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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...

Tuesday, December 16, 2014

What PSPRS can learn from the Arizona State Retirement System (ASRS)

If you want to see an illustration of what is wrong with PSPRS, check out this article, "Public workers, employers to pay less for pension plan," by Craig Harris from the December 5, 2014 edition of the Arizona Republic.

Mr. Harris writes about the fiscal year 2016 contribution rates and COLA's for employed and retired members, respectively, of the Arizona State Retirement System (ASRS).  ASRS is the largest defined benefit pension system in the state.  It basically covers any non-federal government worker in Arizona who does not work in public safety, corrections, or as an elected official or does not work for the cities of Tucson or Phoenix.  This includes the three state universities, community colleges, school districts, and state, county, and municipal governments.  It is a huge system with assets about four times that of PSPRS.

ASRS is often held up as an exemplar when compared to PSPRS, and ASRS is a stick with which critics like to beat PSPRS.  This has especially been the case over the past two years when so much negative attention was focused on PSPRS' former Administrator and staff.  This is not an unfair comparison because it is funded at almost 77%, significantly better than PSPRS' 49% funding ratio, and returned 18.6% last fiscal year versus 13.2% for PSPRS.  However, Mr. Harris gives some important details about ASRS that can give us some some understanding as to why ASRS is in such better shape than PSPRS that goes beyond any difference in the funds' respective management.

The article states that ASRS' employers and employees will see a drop in their contribution rates next fiscal year.  The drop is small from 11.48% to 11.35% but shows that ASRS is moving in a positive direction.  This also means that ASRS employees will pay less next fiscal year than PSPRS employees, who will see their contribution rate increase (and finally top out) at 11.65%.  As far as I know, all non-public safety employees in Arizona must also pay into Social Security, which is fixed at 6.2% apiece for the employer and employee

Like Social Security, ASRS equally splits the annual required contribution (ARC) between the employer and employee.  This is starkly different from PSPRS where employees will be capped at 11.65% next year, but employers have an open-ended commitment to the remainder of the ARC.  For next fiscal year, PSPRS has an average employer contribution rate of  over 41%.  Individual employer rates can be much worse, such as that of the City of Tucson which will have contribution rates in the mid-60% range for both its police and fire departments.  This means that the City of Tucson will have to pay over $0.60 for every dollar of pensionable income paid to its police officers and firefighters.

The importance of equally splitting contribution rates cannot be overstated.  It is the best barometer employees have to measure the health of their pension system and receive forewarning that a problem is brewing.  Politicians are reactionary and will act only after the problem becomes too big to ignore.  The higher ranks of public safety unions tend to be comprised of more senior members who have little incentive to advocate for proactive changes that may adversely affect their own retirements.  Therefore, a rising contribution rate can work as an early warning system for rank-and-file employees when past and/or current policies begin to show deleterious effects on PSPRS and, at the very least, force consideration of corrective actions.

PSPRS was about 127% funded on June 30, 2001.  PSPRS was 49.2% on June 30, 2014.  ASRS was 113% funded on June 30, 2001 (but had actually peaked at 120% funded the previous fiscal year) and was 77% funded on June 30, 2014.  During this 14-year period, ASRS employers and employees saw contribution rates increase from 2.49% (FY 2002) to 11.35% (FY 2016).  PSPRS employees had a fixed rate of 7.65% until fiscal year 2012 when it began to increase incrementally, reaching the maximum rate of 11.65% in fiscal year 2016.  The average PSPRS employer rate increased from 4.21% (FY 2002) to 41.08% (FY 2016).  We see in ASRS a steady increase in the contribution rate that was shared equally by employer and employee.  ASRS began with a lower contribution rate than PSPRS and raised it to meet funding shortfalls and now is in a position to begin lowering it back down.  On the other hand, PSPRS' fixed employee contribution rate hid rapidly escalating pension shortfalls from employees, who are now in a worse financial position than ever as increased employer contribution rates eat into their current wages.

As well as having a more transparent method of allocating ARC's, ASRS has a stricter COLA policy.  Mr. Harris writes:
For a permanent benefit increase to kick in, the trust must produce a rate of return in excess of 8 percent — the assumed rate of investment growth — for 10 years and generate a pool of excess earnings.
I am not sure how ASRS determines when there is "a pool of excess earnings," but ASRS, unlike PSPRS, has a proper understanding of COLA's.  We will not go into the details of the Fields decision again here, but even those whom the decision benefited must acknowledge that it is bad for all PSPRS members, working or retired.  It is simple common sense that a pension system cannot pay COLA's when it is underfunded, especially when it is less than half funded.  Paying COLA's to retirees from an underfunded pension is simply consuming the seed corn that is necessary to bring PSPRS back to financial health.  As in the case of employees and contribution rates, the real and pernicious damage caused by the pre-SB 1609 COLA formula was hidden from retirees, despite the potential financial risk to themselves and the certain financial burden it places on those that follow them in public safety careers.

While ASRS and PSPRS started at the same place in 2001, their financial fortunes have diverged dramatically over the past 14 years.  Both systems had to endure the dot.com crash and Great Recession, yet ASRS is in such a better position than PSPRS.  How did this happen?  Even if we attribute some of this to the systems' respective management teams, we cannot deny that PSPRS' problems went unaddressed for much longer than ASRS'.  ASRS was increasing employer/employee contribution rates and cutting retiree COLA's well before the Great Recession.  The legislature and public safety unions did nothing about PSPRS until well after the market crashed for the second time in the decade, and the state firefighters' union was even denying any reform was necessary at the time SB 1609 was passed, though they are now advocating their own bad reform proposal.

Obviously, ASRS is better designed than PSPRS and already has mechanisms in place to better allocate costs between workers, retirees, and employers.  These mechanisms makes financial sense, but more importantly, they ensure that every stakeholder is aware of and bears the pain of pension funding shortfalls.  This is something that is sadly missing from PSPRS.  If employees saw their checks shrinking year on year and retirees saw their COLA's diminished or eliminated, it would have forced them to look more critically at the policies that were slowly depleting PSPRS, and hopefully, do something about them before they spiraled completely out of control.

Monday, November 24, 2014

The sideshow finally ends: Completed federal investigation into PSPRS real estate valuations finds no criminal wrongdoing.

This article, "Arizona public safety pension fund cleared in probe," by Craig Harris appears in today's Arizona Republic.   It references a letter by U.S. Attorney Elizabeth Strange to PSPRS' attorney that states:

As you are aware, the U.S. Attorney’s Office for the District of Arizona (“USAO”) and the Federal Bureau of Investigation (“FBI”) have been conducting a criminal investigation concerning certain valuation decisions and disclosures made by your client, the Public Safety Personnel Retirement System (“PSPRS”).
I can now confirm, through this letter, that your client is not a subject or target of the investigation. Based upon our joint investigation with the FBI, at this time we do not believe that PSPRS committed any criminal misconduct. This Office takes no position on civil or administrative liability, however, as our review focused exclusively on whether PSPRS engaged in criminal conduct in violation of federal law. Thank you for your assistance and professional courtesy in this matter.

I hope that this finally ends this whole sorry episode.  PSPRS had (and still seems to have) a disproportionate share of its real estate portfolio invested with Desert Troon.  This never made any financial sense, but neither did PSPRS' former equity-heavy portfolio and appears to be a legacy of past administrations.  However, the notion that PSPRS staff knowingly inflated real estate valuations for the express purpose of triggering their own bonuses always seemed absurd to me. 

