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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...

Sunday, September 30, 2012

The usual suspects, part 4

The last post showed how private sector labor unions achieved success, not through direct confrontation with management, but through politics.  The ability to influence politicians was critical for labor to get necessary legislation and government support to fight management on more equitable terms.  There is nothing wrong with this, as this is how all special interest groups, attempt to create favorable conditions for themselves.

Once the fights over issues like work hours, overtime, workplace safety, and collective bargaining were won after many years of struggle and sacrifice, unions had already internalized the idea that they had won their battles against management through force of will and combativeness.  These values became part of the self-image of private sector unions, and as a result, an adversarial attitude toward management became normal, even with employers who had already accepted unionization and viewed employees as valuable resources.

This adversarial attitude toward management caused private sector unions to portray any conflict with management as a grand struggle for workers' rights, even if it is over less lofty issues like pay, benefits, or job security.  For hardcore unionists, this attitude is perfectly logical.  If one views labor as the source of all value in the private sector, then any negotiation is over how much labor allows management, as representatives of owners or shareholders, to share in the fruits of the workers' labor. This means that any benefit extracted from management is an earned benefit, and any attempt to take away an existing benefit is a form of theft.

The Jobs Bank that GM created to pay laid-off workers would only be proposed by a union that believed that, once given, a job at GM was a permanent earned benefit.  This benefit could never be taken away, regardless of how many vehicles GM sold or how much money it earned.  While the Chicago Public Schools (CPS) believed it had the right as employers to dictate how teachers were evaluated, rehired after layoffs, or awarded for merit, the teachers' union had a different philosophy.  CPS's demands encroached on earned benefits and were worth striking over.  This was all in a city where 80% of its eighth-grade student are not proficient in math and reading and one of the most union-friendly in America.

So etched in the DNA of public sector unions are both a dependence on politics (and politicians) for power and a militancy about benefits.  Public sector employee unions arrived late on the scene but inherited these tendencies.  The next post will discuss how these tendencies affect the public pension crisis.

Friday, September 28, 2012

The usual suspects, part 3

The final member of the troika that gets blame for the public pension crisis are public sector employee unions.  Small government advocates are particularly critical of public sector employee unions.  They believe that the unions use financial and political clout to elect politicians that will maximize union members' pay and benefits.  The idea that a special interest group has a disproportionate influence in choosing its own boss is viewed by some as an egregious conflict of interest that hurts taxpayers through higher taxes and decreased services.  Before dealing with this issue, here is a little back story.

Labor unions are most associated with private sector industries since the titanic and sometimes violent struggles between workers and management occurred in the private sector.  The main problem in the private sector was that, as industrialization altered the labor market, more and more workers were forced into jobs where they had little control over their working conditions, hours, and pay.  They had dangerous and unhealthy working conditions, low wages, and long hours with no recourse except the ability to withhold labor.  Unions were formed to bring collective power to workers so they could strike, but strikes were often met with harsh responses from management and workers could often be easily replaced.  The contentious struggles between workers and management continued until the 1930's when significant legislation was enacted to give labor unions more power.

Government workers did not suffer the same hardships as private sector workers.  The main problem in the public sector was the patronage and spoils system in which political connections often determined whether someone could get or keep a job in government.  The federal civil service system was developed in 1871 to address the patronage and spoils issue by creating fairer hiring and retention policies that were based on merit and not who you knew.  State and local governments modeled their own  systems on it, and the system remains in place today.  The birth of public sector employee  unions is a relatively new phenomenon.

While labor unions ("the ones who brought you the weekend") will often take credit for every improvement in the worklives of Americans, they only affected change by becoming a political force.  Labor unions had to go to politicians to get what they wanted because the ability to withhold labor was simply not a powerful enough tool, especially in low-skill occupations, to force management to change.  However, with political power, unions were able to attack management from a side they could not defend.  Politicians and unions formed a symbiotic relationship and altered the balance between labor and management so both parties were on more equal footing.  So don't forget to thank self-interested politicians for the weekend since they are really the ones that gave Americans the 40-hour work week.

