against management through force of will and combativeness.  These values became part of the self-image of private sector unions, and as a result, an adversarial attitude toward management became normal, even with employers who had already accepted unionization and viewed employees as valuable resources.

This adversarial attitude toward management caused private sector unions to portray any conflict with management as a grand struggle for workers' rights, even if it is over less lofty issues like pay, benefits, or job security.  For hardcore unionists, this attitude is perfectly logical.  If one views labor as the source of all value in the private sector, then any negotiation is over how much labor allows management, as representatives of owners or shareholders, to share in the fruits of the workers' labor. This means that any benefit extracted from management is an earned benefit, and any attempt to take away an existing benefit is a form of theft.

The Jobs Bank that GM created to pay laid-off workers would only be proposed by a union that believed that, once given, a job at GM was a permanent earned benefit.  This benefit could never be taken away, regardless of how many vehicles GM sold or how much money it earned.  While the Chicago Public Schools (CPS) believed it had the right as employers to dictate how teachers were evaluated, rehired after layoffs, or awarded for merit, the teachers' union had a different philosophy.  CPS's demands encroached on earned benefits and were worth striking over.  This was all in a city where 80% of its eighth-grade student are not proficient in math and reading and one of the most union-friendly in America.

So etched in the DNA of public sector unions are both a dependence on politics (and politicians) for power and a militancy about benefits.  Public sector employee unions arrived late on the scene but inherited these tendencies.  The next post will discuss how these tendencies affect the public pension crisis.

Friday, September 28, 2012

The usual suspects, part 3

The final member of the troika that gets blame for the public pension crisis are public sector employee unions.  Small government advocates are particularly critical of public sector employee unions.  They believe that the unions use financial and political clout to elect politicians that will maximize union members' pay and benefits.  The idea that a special interest group has a disproportionate influence in choosing its own boss is viewed by some as an egregious conflict of interest that hurts taxpayers through higher taxes and decreased services.  Before dealing with this issue, here is a little back story.

Labor unions are most associated with private sector industries since the titanic and sometimes violent struggles between workers and management occurred in the private sector.  The main problem in the private sector was that, as industrialization altered the labor market, more and more workers were forced into jobs where they had little control over their working conditions, hours, and pay.  They had dangerous and unhealthy working conditions, low wages, and long hours with no recourse except the ability to withhold labor.  Unions were formed to bring collective power to workers so they could strike, but strikes were often met with harsh responses from management and workers could often be easily replaced.  The contentious struggles between workers and management continued until the 1930's when significant legislation was enacted to give labor unions more power.

Government workers did not suffer the same hardships as private sector workers.  The main problem in the public sector was the patronage and spoils system in which political connections often determined whether someone could get or keep a job in government.  The federal civil service system was developed in 1871 to address the patronage and spoils issue by creating fairer hiring and retention policies that were based on merit and not who you knew.  State and local governments modeled their own  systems on it, and the system remains in place today.  The birth of public sector employee  unions is a relatively new phenomenon.

While labor unions ("the ones who brought you the weekend") will often take credit for every improvement in the worklives of Americans, they only affected change by becoming a political force.  Labor unions had to go to politicians to get what they wanted because the ability to withhold labor was simply not a powerful enough tool, especially in low-skill occupations, to force management to change.  However, with political power, unions were able to attack management from a side they could not defend.  Politicians and unions formed a symbiotic relationship and altered the balance between labor and management so both parties were on more equal footing.  So don't forget to thank self-interested politicians for the weekend since they are really the ones that gave Americans the 40-hour work week.

The National Labor Relations Act of 1935 (aka The Wagner Act) awarded workers significant powers in relation to management.  These included the ability to collectively bargain and certain job protections when they chose to strike.  Management's primary power, the ability to fire workers, was severely curtailed.  This placed workers on more equal footing with management.  Strikes and the threat of strikes allowed unions to extract concessions from management that were impossible before the Wagner Act.  These included concessions related to pay and benefits, as well as safety and working conditions.

Since the 1930's through the heyday of unions in the 50's and 60's and the decline in the 80's and on, much has changed in the private sector.  First, many low-skill jobs, where most union protections are needed, have moved overseas where wages are much lower.  Second, management had to change its philosophy as workers became more highly skilled.  As both management and workers have invested more in training and education, retention of skilled workers is more critical . Third, outrageous unions demands have crippled companies.  The epitome of this was the United Auto Workers (UAW) demand that General Motors (GM) create the Jobs Bank.  The Jobs Bank was a program that allowed laid-off GM workers to be paid even if they had no work to do.  These workers could sit all day and literally do nothing.  This program was discontinued after GM had to be bailed out by the federal government.  Finally, the necessity of private sector unions has been deemed unnecessary by many workers.  This is mostly because private sector unions have won all their important battles, and government agencies and courts now provide adequate protection to workers from any real or perceived sins of management.

The next posts will deal with how this history of private sector unions relates to public sector employee unions.