This blog addressed the issue of potential criminal wrongdoing in the January 2014 post, Notes on a (PSPRS) scandal.  Readers can see that post for more detail, but in short, PSPRS addressed the problems noted by the Arizona Auditor General and revalued the Desert Troon portfolio accordingly.  In the end, the adjusted valuations done per the Auditor General's required standards were closer to the allegedly "inflated" Desert Troon valuations than they were to the "correct" and lower, initial valuations.  This hardly makes the case for a criminal conspiracy.  What it does make the case for is a more diversified real estate portfolio.  A better real estate portfolio would be one in which the investment in a single company would not impact PSPRS' total value to such an extent that staff bonuses could even remotely factor into the choice of a valuation methodology.  A better real estate portfolio would be one in which its value can be clearly determined and not be so opaque that a consensus can not be reached even among PSPRS' own in-house personnel and the Board of Trustees.

One final absurdity is that, in addition to all the unnecessary legal costs incurred by PSPRS to defend itself against charges of criminal behavior, the state of Arizona is on the hook for the private legal expenses of the four former PSPRS staffers who accused PSPRS of misconduct.  According to the Arizona Republic, Desert Troon is suing the four employees for "engaging in a post-employment conspiracy to defame and falsely disparage senior management at the company and the pension system."  Hopefully, for the sake of the former employees and Arizona taxpayers, Desert Troon will drop the lawsuit now that the U.S. Attorney has exonerated PSPRS of any wrongdoing, but who knows what they will do, especially if these accusations led to lost business for their company.  Some expressed outrage that former PSPRS Administrator Jim Hacking had a stipulation in his severance package that PSPRS would pay any legal costs "relating to actions taken in the course and scope of his employment" with PSPRS, but now it appears that PSPRS' accusers could end up costing taxpayers more.

Now that the sideshow is over maybe the misplaced outrage can be redirected where it should have gone in the first place.  Issues like pension spiking, unsustainable COLA's, intergenerational inequities, and the fragility of PSPRS in the face of future financial crises are the real problems that plague PSPRS.  People got their investigation and they got Mr. Hacking's job, now can we end the collective tantrum and move on to more important things?

Tuesday, November 18, 2014

The financial markets will not save you: the limited effect of investment returns on PSPRS' funding ratio

While we are on the subject of investment returns, I thought it would be interesting to see the effects past years' investment losses have on PSPRS' funding ratio.  The following is taken from PDF page number 23 of the 2014 PSPRS Consolidated Actuarial Valuation Report:

A. Beginning Year Funding Value $ 5,905,509,127
D. Non-investment Cash Flow $    (65,772,608)
E.Amount for Immediate Recognition $    461,000,892

F1. FY14 (Just ended)  $    33,458,496
F2. FY13  $      9,542,555
F3. FY12  $  (72,234,304)
F4. FY11  $    40,557,028
F5. FY10  $      9,473,791
F6. FY09  $ (183,695,537)
F7. FY08  $ (118,855,348)

G1. End of Year Funding Value (Prelim)  $ 6,018,984,092

Total Accrued Liability  $12,233,016,817
Funding Ratio 49.20%

This shows how PSPRS calculates its funding ratio.  The funding ratio is calculated by dividing its funding value (a valuation of its investments as of June 30, 2014) by its total accrued liability (what it needs to pay all the benefits it owes to retirees and current workers).  Calculating the funding value is not as simple as reporting the market value of all its investments as of June 30. 2014.  PSPRS, like many pension systems, uses a smoothing period when recognizing investment gains and losses.  PSPRS uses a seven-year period, while other systems use longer or shorter smoothing periods.

The smoothing period lessens the effect of year-to-year fluctuations in market returns so that funding ratios and contributions do not dramatically change from year to year.  This is especially important to employers who have to budget for employee costs and do not want their contribution rates yoyoing up and down each year.  With the seven-year smoothing period that PSPRS uses, this means that only 1/7th of each gain or (loss) incurred over the last seven years is recognized in the current year's  funding ratio.  Lines F1-F7 represent 1/7th of the gains and (losses) of each of the past seven years above or below the 7.85% expected rate of return (ERR).  The $461 million in Line E represents the expected 7.85% return that PSPRS should have earned on its investments in fiscal year (FY) 2014, which ended June 30, 2014.  This amount is recognized immediately.  The $33,458,496 in Line F1 represents 1/7th of the amount over 7.85% that PSPRS earned in FY14.  This means, for funding purposes, any year that PSPRS does not achieve its ERR will show a loss.

Each year, the oldest year drops off and is replaced by the newest year.  Looking at the table we can see that the two oldest years, FY08 and FY09 covering the two-year period from July 1, 2007 to June 30, 2009, are responsible for gigantic losses to PSPRS.  Over $118 million in losses will fall out of next fiscal year's calculations, and over $183 million in losses will fall out when FY16 ends June 30, 2016.  Hopefully, these losses will be replaced by large gains, but regardless, it is unlikely that losses of such size recur unless we have another financial crisis of the magnitude of the Great Recession. The funding ratio should increase, and that is good news for all of us and our employers. A higher funding ratio will mean lower employer contribution rates and more money available in employers' budgets.

So how much will the funding ratio increase when these losses drop off?  It is impossible to predict what will happen this fiscal year, so the best we can do is simply change some of the amounts in Lines F1-F7. I tried several different scenarios.  The first scenario used was one where PSPRS had suffered no losses or gains in either FY08 or FY09.  This would mean that PSPRS earned exactly 7.85% each of those years.  Under this scenario the End of Year Funding Value (Line G1) would increase to $6,321,534,977.  Liabilities of $12,233,016,817 would remain the same in all scenarios, so the funding ratio would go from 49.20% to 51.68%, an increase of 2.47%.

In the second scenario, I made it so PSPRS suffered no losses or gains in FY08, FY09, and FY12 and earned exactly 7.85%.  Line G1 increased to $6,393,769,281 and the funding ratio improved to 52.27%, an increase of 3.06%.

In the third scenario, I made it so PSPRS, instead of suffering losses, actually gained the same amount each year in FY08 and FY09 as it did in FY14, $33,458,496.  Line G1 increased to $6,388,451,969, and the funding ratio increased to 52.22%, an increase of 3.02%.  The increase here is less than the second scenario since the gains plugged into FY08 and FY09 do not fully make up for the loss in FY12.

In the fourth, most optimistic scenario, I made it so PSPRS actually gained the same amount each year in FY08, FY09, and FY12 as it did in FY14.  Line G1 increased to $6,494,144,769, and the funding ratio improved to 53.09%, an increase of 3.88%. 

These numbers are very sobering.  The losses from FY08 and FY09 falling out of the seven-year smoothing period produce an immediate gain of almost 2.5% in the funding ratio.   That is great.  However, when we look at the most optimistic scenario where all the loss years were turned into years of gains similar to FY14, we only improve our funding ratio by another 1.4% above the initial 2.5% increase.  While I hope I am wrong about this, I think the the gains in FY14 are likely to be as high as PSPRS will ever earn in its current risk-adjusted portfolio.  This means that investment gains going forward will have limited effect on raising PSPRS' funding ratio in the near-term.

PSPRS investment returns through September 2014

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for September 2014, the third month of the current fiscal year, with the June 2014 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%

7/31/2014 -0.67% -0.67% -1.97% -1.97%
8/31/2014 1.73% 1.05% 4.20% 2.14%
9/30/2014 -1.53% -0.49% -2.08% 0.01%

There is usually about a two-month lag in PSPRS reporting its investment returns.  This is usually not a problem, but with such volatile markets, it would be nice to see a shorter reporting time.

If there is a pattern for market returns for the current fiscal year, it is that there is no pattern. Year-to-date returns should return to positive since October 2014 returned 2.75%, though daily returns were a roller coaster ride.  November 2014 has had much less volatility and is up about 1.0% month-to-date.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees, except on the final report of the fiscal year.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

Thursday, November 13, 2014

PSPRS actuarial reports by employer are now available

PSPRS actuarial reports by employer for the fiscal year that ended June 30, 2014 can now be found here.  These reports give the current funded ratios and contribution rates for fiscal year 2016, which starts July 1, 2015, for each individual employer.  PSPRS had previously posted the aggregate report, but each employer will have a different funded ratio and contribution rate depending on their own particular situation.

