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Monday, December 28, 2015

A little bit more on PSPRS pension reform before the end of the year

While I was hoping there would be more definitive information available this month, it looks like we will have to wait until January 2016 to find out what the Arizona Legislature has in mind for PSPRS.  However, there were two brief blurbs on Phoenix news radio station 550 KFYI website that give us a smattering of news.  The first gives us an update on the progress of the plan and when we may see it:
(KFYI News/AP) - An overhaul plan for Arizona's public-safety pension plan is almost done.
State Senator Debbie Lesko of Peoria says a deal is close after months of meetings between lawmakers, pension officials, and others. She says the deal may even be ready in January.
A recent report found the system can only pay half its promised pensions, although contribution rates have soared.
The second gives us more clues about what might be in it and when it will appear on the ballot:
(KFYI News) – Arizona voters may see a second ballot measure in the May 17 special election.
Voters will already have their say on Proposition 123, a referendum to amend the Arizona constitution to allow increased withdrawals from the state's land trust fund to boost funding for K-12 education.
The Arizona Capitol Times reports lawmakers may add a referendum on amending the state constitution to change how the state's pension system for police and firefighters is funded.  As it stands now, the Public Safety Personnel Retirement System (PSPRS) is severely underfunded. 
Under the proposal, which is reportedly very close to agreement between legislative leaders and union representatives, benefit levels for public safety employees would be capped, and a 401(k) type of component would be added, where enrollees would have to save some of their own money on top of the pension contribution.
If approved, the changes would affect both new employees and existing public safety employees statewide.  The changes would have to be OK'd by voters because under the state constitution, retirement benefits for existing government employees cannot be changed by the legislature.
This 550 KFYI story references an Arizona Capitol Times story, which unfortunately is behind a paywall.  Not much to go on, but it does look like things will move fast once we get into 2016.  Have a safe and happy New Year.

Wednesday, December 9, 2015

The 11 most terrifying words: We're from PSPRS and we're here to help with pension reform

The PSPRS Board of Trustees meeting was cancelled for December 2015.  This is disappointing since I was interested to see how PSPRS' investments did during October when the the Russell 3000 returned a whopping 7.90%.  We will now have to wait until January 2016 to find out.  However, there was another meeting today at PSPRS, but this body was something new called the Pension Reform Work Group Committee ("the Committee").  I unfortunately missed the beginning of the meeting so I am not sure who is on this committee, but it appears that at least some of the Trustees, including Chairman Brian Tobin are part of it.  The webinar lasted approximately 90 minutes.

I missed about the first ten minutes of the webinar, but it appears that the prepared portion, which had several Powerpoint slides, was just an introduction with a condensed lesson about PSPRS' recent history.  It was, as most public statements that emanate from the PSPRS bunker, a self-serving display with finger-pointing at past Trustees and administrations for PSPRS' current problems and self-congratulations about their own perceived progress/success.

While most of the prepared portion of the meeting covered areas most of us are already well aware, there were two interesting things said in that portion.  The first was a statement by the Committee that, up until 2011, PSPRS had been neutral when it came to the laws governing PSPRS.  They just followed whatever was mandated by the Arizona Legislature and did not make value judgments on any law.  According to the Committee, this changed in 2011 when PSPRS became more proactive and presented several proposals that influenced the writing of SB 1609.  Obviously, there are problems with this since PSPRS has a fiduciary duty to it members.  This is why the neutral position is the normal default for an organization like PSPRS.  Otherwise, it will be forced to pick sides among the different groups it serves.  This is the heart of this March 20, 2014 claim against PSPRS by retired judge Kenneth Fields.  It includes this passage:
     In its brief to the Arizona Supreme Court, the EORP stated: "EORP and the members of the PSPRS Board of Trustees, which administers the plan . . . are essentially neutral stakeholders standing between the legislature and the EORP member."  EORP Appellants' opening brief at page 2.
      Contrary to it fiduciary duties of loyalty and to avoid conflict of interests with its plan members and plan beneficiaries, and contrary to the statements made by the EORP Trustees that they were actually neutral in the Fields litigation, in truth and in fact the EORP Board of Trustees and individual Trustees consistently and aggressively took positions in the Fields case contrary to the interests of its retiree beneficiaries.  Upon information and belief, based upon the litigation pleadings in the case, the Board of Trustees and Trustees worked closely with the State of Arizona to provide a unified litigation strategy against the EORP beneficiaries.
     In truth and in fact, in every instance in the Fields case, in every pleading and filing, the EORP Board of Trustees and Trustees took positions opposing beneficiaries, argued against the beneficiaries, and acted as lead adversary counsel in the case both in briefing in the trial and the appellate courts, and in oral argument and trial before the Supreme Court.
      The EORP Board of Trustees and individual Trustees never advocated a single position that favored its own beneficiaries.  The EORP Trustees admitted as much in their opening brief to the Supreme Court: "But while the EORP Defendants do not opine on the ultimate result . . . . the EORP defendants seek to provide the Court with the facts, legal precedent and analytical tools that it will need to decide the issure presented."  EORP Appellants' opening brief at page 3.  The Trustees then argued in their brief for the Supreme Court to reverse the decision of the trial court and opposed every position taken by the beneficiaries.
 As Trustees, a "neutral" position would have been just that, to take no position with respect to the lawsuit.  The Board of Trustees and the Trustees never took a neutral position on any issue of fact or law in the Fields case.
 In another pending case before the Superior Court, involving active members of the EORP, the Board of Trustees and Trustees are undertaking similar tactics.  The fiduciary breaches in the Fields case are continuing in other parallel litigation.
At the time of this claim, I was under the impression that PSPRS was just defending the legal requirements foisted upon it by the Arizona Legislature.  Now it seems that SB 1609 was legislation PSPRS had a hand in initiating and crafting, knowing full well that it would negatively impact it own beneficiaries.
 
Of course, the proactive PSPRS is the image the Committee wants to portray now that more pension reform legislation is coming.  Reform is in the air, and PSPRS must want to look like they were there from the beginning.  However, contrast the supposedly proactive PSPRS to the one presented in the September 2015 Performance Audit and Sunset Review by the Arizona Auditor General.  This passage from the audit is very revealing:
. . . the System’s actuary had not been factoring in the cost of future benefit increases until recently. Specifically, according to the System, a 2007 audit of the System’s actuary found that it had not incorporated benefit increases when determining contribution rates,
which resulted in underestimated and thus unfunded liabilities.  Despite this 2007
audit finding, the System’s actuary did not begin including the costs of expected future benefit increases when determining contribution rates until fiscal year 2014. The System indicated that it believed Laws 2011, Ch. 357, would address these issues and make benefit increases unlikely in the future. However, given the Fields decision, starting in fiscal year 2014, the plans’ actuarial valuations reflect expected future benefit increases and has two different assumptions, one for members retired on or before July 1, 2011, and one for those retiring after that date. (boldface mine)
The first problem here is that no one in PSPRS' administration noticed that their actuary was not accounting for permanent benefit increases (PBI's), now identified as the single biggest driver of PSPRS' unfunded liability, but even if we put that aside, why did PSPRS wait four years until 2011 to address this problem?  Where was the proactive PSPRS when it could deal with a problem that was within its own purview?  We can all make our own guesses why, but being able to blame a financial crisis rather than their own poor oversight and management might have something to do with it.  So years of failing to even notice they had problem was followed by four more years of inaction, which was then followed by a lobbying effort to legislate a solution to a problem they caused.

The other interesting statement during the prepared portion of the Committee meeting was a comment from another Committee member about the reduction of PSPRS' rate of return.  This Committee member essentially stated that the reduction of the expected rate of return (ERR) was a natural process based on the actuarial data gleaned from past experience.  This is a rather misleading proposition when we understand that PSPRS controls its own investment portfolio.  PSPRS will certainly have to reduce their ERR if they invest in a manner that limits their returns to no more than 9%, as Chief Investment Officer Ryan Parham has publicly said PSPRS is "incentivized" to do.  As they continually underperform the 9% threshold, whether deliberately to avoid paying PBI's as Mr. Parham implies or just because their strategy is bad and could never reach 9% anyway as it appears more likely, they will have to reduce their ERR to match the reality they have created.  This is not some condition like mortality rates over which PSPRS has no control, but a situation they are producing with their investment policies.

