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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...

Monday, February 24, 2014

You take the good, you take the bad, you take them both, and there you have . . . "The Facts About DROP"?

PSPRS Administrator Jim Hacking posted this memorandum about the Deferred Retirement Option Plan (DROP), dated February 12, 2014, on PSPRS' homepage.  As document links like this can disappear, I have posted the memorandum verbatim (with the exception of a few format changes to make it fit):
The Facts About DROP
DROP was a mechanism initiated in 2000 to enable System employers to retain highly-experienced personnel who, prior to DROP’s implementation, tended to retire after completion of the 20 years of credited service required for retirement. Concerned about losing a significant portion of their senior workforce, the System’s employers designed DROP to entice senior employees otherwise eligible to retire to continue working for up to an additional 5 years. Under DROP, the retirement benefits that would otherwise be paid a retirement-eligible employee would be paid into a separate account (a “DROP Account”) which would bear interest at a specified rate.* The employee would continue working for up to 5 years, and after the employee actually terminated employment, he/she would be paid the deferred retirement benefits accumulated in the DROP Account, plus accrued interest. 
DROP’s benefits to the employer were two-fold: during the period the employee was enrolled in the DROP program, the employer would not have to make employer contributions toward the employee’s retirement, since the employee’s retirement benefits were already being remitted to his DROP Account.  These contribution savings were significant, and in some cases, equaled more than 25% of each employee’s pay during the DROP period. Second, the employer retained highly-skilled staff which it otherwise would lose and at great expense, have to replace with less experienced workers. 
DROP’s benefits to the employee were also two-fold: while the employee would not receive the benefit of his already accrued retirement benefits until such time as his DROP period expired, he would nevertheless continue working during his DROP period and receive a paycheck. Further, the employee would have a “guaranteed” return on his DROP Account and not have to worry that his retirement benefits would be dissipated in the securities markets.
While the media has made much of the fact that some participants in the DROP program are receiving significant lump sum payments upon expiration of their DROP periods, the fact remains that the amounts paid DROP participants are simply the money they otherwise would have been paid had they retired before participating in the DROP program, plus interest.
The employers actually incur less payroll expense for DROP employees, because they often save more than 25% in payroll expense for each DROP recipient. And while the DROP program has been terminated for new hires effective January 1, 2012, the program definitely achieved its purpose while in effect. During the past 13 years, the System’s employers were able to retain a great many of their senior level employees for 5 years beyond their 20 year normal retirement date,** and we expect these numbers to fall precipitously as fewer employees qualify to participate in DROP over the ensuing years. The result will be that as time progresses, more employees will retire upon their normal retirement date, employers will have to bear greater employment expense for new hires, and employee turnover will be heightened.
* DROP Accounts of employees with at least 20 years of service before January 1, 2012 are credited with interest at the System’s assumed earnings rate (currently, 7.85%). DROP Accounts of employees participating in the System before January 1, 2012 but with less than 20 years of service before that date (and who elect to participate in DROP thereafter) accrue interest at a rate equal to the System’s average annual return on the market value of its assets over 7 years (currently, is 3.2%).
** This is evident by data reflecting that, four years after implementation of the DROP program, only 280 employees retired in contrast to the following year, wherein 648 employees retired upon expiration of the maximum 5 year DROP period. This means that DROP increased by 200% the number of retirees who elected to continue working beyond
their 20 year normal retirement date.  4841-9854-1592.1

While this memo is called "The Facts About DROP," it seems a bit short on information showing the cost versus benefit of the DROP.  Other than the second footnote, there is no statistical data about the DROP, and even this footnote is of limited value.  What was the value of those additional 368 statewide employees who worked one more year than those who retired the previous year?  Is there any quantifiable measure to show that employers got more arrests, less crime, less property damage, fewer injuries, or better medical outcomes of EMS patients because those 368 employees delayed their retirements one year?  Was there no other incentive that could have retained these employees ?  None of these questions are answered.

The real questions here are financial.  Did employers really save money as stated in the memo?  Without the DROP, what would employers' annual required contribution (ARC) rates now be if employers and employees had fully paid their contributions into PSPRS over the last 13 years?  What if PSPRS had not been paying interest on DROP benefits in excess of its annual returns, even in years when PSPRS had negative returns?  What would PSPRS' funding ratio be if there had never been a DROP?  As for the experience question, what is the average years of service at retirement before and after the DROP was implemented?  And again, what benefits are gained by the extra five years of service for an average employee and can it even be quantified in any measurable way?  PSPRS is the only one that has the data to answer these questions, which are the most important ones if you are trying to defend the DROP to the media, politicians, and citizens.