Friday, October 31, 2014

2014 Consolidated Actuarial Valuation Reports for PSPRS, CORP, and EORP

PSPRS has officially posted the Fiscal Year 2014 Consolidated Actuarial Valuation Reports for the three pension systems managed by PSPRS.  The reports are in a more user-friendly PDF format than the Board of Trustees' Meeting notes that were referenced in an earlier post.  The report for each system can be found at the following links:
Public Safety Personnel Retirement System (PSPRS) 2014 Annual Actuarial Valuation Report
Corrections Officer Retirement Plan (CORP) 2014 Annual Actuarial Valuation Report
Elected Officials' Retirement Plan (EORP) 2014 Annual Actuarial Valuation Report
Actuarial reports for individual PSPRS employers are not yet available, but funded ratios and employer contribution rates for fiscal year 2016, which starts July 1, 2015, can be found in the appendices.  Funded ratios can be found on Appendix III starting on PDF page 79.  Contribution rates can be found in Appendix IV starting on PDF page 85.

Thursday, October 23, 2014

PSPRS investment returns through August 2014

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for August 2014, the second month of the current fiscal year, with the June 2014 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%

7/31/2014 -0.67% -0.67% -1.97% -1.97%
8/30/2014 1.73% 1.05% 4.20% 2.14%

There is usually about a two-month lag in PSPRS reporting its investment returns.  This is usually not a problem, but with such volatile markets, it would be nice to see a shorter reporting time.

If there is a pattern for market returns for the current fiscal year, it is that there is no pattern.  Returns were negative in July and positive in August.  I believe September was another negative month, and who knows how the roller coaster month of October, which has already had several daily swings of 1-2%, will end.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees, except on the final report of the fiscal year.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

Monday, October 20, 2014

Arizona Horror Story: PSPRS' Fiscal Year 2014 actuarial valuation report

Just in time for Halloween PSPRS has released the annual actuarial valuation report for the fiscal year that ended June 30, 2014.  The report is not available as a stand-alone document and, as of now, is only included in the October 22, 2014 Board of Trustees Meeting Materials.  The document is 400 pages long so navigating is easier if it is opened in the Adobe PDF program.  The report by Gabriel Roeder Smith & Company starts on PDF page 161.

Even for the most pessimistic among us, this report is incredibly bad.  From fiscal year 2013 to fiscal year 2014, PSPRS' aggregate funded ratio dropped from 58.7% to 49.2%.  The aggregate contribution rate that will begin next fiscal year increased from 31.03% to 41.08%.  Shockingly, the reversal of SB 1609's changes to the COLA formulation by the Fields case is responsible for dropping the aggregate funded ratio 6.1% and increasing the aggregate contribution rate 7.17%.  For anyone who is hoping that Parker and Hall are successful in their cases against PSPRS and EORP, respectively, this should make you reconsider.  If you want to know where your particular employer stands, go to PDF page 239 to see individual employer funded ratios and PDF page 245 for individual employer contribution rates for fiscal year 2015.  I, for one, will not be counting on a raise next year.  My employer's contribution rate increased by over 15%, which means that for just me, my employer will need to find another $10,000 in the budget to pay for increases in the unfunded liability.

In the last post, we discussed the Phoenix pension reform initiative, Proposition 487.  I am sure the proponents of Proposition 487 will be bringing up PSPRS' bad numbers to help make their case for ending the City of Phoenix's pension.  We will certainly be discussing this report more in the near future.

Sunday, October 19, 2014

Some thoughts about Proposition 487, the pension reform ballot measure in Phoenix

Reporter Dustin Gardiner had an excellent article entitled, "Fact Check: Will Phoenix pension reform save money?," in the October 15, 2014 Arizona Republic.  If passed this November, Proposition 487 would close the city of Phoenix's defined benefit (DB) pension plan to new employees.  New employees would be placed in a defined contribution (DC) retirement plan, like a 401(k), 403(b), or 457(b) plan, while current employees would remain in the DB plan.  The Phoenix DB pension is one of the six major public DB pension plans in Arizona, along with PSPRS, the Corrections Officers Retirement Plan (CORP), the Elected Officials Retirement Plan (EORP), Arizona State Retirement System (ASRS), and the City of Tucson's DB pension.  EORP's DB plan is already closed to new employees.  Last year Tucson had Proposition 201, a ballot measure similar to Proposition 487, ready for the November 2013 ballot, but a lawsuit tied up the measure in the courts and it never went before the voters.  Neither the Phoenix or Tucson measures would affect new public safety employees.

Mr. Gardiner does an excellent job of explaining the financial arguments, and his conclusion as to whether it will save money is "it depends."  The measure includes other money-saving provisions that are not certain to be enforced by the city council and/or are able to withstand any legal challenges.  For the record, the Arizona Republic has officially endorsed Proposition 487.

Proposition 487 will be a good gauge of voter sentiment, so I am very interested to see if and by how much it does or does not pass.  Depending on the result, it also has the potential to lead to some good or bad reforms to PSPRS.  There will be much more to talk about if it does pass.  In the meantime, here are a couple of points:

It's all about the legacy costs.  Despite all the rhetoric, it is virtually impossible that Proposition 487 costs more than it saves in the long run because it permanently ends the open-ended commitment that taxpayers have to City of Phoenix employees/retirees.  With a DC plan, the City ends its financial obligation to an employee once that employee retires, and the City is not subject to unseen costs that could last for decades.

While Tucson voters did not get a chance to vote on pension reform last year, the City of Tucson changed (with virtually no opposition) a retiree benefit four years ago that will permanently save it millions of dollars.  Starting in 2011, the City stopped paying a percentage of the health insurance premiums of non-Medicare-eligible retirees and began paying them a flat subsidy instead.  In the current year, the monthly HMO premium for a retiree, who retired before 2011, and a spouse is $250.  If the same employee had retired in 2011 or later, he would pay $625.  This $4,500 in annual costs, times however many years until he becomes Medicare eligible, is now permanently shifted from the City of Tucson to the employee.  Even more importantly, it makes costs more manageable because now the City can plan and budget for subsidies rather than be at the mercy of unknown future insurance costs that can go significantly higher.

In the same manner, matching contributions by the City of Phoenix into employees' DC accounts can be planned for and budgeted.   They can be increased or decreased depending on prevailing economic conditions, and there are no unforeseen costs waiting in the future to decimate the City's finances.

Current employees provide a benefit to a city.  Roads, buildings, and sewage treatment facilities provide a benefit to a city.  Programs that make a city safer, cleaner, or attract more jobs benefit the city.  Legacy costs for retiree healthcare and pensions do nothing for a city, except make paying for all the other beneficial things more difficult.

Do employees use the power of math for good or evil? According to its 2013 annual report, the City of Phoenix Employees' Retirement System (COPERS) uses a point system where an employee becomes eligible to retire when the combination of his age and years of service equals 80.  Benefits are calculated at 2% per year of their final average salary for up to the first 32.5 years of service with lower multipliers for years past 32.5 years.  Employees contribute 5% of gross pay toward their retirement. Note: COPERS went to a two-tier system some time after the 2013 report. Tier 2 members split the annual contribution to COPERS equally between themselves and the City, making the contributions rates for Tier 2 employees much higher than Tier 1 employees.

With an 80 point minimum, an employee starting at 24 years of age could retire at 52 years of age with an annual retirement benefit of 56% of his final average salary.  I used a spreadsheet to calculate for an employee that started his career at $35,000 per year with 3% wage inflation for each year.  His final high three-year average salary would have been a little over $75,500.  Multiply this by his 28 years of service by the 2% per year multiplier, and you get an annual retirement benefit of $42,280 or about $3,523 per month. 