Now if PSPRS feels like it needs a lower ERR in order to achieve a safe and steady return, that is fine.  They should just be honest and say so, tell us what they want the ERR to be, and detail their plan to reach that goal.  They should also be honest and say that they have worked externally and internally to create an environment where PSPRS will not have to pay PBI's.  I would consider this another breach of fiduciary duty, as well as a veiled form of extortion in which retirees can choose whatever new, lowered PBI formulation that is developed in the next year or subject themselves to the tender mercies of the PSPRS administration and Board of Trustees, who seem intent on doing whatever is in their power to avoid paying PBI's.

After the prepared portion was over their were questions and comments from the audience.  These were from some labor representatives of law enforcement and another man who represented judges.  A lawyer, who I believe is representing PSPRS in the Hall case, also spoke.  During the discussion with the labor representative, it was brought up that there should be some preliminary pension reform ideas coming from the Arizona Legislature around December 17 or 18, 2015.  This appears to be when the study group headed by State Senator Debbie Lesko will release something to build on in the upcoming legislative session.  A present for all of us just in time for the holidays.

The lawyer was asked if he had a timeline for when a final decision in the Hall case will be announced.  He stated that he could not give an exact time, but he expected it to be in late spring or early summer 2016 and that the decision should be faster than a normal Supreme Court case since this is the only case the five judges will have and they understand its urgency.  He stated that this was only the second time that the Arizona Supreme Court has recused itself from a case.  The panel will be made up of two appellate judges and three superior court judges; the two appellate judges were the only two appellate judges in the entire state that were not serving when SB 1609 went into effect and both have criminal law backgrounds.  Arguments before the panel will be made February 18, 2016.

Happy holidays and stay tuned.

Friday, December 4, 2015

Some observations about the League of Arizona's Cities and Towns' Pension Task Force final report on PSPRS

If you have not had a chance to read the League of Arizona Cities and Towns' Pension Task Force ("the Task Force") report, "The Yardstick: A Tool to Evaluate Proposed Reforms of Arizona's Public Safety Personnel Retirement System (PSPRS)," I would highly recommend that you do.  PSPRS is likely to see some big changes in 2016, and I think that the Task Force report will likely be part of any proposed reforms to PSPRS.

I had already discussed the main points of the preliminary report here, in case you are interested, and I found most of their recommendations to be quite good.  However, the big problem with the preliminary report was that it did not propose any method for funding the huge unfunded liability already existing in PSPRS if and when a new pension tier is created.  Unfortunately, this final report still does not address this problem, though the final report makes it clear that it is not a plan but rather "an evaluation tool for the current system and for potential reform proposals . . "   Still, the final report is a fuller and more detailed version of what was available back in May 2015, and there are several new things to discuss that were not available then.

1. The Deferred Retirement Option Plan (DROP) is an unfunded benefit.

I was happy to see the Task Force call the DROP what it actually is--an unfunded benefit.  Under the heading "Benefit Increases" the final report says, "The creation of the Deferred Retirement Option Plan (DROP) was a cost to the system when it was first implemented."  The Task Force also wrote, "We see the DROP as a costly method to extend retirement and a significant cost to employers during that period; therefore, it is recommended that the Deferred Retirement Option Plan not be included in any future system design."

I find it very encouraging that the Task Force is calling the DROP what it is, not a win-win for employees and employers or cost-neutral or any other of the other ridiculous terms that were used to justify this awful program.  However,  I disagree with the Task Force on one important semantic point.  While the DROP is a benefit, it is not a retirement benefit since it does not affect an employee's retirement benefit.  Rather, it only allows an employee to continue to work with their current employer while collecting a deferred retirement benefit, which essentially amounts to a 50% or higher raise for up to five years.  The Arizona Legislature should have eliminated the DROP as part of SB 1609 in 2011 since it likely would have been constitutional, and the Legislature should consider eliminating it now since it should have no part in any future reform measures.

The Professional Fire Fighters of Arizona (PFFA) is still trying to prop up the fiction that the DROP is necessary and beneficial, only now under a different rationale.  Their brilliant proposal is to rename the DROP the Inflation Protection Program and hope no one notices that it is the same bad idea.  The DROP was an ill-conceived and selfish program that should have never existed in the first place.  Its demise is long overdue.

2. Pension increases are to maintain purchasing power.

We all know that the current method of calculating cost of living adjustments (COLA's) or permanent benefit increases (PBI's) does serious damage to PSPRS.  Despite the victory of the plaintiffs in the Fields case and the likely victory of the plaintiffs in the Hall case, the excess earnings PBI model has been wrong from the beginning.  It was never sustainable and like the DROP was an ill-conceived and selfish idea that looked to lock in permanent benefits for one group at the expense of others.  It placed all the upside with retirees and all the downside with active workers and taxpayers.  Retirees were even paid PBI's even as active workers were having their pay and benefits frozen or cut.

However, retirees could be learning a hard lesson that they will not remain unscathed.  By putting their faith in the PSPRS' Board of Trustees and managers to earn enough to continue funding PBI's, they have also left themselves at their mercy.  Chief Investment Officer Ryan Parham publicly stated in the Arizona Capitol Times last December:
PSPRS wants its retirees to enjoy increases, but we are incentivized to seek lower returns in the range of 9 percent to maximize earnings that can be applied to cover – and hopefully reduce – unfunded liabilities.
PSPRS appears to be deliberately ratcheting back its investment returns in order to not exceed the 9% threshold that would trigger PBI's.  PSPRS has even lowered its expected rate of return (ERR) from 7.85% to 7.50%.  This is the unfortunate flip side of the excess earnings formula.  The Task Force writes:
. . . the new tier should should include cost-of-living adjustments (COLA's) to maintain the purchasing power of a retiree's pension.  The financial impact of COLA's should be included in the normal cost, not isolated in a separate fund and funded from investment performance.
We can see that the Task Force gets it.  They do not want to rely on investment performance, and they want true COLA's that keep retirees whole throughout retirement, which should be the real goal of any COLA.  Furthermore, budgeting for the COLA's in the normal cost (a percentage charged to pay the future benefit for an active employee) allows the COLA to rise with inflation of active workers' wages.  Union locals generally do a good job for their members, so if they are vigilant, they can keep both their members and retirees even with inflation by getting their members regular wage increases.  This way everyone's interests align.

This compares to the PFFA's plan, which would take 4% of active workers' pay to fund retirees' PBI's.  This PBI would be the lower of 2% or the consumer price index (CPI).  Here we again see the almost innate selfishness of those proposing this plan.  Those close to retirement, who will have to pay little or none of the 4% contribution, are likely retiring with large DROP payments, and are aware of PSPRS' deliberate lowering of investment returns, will transfer the cost of PBI's on to another generation of fire and law enforcement personnel who will pay 4% of their lifetime earnings to get up to a 2% benefit in retirement.

3. Consolidating PSPRS and the Arizona State Retirement System (ASRS) could reap huge benefits.

I do not know how ASRS feels about this.  For all we know, ASRS may want nothing to do with PSPRS.  However, we do know that ASRS has a better track record than PSPRS.  This is probably somewhat due to better management, but I think it is mostly due to the different rules under which ASRS operates.  Among these are equal cost sharing, stricter benchmarks for PBI's, and pooled assets and liabilities, all which are ideas the Task Force wants to implement with any new pension tier.