I have previously written about how the DROP is essentially an end-of-career windfall for employees that increases costs for employers without providing them with any of its purported benefits (see "The folly of the DROP," part one, part two, and part three).  I see nothing in this memo that would change that opinion.

Friday, February 21, 2014

How much will the Fields decision cost PSPRS?

The following press release was posted to PSPRS' website in response to the Arizona Supreme Court's decision in the Fields case:
PSPRS Board responds to consequences of Supreme Court Fields decision
Feb. 20, 2014. PHOENIX, AZ:
The Public Safety Personnel Retirement System’s (PSPRS) Board is disappointed by the Arizona Supreme Court’s decision to hold the Permanent Benefit Increase (PBI) changes made by Senate Bill 1609 unconstitutional. The ruling in this case undermines the legislature’s attempt to make PSPRS healthier and more financially stable for public safety personnel, judges, elected officials and correctional employees.
“We estimate that retroactive payments to beneficiaries of all three PSPRS Plans will total $40 million,” PSPRS administrator Jim Hacking said. “We also estimate that we will have to transfer $335.6 million to the reestablished Reserve Accounts of our three Plans.”
The upcoming asset transfers will further reduce the funding ratios of the three PSPRS Plans (PSPRS, CORP and EORP). Such an impact will force up employer contribution rates.
In 2011, the PSPRS Board supported the passage of SB 1609 in order to protect the long-term viability of the pension system. Prior to the passage of SB 1609 in 2011, during any year with an investment return in excess of nine percent, half of the excess was diverted to a reserve account used to fund fixed annual Permanent Benefit Increases (PBI).
“The funds set aside for PBIs could not be used to offset PSPRS’s liabilities,” said PSPRS Board Chairman Brian Tobin. “This proved costly to the fund during 2008 and 2009 when the country was in the midst of a crippling recession, adversely affecting investment returns. The State’s and its political subdivision’s heavy budget cuts left fewer people contributing to the fund. Even while the system was losing money, PSPRS was still forced to pay fixed PBIs to its retirees.”
The most important figure is the $335.6 million that will have to be transferred to the Reserve for Future Benefit Increases. According to the January 15, 2014 PSPRS Board of Trustees meeting minutes the total combined fund (the "fund"), which pools the assets of PSPRS, EORP, and CORP for investment purposes, was valued at $7.695 billion, as of November 30, 2013.  $335.6 million represents 4.36% of the fund's assets as of November 30,2013.  This $335.6 million will not be "lost" as it will remain in another account under control of PSPRS managers, but for the purposes of calculating PSPRS' funding ratio, its sequestration represents a loss of 4.36% of the fund's assets since it can only be used to pay COLA's*.  This is why PSPRS is saying employer contribution rates will increase.

Before SB 1609 was signed into law in April 2011, the fund placed half of any investment earnings over 9% in the Reserve for Future Benefit Increases (the "Reserve").  It was from this Reserve that COLA's were paid out.  No excess earnings have been paid into the Reserve in the three fiscal years (FY's) since SB 1609 was signed into law.  Investment rates of return in FY's 2011, 2012, and 2013 were 17.37%, -0.79%, and 10.64%, respectively, so the $335.6 million represents a portion of excess earnings in FY's 2011 and 2013.  Even though a loss was sandwiched between the two years with rates of return over 9%, the excess earnings of the two positive years will still be siphoned off into the Reserve, instead of being used to make up for that loss.  The FY 2012 loss of 0.79% is actually quite a bit worse for PSPRS because the fund has an expected rate of return (ERR) of 7.85%, and anything under that negatively affects PSPRS.  From just looking at this three-year period, we can see, in a nutshell, what the problem is with the old, now reinstated COLA formula.  An underfunded pension needs the excess earnings of the good years to make up for losses of the bad years.  There is also an inherent unfairness in some reaping the benefits of the good years while bearing none of the costs of the bad years.  PSPRS already needs many years of really, really good investment returns to get back into financial shape.  This decision just made that a whole lot more difficult.