The spreadsheet got a little more complicated when I calculated his total contributions.  Using the same 3% annual wage inflation with 26 annual pay periods at the 8.0% expected rate of return (ERR) compounded every two weeks, I show the total contributions paid by this employee paying 5% out of each biweekly checks growing to $230,733 when he retired.  (The employee paid a little over $75,000 in real dollars and 28 years of interest took care of the balance.)

An annuity calculation at Bankrate.com shows that this employee would need over $483,000 to get $3,523/month in income using the same expected rate of return of 8%. Even if the City had matched the employee's 5% annual contribution, he would be over $20,000 short of what was necessary to have enough saved to pay the expected lifetime income promised.  However, I think that most people would agree that $20,000 is a reasonable margin of error and would accept the argument that a public DB pension is a fair and feasible benefit that uses professional management and pooled resources to get a better deal than the employee could get investing on his own.

I am sure that the reader see several problems here, most obviously with actuarial assumptions including ERR, life expectancy, and wage inflation.  Changes in these will make all the final numbers change.  This also does not take into account things like spousal death benefits that may add years to the benefit payment and future COLA's.  These actuarial assumptions could, of course, change in a way that is beneficial to the pension's finances, but this is not likely to be the case with the current economy.

A more important point I want to make here regards pension spiking.  Using all the same data, if our hypothetical employee was able to raise his average compensation for his last (high) three years by $10,000, he would raise his final salary to about $86,115 and his retirement benefit to about $48,224 or $4,018 per month.  However, total contributions with interest would only increase by $1,793 from $230,733 to $232,526.  With the employer's 5% matching, we get $465,502 total paid in for this employee.  This is still less than what is required to pay the non-spiked pension, but what is our new annuity calculation?  At 8.0% ERR for 30 years, the cost to purchase an annuity for the spiked pension increases $68,000 to over $551,000.  Spiking the pension by $5,000 per year in the high three years would increase the annuity cost by over $54,000; spiking the pension by $15,000 per year in the high three years would balloon the annuity cost by $118,000.  Just a small change in the employee's final three years of salary makes for big changes in the cost of the employee's retirement.

The unforgiving nature of compound interest shows that there is no shortcut to retirement income.  The math is simple.  You have to save X in order to receive Y over your retired life.  If enough employees lowball X and/or highball Y, you will eventually have a pension system in financial trouble.  When any employee, not just high earners, spikes his pension, he slowly chips away at the foundation of his own retirement system.  Yet those who should be most concerned about pension spiking are doing nothing about it.  How do you stop pension spiking if elected officials show a lack of motivation in dealing with it and employees think that it is okay?

This November we will see if Phoenix voters have an idea.

Thursday, October 16, 2014

PSPRS investment returns through July 2014

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for July 2014, the first month of the current fiscal year, with the June 2014 returns included for comparison:

Report PSPRS PSPRS Russell 3000 Russell 3000
Date Month End Fiscal YTD Month End Fiscal YTD
6/30/2014 0.78% 13.82% 2.51% 25.22%

7/31/2014 -0.67% -0.67% -1.97% -1.97%

This fiscal year I have begun using the Russell 3000 instead of the S&P 500 because it is the benchmark that PSPRS uses for its domestic equity portfolio.  The Russell 3000 is a much broader index and, as the name implies, tracks 3,000 stocks.  This compares to the S&P 500 and The Dow Jones Industrial Average, which tracks only 30 stocks.  There is usually about a two-month lag in PSPRS reporting its investment returns.  This is usually not a problem, but with such volatile markets, it would be nice to see a shorter reporting time.

As can be seen, the current fiscal started off badly, but it only represents the first month of the year.  I believe that August was a positive month and September was a negative month.  October has so far been horrible for equities (-5.36% month-to-date), so who knows what the final monthly return will be.  PSPRS' investment staff looks like they are getting a good opportunity to test the effectiveness of their risk/return-balanced strategy.  It should be an interesting year.

* Returns, gross of fees, are used because PSPRS usually does not report returns, net of fee, except on the last report of the fiscal year.  The past two years fees have reduced the final annual reported return by about one-half of a percent.

Monday, October 13, 2014

What are two most important legal issues facing PSPRS, Part I? (Hint: Neither has anything to do with James Hacking or real estate investments)

In the last post I mentioned the Pension Task Force that has been set up by the League of Arizona Cities and Towns ("the League").  I have not had a chance to read every document posted on the Task Force's homepage, but the one that caught my eye and seemed like required reading is titled "Kutak Rock Presentation."  I recognized the Kutak Rock name as that of PSPRS' law firm, so I was hoping there would be some updated information about the still pending Parker v. PSPRS and Hall v. Elected Officials' Retirement Plan (EORP) cases.  The Parker and Hall cases were filed by individuals who were active law enforcement personnel and active judges, respectively, at the time SB 1609 went into effect.  These cases are challenging both the change in COLA calculations for active personnel hired before SB 1609 went into effect, which was the issue resolved when the already retired judge Fields won his case against EORP, and the increase in contribution rates.  In the case of PSPRS, contribution rates have had stepped increases annually starting from 7.65% and will top out at 11.65% next fiscal year.

Unfortunately, there was no updated information about the cases.  This is frustrating since the outcome of these case will financially affect so many of us both now, when it comes to contribution rates, and in the future, when it comes to how our COLA's are calculated.  However, the presentation by Marc R. Lieberman, a partner at Kutak Rock, is still very interesting.  The critical issues it covers are the options available to change the Arizona Constitution with respect to public retirement systems and the principal legal issues involved in the Hall and Parker cases.  In this post we will discuss the options available to change the Arizona Constitution with respect to PSPRS.

Article XXIX of the Arizona Constitution states the following:
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.
This one sentence is at the heart of all the legal challenges to SB 1609.  Mr. Lieberman breaks the sentence down into two clauses with the first clause being the "Contract Clause" and the second being the "Pension Clause," which I have seen other references to as the "pension protection clause."  The distinction between the two clauses is important because the Contract Clause seems to offer less protection than the Pension Clause.  The Contract Clause was not considered in the Fields case, which relied strictly on the Pension Clause as justification to overturn the COLA formulation changes to the pensions of retired EORP members.  This is important because he writes Article II, section 25 if the Arizona Constitution:
. . . prohibits a government's impairment of contracts ("No . . .  law impairing the obligation of contract, shall ever be enacted").  Despite the fact that the provision appears absolute, the courts have construed Art. II, section 25 as allowing governments to enact legislation impairing contracts if certain elements are satisfied.
He writes that among these certain elements are "significant and legitimate public purpose" and "reasonable and appropriate measure to achieve the public purpose," and in the Fields case:
 the Court emphasized that the Contract Clause pertains to "the general contract provisions of a public retirement plan, while the Pension Clause applies only to public retirement benefits."
 As a result of this dichotomy, the Court held that the Pension Clause "confers additional, independent protection for public retirement benefits separate and distinct from the protection afforded by the Contract Clause."
So there we can see the importance of the Pension Clause.  Mr. Lieberman writes,
Fields confirmed earlier decisions (Yeazell, Thurston) holding that members and retirees have a vested right to rely on benefits promised them at the time of their hire.
The question remaining here is if it was possible that Fields might have lost his case against EORP if the Pension Clause was not in the Constitution.  We will never know since the Contract Clause was not considered in the Fields case, and this would, no doubt, bring in other legal issues and precedents that Mr. Lieberman did not cover in his Powerpoint slides.

Mr. Lieberman mentions two possible changes to the Arizona Constitution which he refers to as consensual and non-consensual changes.  As an example of consensual change he mentions "fire fighter legislation," which I take to mean the ridiculous Professional Fire Fighters of Arizona (PFFA) PSPRS reform proposal.  I wrote about the PFFA proposal in several posts, including here, so I will not go into it further now.  The  most likely option of the non-consensual changes involves simply repealing all or part of Article XXIX of the Arizona Constitution.