The National Labor Relations Act of 1935 (aka The Wagner Act) awarded workers significant powers in relation to management.  These included the ability to collectively bargain and certain job protections when they chose to strike.  Management's primary power, the ability to fire workers, was severely curtailed.  This placed workers on more equal footing with management.  Strikes and the threat of strikes allowed unions to extract concessions from management that were impossible before the Wagner Act.  These included concessions related to pay and benefits, as well as safety and working conditions.

Since the 1930's through the heyday of unions in the 50's and 60's and the decline in the 80's and on, much has changed in the private sector.  First, many low-skill jobs, where most union protections are needed, have moved overseas where wages are much lower.  Second, management had to change its philosophy as workers became more highly skilled.  As both management and workers have invested more in training and education, retention of skilled workers is more critical . Third, outrageous unions demands have crippled companies.  The epitome of this was the United Auto Workers (UAW) demand that General Motors (GM) create the Jobs Bank.  The Jobs Bank was a program that allowed laid-off GM workers to be paid even if they had no work to do.  These workers could sit all day and literally do nothing.  This program was discontinued after GM had to be bailed out by the federal government.  Finally, the necessity of private sector unions has been deemed unnecessary by many workers.  This is mostly because private sector unions have won all their important battles, and government agencies and courts now provide adequate protection to workers from any real or perceived sins of management.

The next posts will deal with how this history of private sector unions relates to public sector employee unions.

Thursday, September 27, 2012

The usual suspects, part 2

A previous post (Eat, drink, and be merry for tomorrow our pension may die) addressed the city of Stockton's foolish decision to finance its pension debt with bonds.  This New York Times article by Mary Williams Walsh (How a Plan to Help City Pay Pensions Backfired) details how Stockton was assisted in this debacle by Wall Street investment bank Lehman Brothers.   For those who already blame Wall Street for the public pension crisis, this article will serve as a convenient morality play in which evil Wall Street, represented by the now-defunct Lehman Brothers, leads the naive politicians of Stockton down the path of ruin.

The situation in Stockton is a mess with taxpayers, city employees, and retirees left to watch the spectacle of the city government, CalPERS, bond insurers, and other creditors fight it out in court over who gets paid, who gets stiffed, and who gets stuck with the tab.  Lehman Brothers would be involved in this battle as well if it had not gone bankrupt, but Lehman Brothers does serve a purpose by lingering in the background as a ready-made scapegoat.  This allows the Stockton city council, CalPERS, and bond insurers a way to mitigate their poor choices and lack of foresight by utilizing the it's-all-Wall-Street's-fault excuse.

For many people Wall Street occupies the same economic environment as the much-derided "middleman" in the retail industry.  The consumer has been led to believe that the middleman is a superfluous entity whose only purpose in the supply chain is to take his cut and raise final costs.  However, the middleman does provide a service to manufacturers who want to move their goods quickly and retailers who only want to carry enough inventory to match their sales.  If Target or Safeway tried to operate their business like Costco, they would need buildings that dwarfed your typical Costco.

Wall Street exists to facilitate transactions that transfer risk between parties.  Market makers, insurers, investment banks, currency and commodities traders, and brokerages all link up parties willing to buy and sell risk.  This is no different than when a homeowner buys insurance; he is simply transferring the risk of catastrophic loss to the insurer for an annual fee.  The financial system is supposed to price risk based on the likelihood of default, and products more likely to default have higher interest rates.  The problem that will always exist is the danger that risk is miscalculated or that the parties do not understand the true risk of the product they have bought or sold.  This is not to say that there is not fraud or unethical behavior on Wall Street.  In the documentary Enron: The Smartest Guys in the Room, some Enron traders gloated to coworkers when they made a trade that they knew would end badly for the unsuspecting buyer.  How prevalent that type of attitude is on Wall Street would have to be answered by an insider, but regardless, a market for risk-trading exists and Wall Street profits by making that market work.