*( A quick note about terminology is in order here.  PSPRS has recently taken pains to use the term Permanent Benefit Increases (PBI) instead of COLA, which stands for cost of living allowance and is a more familiar term.  PBI is the more appropriate term because increases are not indexed to any measure of inflation.  However, even PSPRS often uses the terms interchangeably, and I find it easier to use the term COLA.)

Thursday, February 20, 2014

******Breaking News: Arizona Supreme Court rules against EORP/PSPRS in Fields case******

That sound you heard this morning was the hole being blown in PSPRS' financial condition.  The Arizona Supreme Court issued its ruling today in Fields v. Elected Officials’ Retirement Plan (EORP) (CV 2011-01744).  See this story, Court's pension ruling could cost Arizona taxpayers millions, by Craig Harris in today's Arizona Republic for more detail.  This ruling means that those retired before SB 1609's reforms went into effect must have their COLA's calculated under the old formula.  This means that these retirees should expect some type of retroactive COLA's paid to them.  A more thorough explanation of the new and old COLA formulas can be found here.

This decision is hardly a surprise as the retirees had a rock-solid legal case, and I expect to see some interesting figures coming from PSPRS as to how this decision affects funding ratios and annual required contributions from employers.  Phoenix and Tucson have already projected budget deficits for the next fiscal year, so this is not good news for them or their law enforcement and fire/EMS personnel.

This is only going to get more interesting as the Hall v. Elected Officials’ Retirement Plan (EORP) (CV 2011-021234) and Parker v. Public Safety Personnel Retirement System (PSPRS) (CV 2012-000456) are decided.  (Whichever one is decided by the Court will set precedent for the other.)  These cases involve active employees who were employed before SB 1609's reforms went into effect.  They are suing not only to restore the old COLA formula when they retire but to also lower the employee contribution rate back to 7.65% and return any excess contributions paid since the rates were raised.  This will have even more dire financial consequences if they win their cases.

These two cases were basically postponed since a loss by retirees would have made the Hall and Parker cases moot.  Now that the retirees have won, this cases are the new, more critical battleground.  Definitely stay tuned.

Additional note: I should have made it clear that, in the same way that there are two cases involving active EORP members and active PSPRS members, there was second case, Rappleyea v. Public Safety Personnel Retirement System (PSPRS) (CV 2012-00040), by PSPRS retirees suing over the same constitutional question as Fields.  The Fields decision will carry over to those PSPRS members who retired before SB 1609 pension reforms went into effect.

Tuesday, February 18, 2014

What does the law say about calculating PSPRS pension benefits?

Many of you have probably already seen this February 17, 2014 Arizona Republic article by Craig Harris, Walking fine line on pension 'spiking' lawsuits.  For more on the issue of pension spiking, this blog had a series of three posts in August 2013 entitled "PSPRS and pension spiking" that can be found here: part I, part II, and part III.

For those not familiar with the relevant A.R.S. statute regarding pensionable income, this is it:
"Compensation" means, for the purpose of computing retirement benefits, base salary, overtime pay, shift differential pay, military differential wage pay, compensatory time used by an employee in lieu of overtime not otherwise paid by an employer and holiday pay paid to an employee by the employer on a regular monthly, semimonthly or biweekly payroll basis and longevity pay paid to an employee at least every six months for which contributions are made to the system pursuant to section 38-843, subsection D. Compensation does not include, for the purpose of computing retirement benefits, payment for unused sick leave, payment in lieu of vacation, payment for unused compensatory time or payment for any fringe benefits. (Italics mine)
While workers should certainly be compensated for their unused sick and vacation time, this passage makes it clear that payouts for sick and vacation time can not be used to calculate retirement benefits.  The thin reed clung to by defenders of including sick and vacation time payouts in pension calculations is summed up here by Mr. Harris:
Supporters of the practice say those who benefit are not breaking the law because the excess vacation and sick leave are not being cashed out in a lump sum. Instead, they are being paid in the form of extra pay over numerous paychecks.
This defense is irrelevant since A.R.S. makes no distinction between sick and vacation time payouts that are paid incrementally or in a lump sum.  If we contrast this with how clearly A.R.S. deals with longevity pay, requiring it be paid at least every six months, we can see that there is little room for interpretation.  Payments for unused sick and vacation time can not be used in pension calculations, no matter how they are paid to employees.  The reason sick and vacation payouts are done incrementally is to limit the large tax hit employees would suffer if their payout appeared on a single paycheck.  The excess taxes paid on that one paycheck would then not be recouped until the employee got his tax refund the following year.  Incremental payments are an obvious benefit to the employee, who keeps control of more of his own money.

