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

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

Friday, February 21, 2014

How much will the Fields decision cost PSPRS?

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

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

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

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