However, there is no doubt that ASRS has had better investment results over the years, which has nothing to do with the rules under which each system must operate.  Here is a comparison of their annualized net returns as of June 30, 2015:


One Year Three Year Five Year Ten Year
PSPRS 3.68% 9.22% 8.69% 5.22%
ASRS 3.20% 11.40% 11.80% 6.90%
Difference 0.48% -2.18% -3.11% -1.68%

As we can see, ASRS bested PSPRS in all but the one-year return.  Of course, this was more than compensated for when ASRS earned 18.6% last fiscal year versus 13.28% for PSPRS.  As of June 30, 2015, PSPRS had about $6.218 billion in assets, the additional 1.68% averaged over ten years would earn an additional $1.775 billion.  This alone seems reason enough to consolidate PSPRS and ASRS.

4.  Forcing employers to contribute to the "third leg" of the retirement stool is a bad idea.

The Task Force talks about the need for a supplemental retirement program for those PSPRS members who do not participate in Social Security:
Retirement is often described as a three-legged stool, with one leg as the public pension, the second leg as personal savings, and the third leg as Social Security. Not all members of PSPRS participate in Social Security, which creates different retirement realities for each member. Many cities in Arizona employ a sworn police force that participates in Social Security; however, the same cannot be said about sworn fire fighters, who are typically exempt from participation.
Mandatory participation in Social Security would be a challenging feat. If PSPRS were to mandate that all members participate in Social Security, it would require a 100% vote by the current membership. Although this route would be ideal by offering another leg of the stool to members, it would be challenging to achieve.
Fair enough, but both the International Association of Fire Fighters (IAFF) and the Fraternal Order of Police (FOP) oppose mandatory participation in Social Security by their members, at least for those not already participating.  If you follow the FOP link, you will notice that they also want to repeal the Windfall Elimination Program (WEP) and Government Pension Offset (GPO).  The IAFF also supports elimination of the WEP and GPO, if it does not require mandatory participation in Social Security.

At first glance, the GPO and WEP may seem unfair to those who have paid into Social Security for the minimum 40 quarters.  However, we have to look at Social Security's original and actual purpose, which is clearly revealed in its name.  Social Security may be sold as a retirement plan for all Americans, but it is really meant to provide people security, in particular, security that they will have some form of income when they are no longer able to work.  (For more information about WEP, see this post.)  Both the WEP and  GPO are designed to prevent disproportionately generous benefits being paid to those whose years of non-participation in Social Security made their lifetime income seem smaller than it actually was.  These policies are designed to preserve as much income as possible to lower lifetime earners.  This is not popular to those who believe that Social Security is a retirement program like PSPRS, but it allows Social Security to fulfill its stated purpose.

It is hypocritical to demand an exemption from Social Security yet demand the maximization of  one's own benefits, especially when it hurts those that may have made much less in lifetime income.  This brings us back to the Task Force's ideas about the "third leg" of the retirement stool:
. . . the Task Force developed the idea of creating a Social Security-like replacement program for those not eligible for Social Security. Essentially, the replacement program would function as a defined contribution plan where both the employer and employee contribute equally.
If public safety unions are openly opposed to participation in Social Security, why does the Task Force feel there a need for another "third leg" to be created?   The third leg already exists, and if a group opposes participation, that is there own choice to forgo that leg.  There is nearly universal participation by American workers, including most other government workers and the US military, in Social Security.  Furthermore, why should employers and taxpayers be committed to another long-term employee benefit when a program already exists that employers and taxpayers must pay into themselves?

This is not to say that Arizona's public safety unions and their members are necessarily opposed to participation in Social Security, regardless of what the national organizations might say.  I do not know how they feel about the issue, and I understand that it would be virtually impossible to force current PSPRS members into Social Security.  However, the national organizations speak for public safety members on what would be a matter of federal legislation, so their position is the one that carries the most weight.  At the very least, new hires should have the freedom to choose to participate in Social Security, or if the Task Force believes the "third leg" is so important, they should be advocating that  all new public safety employees be required to participate.

I would love to see employers provide matching contributions toward a defined contribution plan for PSPRS members.  However, it is short-sighted and financially risky for the Task Force to recommend that employers be forced to contribute to another retirement program.  Employers can choose to contribute voluntarily to a defined contribution plan, but only as a negotiated benefit that is subject to modification when labor contracts are renewed.

5. Does the Task Force really know what PSPRS' fundamental problem is?

While overall the Task Force's final report is very good, they seem to have a curious misunderstanding of the relationship between PSPRS and its 256 employers.  Their final report says:
The PSPRS Board of Trustees functions as the plan administrator responsible for fiduciary responsibilities, such as investment management, setting actuarial assumptions, and benefits administration. Additionally, unique to this system, is the fact that each plan has a local board.  The local board makes decisions regarding eligibility, such as accepting members into the plan and determining disability retirements.
In practical terms, it means each local entity is responsible for managing a public safety pension plan, or plans. For example, the City of Phoenix has to manage two pension plans: police and fire. Self-management has proven to be an issue. Other than the largest member employers in the system, most entities do not have the resources and professional staff to manage a pension system. As such, they rely on the PSPRS Board and administration to provide oversight and management of their plans.
Unfortunately, self-management and the PSPRS Board have not resulted in the type of active management needed to prevent unfunded liabilities. For example, only a handful of employers have completed a detailed study of how their actual performance has compared to the actuarial assumptions. To this point, the Task Force created “Employer Recommended Practices” to assist employers with evaluating and improving the financial condition of their plan. These are included in this report as Appendix A and we encourage all employers to implement these practices.
Finally, given the fact that the employee contribution is capped at 11.65% of salary, any differences between actuary assumptions and actual performance manifests in unfunded liability, which is the sole responsibility of the employer.
The Task Force, which was comprised almost exclusively of municipal officials like city managers and finance and human resources directors, should know better how this all works.  Do they not know that the laws that govern PSPRS are made at the state level but must be followed by all employers, regardless of the employer's financial situation?  Do they not understand that employers have no control over actuarial assumptions, so if PSPRS chooses to use outdated mortality tables or an overly optimistic ERR, employers will have to make up the difference?  Do they think employers are just supposed to keep sending more and more money to PSPRS, even though they have no control over the bad laws or bad actuarial assumptions coming out of Phoenix?

The Task Force, of all people, should know where the fundamental disconnect in PSPRS lies.  Being a state agency, PSPRS is governed by state law, but the financial liabilities are borne by employers.  With the exception of the Department of Public Safety, the state government has very few PSPRS-eligible employees to worry about, and the state has much deeper pockets than any other employer.  Yet even some large employers like Phoenix, Tucson, and the state's counties are struggling to pay their annual required contributions, which are so high because of unfunded liabilities.

This is because there is no governance of the system from the employers themselves.  State legislators are lobbied by public safety unions to increase benefits, the costs of which fall, not on the state, but on the local employers and taxpayers.  It is easy to give things away when you do not have to pay for them.  Contrast this with what happened with the Elected Officials' Retirement Plan (EORP).  Though very small in comparison to PSPRS, this plan is the worst funded of the three that PSPRS manages.  EORP is for the most part a state plan, covering elected officials and judges.  When it became obvious that it was unsustainable, the Arizona Legislature simply closed the defined benefit EORP pension to new members and placed new members into a defined contribution plan.  Of course, those legislators who voted to exclude new members did not vote themselves out of the defined benefit plan, only those that came after them.

The Task Force is made up of the very people who should have been telling the Legislature that programs like the DROP were wrong or that a 9% ERR was unrealistically high.  If they had, PSPRS might be in better shape it is in now.  Of course, the municipal officials are at the mercy of their own local elected officials.  Look at what the Tempe City Council did when it allowed its firefighters to spike their pensions via a reconfigured sick leave sellback program.  The Tempe Fire Department is only 48.6% funded, and this will drive it further into deficit.  I would like to know what Task Force member Marge Zylla, a Tempe city official, thinks about what the Tempe City Council did.

These are just a few observations about the Pension Task Force's final report.  Hopefully soon we will take a closer look at the Arizona Auditor General's performance audit of PSPRS.