This post is not meant to be a explanation or history of the Great Recession, and there are several good books like Gretchen Morgenson's Reckless Endangerment,Bethany McLean and Joe Nocera's All the Devils Are Here,Edward Conard's Unintended Consequences,and Michael Lewis' The Big Shortthat do a great job of explaining what happened.  For the city of Stockton, Mr. Lewis' book has the most cogent passage.  He writes about a trader named Danny Moses whose question to any Wall Street firm that tried to sell him on a supposedly risk-free trade was, "I appreciate this, but I just want to know one thing: How are you going to f*** me?"  For Mr. Moses this was not a rhetorical question, and he demanded an honest answer and would trade only if he was told the truth.

Ms. Walsh's article tells how the Stockton city council sensed that the pension bond idea was too good to be true, and one council member even professed ignorance about the bond market. Lehman Brothers eventually sold them on the bond proposal in 2007, but with how much skepticism, willing suspension of disbelief, and unanswered questions from the city council is not detailed in the article.

So how much is Lehman Brothers to blame?  They appear as Harold Hill-like characters selling a dream to gullible townsfolk, but the product actually succeeded in its purpose of transferring risk.  Stockton transferred risk to bondholders and then insured the bonds.  The insurer of the bonds will have to reimburse bondholders for their principal, but the insurer has filed a claim against the city in bankruptcy court.  Depending on how the bankruptcy judge rules, Stockton may get out of this debt at a discount or even scot-free.  This was not how it was supposed to work, but it may turn out to be a good deal for the city after all.

The overarching question is the culpability of Wall Street in the public pension crisis.  The criticism that Wall Street created bad products like mortgage-backed securities and credit default swaps that were destined to crash the market is valid, though bond rating agencies, government regulators, government-sponsored entities like Fannie Mae and Freddie Mac, and institutional investors also share some of the blame.  However, the market has since recovered, and yet, many public pensions are still in bad financial shape.  As convenient as it is to blame Lehman Brothers for some of Stockton's financial problems, the trouble started long before Lehman Brothers ever entered the picture.  The awarding of generous retirement benefits with unrealistic expectations of how they were to be funded is the real reason Stockton is bankrupt.  And so it goes for the public pension crisis.  Even if Wall Street may have helped crash the market, the seeds of the public pension crisis were sown long before the crash.

The next post will cover the last of the usual suspects that get blamed for the public pension crisis: public employee unions.

Wednesday, September 19, 2012

The usual suspects, part 1

“I do not believe that the solution to our problem is simply to elect the right people. The important thing is to establish a political climate of opinion which will make it politically profitable for the wrong people to do the right thing. Unless it is politically profitable for the wrong people to do the right thing, the right people will not do the right thing either, or if they try, they will shortly be out of office.”
      Milton Friedman, Nobel Prize-winning economist
For public employee unions seeking to find someone to blame for the public pension crisis, there are always the standard issue villains: Wall Street and politicians. For advocates of small government, the villains are public employee unions and politicians.  At least both sides have one villain they can both agree upon.  David Crane in his editorial on September 15, 2012 (Pension problems not the fault of employees) lays blame for the public pension crisis squarely on politicians.  He takes politicians to task for promising benefits but failing to adequately fund them.

Based on his background, Mr. Crane is obviously no naif when it comes to government or California politics.  However, he is missing the most fundamental problems with politicians: they deal in immediate benefits but deferred and diffused costs.  Politicians can immediately reward constituencies or special interest groups through laws and regulations but hide the true cost by deferring it to the future or diffusing it over a large number of taxpayers.  One group can receive something now while those that have to pay for it are unaware of the true cost because it will not hit until the future.  This cost can also be spread out over a large enough number of taxpayers that it is not readily apparent, but the small costs will accumulate over time and steadily increase the taxpayers' burden.

Those who receive the immediate benefits have a very strong incentive to get politicians to take their side and will use whatever resources they have to accomplish this.  Taxpayers, unfortunately, are given a misleading picture of what this is doing to the long-term financial health of the government and its ability to provide necessary services.

Mr. Crane may be correct that politicians are at fault. He writes that pensions and retiree health benefits are simply forms of deferred compensation that were promised by California's politicians but not adequately funded.  But this is just another product of the system in which politicians exist, and the system usually works fine until all those deferred and diffused costs become so great that they can not and will not be paid.  Then it breaks down and you have a situation like the public pension crisis.

Milton Friedman had a better understanding of the situation and why politicians themselves are not the real problem.

