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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, January 9, 2015

Parham's Paradox: true confessions from PSPRS' Chief Investment Officer

One of the more remarkable things I have ever read about PSPRS is this piece by PSPRS Chief Investment Officer (CIO) Ryan Parham, "The truth about PSPRS investment performance," that appeared in the December 18, 2014 Arizona Capitol Times.

Whenever an interested party proclaims to tell you the "truth" about a matter in which they are involved, you should be suspicious.  However, I read this with an open mind since I do not reflexively believe that the PSPRS administration and staff are responsible for PSPRS' financial woes, and after reading it through, I can not really dispute Mr. Parham's points about the relative quality of PSPRS' recent investment performance, the punishing effect that permanent benefit increases (PBI), more commonly referred to as COLA's, have on PSPRS' funded ratio, and the need to change the current COLA formulaton.

However, the most amazing thing that Mr. Parham writes is this:
. . . it is important to remember our innovative, low-risk, moderate return strategy is by conscious design, due to a pension benefit that PSPRS alone must pay to pensioners. This benefit, called the Permanent Benefit Increase, or “PBI,” siphons and distributes half of all returns in excess of 9 percent to eligible retirees. Not only are these increased payment levels made permanent, the investment gains only serve to increase – not decrease – unfunded future liabilities.

This rang true in fiscal years 2013 and 2014, in which PSPRS net performances were a positive 11 percent and 13.3 percent, respectively, while the system’s funded ratio dropped on both occasions. The cruel irony of this is that unless the PBI is modified to allow the PSPRS to retain and reinvest all of its gains, it is unlikely that we will ever be able to significantly impact the decline in our funding ratio.
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. (italics mine)
This passage is astonishing, and I had to read this a couple of times to ensure that I understood what Mr. Parham was saying.  Incredibly, he is saying that PSPRS' investment strategy is not designed just to balance investment risk and reward, but is also consciously designed to target as closely as possible the 9% threshold that triggers the excess earnings transfer into the Reserve for Future Benefit Increases ("the Reserve").  This is a stunning admission that PSPRS is deliberately low-balling its potential investment returns in order to limit contributions to the Reserve from which COLA's are paid.  I would like reiterate that this information is coming directly from the chief investment officer, a man who probably knows more about PSPRS than anyone else working there, in a piece that is giving us "the truth about PSPRS investment performance."

If you are a retiree, this likely outrages you. The CIO just confessed that PSPRS is purposefully trying to minimize its ability to pay COLA's.  But for everyone, this situation is just perplexing.  Mr. Parham is saying that with the current COLA formulation, earning over 9% actually has a negative effect on PSPRS' finances.  How can that be?  50% of anything over 9% would seem to be better than nothing, but he does not give any numbers to explain this.  If I were to speculate, I would guess that this would be due to the compounding effect over time of increased benefits, but I would need to see a more detailed explanation by Mr. Parham to better understand this situation.  Regardless, with a current expected rate of return (ERR) of 7.85%, this gives PSPRS a pretty small window of 1.15% to work with to help increase its funding level.

We should note that Mr. Parham's piece appeared in the Arizona Capitol Times, a newspaper which describes itself as "your inside track to Arizona politics."  By publishing his piece in a newspaper geared toward Arizona's governmental/political class and not a more mainstream paper like the Arizona Republic, it appears that Mr. Parham is appealing to the state's movers and shakers with a bit of inside information about the real reason why PSPRS' returns are so low.  I guess the rest of us just could not contemplate the subtleties of such a complex strategy, so Mr. Parham did not even bother to place a link to this piece on the PSPRS website like they usually do with other pieces written by PSPRS staff and trustees.