Wednesday, December 2, 2015

2015 Actuarial Valuation Reports by Employer are now available

The 2015 actuarial valuation report for your employer are now available.  PSPRS has upgraded its website, which now allows access to individual employer reports going back to 2009, and uses a drop down menu to choose the employer and report year.  You will need Adobe Acrobat to access the reports.

Monday, November 30, 2015

Worse than it seems: PSPRS' 2015 Actuarial Valuation

The PSPRS Actuarial Valuation as of June 30, 2015 (Fiscal Year 2015) is now available on the PSPRS website.  The actuarial reports for individual employers have not been released, but if you would like to know what your employer's funded ratio is it can be found in Appendix III starting on PDF document page 75.  Your employers contribution rate for the next fiscal year starting July 1, 2016 can be found in Appendix IV starting on PDF document page 81.

Some of the highlights (or lowlights as the case may be) of the report are:
  • The aggregate funded ratio dropped from 49.2% to 49.0%.
  • The aggregate non-phased-in contribution rate increased from 41.08% to 42.36%.  Employers who chose to pay a lower phased-in rate to help pay the increased costs caused by the Fields case have a lower rate that will be made up in future years.
  • PSPRS' total assets increased about $199 million from $6.018 billion to $6.217 billion.
  • PSPRS' total liability increased about $453 million $12.233 billion to $12.686 billion.
  • PSPRS' total unfunded liability increased about $254 million from $6.229 billion to $6.483 billion.
  • The actuary projects the aggregate contribution rate to stay between 42 and 43 percent through 2027, though this is likely to be too low since the actuary used the old 7.85% expected rate of return (ERR) and not the current 7.5% ERR.
  • There were 18,409 active, contributing members of PSPRS at the end of FY 2015 versus 18,526 at the end of FY 2014, a decrease of 117.
  • There were 11,034 retirees and beneficiaries and 1,675 Deferred Retirement Option Plan (DROP) members for a total of 12,709 non-contributing members of PSPRS at the end of FY 2015.  This is an increase of 626 from the 12,083 (10,524 + 1,559) non-contributing members at the end of FY 2014.  (Depending on when a member entered the DROP, the member may make no contributions to PSPRS while in the program, or the member may continue to contribute to PSPRS while in the program then receive a full refund of the accrued contributions and 2% interest when the member finally leaves work.  Regardless, PSPRS ends  with no employer or employee contributions for the up-to-five years a member is in the DROP.)
  • The FY 2015 ratio of active, contributing members to non-contributing members dropped to 1.45.  Last fiscal year the ratio was 1.53.
  • The average annual pay for an active, contributing member increased from $75,048 to $76,114.
  • The average annual retirement benefit for retirees and beneficiaries increased from $51,616 to $51,833.
  • The average annual pay for a member in the DROP increased from $64,173 to $64,659.
  • Employers contributed about $448 million to PSPRS in FY 2015 versus about $414 million in FY 2014.
  • Employees contributed about $165 million to PSPRS in FY 2015 versus about $152 million in FY 2014.
The decreased funded ratio and increased employer contribution rate speak for themselves, but it is actually worse than it seems.  Even though the funded ratio dropped only 0.2% and the employer contribution rate increased by only 1.28%, we have to remember how PSPRS recognizes its investment gains and losses.  PSPRS uses a seven-year smoothing period to lessen the impact that extraordinarily good or bad years may have on PSPRS' funding ratio and the subsequent calculation of employer contribution rates.  If you are interested in a more detailed explanation of the smoothing period, please see this post.

The Great Recession gave PSPRS two large investment losses in FY 2008 and FY 2009, but these two losses are far enough in the past that they are now beginning to fall out of the seven-year smoothing period.  The FY 2008 smoothed loss of about $119 million was eliminated from the calculation of the FY 2015 funded ratio and replaced by a smaller loss incurred in FY 2015.  This dropped PSPRS' recognized loss over the seven-year period by about $82 million from $282 million to $200 million, and yet, PSPRS' funded ratio continued to drop and the employer contribution rate continued to rise.  This means that liabilities are continuing to grow faster than assets, even as the negative impact of the Great Recession begins to lose some of its effect on PSPRS.

In one of the few years when we could expect to see some improvement in PSPRS finances we instead have another disappointing year.  What do we have to look forward to in the near future?  PSPRS' lowering of its ERR from 7.85% to 7.50% will raise the aggregate employer contribution rate 3%, and a plaintiff victory in the Hall case could raise it another 6% on top of that.  So we could see the aggregate employer rate increase by as much 9% over the next year.  Of course, who knows what is really going to happen next year.  The only certainty is that no matter what happens PSPRS and its Board of Trustees will be there to tell us all how great a job they are doing.

Thursday, November 26, 2015

What will PSPRS look like the next time we celebrate Thanksgiving?

As most of us are aware, 2016 will be a watershed year for PSPRS.  The panel of judges selected by the Arizona Supreme Court to adjudicate the Hall case (CV-15-0180-T/AP) will hear oral arguments on February 18, 2016 and will probably deliver a final decision sometime before the end of the current fiscal year.  If you would like to read updates on the case, though there should be no more coming until after oral arguments are heard, you can follow the Pension Litigation Tracker link or go to the Arizona Supreme Court case page directly then click on the active civil cases link and search that page for the word "Hall."

We also have that other branch of government involved too.  This AP story, Lawmakers work on public safety pension system overhaul plan, by Bob Christie appeared in the November 26, 2015 Arizona Daily Star.  It gives tantalizing clues to some of the changes to PSPRS that the Arizona Legislature will be considering in the next legislative session.  Among these are:
  • Changes to how permanent benefit increases (i.e. COLA's) are calculated
  • Income level caps for pension calculations to combat pension spiking
  • Having equal contribution rates for employees and employers
There is not a lot of detail in the article, but it appears that the Legislature is incorporating some ideas from both the League of Arizona Cities and Towns' Pension Task Force Report and the Professional Fire Fighters of Arizona's (PFFA) awful plan.  Mr. Christie attempted to get a comment from PFFA President Bryan Jeffries for his article, but he declined to comment.  Whatever comes out of the Legislature will have to be referred to the voters for final approval, and it seems likely that they would want to do this in November 2016 during a presidential election year when voter turnout will be the highest.

I hope everyone has a safe and enjoyable Thanksgiving this year.  Next Thanksgiving may find all of us in a very different pension system. 

Wednesday, November 25, 2015

PSPRS investment returns through September 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for September 2015, the third month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%





7/31/2015 0.13% 0.13% 1.67% 1.67%
8/30/2015 -1.43% -1.31% -6.04% -4.47%
9/30/2015 -1.02% -2.31% -2.91% -7.25%

There is usually about a two-month lag in PSPRS reporting its investment returns.  PSPRS again outperformed the Russell 3000 in a negative month, suffering about 35% of the loss of the Russell 3000.  As in August, both US and non-US equity were the big September losers with US equity down 3.04% and non-US equity down 4.63%.  The Russell 3000 returned an incredible 7.90% in October 2015, and through November 24, 2015, the Russell 3000 has a more modest 0.80% return.  It will be interesting to see what PSPRS' returns are in October 2015 and how much it recoups of the current year's losses, particularly in comparison to the Russell 3000.

Looking at PSPRS' annualized 5-year rate of return, we can see that during the first quarter of the current fiscal year it has dropped from the 9.2%, gross of fees, that it had as of June 30, 2015 to a current rate, gross of fees, of only 7.04%, well below PSPRS' expected rate of return (ERR) of 7.50%.  Since November 2014, this is the first time the annualized 5-year rate has dropped below the ERR.  It does not bode well for the future if PSPRS cannot achieve its ERR during a 6 1/2 year long bull market in which the Russell 3000 earned 13.28% over the same annualized 5-year period.

