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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, 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.

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