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Thursday, October 25, 2012

The incredible shrinking PSPRS

PSPRS' consolidated annual financial report for the fiscal year ending June 30, 2012 should be released in the next month or two.  PSPRS Administrator James Hacking has already hinted that this upcoming annual report will show that PSPRS' condition has worsened over the past fiscal year.  With an already inadequate funding ratio of 61.9% on June 30, 2011, PSPRS members should brace themselves for some bad news just in time for the holidays.

If we want to know how bad, we can look to this piece by Byron Schlomach of the Goldwater Institute (Government Pension Funds: In Worse Shape Than They Admit).  Mr Schlomach shows that PSPRS has a funding ratio of only 53.9%, a drop of 8% over the previous fiscal year.  He lists Arizona State Treasurer Doug Ducey as the source of this official funding ratio, though he does not say if this is the funding ratio that will be included in the upcoming annual report.

If a 53.9% funding ratio is not alarming enough, Mr. Schlomach shows that the funding ratio for PSPRS would only be 37.1% if PSPRS used a more conservative rate of return of 5%, instead of its current rate of 8.25%.  Remember that the Government Accounting Standards Board (GASB) will soon require public pensions to be more conservative about how they use rates of return to calculate pension liabilities (PSPRS members: A dozen more reasons to be concerned about your pension )

Rates of return necessarily rise with risks taken, so the trap PSPRS has fallen into is one where it is forced to seek a riskier 8.25% return in order to meet its financial obligations.   This sets up PSPRS for the same type of devastating losses it experienced following the dot.com bust and housing market collapse if there is another financial crisis (e.g. Eurozone problems, Middle East war, fiscal cliff, etc.).  The other alternative is to use a lower assumed rate of return on its investments and acknowledge that PSPRS is critically underfunded and not able to meet it future obligations without a major infusion of capital.  This could mean requiring PSPRS members and/or taxpayers to contribute more each year to PSPRS or cutting benefits to retirees.

PSPRS deserves credit for diversifying its holdings away from its stock-heavy portfolios of the past.  We can all hope that diversification combined with a sustained bull market and growing economy will lead PSPRS back to financial health.  However, it appears that hope is a losing strategy that PSPRS members should not rely on.

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