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

Friday, October 23, 2015

PSPRS investment returns through August 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for August 2015, the second month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%





7/31/2015 0.13% 0.13% 1.67% 1.67%
8/30/2015 -1.43% -1.31% -6.04% -4.47%

There is usually about a two-month lag in PSPRS reporting its investment returns.  As can be seen, PSPRS outperformed the Russell 3000 in a negative month, suffering less than a quarter of the loss of the Russell 3000.  Out of its ten asset classes, seven had losses and three had monthly gains with real estate being the biggest monthly gainer at 2.91% and non-US equity the biggest loser at -6.39%.  Through October 22, 2015, the Russell 3000 is up 6.56%, with another big gain today (October 23) that will further offset the combined losses of August (-6.04%) and September (-2.91%).  Hopefully PSPRS will do better than it did in July, when it captured only about 8% of the gains of the Russell 3000, if October ends the month with a significant gain.

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


Tuesday, October 13, 2015

PSPRS investment returns through July 2015 and a look at investment fees paid last year

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for July 2015, the first month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%
6/30/2015 -0.73% 4.21% -1.67% 7.29%





7/31/2015 0.13% 0.13% 1.67% 1.67%

There is usually about a two-month lag in PSPRS reporting its investment returns.  As can be seen, PSPRS trailed the Russell 3000 in a positive month, capturing less than 8% of the gain in the Russell 3000.  PSPRS will need as many positive months as possible this fiscal year since the markets have already had two very bad months this fiscal year.  The Russell 3000 had a monstrous 6.04% loss in.August 2015 and another loss of about 3.00% in September 2015.  The good news is that, through October 12, 2015, the Russell 3000 is up 5.17%, which has offset some of the losses from August and September, but who knows how the month will end.

The following table shows a breakdown of what PSPRS paid in fees for each of its asset classes:



Gross
Net

Asset Class
Returns
Returns
Fees







US Equity
6.70%
6.32%
0.38%
Non-US Equity
-4.58%
-4.79%
0.21%
Private Equity
14.05%
12.72%
1.33%
Fixed Income
2.31%
2.19%
0.12%
Credit Opportunites
5.36%
4.82%
0.54%
Absolute Return
5.80%
4.86%
0.94%
GTAA
6.34%
6.28%
0.06%
Real Assets
-3.55%
-4.24%
0.69%
Real Estate
5.33%
4.32%
1.01%
Risk Parity
0.94%
0.87%
0.07%
Short Term Investments
0.13%
0.02%
0.11%







PSPRS Total
4.21%
3.68%
0.53%

An explanation of the different asset classes can be found on PDF page six of this paper, which includes among its co-authors several members of PSPRS's staff.  Fees are relative, and paying 1.33% on an investment that nets you 12.72% is a good value, while paying nearly 85% of of your gross returns in fees to get a paltry .02% return seems like a bad one.  Fortunately, short-term investments make up only 3.85% of PSPRS' portfolio and is the most liquid of the asset classes. The high proportion of fees paid may have to do with the high turnover in an asset class that is likely used as a temporary parking place for money waiting to be invested in other asset classes.

The big sore thumb sticking out here is the real estate asset class, which makes up nearly 10% of PSPRS' portfolio.  Real estate was the only asset class, other than the much more profitable private equity, that had fees over 1.00%, but it really stands out because it lagged its benchmark by the most of any of the classes.  Only three asset classes did not meet their benchmarks: US equity by 0.97%, real assets by 6.42%, and real estate by 8.66%.  Even non-US equity bested its benchmark 0.47%, despite having a loss for the year.  At 12.98%, real estate had the highest benchmark return of any asset class, and PSPRS paid 1% in fees to achieve a return just one-third of the benchmark.  It would be interesting to know what, if any, effect the Desert Troon investments are still having on PSPRS' bottom line or if more recent real estate investments have been more profitable because PSPRS, unlike last fiscal year when it lost 1.26%, at least had a positive return on its real estate portfolio.  Unfortunately I have been unable to find any information about the fiscal year 2015 real estate investments in any of the recent Board of Trustees meeting materials. 

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

Wednesday, September 30, 2015

Not in the best of hands: The PSPRS Board of Trustees summed up in one revealing passage

In case you missed it, the Arizona Auditor General released its "Performance Audit and Sunset Review of the Public Safety Retirement System" on September 18, 2015.  The Arizona Republic distilled the Auditor General's conclusions in this September 23, 2015 editorial, Public-safety pensions, summed in 1 bad word.

That bad word would be "deteriorating."  I would also like to point out another report from the Arizona League of Cities and Towns ("the League") entitled, "The Yardstick: A Tool to Evaluate Proposed Reforms of Arizona's Public Safety Personnel Retirement System (PSPRS)."  This report was released on August 18, 2015, and like the Auditor General report, does some myth-busting about PSPRS and confronts issues that need to be dealt with if PSPRS is to survive.

If the Arizona Republic would like to summarize the Auditor General report in one word, I would like to point to one particular passage in the League's report that shows one of the roots of PSPRS' problems.  The following appears on page 8 of the League's report:
It is also important to point that prior to FY 2015-16, the cost of the PBI (permanent benefit increase) was not included in the employer contribution rate.  Excluding the PBI from the calculation effectively underestimated the normal cost of the pension plan, causing it to manifest itself in the unfunded liability.  This issue was identified by PSPRS actuaries several years ago, but the PSPRS Board did not take action to address it. (boldface mine)
Unfortunately the League does not get into more specifics about why the Board ignored their own actuaries or what internal actions or discussions took place within PSPRS to address (or downplay) the issue.  However, the Republic does give PSPRS Administrator Jared Smout's take on the issue, "By design and structure, that (pay-out formula) depletes money out of the system faster than you can replace it with investment returns.”  The Republic does not give any explanation from PSPRS lifer Jared Smout as to why PSPRS never recognized the huge costs of the PBI's, even though they were told about them several years ago, and knew the damage they were doing to PSPRS' bottom line.

Of course, Mr. Smout is beholden to the Board of Trustees for his job, and it seems unlikely that he would publicly acknowledge mistakes by either the Board or him and his staff. When the Arizona Republic was hyping the alleged improprieties of real estate valuations to enhance staff bonuses and the Arizona Police Association was requesting a criminal probe of PSPRS, the danger was that these bogus charges would divert attention from the actual, serious problems with PSPRS.  PSPRS and its staff were rightfully exonerated of the ridiculous and unfair charges of wrongdoing in its Desert Troon real estate valuations, but now there seems to be little interest now from the same media and labor organization accusers about the general incompetence and lack of oversight by PSPRS' Board of Trustees.

The Board, ostensibly the watchdog of PSPRS, failed to deal with a problem that Mr. Smout now characterizes as a permanent financial drain on PSPRS, despite being aware of the problem "several years ago."  I now see why the League wants to alter the structure and personnel makeup of the PSPRS Board.  The individuals on the Board of Trustees (or Fund Managers, as they used to be called) has changed over the years, but their ability to make horrible decisions has remained consistent.  Approving bad investment choices, whether in individual stocks, real estate, or an underperforming low-risk portfolio, has been their usual modus operandi.  However, ignoring their own actuaries and knowingly excluding the costs of PBI's in contribution calculations is a new low for the Board.

Why would the Board do this?  Were they hoping that a defendant victory in the Fields case would make dealing with the actuaries' disclosure unnecessary since a new PBI structure would then be in place?   I don't know.  Your guess is as good as mine.   The fact that the PBI's were never included in the contribution calculations (which passed them on to future employees and taxpayers) before the disclosure is disturbing enough and makes one lose confidence in the actuaries (see this blog post for more about actuaries), but delaying any action until the 2015-16 fiscal year gives one zero confidence in the current Board of Trustees.  My guess is that a similar situation in a publicly-traded company would generate a queue of law firms at the courthouse filing class action lawsuits against the company.  As I have said before, it looks like it might be time for Governor Ducey to replace some or all of the Trustees.