Article XXIX is a relatively new addition to the state Constitution, only being ratified by Arizona voters on November 3, 1998.  I suspect that Proposition 100, as it was then labeled on the ballot, would not pass if it were put before the voters now.  Mr. Lieberman brings up the potential for simply repealing the Pension Clause while retaining the Contract Clause of Article XXIX.  This would allow the potential for some type of impairment of pension benefits (like changes to unsustainable COLA's), in what I would assume to be in extreme cases of underfunding and exorbitant contribution rates, but retaining the same protections of any other binding contract in normal circumstances.  This would obviously mean more lawsuits when the Legislature tried to implement changes but would not allow any pension reform to be dismissed out of hand, regardless of PSPRS' financial circumstances, as was done in Fields.  Would Arizona voters approve changes to Article XXIX?  Perhaps the results of Phoenix's pension referendum will give us an idea.

Mr. Lieberman ends his presentation with a great question:
What's more important, preserving the plans' fiscal health for future generations or protecting the pension rights of existing members?
I would add to this my own question about the crucial issue of fairness.  How much (more) financial sacrifice should be made by future (and current younger) generations so that the financial sacrifice of existing or (soon-to-be) retirees is minimized?

The next post will cover the other major issue facing PSPRS.

Saturday, October 11, 2014

A Beginner's Guide to PSPRS and Defined Benefit Pensions

The League of Arizona Cities and Towns ("the League") and the Arizona City/County Management Association (ACMA) and the Government Finance Officers Association of Arizona (GFOAz) has created a Pension Task Force.  Normally, when a committee or task force is formed it is bureaucrat-speak for "let's try and make it look like we are concerned about an issue when we really have no intention of doing anything about it."  However, in this case the League and its partners seem to be serious about their work.

Since June 24, 2014 when the Task Force was initiated, they have held five meetings, which alone indicates a level of urgency and seriousness, but if you go to the Pension Task Force homepage, you can see another surprising thing--there is actually a wealth of information there about PSPRS and defined benefit (DB) pensions that is accessible to the layperson.

This information is available to anyone interested, though you will need Powerpoint software to access some of it.  There are presentations by PSPRS staff, their actuary, and their lawyer, advocacy groups with differing views about DB pensions, and other outside organizations with research and  opinions about DB pensions.

The League and its partners deserve big thanks for the work they are doing both to understand PSPRS and any potential reforms and educate the rest of us.  If you want a crash course in PSPRS and DB pensions, the Task Force homepage is the best place I have seen to get one.

Wednesday, October 8, 2014

Is PSPRS getting value for the investment fees it pays?

PSPRS posted to its website the meeting materials for its Board of Trustees Meeting for September 24-25, 2014.  Included in these materials are the performance figures, net of fees, for the fiscal year that ended on June 30, 2014.  We had previously looked at returns, gross of fees, in this post.  The following table shows the various asset classes, their benchmark returns, returns gross and net of fees, and the percentage of fees paid on each asset class.

Bench Gross Net
Asset Class
Mark Of Fees Of Fees Fees
US Equity 
25.22% 22.32% 21.90% 0.42%
Non-US Equity
21.75% 20.59% 20.35% 0.24%
Private Equity
26.22% 28.18% 26.60% 1.58%
Fixed Income
7.39% 6.29% 6.21% 0.08%
Credit Opportunities
8.59% 11.85% 11.31% 0.54%
Absolute Return
2.05% 9.86% 8.28% 1.58%
3.23% 7.57% 7.51% 0.06%
Real Assets
4.08% 9.86% 8.85% 1.01%
Real Estate
11.21% -0.62% -1.26% 0.64%
Risk Parity
12.07% 10.04% 9.71% 0.33%
Short-term Invest.
0.05% 0.34% 0.27% 0.07%
PSPRS Total Fund
13.82% 13.82% 13.28% 0.54%

As can be seen, fees range from a high of 158 basis points (1.58%) to a low of 6 basis points (0.06%).  A basis point (bp) represents 1/100th of one percent and is a more convenient way to write about interest rates.  I was interested to see if PSPRS was getting its money's worth when it comes to some its alternative investments, which I would classify as those that are most familiar like equity (stocks), fixed income (bonds), short-term investments (cash and equivalents), and real estate.  Following are definitions of those alternative investments from the April 2014 article, Modern Pension Fund Diversification*, which has among its co-authors several PSPRS staff members:
  •  Private Equity (Introduced in July, 2008): Investments in equity or debt (with equity participation) in commingled assets that are generally not traded on public exchanges and usually illiquid in nature. 
  • Credit Opportunities (Introduced in July, 2008): Investments in corporate credit including bank loans, high yield debt, convertible securities, “distressed” corporate debt, mezzanine loans, structured products (such as CLOs and MBS), and other credit-sensitive instruments that may or may not be publicly listed. 
  • Real Assets (Introduced in April, 2009): Investments in energy, core capital assets, special situations, natural resources, infrastructure, commodities, and marketable securities. 
  • Global Tactical Asset Allocation (GTAA) (Introduced in March, 2010): Encompasses strategies that trade across highly diversified and liquid markets utilizing distinct processes to execute their broadly global trading strategies. Strategies within this sub-portfolio include Global Tactical Asset Allocation, Commodity Trading Advisor (CTA), Global Macro, and Multi Asset Strategies. 
  • Absolute Return (Introduced in November, 2010): Consists of management by general partners that do not adhere to specific benchmarks and whose strategies do not neatly fit within another asset classes. 
  • Risk Parity (Introduced in July, 2012): Allocation of capital among major asset classes such as equity, nominal bonds (such as the US Treasuries), inflation linked bonds (such as TIPS), and commodities, based on expected volatility, to capture risk premiums across asset classes.
PSPRS' commitments to these alternative investments range between over $1 billion dedicated to private equity to $282 million dedicated to risk parity.  All total these alternative investments make up 45.32% of PSPRS' total portfolio.  These alternative investments are part of PSPRS' risk/return -balanced investment strategy.

I was curious to see if PSPRS was getting a good return on these alternative investments.  Five of the six classes surpassed their benchmarks with only risk parity missing its benchmark by 236 bps.  Five of the six, including risk parity, surpassed PSPRS' expected rate of return (ERR) of 7.85%, while only GTAA performed below the ERR, though it beat its benchmark by 428 bps.

Among traditional asset classes, only short-term investments surpassed its benchmark by 22 bps.  Total equity (U.S. and non-U.S.), fixed income, and real estate underperformed by 248 bps, 118 bps, and 1247 bps, respectively.  Only total equity beat the ERR, earning 21.20% for the year.

The past year was an incredibly prosperous year so let's push the returns out to a longer period.  Ten years is not helpful since PSPRS had no alternative investments at that time, and at five years out, PSPRS had not yet invested in absolute return, GTAA, or risk parity.  Three years includes all the alternative categories except risk parity so we will have to use the three-year period for some perspective.  The following table shows data for the past three fiscal years.

Bench Gross Net
Asset Class
Mark Of Fees Of Fees Fees
US Equity 
16.46% 14.08% 13.85% 0.23%
Non-US Equity
5.73% 5.70% 5.54% 0.16%
Private Equity
17.46% 16.40% 14.46% 1.94%
Fixed Income
2.57% 4.76% 4.62% 0.14%
Credit Opportunities
7.70% 8.44% 7.89% 0.55%
Absolute Return
2.07% 10.81% 9.54% 1.27%
3.33% 4.84% 4.78% 0.06%
Real Assets
3.84% 5.35% 4.24% 1.11%
Real Estate
11.32% 2.08% 1.54% 0.54%
Risk Parity
Short-term Invest.
0.07% 0.00% -0.05% 0.05%
PSPRS Total Fund
8.84% 8.15% 7.65% 0.50%

It is clear that the three-year returns are not as impressive as the one-year returns.  However, we can still see that among the alternative investments credit opportunities, absolute return, GTAA, and real assets surpassed their benchmarks with two of them beating the ERR of 7.85%.  Private equity missed its benchmark by 300 bps, but it still beat the ERR by 661 bps.  The only traditional investment to surpass its benchmark was fixed income by 205 bps.  Total equity, real estate, and short-term investments underperformed by 142 bps, 978 bps, and 12 bps, respectively.  Total equity at 10.36% was the only traditional investment to beat the ERR.