Thursday, September 13, 2012

PSPRS members: A dozen more reasons to be concerned about your pension

The Government Accounting Standards Board (GASB) issued two new rules that will dramatically affect public employee pensions.  Released on June 25, 2012, GASB Statements Nos. 67 and 68 will change how pensions like PSPRS have to report their financial condition.  This key passage come from GASB's "plain language" article (New GASB Pension Statements to Bring About Major Improvements in Financial Reporting):
To the extent that a pension plan's net position and projected contributions associated with active and inactive employees, including retirees, is expected to fully cover projected benefit payments for those individuals, the long-term expected rate of return will be used.  If there comes a point in the projections when plan net position and contributions related to active and inactive employees is no longer projected to be greater than or equal to projected benefit payments related to those employees and administrative expenses, then from that point forward a government would be required to discount the projected benefit payments using a municipal borrowing rate--a tax-exempt, high quality (an average rating of AA/Aa or higher, including equivalent ratings) 20-year general obligation bond index rate.
That's supposed to be "plain language"?  Here is a clearer explanation from Andrew Biggs of the American Enterprise Institute (The Accounting Trick that Will Haunt Public Pensions):

Under GASB' current accounting standards, state and local pensions "discount" their future benefit liabilities using the assumed rate of return on pension's assets, typically 8 percent. Discounting calculates the present value of a future payment by subtracting interest each year, something like compound interest in reverse.
In response to criticism, GASB in June proposed amended rules. Under the new standards, the current 8 percent discount rate could be applied to benefits only through the years in which the plan's assets are expected to last. Liabilities occurring in years after plan assets would be exhausted must be valued using a lower municipal bond rate.

What this means for PSPRS is that it can only use its expected rate of return on a portion of its liabilities.  Using the lower rate on the other portion will increase PSPRS' total liability and decrease its funded ratio.  We can see how much lower in this Wall Street Journal article (Is Your Pension Underfunded?).  These figures were for fiscal year 2010, but if this same 12% decrease were applied to the fiscal year 2011 funded ratio, PSPRS would have a funded ratio under 50%.  The new GASB rules will go into effect over the next two years.

The only good thing to take away from the Wall Street Journal article is that, at least, we aren't teachers in Chicago.

Wednesday, September 12, 2012

The folly of the DROP, part three

For those who may remain unconvinced that the Deferred Retirement Option Plan (DROP) was a shortsighted and ill-conceived plan, here are some other points:

  1. The DROP existed for barely a decade before it was eliminated.  That is hardly a ringing endorsement of its financial genius.  Unfortunately, it will continue to harm PSPRS until the last of those grandfathered in finally leave the job.
  2. Though touted as a cost-neutral or even money-saving program, the DROP was only created for a small group of public safety personnel.  If it was so great, other departments would have created their own versions of the DROP.
  3. It creates a two-class system among PSPRS members.
To illustrate the last point, consider a new hire with no access to the DROP and an individual entering the DROP today with a very modest $3,000/month retirement benefit.  The employee who enters the DROP today, using the minimum interest rate of 2%, will receive a DROP payment after five years of $189,457.  At the current 4.4% interest rate, he would leave with $201,662.  This lump sum payment can then be rolled over into another tax-deferred account like an IRA or 457(b).

The new hire is ineligible for the DROP, but she can be extremely frugal and put away the current maximum $17,000 per year into her 457(b).  If she made regular monthly deposits of $1,417/month and earned a 4.4% interest rate, compounded monthly, it would take her over 9 years to save up about the same amount as the employee earning only 2% in the DROP.

The employee who entered the DROP would do nothing more than fill out some paperwork five years before he would have retired anyway.  But the new hire would have to make enormous sacrifices to achieve the same end.  She and her family would suffer, all while taking on the added burdens of working longer and paying more into PSPRS.  This is the folly of the DROP, personified.