I hope that the same groups who so breathlessly pursued PSPRS over bogus charges will, at least, do some follow up, on this.  There is a lot more to discuss about both the League's final report and the Auditor General's audit and review.  Please stay tuned.

Thursday, September 17, 2015

The Stuart Smalley world of PSPRS: they're good enough, smart enough, and doggone it, their strategy is working

On September 9, 2015 we were given another of PSPRS' self-serving press releases:
PSPRS fund realizes 4.2 percent gross returns
Stability, $210 million in growth during year of market volatility
PHOENIX – The state’s Public Safety Personnel Retirement System fund realized a 2015 fiscal year investment return of more than 4 percent, placing the $8.3 billion system among top public pension performers during a year marked by high stock market volatility.
The system’s 4.2 percent gross-of-fees returns fell below the assumed earnings rate of 7.5 percent, but still showcased a strong 14.1 percent net return for the PSPRS private equity portfolio. In recent years, PSPRS increased its private equity investments – and decreased holdings in stock market-traded equities – as part of its strategy to minimize risk through a broad diversification across asset classes.
The 4.2 percent gross of fees performance of PSPRS places the system within the top 18 percent of 92 comparable public pension funds, according to Allan Martin, of NEPC, the Fund’s Investment Advisor.
“Our portfolio is designed to deliver earning potential while providing significant protection on the downside,” said PSPRS Chief Investment Officer Ryan Parham. “In a world where treasuries are earning less than 1 percent and stocks are flat or down, our 4.2 percent gross of fee returns shows the true value of diversification.”
When adjusted for measurable levels of investment risk taken, PSPRS outperformed 94 percent of its comparable peer pension funds, while the system has shown dramatic overall peer-to-peer performance ranking improvement over the course of the last 3, 5 and 10-year periods.
“The past year, and especially recent weeks, provide a clear example of the type of rocky environment this portfolio is built to withstand and even perform under,” said Martin. “For five years now, PSPRS has ranked well within the top 5 percent of its peers in terms of risk-adjusted returns, while earning 9.2 percent per year in gross-of-fee returns.”
The gross-of-fees performance of PSPRS exceeded that of peers by roughly 1 percent, according to Martin. PSPRS calculations indicate the additional 1 percent return resulted in producing more than $82 million to the PSPRS trust in fiscal year 2015.
The comparable returns on a net-of-fee basis are 3.7 percent for one year and 8.7 percent per year for the five-year period, respectively. On a net-of-fee basis, the fund increased in value during the 2015 fiscal year by $210 million and is now valued at more than $8.3 billion.
The PSPRS trust along with the Corrections Officers Retirement Plan (CORP) and the Elected Officials Retirement Plan (EORP) provides retirement, disability and survivor benefits to approximately 50,000 retired and active members.
Apparently, PSPRS thinks everything is going great.  Their paid pension consultant, NEPC, seems to agree, so why should any of us trust what we read with our own eyes?  After all, it's just our current and future income, security, and quality of life we're talking about here, right?

Let's start off with the obvious problems.  First, the headline states that PSPRS earned 4.2% gross returns for the fiscal year, which is not particularly great to begin with, but it is better than what PSPRS actually earned, 3.7%.  Of course, this does not appear until the penultimate paragraph, just in case people do not read the release all the way through.  Earning less than half your assumed rate of return (ARR) might make people think that you do not really know what you are doing.

This brings us to the glaring misrepresentation about PSPRS' ARR.  PSPRS' ARR was 7.85% last fiscal year.  PSPRS just lowered its ARR to 7.50% this fiscal year, so actually PSPRS fell even further below its ARR last year than the press release indicates.  But once again, why trouble PSPRS members with such details since it would reflect even more badly on its investment performance.

Now we get to the numbers, PSPRS' favorite embellishment tool.  Shouldn't we all see that PSPRS is doing quite well versus its "comparable peer pension funds?"  I do not know what qualifies as a peer pension fund.  Are the 92 peers based on assets, membership, investment strategy, or some other criteria?  In the last post, we saw that PSPRS surpassed the 3.2% average return of 265 public plans with more than $1 billion in assets by about a half-percent, but the referenced Pension & Investments article does not give enough information to rank PSPRS or place it in a percentile.  Is PSPRS still in the top 18% among the 265 funds?  Who knows, maybe PSPRS is better, maybe worse, but there are 173 other public plans not included in NEPC's calculations.  Ultimately, it means nothing to compare one's returns to a particular subset of public plans and highlight your performance against them, unless they are the well-funded, ARR-besting plans worthy of emulation.  It is like a perennially 8-8 NFL team comparing itself against all the teams with losing records, instead of the teams that regularly have double-digit wins and make the playoffs every year.  In this press release, PSPRS' comparative numbers are essentially worthless.

The press release also highlights PSPRS' five-year returns of 8.7%, net of fees.  This is fine until we look at last year when it was 10.68%, net of fees.  This two percent decrease, year-to-year, is conspicuously omitted, and this decrease was during the best five-year market PSPRS is likely to ever see.  It really can only get worse from here on out, as August 2015 showed.  PSPRS' ten-year returns are only about 5%, well below the ARR ,regardless of which ARR PSPRS chooses to use.

Lastly, we have to discuss the puffery from PSPRS Chief Investment Officer (CIO) Ryan "9%" Parham.  Yes, your diversification strategy seems to be minimizing risk on the downside, but PSPRS still needs, at the very least, to earn its ARR over the long run, even if you are claiming that PSPRS' disappointing earnings are caused by the incentive to lowball returns so as not to pay out COLA's to retirees.  Your strategy seems only to be halfway working.  This past fiscal year was not a flat or down year.  The Russell 3000 earned about 7.3% and even an equal dollar weighting of foreign (down 5.26%) and domestic stocks would have still earned about 2%, just 1.7% below your actively managed PSPRS portfolio.  If this past year is Mr. Parham's definition of success, we are all doomed.

If PSPRS dryly stated the facts of what happened last fiscal year, there would be no problem with this press release.  PSPRS did do a little better than average and did better than the Arizona State Retirement System, both good things that should be known in order to put PSPRS' performance in perspective.  However, this is all that needs to be said, not a bunch of misleading, happy talk about how a substandard year is some great success, if you just look at it the right way.  I am happy that PSPRS replaced the dangerous stock-picking strategy of past years, but that was not a justification to swing completely in the other direction to the point where you are so conservative that you can only earn your ARR in years when the markets are producing returns of 14% or more.  The danger in the past was that people were blinded by good PSPRS returns to the point that they did not see that those returns were unnecessarily risky and could have just as easily been produced by a much safer passive investment strategy.  The good returns were a factor of an extended bull market and had nothing to do with what individual stocks were chosen or who was making the choices.  Anyone can be a genius in a bull market.  However, the danger to PSPRS' portfolio was not an illusion and became very apparent when the dot.com market crashed and took a lot of PSPRS' individual stock picks down with it.  A mirror version of the same problem could just as easily happen if the only metric you look at is managing downside risk, and you cannot see that you have made it virtually impossible for PSPRS to ever earn an adequate return.  You are only supposed to play prevent defense when you are protecting a lead at the end of a game.  PSPRS is about five touchdowns behind late in the fourth quarter.

PSPRS is fond of presenting stress test models of how their current strategy would have lessened the losses of past financial crises, but they do not throw in a third comparison using a passive index fund strategy as a neutral baseline.  Also, they do not show how much lower the returns under the current strategy would have been in the years when PSPRS was doing well, such as during the bull market years of the 80's and 90's.  Lower returns in those good years, especially the 80's and 90's when the ratio of workers to retirees was much higher, would have had a negative compound effect over time that should be factored into any fair comparison of strategies.  Does PSPRS really know if their "nationally recognized" strategy is working, or are some people so personally invested in it that they can not objectively assess it?