Unfortunately, three years does not give us a long enough period to analyze.  So far, though, it seems that PSPRS is getting value for the fees it is paying with benchmarks being met in all but the private equity class (and risk parity for a single year).  However, over three years, private equity still beat the returns on U.S., non-U.S., and total equity, in spite of its nearly 2% fee.  Risk parity did not beat the equity returns but still returned more than the ERR with a relatively low fee of 0.33%.  We will need several more years of data to better analyze this, including some down market years, to see if PSPRS is truly getting its money's worth.

*Anderson, Marty and Chen, Shan and Hacking, James and Lundin, Mark and Maleckaite, Vaida and Parham, Ryan and Steed, Mark and Lieberman, Marc and Martin, Allan, Modern Pension Fund Diversification (April 18, 2014). Available at SSRN: http://ssrn.com/abstract=2426593 or http://dx.doi.org/10.2139/ssrn.2426593

Tuesday, September 23, 2014

The effect of Desert Troon on PSPRS' investment returns

On September 3, 2014 PSPRS released this press release, Public safety pension gains for 2014 near $1 billion.  Being a press release, it is, of course, a self-serving piece, but after the last two years the PSPRS staff has the right to tout good news when it has some.  PSPRS' financial returns were covered in the September 4, 2014 post, "How did PSPRS' investment do in the fiscal year that just ended?", so there is really nothing new to discuss in regards to the press release.

What I was interested in was the document attached at the end of the press release.  The PSPRS 2014 Investment Summary ("the Summary") is a type of document that I have never before seen on the PSPRS website.  If they have released them in the past, I have not been able to find them on the website.  I suspect that this is not the type of document they would post to the website when PSPRS lost money in the prior fiscal year, but hopefully it will now be part of their regularly disclosed reports.  The Summary covers the fiscal year that ended June 30, 2014 and was produced by NEPC, LLC, an independent investment consulting firm.  The Summary breaks down all of PSPRS' investments, not just by asset class, but gives the portfolio of investments within each asset class as well.  This allows us to see what funds and firms PSPRS has invested with, how much, and the returns earned from each of them.

I was most interested to get a more detailed look into PSPRS' real estate portfolio.  In particular, I wanted to see exactly what effect the investments committed to Desert Troon had on PSPRS' overall performance.  If you go to page 50 of the PDF document, you can see a breakdown of PSPRS entire real estate portfolio.  At the end of the past fiscal year, PSPRS' total real estate portfolio had a market value of $873,820,740.  This accounts for 10.8% of PSPRS' $8,127,506,488 total market value.  The 10.8% allocation falls just about right in the middle of PSPRS' target range for real estate investments of 6-16% of the total investment portfolio.

The Desert Troon commitment to the real estate portfolio is $297,862,000.  This makes up 34% of the real estate portfolio and 3.7% of PSPRS' total investment portfolio.  The next largest real estate investment is in "Blackstone Rep IV" at $90,006,272, which makes up 10.3% of the real estate portfolio and 1.1% of the total portfolio.  The real estate portfolio is made up of 22 total separate investments with only two others valued at over $50 million.  So we can see that Desert Troon has a grossly disproportionate share of PSPRS' real estate portfolio.  Even more concerning is that Desert Troon's 3.7% of the total PSPRS investment portfolio is higher or equal to all but three other investment commitments: SSGA International Equity at 9.7% of the total portfolio, SSGA US Equity at 6.5%, and Black Rock Core Active at 3.7%.  The first two are index funds that are parts of the international and domestic equity portfolios.  The third is a bond fund that is part of the fixed income portfolio.

The total real estate portfolio had a -0.6% return for the past fiscal year.  This compares to the benchmark National Council of Real Estate Investment Fiduciaries (NCREIF) Property Index return of 11.2%.  Real estate was the only asset class to have a negative return for the past fiscal year.  The Desert Troon commitment had a return for the past fiscal year of -16.4%.  16 of the 22 real estate investments had an annual return that surpassed the 11.2% benchmark, three had returns of 8-10%, one had no returns shown, perhaps because it was made in June 2014, and two had negative returns.  The other one that suffered a loss was "OWH Berkana Hld," which lost 24.8% and shows a market value of about $13.15 million.  If we do the math, the Desert Troon investment had an annual loss of $58.43 million, while the OWH Berkana investment had an annual loss of $4.34 million.  For perspective, the Blackstone Rep IV, the second highest real estate commitment, had a return of 32.6% and earned $22.13 million.

If we look at the three-year returns, 15 out of the 17 investments that have been held that long have a positive return, with nine meeting the benchmark.  Desert Troon is one of the two to have a negative three-year return (-3.1%), though it beat the other negative returner which had a -22.4% return.  Five-year returns show that 6 out of the12 that have been held that long show a positive return, with four meeting the benchmark.  Desert Troon is one of the six with a negative five-year return (-4.7%), though it bested three of the other six negative returners.  Desert Troon did have the dubious distinction of being the only real estate investment held for at least five years that had negative returns for one, three, and five years.  I guess they get some credit for consistency.  Even the other annual loser, OWH Berkana, managed a positive return over the three-year period.

If the total real estate portfolio of $873,820,740 had a return of -0.6%, this would equate to a loss of about $5.27 million for the fiscal year on a beginning year market value of $879,095,312.  If the Desert Troon investment had broken even, the total gain on the real estate portfolio would have been about $53.16 million.  This would have produced an annual return on the real estate portfolio of 6.05%, so the Desert Troon commitment dragged the real estate portfolio down by 6.11%.  If the Desert Troon investment had earned a modest 5% for the year, approximately $17.81 million, the real estate portfolio would have returned about 8.07%.  The total PSPRS investment beginning year portfolio value was $7,246,805,889, so the $58.43 million loss on the Desert Troon investment represents a 0.8% loss on the total PSPRS portfolio.

In summary, there appears to be an over-weighting of the real estate portfolio in Desert Troon while the portfolio itself has been consistently underperforming over the past five years.  In addition, if we go to the Desert Troon website, we can see that their properties are heavily concentrated in Arizona, though the website does not indicate what, if any, of the properties featured there have PSPRS funds invested in them.  In fairness to both Desert Troon and PSPRS, I would like to have seen 10-year and 20-year rates of return to determine if there was a long-term profitable relationship, but the current Summary is all that is available.  Regardless, it does appear that the relationship will need to change so that PSPRS can diversify its real estate portfolio and not have its returns so closely tied to a single company.

After hearing for over a year about Desert Troon, allegations that over-valuations were done to pad staff bonuses, federal investigations, and whether subpoenas should be made public, it is nice to see some actual investment numbers.  There are some who are really interested in that issue, but I am not one of them.  The valuation of real estate often appears to be more art than science when you are dealing with properties that are held for development purposes, and the valuations seems to change depending on the criteria used and who is doing the valuation.  I am more interested in how such a close relationship between PSPRS and Scottsdale-based Desert Troon developed.  I want to know why no one saw red flags with committing so much money with a single company that was so heavily dependent on the Arizona real estate market.  I am curious as to why REIT's or real estate index funds were not considered as a smarter, safer, and less costly real estate investment option.   None of this implies anything inappropriate, but rather, speaks to the need to examine the past behavior so it is not repeated.

