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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...

Friday, July 11, 2014

Beggar thy younger brothers and sisters: The Professional Fire Fighters of Arizona (PFFA)'s underwhelming and offensive PSPRS reform proposal

In the last post, we posed the question of why the changes proposed by the Professional Fire Fighters of Arizona (PFFA) are necessary when simply allowing SB 1609 to stand as originally passed by the Arizona Legislature would have the same results?  In this post we will focus mostly on how the cost of living allowance (COLA) will change under the PFFA proposal.  Following is the chart we referenced in the last post:

Before SB 1609 became law COLA's were paid out of a Reserve for Future Benefit Increases ("the Reserve").  The Reserve was funded by half of any earnings over 9%, the expected rate of return (ERR) at that time, earned in any fiscal year.  This portion of excess earning went into the Reserve without any consideration of PSPRS' funded ratio or its past earnings.  For example, PSPRS could lose 20% one fiscal year, then earn 12% the next fiscal year, yet money would still flow into the Reserve that second year.  For a more complete explanation see the post Have a COLA and a smile.  This formula is not sustainable as the chart shows, but it was reinstated for those retired at the time SB 1609 went into effect.  The Fields decision by the Arizona Supreme Court deemed the changes to the COLA formulation in SB 1609 unconstitutional.

SB 1609 eliminated the Reserve and changed the COLA formulation as follows:
  • If the ratio of the actuarial value of assets to liabilities is 60-64% and the total return is more than 10.5% for the prior fiscal year, 2% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 65-69% and the total return is more than 10.5% for the prior fiscal year, 2.5% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 70-74% and the total return is more than 10.5% for the prior fiscal year, 3% maximum increase to all eligible retirees and survivors.
  • If the ratio of the actuarial value of assets to liabilities is 75-79% and the total return is more than 10.5% for the prior fiscal year, 3.5% maximum increase to all eligible retirees and survivors.
  •  If the ratio of the actuarial value of assets to liabilities is 80% or more and the total return is more than 10.5% for the prior fiscal year, 4% maximum increase to all eligible retirees and survivors.
As can be seen, this new formulation takes into account PSPRS' funded ration and raises the ERR threshold to pay COLA's from 9% to 10.5%.  However, it also allows for a sliding scale of COLA's from 2-4% based on PSPRS' funded ratio.  This formulation was designed to allow PSPRS to slowly recover yet still pay some COLA's to retirees.  The chart shows that this change and others made by SB 1609 would steadily bring PSPRS back to full funding and drop employer contributions to a reasonable level.

The significant changes proposed by the PFFA that were used to produce the chart are:
  • COLA delayed until 7 years after commencement of benefits or age 60. 
  • Tier 2 members can retire at 25 years of service (no minimum age required).
  • Employee Self funded Inflation Protection Program (IPP) provided for all active generations.  Members can participate in a Non-contributory, Contributory or Reverse IPP (dependent on the date of hire).  
  • Pensionable income limited to $180,000 indexed with CPI. 
  • Eliminate the current excess earnings model for the COLA.  
  • Reduce employee contribution rate to 7.65% (eliminating the 4% maintenance of effort contribution). 
  • Create a new account funded by 4.0% employee contributions (plus actual investment income) which would fund an annual COLA payable after 3 full years of contributions. 
  • A COLA would be paid each year based on funds available.
As can be seen these COLA changes are quite radical when compared to the more modest changes made by SB 1609.  There are multiple issues here, but the most outrageous one is the penultimate bullet point regarding the funding of a new COLA fund.  Another reform that was part of SB 1609 raised the employee contribution rate from 7.65% to an annually increasing rate that tops out at 11.65% in the 2015-16 fiscal year.  The rate just increased from 10.35% to 11.05% on July 1, 2014.  The PFFA wants to take that additional 4% employees will ultimately be paying into the general PSPRS fund and place it into a COLA fund to pay retirees.  PFFA wants to go from the excess earnings model to one that pays COLA's from the paychecks of current employees.

Remember there are still two outstanding lawsuits by a PSPRS member and an EORP member who were active employees when SB 1609 went into effect.   These members are suing over both the COLA formula change and the increase in member contributions.  They are virtually certain to win their case over the changes to the COLA formulation based on the results of the Fields case, but the increase in employee contributions is a new issue for the courts.  The PFFA seems to believe that the SB 1609 increase in employee contribution rates will also be deemed unconstitutional and wants to lock down this money for another purpose before it is returned to current employees.

A quick word about the "excess earnings model for the COLA," which is made to look like the villain here.  There is nothing wrong with using excess earnings to pay COLA's.  PSPRS is not designed as a pay-as-you-go system, and in fact, COLA's should only be paid out of excess earnings.  What is wrong with the current excess earnings model is banking the excess earnings in good years but leaving PSPRS (and taxpayers and current employees) to suffer the losses during the bad years.  Earnings, particularly in fixed income investments, should track with inflation and produce excess earnings in the future if the cost of living should increase.