The folly of the DROP, part two

The most compelling argument for the Deferred Retirement Option Plan (DROP) is that it is a win-win proposition for employees and employers.  The DROP allows an employee to "retire" out of PSPRS but continue working for up to five more years.  The employee's monthly retirement payments accumulate tax-free while in the DROP and are paid out with interest when the employee finally leaves the job.  The final lump sum payout to the employee can be hundreds of thousands of dollars.  It proves to be such an attractive idea because it contradicts the old adage that there is no such thing as a free lunch.  Is it really possible to create a program that earns PSPRS members a large end-of-career bonus and save taxpayers money?

Of course not. Many years ago Fram had a commercial that highlighted the importance of preventive maintenance through the use of its oil filters.  Mechanics would contrast the cost of regular oil changes versus the expense of rebuilding an engine.  They would end the commercial by saying, "You can pay me now or pay me later."  This sums up the problems with the DROP.

The DROP was sold to politicians as a money-saving measure because, while an employee is in the DROP, the employer does not have to contribute anything to PSPRS for that employee.  This can save an employer thousands of dollars a year for just one employee and free up money for other purposes.  If hundreds of employees are in the DROP, the savings can be in the millions.  So far, so good--sounds like a great idea.

The problems begin when we consider that an employee enters the DROP at his highest earning years.  When both the employer and the employee should be making their greatest contribution to PSPRS, they both pay nothing.  Furthermore, those in the DROP were guaranteed an interest rate as high as 9% on their accumulated retirement payments.  This interest was paid even in years when PSPRS suffered huge losses on it investment portfolio.  The DROP not only starves PSPRS of funding but can rob principal from PSPRS when investment returns are bad.

That should be enough to make the DROP unworkable, but it gets worse.  Employees have a fixed contribution rate, which limits their liability.  Taxpayers, however, have an open-ended commitment to PSPRS.  After employees have paid their fixed contribution, taxpayers must pick up whatever else is needed to make up for shortfalls in PSPRS.  Taxpayers never received any true savings and just deferred costs they could have paid in the past (during a better economy) until now.  "You can pay me now, or you can pay me later."

Politicians look only to the next election, so of course, they approved the DROP.  It freed up money they could spend immediately at the expense of the future.  Those who pitched this to politicians selfishly helped themselves to a huge windfall.  While this was supposed to benefit taxpayers by saving money and retaining experienced personnel, taxpayers ended with nothing but debt.  Somebody won with the DROP, but it certainly wasn't the taxpayer.

Tuesday, September 11, 2012

PSPRS pension debate primer

My union local emailed me this link to a rebuttal written by Professional Fire Fighters of Arizona (PFFA) President Tim Hill (Hill: Robb fails to mention some important facts on public safety pensions).  It responds to Robert Robb's August 10, 2012 piece in the Arizona Republic (Public pension funds are ticking time bomb).  Here are some important facts that Mr. Hill did not mention in his piece:
  1. The S&P 500 index hits its all-time high of 1,565.15 on October 9, 2007 and closed at 676.53 on March 9, 2009.  It closed at 1,429.08 yesterday (September 10, 2012).  This is 90% of the all-time high, but a 211% increase over the market low during the most recent recession. Markets and returns can and do fluctuate.
  2. PSPRS' funding ratio was 126.9% on June 30, 2001.  It was 61.9% on June 30, 2011 and may have dropped below 60% at the fiscal year end on June 30, 2012. The funding ratio measures the ability of PSPRS to meet its obligations.
  3. Employers (i.e. taxpayers) paid a contribution rate of 20.11% vs. 7.65% for employees in fiscal year (FY) 2010-11.  This employer rate is estimated to increase to 27.18% vs. 9.55% for employees in FY 2012-13.
  4. Employers (i.e. taxpayers) contributed $44,518,693 to PSPRS in FY 2001-02.  In FY 2010-11, they contributed $273,824,144.  (Note: taxpayers also contribute to PSPRS through a fire insurance premium tax.  This tax is not included in the figures above.)
  5. Employees contributed $62,486,725 to PSPRS in FY 2001-02.  In FY 2010-11, they contributed $99,262,271.
  6. The average PSPRS pension in FY 2001-02 was $30,759.  In FY 2010-11, it was $47,739.
  7. There were 15,557 active members (current employees) vs. 5,989 retirees in PSPRS as of FY year end June, 30, 2002.  As of FY year end June 30, 2011, there were 18,638 active members vs. 9,522 retirees.
  8. As of FY 2001-02, there were 645 in the DROP.  As of FY 2010-11, there were 1,419 in the DROP.  Those in the DROP do not pay into PSPRS nor does the employer contribute anything toward those in the DROP.
  9. Taxpayers are constitutionally bound to fund PSPRS.  This leaves taxpayers with virtually unlimited liability to PSPRS, and they are left to make the greater sacrifice to keep PSPRS funded.
  10. $40,000 a year may not seem like a lot, but if you were to enter the DROP today with a $40,000 ($3,333/month) annual pension, you will walk away with  $224,000 five years later.   Also, $40,000 is the average pension.  When this average is calculated, it includes smaller pensions taken 15, 20, and more years ago as well lower surviving spouse pensions, so it is likely pensions being taken today are much higher.
  11. Anyone hired on or after January 1, 2012 will have to work longer, pay more, and receive fewer benefits.  They will get no DROP.  They will pay for the excesses of those hired before them.
  12. Pension reforms are threatened in the courts and the legislature.  For those hired before January 1, 2012, this may eventually return PSPRS to the status quo before SB 1609.
  13. PSPRS has large investments in hedge funds and private equity firms.  
Readers can reach their own conclusions based on these additional facts.  They are relevant and need to be considered by anyone who wants to seriously engage in debates over PSPRS.