Monday, September 22, 2014

***Corrected information on PSPRS COLA's for fiscal year 2014-15***

PSPRS posted this corrected information about COLA's (aka permanent benefit increases) for fiscal year 2014-15.  The previous post should be disregarded.  This post has additional information and makes it clear that the monthly COLA for PSPRS retirees, who meet the criteria under the "old law," will be $65.20 per month, not $32.60 as I wrote in the last post.  In PSPRS' previous information, I read the $65.20 amount to be the retroactive COLA's for July and August 2014.  I apologize for this mistake (and thanks to the commenter that noted this in the last post).   Following in boldface type is the information PSPRS posted on 9/19/2014:


The retroactive permanent benefit increase (PBI) will post to your account payable for Friday, September 19, 2014.  This payment is for the two month timeframe of July and August 2014. The regularly scheduled benefit payment on September 30 will incorporate the new pension amount going forward from September 30, 2014 through June 30, 2015.  Please note that for the majority of our membership this two month payment may be very small in comparison, especially to the payment for the 3 year retroactive adjustment made in June. 

Below are the average payments for each system/plan:
If membership (hire) date with current employer was before 1/1/2012 (“OLD” LAW) and RETIRED on or before 7/1/2011 plus retired for 2 years (by July 1), or age 55 and retired for 1 year (by July 1)
PSPRS $65.20 monthly increase Monies available in reserve account
1.59% increase Monies available in reserve account
EORP 4.00% increase Monies available in reserve account
If membership (hire) date with current employer was before 1/1/2012 (“NEW” LAW) and RETIRED on or after 8/1/2011 plus retired for 2 years (by July 1), or age 55 and retired for 1 year (by July 1)
If membership (hire) date with current employer was after 1/1/2012 (“NEW” LAW) plus age 55 by July 1, or if receiving a survivor/disability retirement for 2 years (by July 1)
PSPRS No increase available Investment return based on prior fiscal year and current funding status of the Plan
0.81% increase Investment return based on prior fiscal year and current funding status of the Plan
EORP No increase available Investment return based on prior fiscal year and current funding status of the Plan

Remember: This retroactive payment is separate from your regular September benefit payment which will occur on September 30.

Please create a Members Only account (Click Here) if you have not done so in order to view your own personal record. 

This should mean that the retroactive COLA for July and August will be $130.40 ($65.20 X 2), and this should have already been paid out September 19th to PSPRS retirees meeting the criteria under the "old law."  The $65.20 COLA represents a raise of 2.17% for someone with a $3,000 monthly benefit and a 1.63% raise for someone with a $4,000 monthly benefit.  According to InflationData.com, the annualized inflation rate for the 12-month period ending August 2014, the latest listed, is 1.70%.

For anyone who falls under the criteria of the "new law" (i.e. SB 1609), no COLA will be paid.  It is important to remember that the February 2014 Fields decision only covered those who were already retired when SB 1609 went into effect.  Those who retired after that date are still covered under the provisions of SB 1609, which requires a minimum funding level of 60% and a minimum 10.5% rate of return for the previous year.  For the past fiscal year, PSPRS easily exceeded the 10.5% return but did not meet the minimum funding level of 60%.  CORP is better funded than either PSPRS or EORP and met both the required benchmarks to pay a COLA.

There a still two pending cases, the Hall case against the Elected Officials' Retirement Plan (EORP) and the Parker case against PSPRS, which were filed by employees who were still active when SB 1609 went into effect.  These cases are challenging the constitutionality of both the change in the COLA formula and the increase in contribution rates for active employees hired before 2012 .  The issues in the cases are essentially identical, so a decision in either will cover both cases.  A decision in favor of the plaintiffs would mean those covered under the "new law" would have to be paid COLA's for fiscal year 2014-15.  Unfortunately, I do not know the current status of these cases.

Thursday, September 18, 2014

SEE CORRECTED POST on 9/22/2014 ***Latest update on PSPRS COLA's for the current fiscal year***


Following in boldface is the latest information taken from the PSPRS website on COLA's (aka permanent benefit increases) for the 2014-15 fiscal year:


The retroactive permanent benefit increase (PBI) will post to your account payable for Friday, September 19, 2014.  This payment is for two month timeframe of July and August 2014. The regularly scheduled benefit payment on September 30 will incorporate the new pension amount going forward from September 30, 2014 through June 30, 2015.  Please note that for the majority of our membership this two month payment may be very small in comparison, especially to the payment for the 3 year retroactive adjustment made in June. 
Below are the average payments for each system/plan:

PSPRS: $65.20 payment
(Tier 1)
1.59% increase
(Tier 2)
0.81% increase
EORP: 4.00%

Remember: This retroactive payment is separate from your regular September benefit payment which will occur on September 30.

Please create a Members Only account (Click Here) if you have not done so in order to view your own personal record.  

It appears that the monthly COLA for PSPRS retirees is a modest $32.60 per month for the 2014-15 fiscal year, and all eligible PSPRS retirees should see a permanent $32.60 increase to their monthly benefit starting with the next scheduled payment on September 30, 2014.  There is always a lag for COLA's while PSPRS calculates its final returns for the prior fiscal year that ends on June 30, and the $65.20 to be paid September 19th is a separate retroactive payment for the July and August benefit checks

This COLA amount represents a 1.09% raise for someone with a $3,000 monthly benefit, and a 0.81% raise for someone with a $4,000 monthly benefit.  According to InflationData.com, the inflation for the 12 month period ending August 2014, the latest listed, is 1.70%. 

Thursday, September 4, 2014

How did PSPRS' investments do in the fiscal year that just ended?

PSPRS' consolidated annual financial report (CAFR) is usually not available until November or December, and the consolidated and individual employer actuarial reports are usually not available until September or October.  However, for those interested in seeing how PSPRS' investments did for the fiscal year (FY) that ended June 30, 2014, you can go to PDF page number nine of the August 27, 2014 Board of Trustees Meeting Materials.  Following is a brief synopsis of the investment returns for FY 2013-14.

For the fiscal year, PSPRS' total fund earned 13.82%, gross of fees.  If we subtract 0.50% (last year's amount) for fees paid to outside investment firms, we get an estimated annual return, net of fees, of 13.32%.  This 13.32% annual rate of return beats PSPRS' expected rate of return of 7.85% by nearly 5.5%, and it surpasses the 9.00% threshold for adding money to the Reserve for Future Benefit Increases ("the Reserve").  This means that half of the 4.32% over the 9% threshold will go into the Reserve to be used to pay COLA's in the future.

As we all know the stock market has had an incredible run over the past two years, so let's see how PSPRS' fiscal year returns compare with the Russell 3000.  (Note: in the past I have used the S&P 500 to compare PSPRS' returns against, but the Russell 3000 is what PSPRS uses in its own reports as a benchmark for its US equity portfolio, so henceforth I will use it as a standard benchmark as well.)  The Russell 3000 returned 25.22% for the year ended June 30, 2014, which is nearly 12% higher than PSPRS' 13.32% return!  However, PSPRS has a more diversified investment strategy and currently invests only 16.5% of its assets in US equity and only 14% in non-US equity.  The rest of PSPRS' portfolio is made up of fixed income, real estate, and other alternative investments, each of which has its own benchmark.  Both the US and non-US equity portions missed their benchmarks but each still returned over 20% for the fiscal year.  PSPRS' total fund benchmark was exactly 13.82%, so after fees the total fund will also miss its benchmark.

Readers can look through the returns of all the different types of investments if they like, but it is more difficult to get a sense of their final performance because they all have different fees attached.  Equity and fixed income investments tend to have lower fees, while the alternative investments have higher fees.  For example, last fiscal year total equity (32.26% of total fund) took only 0.18% in fees, real estate (13.36% of total fund) took 0.41% in fees, and private equity (11.30% of total fund) took a rather large 1.53% in fees.  The most glaring thing in the report is the real estate portfolio, which was the only category that lost money.  Real estate had a -0.62% return for the year versus a benchmark return of 11.21%.  PSPRS' real estate investments are the source of so many problems, so I guess we should not be surprised that these investments are still causing problems.  If real estate investments had achieved a return of just half the benchmark, the PSPRS total fund would have met its benchmark for the fiscal year.

