Pennywise and pound-foolish: PSPRS staff raises versus the DROP

This article by Craig Harris of the Arizona Republic details the somewhat controversial decision by the Board of Trustees to give raises to several members of PSPRS' staff.  The motion passed by a vote of 4-3 and awards a combined total of $81,696 in raises to five PSPRS employees.  Neither PSPRS Administrator Jim Hacking nor Chief Investment Officer Ryan Parham received raises.  These raises come on the heels of a more recent controversy over bonuses due to PSPRS staff and the subsequent cancellation of those bonuses.

I have already written about how the bonus controversy is an unnecessary distraction from PSPRS' real problems, and these raises are even more irrelevant to PSPRS' finances.  Mr. Hacking states that while these employees are getting raises, there will not be a net increase in PSPRS' payroll because three other employees recently resigned.  These employees, who the article states "quit in protest following disputes with Hacking over whether trust management inflated the values of real-estate holdings," gave PSPRS $363,300 in salary savings.  Mr. Hacking justified the raises as fair compensation for the remaining employees' increased workload.

Even though PSPRS' payroll will still be $281,604 lower, this did not stop criticism.  The article's reader comments are unanimously negative.  The article itself has only one quote expressing displeasure about the raises.  The article states:

Rich Edwards, a retired Arizona Department of Public Safety officer who now is a Glendale police officer, called the board’s actions “ridiculous and crazy.” He said it was surprising the board would grant the raises when retirees had their pensions frozen.

On the face of it this seems like a fair comment, but what do the numbers say?  Since Mr. Edwards has a connection to both the Arizona Department of Public Safety (DPS) and the Glendale Police Department (GPD), let's take a quick look at the Deferred Retirement Option Plan (DROP) numbers for those departments.

The latest PSPRS actuarial report gives us the following data about Arizona DPS and GPD.  DPS and GPD pensions are both underfunded; DPS is badly underfunded at 46.10%, while GPD is only 54.60% funded.  DPS has 141 DROP participants, while GPD has 25.  Looking at the highest officer salaries in each department we find that a topped-out, step 9 DPS officer makes $62,660 in base pay.  A topped-out, step 8 GPD officer makes $72,861 in base pay.  The current fiscal year employee contribution rate for all employers is 10.35%.

Participants in the DROP either make no employee contribution (if they had 20 years of service before January 1, 2012) during their time in the DROP, or they receive their accumulated employee contributions back plus interest after they finally leave the job (if they were hired before January 1, 2012 but did not have 20 years of service as of that date).  So in either situation, PSPRS will not be benefiting from employee contributions during their time in the DROP.  Using the DPS data, we can see that the 141 members in the DROP X topped-out officer base salary of $62,660 X 10.35% employee contribution rate = $914,429 a year in funds not going into DPS' underfunded pension.  For GPD, the same calculation would show $191,115 a year not reaching GPD's underfunded pension.

Remember these calculations use only a topped-out officer's base salary.  We did not include in our calculations either higher-paid employee salaries or payments in addition to base salary like overtime, shift differential, and sick leave sellback.  If we were to include these, the amounts not being contributed to the DPS and GPD pensions by DROPped member are likely to be much higher.

Between just the two departments Mr. Edwards is associated with, PSPRS is deprived of over $1.1 million a year by members who are in the DROP.   This $1.1 million is not only lost, but it will never have a chance to compound over time.  At PSPRS' current expected rate of return of 7.85%, $1.1 million would earn $86,350 in a year.  Between all entities comprising PSPRS, there were 1,482 members in the DROP.  If we use a modest $50,000 per year average salary, those 1,482 members alone are depriving PSPRS of $7,669,350 per year in funding.

For Mr. Edwards and others who see something wrong with a few PSPRS employees getttng raises, how can they not be equally offended by the DROP?  No matter how one tries to justify it, the DROP does two of the same things that have outraged the Arizona Republic and other critics of PSPRS' management.  The DROP gives both a raise through the elimination of the employee's contribution, and it pays a bonus by allowing the employee to earn up to five years of his retirement while still drawing his regular pay.  Worst of all, the DROP does all this while harming PSPRS' long-term financial sustainability.  While it is easy to use PSPRS' management as the scapegoat for everything wrong with PSPRS, we should be honest about where the real damage to PSPRS is being done.