A 9/11 reminder of the WTC heroism of police, firefighters, and security and safety personnel.

This comes from page 316 of  The 9/11 Commission Report:
The National Institute of Standards and Technology has provided a preliminary estimation that between 16,400 and 18,800 civilians were in the WTC complex as of 8:46 A.M. on September 11.  At most 2,152 individuals died at the WTC complex who were not (1) fire or police first responders, (2) security or fire safety personnel of the WTC or individual companies, (3) volunteer civilians who ran to the WTC after the planes' impact to help others, or (4) on the two planes that crashed into the Twin Towers.  Out of this total number of fatalities, we can account for the workplace location of 2,502 individuals, or 95.35 percent.  Of this number, 1,942 or 94.94 percent either worked or were supposed to attend a meeting at or above the respective impact zones of the Twin Towers; only 110, or 5.36 percent of those who died, worked below the impact zone.  While a given person's office location at the WTC does not definitively indicate where that individual died that morning or whether he or she could have evacuated, these data strongly suggest that the evacuation was a success for civilians below the impact zone. (italics mine)
In a day and age when victimhood is celebrated (Bullied bus monitor honored), no one should forget that the WTC rescuers were not just heroes because they sacrificed their lives to save their fellow citizens.  Under nearly impossible conditions, they succeeded at their mission.  This should be remembered during all of today's somber memorials.

Monday, September 10, 2012

The folly of the DROP, part one

Which one of these urban legends is true?
  1. Mama Cass choked to death on a ham sandwich.
  2. John Denver was a sniper during the Vietnam War.
  3. The Deferred Retirement Option Plan (DROP) keeps experienced personnel on the job and is a win-win proposition for both employees and employers that saves taxpayers money.
The correct answer is . . . none of the above.  Mama Cass died of a heart attack, and John Denver never served in the military.  As for the third one, that legend is self-serving hype and half-truth.

The DROP was sold to politicians and the public because law enforcement and fire entities were rapidly losing valuable, experienced personnel.  These personnel were necessary in order to operate safely and efficiently and that replacing them was difficult and costly.  Without some type of incentive, experienced personnel would leave and service quality would suffer with severe, possibly fatal, consequences.

Experience is supposed to be self-perpetuating in an organization through the normal career progression of its employees.  It does not build up to a certain optimal level, after which it must be maintained at all costs.  The normal movement of workers up the ranks as attrition takes away the most experienced personnel should be sufficient to maintain a core of competent personnel.  If a small number of expereinced employees is so important to an organization that their departure will critically damage the organization, it means the organization is deficient in its training and promotion policies.  Also, those "critical" employees will have failed the organization by concentrating skill and knowledge in themselves and not training replacements.