In the end, applying the strategy is not the goal, consistently earning at or above your ARR over the long run is.  I am sure there was a "successful" strategy in place in 1999 when PSPRS was investing heavily in technology stocks and a "successful" strategy in place in the mid-2000's when PSPRS was investing heavily in real estate with Desert Troon.  We know how those turned out for all of us, but we can all take solace in the fact that PSPRS feels good about how they are doing now.

Friday, September 4, 2015

PSPRS takes the Pension Territorial Cup from ASRS this year

As we had discussed earlier here and here, there will be no permanent benefit increase (aka COLA) this fiscal year (FY) for PSPRS retirees.  This was confirmed by PSPRS Administrator Jared Smout in this message on the PSPRS website.  The only new information in the message is the disclosure of the final FY rate of return, net of fees: 3.68%.  This means that PSPRS missed its expected rate of return (ERR) by about 4% and the COLA threshold by about 5.3%.

According to this August 10, 2015 article, High-return era ends for big public pension plans, by Randy Diamond in Pension and Investments magazine, for this past FY, the median return for public plans with over $5 billion in assets was 3.4%, and the average return for the 265 plans with over $1 billion in assets was 3.2%.  PSPRS surpassed the median by 0.28% and the average by 0.48%.

PSPRS even gets state bragging rights versus the Arizona State Retirement System (ASRS) this year.  ASRS' FY 2015 return was 3.2%, beaten by PSPRS by almost a half-percent.  ASRS also has a higher ERR than PSPRS at 8.0%.  So some congratulations are in order for PSPRS, though these should be qualified by the fact that ASRS has soundly surpassed PSPRS' returns in the three-year, five-year, and ten year averages.  ASRS also returned 18.60% last year versus 13.82% at PSPRS, more than making up the difference for any lagging returns this year.  Most importantly, ASRS is much better funded than PSPRS and has much lower employer and employee contribution rates at 11.47% apiece.

I cannot wait to see the first few months of returns for the current FY.  They should be very interesting. 

Monday, August 31, 2015

Meet the new PSPRS boss, same as the old PSPRS boss

In the latest missive from the bunker comes this underwhelming news:

         August 27, 2015
PSPRS veteran tapped to run $8 billion trust
Board Chairman: Smout ‘exemplary’ during uncertainty 
PHOENIX – The state’s Public Safety Personnel Retirement System Board of Trustees appointed Jared Smout to lead the state’s multi-billion dollar trust that invests and provides retirement benefits to public safety employees, corrections officers, judges and elected officials.
Smout, who has served as interim system administrator since July 2014 and has served PSPRS for more than 18 years, was appointed on Aug. 26 by a vote of the seven-member board led by Chairman Brian Tobin.
Tobin, a veteran City of Phoenix firefighter, praised Smout’s performance and dedication displayed during an era marked by unjustified accusations against the system, legal uncertainty and the added diplomatic task of encouraging reforms aimed at providing financial stability to the trust.
“I think he’s done an exemplary job under very difficult circumstances,” Tobin said. “He has the experience, the education and the skills, and he will serve this state and its public safety employees well in this vitally important position.”
During his tenure as deputy system administrator and acting system administrator, Smout has continued to oversee PSPRS’ nationally recognized investment strategy that seeks steady returns coupled with resistance to market volatility.
“I deeply appreciate the Board’s confidence in allowing me to continue in this role. I absolutely love my job and am grateful every day for the opportunity to serve those who serve this state,” Smout said. “We have a lot to be proud of and we will continue to improve the system, our relationships and our ability to deliver long-term pension stability.”
The risk-averse strategy implemented by PSPRS seeks to diversify assets and reduce exposure to publicly-traded equities, the greatest driver of market fluctuations. The trust performed admirably in fiscal years 2013 and 2014, posting net gains of 11 percent and 13.3 percent, respectively, despite assuming far less risk than the vast majority of public pension plans.
Additionally, PSPRS is expected to outperform more than 80 percent of 66 comparably sized pension trusts for fiscal year 2015, a year marked by low returns for trusts with stock-heavy portfolios.
The PSPRS trust combined with the Corrections Officers Retirement Plan (CORP) and the Elected Officials Retirement Plan (EORP) is valued at roughly $8.3 billion and provides retirement, disability and survivor benefits to approximately 50,000 retired and active members.
While I believe that former PSPRS Administrator James Hacking was unfairly scapegoated for PSPRS' problems and forced to fall on his sword and resign to appease some PSPRS critics, his departure was an opportunity to bring in someone new with a better track record at another pension system or financial organization.  I thought we would have that when in March 2015 PSPRS announced that Kevin Olineck, a vice-president with the British Columbia Pension Corporation (BCPC), was chosen to be the new PSPRS Administrator.  The BCPC is in much, much better financial shape than PSPRS, and no doubt has many good practices that Mr. Olineck could have brought with him to PSPRS.

Unfortunately, this was not to be as Mr. Olineck strangely could not get a visa to work in the United States, and the Board of Trustees' choice went from international to inter-office.  While the press release touts Mr. Smout's 18-year tenure as a plus, a look at his resume shows that with the exception of a three-month stint as acting finance director for the Salt Lake City Public Library, he has worked almost exclusively for PSPRS, starting as an administrative assistant in 1997 and working his way up to Deputy Administrator in 2011.  While he has an admirable record of career advancement in PSPRS, the bulk of his time with PSPRS coincides with its worst financial performance and most problematic management.  Also, according to the August 27, 2015 Arizona Republic article, Arizona public-safety pension trust picks insider as new leader, by Craig Harris, Mr. Smout signed off on the illegal raises that cost Mr. Hacking his job.

Compared to Mr. Olineck or Deric Righter, a former CEO of ThyssenKrupp USA, the other finalist for the Administrator job and another person with a more varied and successful career in finance and management, Mr. Smout appears, far and away, the least likely of the three to implement change at PSPRS.  Closer to home, we can compare Mr. Smout to Paul Matson, Director of the much better managed and much better performing Arizona State Retirement System (ASRS).  Mr. Matson's ASRS biography shows he worked six years for the Alberta, Canada Treasury before joining ASRS, then spent eight years as ASRS Chief Investment Officer before becoming Director.  ASRS' Trustees obviously saw the value in a more well-rounded career with exposure to other systems when they hired and promoted Mr. Matson.  It is unfortunate the PSPRS Board of Trustees did not see things the same way once they knew that Mr. Olineck was unable to take the job.

Trustees Lauren Kingry and Bill Davis, to their credit, voted against Mr. Smout's selection, with Mr. Kingry stating that he wanted to "to examine the available candidate pool."  Unfortunately, the other five Trustees voted to select Mr. Smout without even that cursory amount of due diligence.  Of course, the Board already bungled a months-long hiring process by offering the job to someone who could not work in the United States, a piece of information which was conspicuously omitted from the press release.  They also see fit to boast about their fiscal year 2015 performance, despite the fact that it will only be about half the assumed rate of return, another piece of information missing from the press release.  If this is the mindset of the Board of Trustees, maybe the next thing to be replaced should be some of the Trustees.

Friday, August 28, 2015

PSPRS investment returns through June 2015 (the all-important end of the fiscal year)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for June 2015, the end of the current fiscal year (FY), with the June 2014 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%





7/31/2014 -0.67% -0.67% -1.97% -1.97%
8/31/2014 1.73% 1.05% 4.20% 2.14%
9/30/2014 -1.53% -0.49% -2.08% 0.01%
10/31/2014 0.40% -0.09% 2.75% 2.76%
11/30/2014 0.92% 0.82% 2.42% 5.25%
12/31/2014 -0.18% 0.64% 0.00% 5.25%
1/31/2015 0.01% 0.65% -2.78% 2.32%
2/28/2015 1.91% 2.58% 5.79% 8.25%
3/31/2015 0.83% 3.42% -1.02% 7.15%
4/30/2015 0.95% 4.40% 0.45% 7.63%
5/31/2015 0.54% (est) 4.94% (est) 1.38% 9.01% (est)
6/30/2015 -0.73% 4.21% -1.67% 7.29%

There is usually about a two-month lag in PSPRS reporting its investment returns.  The PSPRS Board of Trustees did not have a July meeting so I do not have exact numbers for May 2015 and estimated the returns based on April and June.  PSPRS returns reverted back to their normal pattern in May and June with gains lagging when the Russell 3000 is positive and limiting its losses when the Russell 3000 is negative.  As can be seen, PSPRS did not even meet its expected rate of return (ERR) of 7.85% much less the COLA threshold, which, as was discussed earlier here, means no COLA will be paid in the current FY.  The returns, net of fees, will probably be around 3.70% for the fiscal year.

