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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...

Wednesday, June 1, 2016

What's next for PSPRS now that Proposition 124 has passed and other questions we would like to see answered


Now that Proposition 124 has passed, what happens now?  The transparency-challenged organization that is PSPRS has deigned to give us this bit of information:


PROPOSITION 124 What does it mean to the retired membership?

On May 17, 2016, the State of Arizona voters had an opportunity to cast their ballots on Prop 124, regarding a COLA (Cost-of-Living Adjustment) for the Public Safety members of the pension fund. The Proposition passed and the new law itself determines the payment schedule and defines the calculation of the new COLA payment. Please note that the passage of Proposition 124 does not affect the members of the Elected Officials’ Retirement Plan (EORP) or the Corrections Officer Retirement Plans (CORP). Here are some questions and answers as to the timeline and other information concerning the COLA:


  • When should we expect to see the first COLA payment? 

  • The first payment will be made with the July 2018 benefit check.



  • Why do we have to wait until July 2018?

  • Proposition 124 becomes law August 6, 2016. The law states that we must prefund this new COLA with a full year of contributions before any payment is made to the members.The contribution rates that will reflect this prefunding will not be published until mid-to-late fall 2016, effective for the fiscal year beginning July 1, 2017. One full year of these contributions ends June 30, 2018. So, the first time we are legally able to pay this COLA will be with the July 2018 benefit check.



  • How is the COLA amount determined?
  • The COLA amount is determined by the change in the Consumer Price Index (CPI) for the metropolitan phoenix-mesa area for the calendar year ending just prior to each July payout.



  • What is the CPI?
  • “The consumer price index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance. Changes in CPI are used to assess price changes associated with the cost of living.” (www.investopedia.com)



  • What percentage or dollar amount will be awarded?

  • The law states that the COLA is up to a 2% cap. For example, if the CPI is 1.8% for theyear, we will award the COLA at 1.8%. If the CPI is 5.2%, we will grant a COLA of only 2% due to that cap. Understand that this means that the percentage, or COLA, will fluctuate each year with the CPI results.
    JaredSig.bmp
    Jared A. Smout
    Administrator

    My favorite part of this series of FAQ's is the last question, which amounts to Mr. Smout telling retirees that they are assured of becoming slowly poorer through their golden years.  If we go to US Inflation Calculator, we can see that between 2001-2015 inflation has been over 2% nine out of the fifteen fiscal years with only one year showing deflation.  In the ten years prior to 2001, inflation was over 2% nine out of the ten years.

    Mr. Smout does not mention that COLA's will now be calculated on a retiree's individual benefit, not the average normal retirement benefit.  This means that those retirees with smaller benefits will no longer see their checks increase at a higher percentage rate than those with higher benefits as the average normal retirement benefit increases over the years.  A benefit check will never change in terms of purchasing power, except that everyone will see their spending power decrease at the same rate via the capped COLA.

    We should also keep in mind that the Federal Reserve's official inflation goal is 2%.  This is the Fed's rationale for this 2% target inflation:
    The Federal Open Market Committee (FOMC) judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve's mandate for price stability and maximum employment. Over time, a higher inflation rate would reduce the public's ability to make accurate longer-term economic and financial decisions. On the other hand, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling--a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken. The FOMC implements monetary policy to help maintain an inflation rate of 2 percent over the medium term.
    While this seems justifiable in the macroeconomic sense, this will be of no comfort to those living in the most microeconomic of worlds: retirees on fixed incomes.  So what happens if the Fed overshoots its target and inflation is 3%, instead of 2%?  That extra 1% means that after 20 years an item that cost $100 the first year will be $122 in year 20.  If inflation is 4%, the extra 2% will add over $48 to the cost of the item.