Another problem with the DROP was that it was not a long-term solution to maintaining experienced personnel.  Some participants in the very first group to enter the DROP may have postponed their retirements to take advantage of a new windfall program being instituted just as they were about to retire.  However, everyone else would simply make the smart financial decision to incorporate the DROP into their original retirement plans.  Someone who planned to retire at 30 years would simply DROP at 25 years.  He would not stay for 35 years just because of the DROP.  At best, only a minimal amount of experience was retained by the DROP.

Finally, the DROP actually has a paradoxical effect on maintaining experience.  One of the problems with governments is that their hiring is subject to the vicissitudes of the economy.  Flush years allow them to hire; lean years force them to shrink via layoffs or attrition.  When public safety personnel are hired in large groups, they will tend to retire in large groups, usually at 20, 25, and 32 years for PSPRS members.  These milestones are when they first reach retirement eligibility, when they can add an extra 0.5% per year of service to their retirement benefit, and when they maximize their retirement benefit at 80%, respectively.  This would make a good case for the DROP to save experienced personnel, but in fact, the DROP only makes these mass exoduses worse.  The DROP created its own milestones when it changed from a fixed to variable interest rate and when it dropped its interest rate.  Large numbers of personnel wisely entered the DROP before these changes went into effect in order to maximize their DROP payment.  The DROP actually makes the retention of experienced personnel even more difficult by creating more incentives for them to leave en masse.

Developing experienced personnel should be a natural function of any organization, so the DROP was superfluous to begin with. The number of experienced personnel retained bythe DROP was minimal and may have actually worsened retention.  The next post will analyze whether the DROP is a win-win situation for employees and employers.

Thursday, September 6, 2012

If PSPRS is broke, don't fix it

The largest public employee pension system in Arizona is the Arizona State Retirement System (ASRS).  It covers the majority of public workers in the state of Arizona.  ASRS is a defined benefit pension like PSPRS, but it uses a different system to calculate benefits.  On April 29, 2011 ASRS had many of its provisions changed by SB 1609, the same bill that modified PSPRS.

However, SB 1614, an earlier bill signed into law on April 6, 2011, included a very significant change to ASRS.  This bill changed the allocation of contributions, which had been split equally between employees and employers.  SB 1614 mandated that, starting on July 1, 2011, employees would be responsible for 53% of the total annual allocation of contributions to ASRS.  Employers would pay the other 47%.  This is not the actual percentage amount taken from an employee's paycheck but the amount of financial responsibility the employee would take versus the employer (i.e. for every total dollar ASRS would collect, employees would pay $0.53 vs. $0.47 paid by the employer)

A lawsuit was filed, and this change to ASRS was overturned (Arizona pension law ruled unconstitutional).  In light of this decision, HB 2264, signed into law on May 7, 2012, required any excess member contributions collected after July 1, 2011 be refunded to ASRS members and the old 50/50 split restored.  The justification for this legal ruling was the same as in the case of the retired judges' COLA's: the change violated a contract that was bound by Arizona's Constitution.

So what does this mean for PSPRS members whose contribution rate will rise annually until it tops out at 11.65% in fiscal year 2015-16?  As anyone hired before 7/1/2011 began their employment when the contribution rate was fixed at 7.65%, a constitutional case can be made that the increase in PSPRS members' contribution rate was a violation of a binding contract at the time of their hiring.   This very case is being made by two Arizona appellate court judges (Arizona judges will rule on own entitlement) against the Elected Officials' Retirement Plan (EORP).

Their lawsuit (case  #CV2011-021234) is still active in Maricopa County Superior Court.  If the EORP's increased member contribution rates are deemed unconstitutional, PSPRS can expect its higher member contribution rates to be overturned as well.  This could mean setting rates back to 7.65% and refunding any contributions over 7.65% taken from members' paychecks dating back to 7/1/2011.  Of course, new hires would still be subject to the higher contribution rates, and taxpayers will have to pay even more to bring PSPRS back to full funding.

As mentioned in previous posts, SB 1609's reforms to COLA's and the DROP are being rolled back in the courts and the legislature.  If successful, this challenge to higher member contribution rates would knock out the last leg of reforms enacted by SB 1609 and set PSPRS back nearly to square one.