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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 23, 2015

Why you should hate the Professional Fire Fighters of Arizona's (PFFA) PSPRS reform proposal, Part I

The art of economics consists in looking not merely at the immediate but at the larger effects of any act or policy: it consists in tracing the consequences of that policy not merely for one group but for all groups. 

                                                               Henry Hazlitt,  
                                                               Economics in One Lesson

If you are an active employee who is keeping an open mind about the Professional Fire Fighters of Arizona (PFFA) PSPRS reform proposal, you may be asking yourself this: 
If SB 1609 already requires me to pay increased contributions into PSPRS, why do I care whether the extra contribution amount goes to pay COLA's to retirees or is used to pay down PSPRS' deficit since it comes out of my check either way?
Okay, maybe you weren't asking that question, but it does allow me to go into some of the unintended consequences of the PFFA's reform proposal.

PFFA President Bryan Jeffries has stated that the PFFA reform proposal, ". . . would fund retirees' cost of living adjustments out of the pockets of current working public safety workers, not taxpayers."  This would be done by taking the aforementioned extra contribution amount already being paid by active workers (currently 3.4%, but topping out at 4% on July 1, 2015) to pay down PSPRS' deficit, and instead, use it to fund COLA's for retirees.  The destructive excess earnings model of paying COLA's would be eliminated.  Active workers would see no net change in their paychecks, as they have to pay the additional 4% for their whole careers anyway; taxpayers would be off the hook for the COLA's; and retirees would still be able to get COLA's, though they will be at a reduced amount.  Win,win, and not a total loss, right?

Not quite.  If you are an active employee making contributions into PSPRS, it is true that your contribution will not change.  However, you will have to consider the unintended consequences of your career earnings becoming the dedicated source of income for retiree COLA's.  Governments (and public employee unions) love to have dedicated sources of income.  This is usually done via some type of tax like a gas tax hike for road repairs, a tax on cigarettes for health programs, or a sales tax increase for some particular program (like was attempted in 2012 with Proposition 204, which would have made the temporary one cent sales tax increase permanent to fund education).

The dedicated funding source is fine as long as the economy is good.  When there is a downturn, the tax will remain, even if the taxpayers are finding their own income diminished.  If we are talking about gas, cigarette, or even sales tax, the taxpayer has some means to offset their loss of income by driving, smoking, or buying less in general.  But what happens to active employees when there is an economic downturn?

Active employees, who have been dutifully funding retiree COLA's with 4% of their earnings, will now see the unintended consequences of the PFFA reform proposal.  Their employers, suffering from decreased tax revenues, will have to find ways to trim their budgets.  This is particularly harsh for those in public safety because economic downturns usually mean that PSPRS suffers investment losses, which in turn, means higher annual required contributions (ARC's) for employers. The employers are hit by this double squeeze of lower tax revenue and higher ARC's.  This spells disaster for active public safety employees.

Wages and benefits are by far the largest part of law enforcement and fire service budgets.  When an employer has to trim public safety budgets, it really has no other option than reducing payroll costs, either individually or in the aggregate.  While it may be good to be the recipient of a dedicated source of income, it is not so good to to be the dedicated source of income.  Active employees will find this out if the PFFA's succeeds in making their proposal part of the Arizona Constitution.

If there is another financial crisis, active employees are going to get hammered because they will be the only source of cost savings in the budget.  However, retirees may not even notice the financial hardship visited on active employees because of the design of the PFFA reform proposal.  Looking at the fiscal year (FY) 2014 actuarial report, we can see that active members contgributed about $152 million into PSPRS.  If COLA's were being paid per the PFFA reform proposal, 4% of this amount, or about $6 million, could be used to pay retiree COLA's.  There were about 10,500 retirees at the end of FY 2014 with an average yearly retirement benefit of $51,600.  The $6 million allocated for COLA's would not be enough to pay a full 2% to all retirees.  $6 million divided among 10,500 retirees would only be about a $571 annual increase for each retiree.

Now let's redo these calculations.  Suppose a bad economy caused employers to give our active employees a 2% pay cut in FY 2014.  This would reduce our total active member contributions to about $149 million from $152 million.  4% of the reduced amount would be about $5.96 million.  With this lower amount to pay COLA's, retirees would receive a $567 annual increase versus $571.

