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Friday, October 26, 2012

Pension Doomsday Scenarios I and II

The issues dealt with most often in this blog are financial issues, which can be complicated enough, though with a little analysis can be understood by anyone who is conversant in basic arithmetic.  Legal issues are another matter since the necessary background knowledge is quite extensive, as well the specialization necessary to understand any particular field of practice.

Included among the possible "doomsday scenario" for PSPRS are a major municipal bankruptcy or another financial crisis, but the most likely scenario that I can think of is a successful referendum to repeal the 1998 Arizona Proposition 100 (Arizona Public Retirement System Rules).  This proposition passed handily 61.4% to 38.6% and added to the Arizona Constitution this key statement, "Membership in a public retirement system is a contractual relationship that is subject to Article II, Section 25, and public retirement system benefits shall not be diminished or impaired."  The main reasoning behind Proposition 100 was to protect the state pensions from lawmakers that might misuse pension funds as had been done in other states and the private sector.

If Proposition 100 was repealed, it could allow the state to decrease benefits for retirees and the promised benefits of those currently working.  The language introduced into the Arizona Constitution is the basis for a successful court challenge to the cost of living allowance reforms that were part of SB 1609.  If Arizona taxpayers became sufficiently concerned about the financial burdens and service cuts being caused by the state's public employee pensions, Proposition 100 could be repealed. It would be a tough fight and any implementation of benefit cuts would assuredly be taken to court, but it remains very possible that it could be repealed.

The following piece by Nick Dranias (Taxpayer Backing? What Taxpayer Backing?) raises the possibility of another doomsday scenario.  The intriguing part of his piece is that it states that there exists no guarantee that state pensions like PSPRS will "perform as promised."  For a layperson like me this raises some intriguing questions.  As it stands right now, Arizona employers have always made good on the contributions demanded by PSPRS, even as they have grown enormously over the past decade to make up for PSPRS' underfunded status, but from this article it appears that employers' financial obligations are limited.

If PSPRS is a separate entity from employers, employers could argue that they are not responsible for the unfunded liabilities of PSPRS that were due either to poor investments or market downturns.  If an employer made matching contributions into an employee's 401(k) investment account and the account dropped because of bad investment choices, market volatility, or fraud, the employer would not be expected to make good on the losses in his investment account.  The employer fulfilled his obligation to the employee with the initial matching contribution and has no further liability.  The same could be said for an employer contributing to PSPRS.  An employer could legitimately argue that their obligation to PSPRS should not include any amounts related to investment losses that were solely the responsibility of PSPRS and its managers.  This would mean that an underfunded PSPRS would have to make up for its own losses and underfunded status.

This whole premise negates the protections of Proposition 100 because the only entity legally obligated to PSPRS members is PSPRS.  PSPRS can demand that employers pay more to make up for market declines or bad investment decisions, but employers seem to have the legal right to refuse to pay amounts related to investment losses.  They could argue that it is PSPRS' responsibility alone to manage and invest the funds it gets from employees and employers in such a way to ensure it has enough money to meet all its obligations .  The question is how do you split out the normal ongoing obligations from the investment losses lumped together in the employer contributions demanded by PSPRS.  Is it even possible to make this split, and has it ever been done before?  Could PSPRS successfully fight back by arguing that employers never provided adequate funding to begin with?

This doomsday scenario is scarier than the repeal of Proposition 100 since it would cut the generally assumed financial obligation employers have to PSPRS.  If a financially strapped or bankrupt employer successfully made this argument, so could all other employers.  PSPRS would then find it very difficult to recover from its underfunded status and would have to rely on the charity of employers to help it, and charity, like hope, is not a good plan for financial health.

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