As I stated before, I find the COLA proposals by PFFA outrageous.  The idea that anyone, much less a union that is supposed to look out for all its members, would propose to fund COLA's on the backs of its working members is offensive.  I know the standard response will be that this may seem unfair now but others will pay it for you when you are retired.  First, I don't think anyone believes anymore in the permanence of PSPRS, much less any of its current policies.  Second, if I were that concerned about COLA's in the future, I would take the 4% and put it away in my own deferred compensation account.  Third, this isn't some sort of shared sacrifice since those who are already retired or close to retirement paid only some or none of the increased contribution rates that current, non-DROPped employees are paying now and will pay for the rest of their careers.  Fourth, we have to remember that this proposal is meant as an amendment to the Arizona Constitution, meaning that it will be the law of the land unless it is repealed through a cumbersome initiative/referendum process.  Employees could pay this extra 4% long after it is necessary.  Fifth, the bad math of this proposal takes 4% of current workers' wages for a promise to pay a maximum 2% COLA sometime in their future.  Finally, as a current employee I understand that more money needs to be paid by current employees, and that is just the way it is, but it needs to be used to bring PSPRS back to full financial health.  We all need to work to get this done, and I am willing to play my part.  I expect others to do the same.

So back to the question we started this post with: why would the PFFA propose these reforms when they produce no net gain over the SB 1609 reforms?  The simplest answer is that the PFFA is afraid that the Arizona Legislature or concerned citizens will attempt to repeal or modify Article 29 (the "pension protection clause") of the Arizona Constitution, which states that "public retirement system benefits shall not be diminished or impaired."  Some legislators have already proposed this, so the PFFA is attempting to offer an alternative, crafted by a labor organization, that ostensibly has the blessing of rank and file workers.

However, the PFFA proposal is overly complicated and will need to be amended to the Arizona Constitution, which is supposed to deal in general state and local governance and individual rights, not financial minutiae of specific legislation that more properly belongs in the Arizona Revised Statutes.  Legislating via constitutional amendment is foolish.  I see little chance that this would ever make it to the ballot, much less be approved by voters.  I suspect that the PFFA recognizes that the best solution to PSPRS' woes is to simply repeal or modify the pension protection clause and give the legislature constitutional cover to make the reforms they know are necessary, namely SB 1609, but being a labor organization, they can never admit to this.  They had to make a proposal once they became involved in the process, even though they appear to have nothing to offer that is better than SB 1609.  Opposition is their stock in trade, so even their own bad proposal must be presented and defended just to show they can confront the powers that be.  The leadership adage that even a bad action is better than inaction may be the working principle at play here.

There are more cynical explanations, but I will leave it up to the reader to consider those explanations.   Sadly missing here is any perspective from law enforcement groups. I do not know if they agree or disagree with the PFFA or have their own proposal to offer.  Any perspective that law enforcement personnel can offer would be appreciated.  In the next post, we will do a little more analysis of the different COLA formulations.


  1. It's all such a mess. Very confusing. I'm an optimist at heart but fixing, let alone saving our pension, seems like a lost cause. It's no wonder most pensions have become a thing of the past. They really just don't work in the long run. They were too expensive for corporations to survive and now they are too expensive for local governments. We've all been sold a bill of goods and have been fooled into thinking that a pension is the best thing for us. Nothing could be further from the truth. It's unnerving heading into retirement to know that my livelyhood is in the hands of union leaders and elected officials. Unions were never meant to have a place in the public sector. A history lesson about this subject would be interesting.

    1. Thank you for your comment. The thing that is so maddening is that no one wants to contemplate the real causes of PSPRS’ shortfalls. As you mention, union leaders and politicians need to look back at the history of PSPRS to see how it got into such a mess.
      I believe that PSPRS can and should work, but there must be an eternal vigilance from those who, ostensibly, are responsible for its wellbeing. The focus has always been on benefits but not the costs necessary to adequately fund those benefits. This does not happen because of the same human failings that have plagued private pensions: greed, selfishness, and power. For a pension system, which in the end is really just a gigantic mathematical equation with inputs put into a formula in order to produce the required outputs, to get so far out of whack takes the work of many self-interested individuals making serial miscalculations over many years. Instead of protecting the pension, those who should have been looking out for the pension instead used it as a tool for their own financial and political gain.
      Now the PFFA is shilling for a plan that will pay for the mistakes of the past from the lifetime earnings of a new generation of public safety workers, all while ignoring the root causes of PSPRS’ problems. Thank you again for your comment and Happy New Year.


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