However, the average FY 2014 salary of our active employees is about $75,000 per year.  A 2% pay reduction means that our average employee loses $1,500 a year.  Retirees will see their COLA reduced by $0.33 per month while the average active employee will see his monthly salary drop by $125.  Even if we drop the active employees' pay 10% ($625 a month), our retiree will only see his monthly COLA reduced by about $4.17 a month.

Here we can see the truly insidious effects of the PFFA reform proposal.  It shifts not only the burden of retiree COLA's on to active employees, but also the punishing effects of any future financial crises.  Retirees will be insulated from most of the effects of any financial crisis since any reduction in their COLA's will be minimal in comparison to active employees.  Active employees will take the brunt of nearly all the downside of financial downturns.  Retirees will take virtually none.  This is the same problem with the current excess earnings COLA model that has made it such a problem for PSPRS: all the upside to retirees, all the downside to PSPRS.  Only now, instead of the costs of the bad model hitting PSPRS, the PFFA wants active employees to absorb them.

The PFFA's desire to make active employees the dedicated source of income for retiree COLA's is so egregious that it is could be used as an example of historian Robert Conquest's Third Law of Politics which says, "The simplest way to explain the behavior of any bureaucratic organization is to assume that it is controlled by a cabal of its enemies."  With a friend like the PFFA . . .

In the next post we will discuss how this plan is bad for retirees as well.

Saturday, February 21, 2015

The PSPRS fix is in: The Professional Fire Fighters of Arizona's (PFFA) Operation Blue Falcon continues apace

The recent death of actor James Garner gave me cause to begin  re-watching his great 1970's detective show The Rockford Files on Netflix.  While I had watched the show as a kid back when it was originally run (at 9:00 PM on Friday nights on NBC, if memory serves me right), re-watching has caused me to notice certain things that I either missed or forgot.  In particular, the episode, "The House on Willis Avenue," was much more interesting in 2015 than it was in 1978, when it was originally broadcast.  Briefly, it involves a murder tied to a private data collection agency that was criminally abusing its access to private personal information.  Rockford exposes the company and brings the perpetrators to justice, but the most interesting thing is a slide that appears at the end of the episodes that reads:
Secret information centers, building dossiers on individual exist today.  You have no legal right to know about them, prevent them, or sue them for damages.  Our liberty may well be the price we pay for permitting this to continue unchecked.
Member, U.S. Privacy Protection Commission
If you are still with me, you are probably wondering what this has to do with PSPRS.  The simple point I think this makes is how years of complacency has made what was once outrageous seem like no big deal.  The level of individual privacy we accept now is lower in 2015 than in 1978, when the ability to maintain your privacy was much greater.  Instead of expecting the government, which should protect us from privacy violation, we just hope that they are not abusing our privacy in a more egregious manner.

This makes a good segue into how this is relevant to PSPRS: the February 20, 2015 Arizona Republic "Into the Mind" editorial with Professional Fire Fighters of Arizona (PFFA) President Bryan Jeffries entitled, "How firefighters would reform Arizona pensions."  I have already written about the PFFA's  reform proposal to "fix PSPRS" in this post, which mostly notes how it provides no improvement over SB 1609,  and I was hopeful that it would have already died on the vine.  Unfortunately, like many bad ideas, it refuses to die, PFFA appears determined to release its Frankenstein monster out of the lab.

First, let me credit Mr. Jeffries for his honesty.  He openly admits to the inter-generational wealth transfer of the PFFA reform proposal by stating, "Our plan would fund retirees' cost of living adjustments out of the pockets of current working public safety workers, not taxpayers."  If you are not familiar with the PFFA reform proposal (which is available at the League of Arizona Cities and Towns Pension Task Force website), it would eliminate the current excess earnings models for cost of living allowances (COLA's) and take the SB 1609-mandated contribution increases of active PSPRS members now being used to pay down PSPRS' deficit, and instead, use them to pay COLA's to retirees.  It would also delay COLA's for up to seven years or until age 60, whichever is sooner.

The additional contributions mandated by SB 1609 will top out at 4% starting next fiscal year.  This 4% taken from current employees will then be used to pay a delayed COLA of up to 2% to retirees.  You do not need to be a mathematician to figure out that someone who works for 25 years paying 4% per year will never recoup in future COLA's what he paid in past contributions unless he lives for a really, really long time.  Compare this to SB 1609, which guarantees a minimum COLA of 2% if PSPRS is at least 60% funded and earned at least 10.5% in the prior fiscal year.  If you are an active PSPRS member, especially one just starting his or her career in public safety, does the PFFA reform proposal sound like a good deal to you?  Would you like to take a guaranteed loss on your total lifetime income as the PFFA wants or would like your future COLA's to track with the overall financial health of PSPRS?