For the fiscal year, all but two of PSPRS' asset classes showed a positive return, but of the positive returners, only the private equity class met or bested the ERR with a 14.05% FY return.  The non-US equity and real assets with -4.58% and -3.55% FY returns, respectively, are the two asset classes with losses for the FY.  PSPRS FY returns are a very mixed bag.  Looking at two years of PSPRS' risk-averse strategy, PSPRS' FY 2014 return was 54.79% of the Russell 3000, while PSPRS' FY 2015 return (estimated net of fees at 3.70%) was 50.75% of the Russell 3000.  If PSPRS' risk-averse strategy can only range between 50-55% of the Russell 3000 each year, it will be really tough for it to ever meet its ERR.  Even at the new 7.50% rate and getting to 55%, the Russell 3000 would have to return 13.64% just to meet the ERR.  Of course, this is limited data, but it is all we have to go on.

The Russell 3000 showed a 1.67% gain for July 2015, but as of August 27, 2015, the Russell 3000 has a monthly loss of -5.48%.  Who knows what could happen by the end of today and on the 31st?  It has been so volatile this month that almost nothing would surprise me.   Regardless, PSPRS likes to highlight the stress tests it has done on its portfolio as proof of how well-designed the portfolio is, so this month they may get a real, live stressor against which to check the design of the portfolio.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

Thursday, August 27, 2015

Why Prescott's PSPRS sales tax measure went down in defeat

Normally, a local election in a city of 40,000 people would not be of much interest to people outside its city limits, but the City of Prescott had an interesting issue on its ballot Tuesday.  Officially listed as Question 3, the City of Prescott ballot asked voters:
Shall the City of Prescott adopt a transaction privilege (sales) tax of fifty-five one-hundredths of one percent (0.55%), the restricted revenue from which shall be dedicated to the payment of the unfunded obligations of the city to the Arizona Public Safety Personnel Retirement Systems, taking effect on January 1, 2016, and continuing until the unfunded obligations of the city to the Systems are paid in full, including any associated financing of said obligations, but ending not later than December 31, 2035?
This attempt to pay off Prescott's PSPRS deficit via a 20-year sales tax increase was soundly defeated 56%-44%.  According to the Prescott Daily Courier, this defeat was in spite of the support of the current City Council and all but one of the candidates who ran for mayor and council seats.  Interestingly, in the only head-to-head race, the one candidate opposing the PSPRS sales tax, Harry Oberg, won the mayoral election against Dan Fraijo, a former Division Chief in the Phoenix Fire Department and a former Prescott Fire Chief, 51%-49%.

Two other tax measures were on the ballot as well.  A measure to increase a road tax from 0.75% to 1.0% was approved, 57%-43%, while a 0.08% tax to pay for open space was  rejected 58%-42%.  So there appears to be more here than an across-the-board rejection of tax increases.

Voters were given dire projections about draconian cuts to city services and lectured about their "responsibility" to pay a legally incurred debt, and yet in spite of this collective shaming by politicians, media personnel, business leaders, and sundry commentators, voters still overwhelming defeated this tax proposal.  It is funny to see the tut-tutting of the Prescott political class with comments such as:
Councilman Greg Lazzell: "There are going to be a lot of hard decisions and a lot of disappointed citizens."
Councilman Steve Blair: "People have the attitude that we have to live within our means, but it is going to involve some serious choices."
Former Councilman Malcolm Barrett, Jr.: Those against the PSPRS tax proposal "talked about sending a message, but the only message they're sending is that 'we're not going to pay our bills."
Councilwoman Jean Wilcox:  Those who voted against the PSPRS tax proposal "were duped by the Tea Party mentality, and don't understand that paying this tax will benefit the whole community."
Nothing like characterizing your constituents as infantile, ignorant deadbeats to win them over.  Compare this to the comments of Joe Pendergast, president of the opposition organization, Citizens Tax Committee:
"I think people have had enough of taxes unless they can be justified."
"My idea was, if [the PSPRS tax] did pass, the pressure is off the council."
"The council is in a little bit of a pickle, and citizens will be up in arms, and will pressure the council to pressure the Legislature (on reform)."
While I do not agree with Mr. Pendergast's reasoning since the Prescott City Council will have scant influence on the Arizona Legislature, except through the League of Arizona Cities and Towns, and barring bankruptcy, will still have to pay this debt, he is correct in pointing out the responsibility of the politicians in this problem.  As politicians are wont to do, they characterized and sold the solution to the PSPRS debt as a revenue problem, never making any concessions on the spending side.

Why did the voters approve the road tax by the same margin they rejected the PSPRS tax, if "they were duped by the Tea Party mentality"?  It is because, in the case of infrastructure, the revenues will have to match the spending.  X dollars will get you X amount of construction and repairs, based on an open bid contract system.  Streets are not paid wages, do not collectively bargain, nor spike their pensions.  Compare this to the PSPRS tax.  While the taxes will have to go toward the PSPRS debt, what drove that debt in the first place?  Wage and benefit policies.  Technically, this PSPRS sales tax is restricted revenue, but the rest of the city's general fund is not.

Without a commitment from the city government to control the wage and benefit policies driving PSPRS costs, what will keep the PSPRS tax from being funneled back into the very spending that caused the deficit in the first place?  I certainly would not begrudge the fire and police unions for working to increase their pensionable wages and benefits as this is what unions are supposed to do.  However, how do you go to someone on a fixed or low income and ask them to pay a higher sales tax without some guarantee that the cost drivers of the tax will be managed as well?  The Prescott government is asking taxpayers to give them money without any transparent mechanism for controlling future pension costs.

Perhaps if the PSPRS tax measure was tied to some concession like a union-negotiated agreement like an employee contribution rate increase or a limiting of pensionable wages to base pay only, it would have shown voters that the city and its public safety employees were willing to sacrifice alongside taxpayers.  This would show a serious effort to pay down the deficit.  The phased-in employer contribution rates for the Prescott Fire Department and the Prescott Police Department are 63.44% (non-phased 74.49%) and 55.12% (non-phased 66.16%), respectively, and I am not sure these rates for Prescott Fire, taken from the 2014 actuarial reports include all the higher costs related to the Granite Mountain Hotshots tragedy.  Excluding overtime and other non-base pay items would save Prescott 55 to 63 cents for every dollar spent on non-base pay.  This would also reduce pension costs long-term by lowering final average salary calculations made on employee pensions.  Employees would also get to keep the 11.65% employee contribution on non-base pay, instead of paying it into PSPRS.

I believe that Prescott voters knew intuitively that the budget savings freed up by the PSPRS sales tax would soon make its way back into the very same cost drivers that created the deficit in the first place, and they would be worse off than before the tax was implemented.  The Prescott political class expects taxpayers to act "responsibly" and pony up their hard-earned money to pay off the PSPRS deficit, but  they conveniently forget that it was politicians like them and their public employee allies who irresponsibly created this mess in the first place.  I think that the voters would agree to a PSPRS tax, just like the roads tax, if it was clearly tied to a pension cost control program.  Perhaps the political class will show some leadership this time around, instead of haranguing voters, by implementing some real reforms going forward.  If not, they shouldn't be surprised that voters don't trust them to do what's right with their money.