Even if you believe the Goldwater Institute is part of some nefarious conspiracy against public safety employees, is a cabal of rich evil geniuses really required to challenge the use of sick and vacation payouts in pension calculations?  I think anyone with basic reading comprehension can see that it violates both the letter and intent of the law, but this is another case where we will have to see what the courts have to say.

Wednesday, February 5, 2014

The Goldwater Institute puts an end to union "release time" in Phoenix

This February 4, 2013 Arizona Republic article by Dustin Gardiner, Phoenix to halt all union 'release time', follows the recent court decision that ruled that union "release time" violated the Arizona Constitution's Gift Clause.  The Gift Clause states:
Neither the state, nor any county, city, town, municipality, or other subdivision of the state shall ever give or loan its credit in the aid of, or make any donation or grant, by subsidy or otherwise, to any individual, association, or corporation, or become a subscriber to, or a shareholder in, any company or corporation, or become a joint owner with any person, company, or corporation, except as to such ownerships as may accrue to the state by operation or provision of law or as authorized by law solely for investment of the monies in the various funds of the state.
This means that a government entity within the state of Arizona can not give financial benefits to another party if the government entity receives no benefit in return.  The Goldwater Institute had sued to stop the practice of paid "release time" by Phoenix police officers by claiming it amounted to a financial benefit to police officers and their union that provided no benefit to the pubic (i.e. a gift).  Superior Court Judge Katherine Cooper ruled in the Goldwater Institute's favor, and the city of Phoenix has now banned "release time" for not only police officers but all the city's employees.

The Arizona Republic has these two editorials taking opposite sides of the issue: Union "release time" wastes taxpayer money by its Editorial Board and Goldwater Institute brands cops as robbers, again by EJ Montini.  The Editorial Board makes the more sober and compelling case if only because it talks about the effects release time has on staffing and public safety, which alone would seem to argue for an end to the practice, nevermind the financial and constitutionality concerns.  The main thrust of Mr. Montini's editorial is that the Goldwater Institute shamefully makes Phoenix police officers look greedy, even though release time is a common, openly negotiated practice.  The case was conducted in open court where the city of Phoenix and the police union had ample opportunity to show how union release time benefits Phoenix residents, but they were unable to do it.  Yet the Goldwater Institute is supposed to be ashamed about bringing the case to court and, even worse, having the audacity to win?

There are a couple points to be made here.  While Mr. Montini and other defenders of union release time are quick to point out that it is a "negotiated" benefit, they fail to discuss what was being negotiated, namely taxpayer money.  The city of Phoenix is not a for-profit company, where employees can make a legitimate claim to some portion of the profits that are the product of their labor.  Every dollar that Phoenix negotiates away is a dollar that could be returned to taxpayers or spent on something else, so every dollar has to provide some benefit to the public.  The fact that it was "negotiated," openly or not, is irrelevant if the item being negotiated provides no benefit to taxpayers.

A second point has to do with the management/union relationship.  The relationship between management and unions is inherently adversarial, otherwise there would be no need for a union in the first place.  No one should begrudge a union for trying to get as much for its members as possible; that is their job.  However, management is not required to subsidize those across the bargaining table who are inherently opposed to management's own interests.  In the case of Phoenix, the City Council, ostensibly the agents of taxpayers, has annually given away $3.7 million to groups whose financial interests are in competition with the taxpayers they are supposed to represent.   This is further complicated by the outsized role unions play in the political process to elect politicians more friendly to their interests than those of taxpayers.

Mr. Gardiner recently wrote this Arizona Republic article that reports Phoenix could see $52 million budget shortfall. While I do not know how the city of Tucson treats release time by its union employees, this February 5, 2014 Arizona Daily Star article by Darren DaRonco, $33 million deficit to lead to service cuts in Tucson, shows that Tucson is having its own budget issues.  The unions have vowed to fight the end of release time; budget deficit be damned.  I suspect that there is some fear that this case will have some resonance beyond Phoenix and Arizona, which explains some of the militancy in defending union release time.  How other courts will eventually rule is anybody's guess, but until unions can somehow conjure up an explanation as to how union release time benefits the public, fighting for this dubious practice will be an embarrassment to union members.