Mr. Jeffries also proposes a false choice of on whom the responsibility for funding retiree COLA's should fall: active workers or taxpayers.  This fallacious proposition fails to identify the fundamental problem with PSPRS which is that it has only one source for COLA's, and it is neither active workers nor taxpayers.  While the excess earnings formula connotes something bad about using excess earnings to pay COLA's, in fact, excess earnings are the ONLY source from which PSPRS can pay COLA's .  The current excess earnings formula suffers from a horribly bad design because it takes half of any earnings over 9% in a fiscal year and segregates it into a fund that can only be used to pay COLA's.  However, if PSPRS loses money, it absorbs 100% of the loss.  This is why PSPRS continued to pay COLA's even as its funded ratio dropped each year.  SB 1609 addressed the problem by tying COLA's to not only the excess earnings percentage but also to PSPRS' funded ratio.  While the Fields decision rolled back SB 1609' s changes, it did not change the fact that an underfunded pension can not pay COLA's. 

The PFFA leadership has blithely offered up the current and future wages and benefits of its active members to maintain the payment of COLA's from a perilously underfunded pension.  Rather than advocating a better solution to the excess earnings model than SB 1609, which correctly prioritized bringing PSPRS back to financial health over paying COLA's, the PFFA has decided that COLA's are sacrosanct and wants to use its active, dues-paying members as a permanent source of COLA funding.  I would hope that most retirees would object to this.  Whether you are a member of PSPRS who just started paying contributions or someone who did his time and has been retired for 25 years, I think that we can agree that we are all in this together.  No one group has a greater claim to PSPRS' assets or a lesser obligation for its liabilities.  If you are in for a penny, you are in for a pound.  In the end, the best way to ensure that COLA's are paid is to bring PSPRS back to financial health as soon as possible, and it does not have to be accomplished through some form of inter-generational theft.

The PFFA leadership has perhaps spent too much time among the media and politicians to realize that, like Colonel Nicholson in The Bridge on the River Kwai, good people can forget whom they represent and for what they are supposed to stand.  PFFA's constituency is out here, not at The New York Times, Arizona Republic, PSPRS office, mayor and city council chambers, or the Arizona Statehouse.  Those entities may be impressed that Mr. Jeffries and the PFFA are willing to sacrifice workers' earnings to garner their favor, but rank and file PSPRS members should see the PFFA reform proposal as a breach of faith that helps neither active workers nor retirees.

So this brings us back to the analogy that started this post.  Is this what we have come to now?  An organization that is supposed to represent the interests of unionized firefighters in Arizona is freely giving up workers' hard-earned and diminished income.  Would unionized public safety workers have meekly accepted a proposal like this 40, 50, or 60 years ago?  Would law enforcement unions have stood by helplessly as another organization transformed the financial landscape beneath the feet of its own members?  Has such a sense of complacency set in that we can not even recognize when we are being hurt by those whose job it is to stand up for us?  There should be a lot more to come on this subject in the future.  Stay tuned.

Tuesday, February 17, 2015

PSPRS investment returns through December 2014

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for December 2014, the halfway point 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%
10/31/2014 0.40% -0.09% 2.75% 2.76%
11/30/2014 0.92% 0.82% 2.42% 5.25%
12/31/2014 -0.18% 0.64% 0.00% 5.25%

There is usually about a two-month lag in PSPRS reporting its investment returns.  2014 ended with no montly change in the Russell 3000 and a slight loss for PSPRS.  PSPRS' total returns were once again brought down by its non-US equity portfolio, which decreased 3.02% in December 2014.  The non-US equity portfolio has an 8.35% loss in the current fiscal year versus a 4.30% gain in the US equity portfolio.  The real assets portfolio has suffered a 3.22% loss for the current fiscal year and is the only other asset class with a loss for the current fiscal year.

PSPRS' monthly return for January 2015 is likely to be quite poor.  The Russell 3000 shows a 2.78% loss  for the month of January 2015, though February 2015 has been so far been a great month.  The Russell 3000 is currently higher than it was on December 31, 2014, but the markets have been so volatile lately that guessing where February will end is a fool's errand.  Regardless, PSPRS is likely to end the month of February 2015 with a fiscal year-to-date return of less than one percent with only four months to reach its expected rate of return of 7.85% by June 30, 2015.

* 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.