We will have more when PSPRS post returns net of fees in the near future.

Wednesday, August 13, 2014

If you want to convince Arizonans to reform PSPRS, you don't go to New York

With thanks to a colleague who informed me of this article, Coaxing Fire and Police Staffs in Arizona to Cut Own Pensions, by Ken Belson in the August 11, 2014 New York Times, I was hopeful that there was going to be some new ideas from Professional Fire Fighters of Arizona (PFFA) President Bryan Jeffries, who recently took over for Tim Hill.  Unfortunately, the article was a disappointment.

The article details Mr. Jeffries' attempt to sell the PFFA reform plan, discussed in several recent posts, as a noble concession by Arizona's current firefighters to help PSPRS, and by extension, taxpayers and future firefighters.  The article has errors*, and the writer does not seem to be very familiar with PSPRS or its recent travails.  I am not sure how the New York Times got involved in this or why they found it newsworthy, but the Arizona Republic, which has done excellent reporting on PSPRS, would have certainly been more accurate and probably given the claims of Mr. Jeffries and others quoted in the article a little more scrutiny.

For me the key passage in the article is this:
To put the plan into effect, Mr. Jeffries wants to change the Constitution to allow for this one-time fix. This would reassure workers that lawmakers could not make even more drastic changes later.
I do not know if the second sentence is a paraphrased quote from Mr. Jeffries or inferred from the desire to embed the PFFA reform plan in the Arizona Constitution.  Either way, this statement rather boldly declares that the PFFA strategy is basically an end run around the Arizona legislature when it comes to PSPRS.  It is arrogant enough for the PFFA to present a final reform plan to the legislature as if it was the perfect solution.  It is another thing to go to the New York Times, hardly an Arizona-friendly paper, portray your organization as a protector of Arizona's taxpayers, and give the impression that you plan to treat the Arizona legislature as a non-entity in PSPRS reform.

As I detailed in recent post the PFFA reform proposal is no good.  I do not know how involved the PFFA was in the drafting of SB 1609 three years ago, but their public position was that no reform was necessary at the time.  Now they are all-in for reform but think that the legislature should just rubber-stamp their proposal, even though it is no improvement over the Arizona legislature's own bill, SB 1609.  So what was Mr. Jeffries' goal in talking to the New York Times?  I do not know, but if he thought a write-up in an elitist east coast paper would help PFFA's case, I think he is badly mistaken.

*PSPRS only takes half of any returns over 9% and places them in the COLA fund, and only part of SB 1609 was overturned, not the entire law.

Monday, August 4, 2014

A modest proposal for PSPRS COLA reform

I have spent several posts criticizing the Professional Fire Fighters of Arizona (PFFA) pension reform proposal, and I have pointed out the fundamental flaws with both SB 1609 and the current excess earnings model in how they calculate COLA's, especially when we consider the possibility of inflation.  (And, once again, for consistency I will again use the acronym COLA throughout instead of the less familiar but more accurate term permanent benefit increase (PBI).)  So what would I propose to do about COLA's?

I think the solution is simple and does not involve any significant change to PSPRS.  It would simply be to eliminate COLA formulas and allow the PSPRS Board of Trustees ("the Board") to determine the next year's COLA based on input from its actuary.  This is such a basic idea that I find it hard to believe that I am the first to propose it, so if someone has already floated this idea in the past, I apologize.

The main opposition to this idea would be that the Board could not be trusted to award fair and appropriate COLA's.  The Board might favor employers (and taxpayers) over employees and retirees, or vice-versa.  In its current statutorily mandated makeup, the Board is made up of two employee representatives--one fire and one law enforcement, two employer representatives--one state and one local, an elected official or judge, and two citizen representative, all appointed by the governor.  As can be seen, the Board is constituted to have representation from all stakeholders in PSPRS: employees, employers, politicians or judges, and taxpayers.  This allows for a diversity of opinion and interests and forces some give-and-take from Board members.  Furthermore, the Board is already responsible for other more critical decisions, particularly how and where funds are invested, so entrusting them to decide COLA's seems reasonable.

The Board would also be required to take input from its actuary, whom they already rely on for the other critical decisions they make.  The actuary does the number-crunching, simulations, and projections that determine funding ratios and annual required contributions.  Within a certain range based on the actuarial calculations, the Board could be restricted in how large or small a COLA could be awarded, and this is where the give-and-take among the Board members could take place and would not allow them to award COLA's based on unrealistic assessments or personal bias.

If we take a historical perspective, this method would have worked fine in the past.  When PSPRS was overfunded and returns were high, COLA's would have been more generous (even exceeding the rate of inflation) and allowed the benefits of excess earnings to be distributed equitably among retirees, current employees, and employers.  However, as PSPRS became more and more underfunded and returns over time were not sufficient to recoup past losses, COLA's could have been reduced or eliminated.  Looking ahead, if PSPRS begins to recover and inflation becomes a problem, COLA's could surpass the 4% or 2% thresholds in place or proposed.

This method of awarding COLA's would avoid the long-term mistakes engendered by hard formulas put into law or, even worse, into the Arizona Constitution.  COLA's would be based on the current financial condition, not from when times were better or worse.  Unions that negotiate for employees have a vested interest in having wages and benefits determined by hard formulas.  These hard formulas create certainty and stability in their contracts that do not allow the negotiated terms to be changed arbitrarily by elected officials.  This works fine with a collective bargaining agreement (CBA) that may last only one or two years, but the use of hard formulas becomes a problem when you are talking 20 or 30 years.  Inflation and returns fluctuate over time and setting in stone a COLA formula based on only your most recent experiences is short-sighted and dangerous.  Would unions accept a 20-year CBA based on the economic conditions that exist now?  Of course not, so why would they think that locking down a permanent, unchangeable COLA formula is a good idea?

The PFFA proposal is bad, and I am thankful that the Governor did not call a special session to consider it.  It is a shame that PSPRS wasted money on an actuarial analysis of such an absurd proposal.  I know that there are multiple labor organizations representing Arizona law enforcement, and I was not sure their feeling about this proposal.  However, a letter copied in Tucson City Council Member Steve Kozachik's Ward 6  June 18, 2014 newsletter indicates support for the proposal from at least one law enforcement organization, the Arizona Lodge of the Fraternal Order of Police (FOP).  The letter says, "Those of us who have worked on the issue believe the Firefighter's proposal has merit and may protect our members from more draconian measures.  This proactive effort represents the best chance for public safety to protect important benefits, our employers, our pension fund, our retirees, our actives, and our future members."  It is disheartening to know they were on board with the PFFA proposal.

While the PFFA pension reform proposal looks dead for now, it was important to analyze it closely to show its flaws.  Even if it never rises again, the PFFA proposal served a useful purpose in exposing the chronic myopia that afflicts the PFFA leadership and, possibly, law enforcement union leadership as well, when it comes to PSPRS.  For someone who is already in the DROP or close to retiring, dedicating 4% of your future career earnings to retirees may not seem like a sacrifice.  If you have many years left to retire or are just starting your public safety career, it will greatly affect the financial well-being of you and your family.  For someone who is expecting a six-figure DROP payout, committing to 2% COLA's in the future may not seem like a hardship.  For someone who retired before the DROP went into effect, a 2% COLA could mean your retirement benefit could get eaten away by inflation.  Looking at pension reform only from the perspective of someone with 20-30 years of time in PSPRS and access to the DROP is not only financially perilous, it is grossly unfair.  Unless the PFFA leadership can start looking at the cost and benefits of reform from the perspective of all affected constituencies, no reform effort proposed by them should ever be taken seriously.