    As we have discussed here before, inflation is great if you are a debtor like PSPRS, which owes billions of dollars to its members.  Inflation will allow it to pay back retirees with cheaper dollars, while it reaps the benefits of higher returns on less risky investments.  Inflation is the magic elixir that will cure all of PSPRS' underfunding.  Of course, it will be on the backs of its retirees.  The defunct excess earnings formula took into account the potential devastation of high inflation, but it was horribly designed and sat like a ticking time bomb that would (and did) eventually wreak havoc on PSPRS.  Now we have another time bomb, only this one will blow up in the face of retirees.

    I did not see the film version of Michael Lewis' excellent book The Big Short, but the book tells how one of the protagonists would refuse to commit to a trade until the salesman explained to him how he was going to f*** him in the deal.  Well, the last FAQ in Mr. Smout's list should have been this same question.  So how is PSPRS going to f*** retirees? The answer is with inflation and a capped COLA.

    Finally, I have one last question for Mr. Smout and Chief Investment Officer (CIO) Ryan Parham.  If you remember, Mr. Parham penned an editorial for the Arizona Capitol Times in December 2014 entitled, "The truth about PSPRS investment performance."   It includes this revealing passage by the man in charge of PSPRS investments:
    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.
    It is this flawed mechanism that serves as the main contributor to PSPRS’ funding drop, and unless changed by a vote of the people or the Legislature and upheld by the courts, we are powerless to slow the decline.
    The insistence on assigning blame on PSPRS investment performance – and by extension our employees – for diminishing funding ratios is inaccurate and misleading and a disservice to policymakers, our beneficiaries and the public alike.
    Given the evident constraints they must operate under, our nationally and internationally recognized investment team deserves appreciation for its service to our state, not derision that has no basis in fact.
    Let us ignore the obvious questions about fiduciary duty contained within the CIO's admission that PSPRS was trying to lowball its own investment returns to circumvent the payment of COLA's under the old excess earnings formula.  I think what every PSPRS stakeholder would like to know is: when will Mr. Parham and his crack investment staff begin to produce the higher returns he implies they are capable of achieving now that the excess earning formula is no longer holding them back?

    Mr. Smout and Mr. Parham, we await your answer.










    6 comments:

    1. You are absolutely right about inflation being a tool that PSPRS can use to change the direction of the overall funding levels. Not only in the area of investment returns, but also in ee/er contributions. Those contributions are actuarially factored for inflation.
      More to the point, what is the goal of PSPRS for it's retired beneficiaries? Was it to provide a retirement benefit that would remain financially constant over the remainder of their lives? Provide a benefit that would increase in purchasing power? I think the implied contract between the employer and the employee who enters into the PSPRS defined benefit plan at the beginning of their career is that they would have a constant benefit that neither increases nor decreases in purchasing power. It seems that Prop 124 swung the pendulum too far in the wrong direction.

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      Replies
      1. Thank you for your comment. PSPRS has been around about 40 years, and I do not what was the original intent of their COLA or permanent benefit increase (PBI) policy was or how it has changed. Based on comments I've heard recently, it seems that the PBI policy that was just changed by Proposition 124 was implemented sometime in the mid-1980's. This would jibe with the tail end of the high inflation period that was finally defeated with high interest rates instituted by the Volcker-led Federal Reserve.

        I have no definitive answers as I was not a PSPRS member then. Perhaps someone who was could give better answers, though I agree with you that we have gone fully blind in the other direction. The old PBI assumed that high inflation was a permanent feature of the economy. Proposition 124 assumes that low inflation is the new normal. This is just as foolish in its short-sightedness but can be much more painful for retirees.

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    2. Since this takes affect in July 2018, will PBI's be calculated the same for July 2016 and July 2017?

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      Replies
      1. My understanding is that there will be no COLA's possible until 2018. It is also highly unlikely that PSPRS will earn the 9% threshold this year as they haven't even earned 1% through the first 9 months of the year.

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    3. Who wrote the portion of this document that comes after Mr. Smout's portion? What qualifications do they have to provide such information and detail? Just asking, not commenting.
      Bob Mitchell

      ReplyDelete
      Replies
      1. I'm just a concerned member of PSPRS.

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