In the end, I have no choice but to give Mr. Parham the benefit of the doubt that his information is correct and that investment gains over 9%, paradoxically, are harmful to PSPRS' financial condition.  Furthermore, if it helps to change the COLA formulation in a beneficial manner (i.e. NOT like the Professional Fire Fighters of Arizona (PFFA) plan of intergenerational theft), this will have been a good thing.  However, Mr. Parham has also implied that PSPRS could produce higher returns than it currently does.  His words should end up on the wall of every PSPRS trustee and state legislator, as well as the governor and state treasurer.  It should not be lost down a memory hole if PSPRS does not produce stellar returns when the COLA formula is finally changed.  Just imagine what PSPRS would look like if its investment staff actually tried to earn as much money as possible.  That's the standard Mr. Parham has set for the investment staff, so I hope they are ready to perform.


  1. Do you think the pension will survive 20 or 30 more years? Are you actively planning to not have a pension?

    1. Thank you for your comment. I wish I could give you a simple answer to your first question. It is important to remember that, unlike other pensions systems like Arizona State Retirement System (ASRS), PSPRS only pools assets, not liabilities. This means that PSPRS' aggregate funded ratio may be better or worse than your own individual employer's, which is solely responsible for it's own employees and retirees. Assets are pooled in order to save expenses, but liabilities are accounted for individually since the policies of each employer can affect their accrued liabilities.

      Generally, those employers that were created or joined PSPRS more recently are in better financial shape than those, like Phoenix, Tucson, or DPS, that have been participating in PSPRS for a very ong time.

      So the pension will survive as long as there are employers that are able to pay their annual required contributions (ARC) every year. I assume that you work in public safety, so you will need to look at your own employer's actuarial report to see how they are doing. If they have current assets to meet their current liabilities, their future is brighter. However, the caveat here is that Phoenix and Tucson appeared to be well funded 10-15 years ago but are now in more dire straits. If and when there is another financial crisis, the PSPRS' assets will decrease in value, which in turn will require higher ARC's from employers, all while the revenue coming in to employers will decrease. This "double squeeze" of higher ARC's when tax revenue is declining is the kind of situation that can lead an employer into drastic budget fixes or even bankruptcy.

      So that was a long way of saying, "it depends." The answer to your second question is "yes," and my advice to everyone, but especially to anyone starting their careers, is to save as if you had no pension. Most public employees have three legs to their retirement: their defined benefit pension, Social Security, and a tax-deferred plan like a 457(b), 403(b), or 401(k). As PSPRS members we have access to only two of three legs since we do not participate in Social Security (and benefits for past Social Security-eligible work is reduced due to the Windfall Elimination), I believe it is dangerous to trust your retirement exclusively to the shaky and unpredictable PSPRS leg. Thanks again for your comment.

  2. Some agencies like Tucson PD also pay social security. But that is always on shaky ground. It is exhausting to be constantly concerned over benefits and the management of benefits. I appreciate the thoughtful articles and responses.

    1. Thank you for your comment. 15 years ago, I thought it was great that I did not have to pay into Social Security, figuring that that 5% deduction went into my pocket instead of into a federal retirement system that looked like it was not going to be there in the long run. Now I don't know what to think.

      Social Security, unlike PSPRS, does not have any Constitutional restrictions on changing anything about it, so tinkering with it through COLA's, retirement ages, contribution amounts, taxation of benefits, etc. is possible. At the same time, it has a huge constituency that can actually affect political change, so there is some populist inertia to prevent the radical changes PSPRS could be exposed to.

      I believe that it is still the official position of the IAFF to oppose professional firefighters paying into Social Security. I do not know what position of law enforcement unions is on this issue. I personally think that this is something that should be left up to the individual worker. I am too old for this to affect me, but a young person just starting a 25-year or longer career might think it is a good retirement supplement. Of course, employers might not be thrilled with having to find another 5% for each employee that decides to opt into Social Security.

      I am with you on how exhausting this is. As you get closer to retirement, you want certainty, not a tug of war between groups that I am not sure any of which have our interests in mind. It is a sad state of affairs that we seem to have gone full circle where you can only rely on yourself and must save as if you have no retirement at all. Thank you again for your comment.


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