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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 17, 2015

Here's the good news and bad news if you're a PSPRS retiree expecting a COLA

Normally around this time every month, we can see the monthly returns for PSPRS.  Unfortunately, the PSPRS Board of Trustees is not having a July meeting this year, so I have no PSPRS month end returns to post for May 2015.  The following table has updated monthly returns from the Russell 3000 and estimates for the YTD returns for May and June 2015:

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%
1/31/2015 0.01% 0.65% -2.78% 2.32%
2/28/2015 1.91% 2.58% 5.79% 8.25%
3/31/2015 0.83% 3.42% -1.02% 7.15%
4/30/2015 0.95% 4.40% 0.45% 7.63%
5/31/2015    ?    ? 1.38% 9.01% (est)
6/30/2015    ?    ? -1.67% 7.34% (est)

As can be seen, the Russell 3000 will have a 12-month return of around 7.30%.  While far removed from the 25.22% the returned last year by the Russell 3000, this is still a good return.  However, we are in the pension world here, so we have to look at two particular PSPRS benchmarks: the expected (or assumed) rate of return (ERR) of 7.85% and the permanent benefit increase (PBI) threshold (aka COLA) of 9.00%.

It is unlikely that PSPRS will reach either benchmark this fiscal year.  PSPRS would have to average about 1.75% for each of the last two months to reach 7.85% for the year.  This is important since not meeting your ERR is, for pension accounting purposes, a negative return and increases your liabilities.  Over a long period this is not a big deal since you will likely make it up in another year like last fiscal year, but PSPRS is already in deficit.  This will add more hardship to employers already struggling to pay their annual required contributions.  There is a remote chance that PSPRS could reach its ERR since it did surpass the Russell 3000's returns by 2.35% over the past two months, but I would still consider this very doubtful, especially when we consider that we must subtract half a percentage point from the final PSPRS returns to cover investment fees.  This would mean that PSPRS would actually have to earn about 2% each month to get to 7.85%.

Obviously, if PSPRS has only a remote chance to reach 7.85%, 9.00% will be impossible. PSPRS would have to earn over 5% in the last two months to get to 9.00%, considering investment fees, and barring a miracle, this ain't going to happen.  This means that PBI's will not be paid for the current fiscal year since, according to PSPRS, the PBI fund was depleted last year, and the failure to meet the 9.00% threshold will not allow any replenishment of the PBI fund this year.  That is the bad news if you are a retiree.

The good news is that for the 12-month period ending June 30, 2015 there was almost no inflation, according to the Bureau of Labor Statistics.  The inflation numbers can be found at the U.S. Inflation Calculator.  The past fiscal year inflation rate was 0.1%, meaning something that cost $100.00 on June 30, 2014 would cost only ten cents more a year later.  The 0.1% annual rate compares with a 2.1% inflation rate the year before.  Of course, your bills may tell a different story about how much things cost versus a year ago, but that's what the Consumer Price Index says.  Anyway, PSPRS, like the Cubs, always has next year.

Tuesday, July 14, 2015

What the Hall is going on? Legal issues surrounding the Hall and Parker cases against EORP and PSPRS

From this July, 13, 2015 Arizona Republic article by Craig Harris, Arizona Supreme Court picks five judges to hear pension case, we can now see that we will most likely have a final decision on the Hall case sometime next year, as the article states that the case will be heard before the end of 2015.  The actual decision may take longer, for if we look at the Fields case, it was argued before the Arizona Supreme Court on June 4, 2013, but the decision was not released until February 20, 2014, a lag of over eight months.  The interesting thing with the Hall case is that, in order to avoid a conflict of interest, the Arizona Supreme Court has appointed five judges who have no stake in the decision, as the five are under the new EORP system.  Hopefully, this specially appointed panel will mean that the case is decided more quickly since this is the only case on the panel's docket, though the judges will still have to deal with their regular assigned caseloads.  Regardless, this is a good time to talk about the legal issues surrounding Hall.

If you were an active member of PSPRS prior to July 2011, the Hall v. Elected Officials' Retirement Plan (EORP) case has huge significance for you.  Unlike Kenneth Fields, a retired judge who successfully sued EORP over SB 1609's change to COLA calculations for retirees, Philip Hall (who, according to Ballotpedia, retired in 2013) was an active judge at the time SB 1609 went into effect.  He, like the plaintiff in Parker v. PSPRS, an active law enforcement officer when SB 1609 went into effect, is suing over both SB 1609's change to COLA calculations for retirees and the increase in employee contribution rates.  Mr. Hall was successful in Maricopa Superior Court, and a final decision was rendered in January 2015.  The result in Hall, which has moved up to the Arizona Supreme Court, will determine the result for PSPRS members as well.  If Mr. Hall's case is fully or partially upheld by the Supreme Court, it would have enormous financial consequences for all PSPRS members.

A good explanation about the court cases involving PSPRS and EORP can be found at the Pension Litigation Tracker website run by the Laura and John Arnold Foundation.  This website gives a great timeline of all the events in both Fields and Hall, and the legal precedents for the decisions as of now.  If you are like me, you probably just want to know if Mr. Hall's case is going to be upheld on appeal.  This will determine how your future retirement COLA's are calculated, and in the near term, whether you will be a due a refund of your excess employee contributions and what your future contribution rate will be (7.65%, 11.65%, or another amount).  If Mr Hall is successful and, for example, you made $60,000 of pensionable income per year in the five fiscal year between July1, 2011 to June 30, 2016, you would be owed a refund of excess contributions of  $7,800 ($600 + $1,140 + $1,620 + $2,040 + $2,400) due to the annually increasing employee contribution rates (1.0%, 1.9%, 2.7%, 3.4%, and 4.0%) during those years.  Of course, it is impossible to know what the final decision will be since it all comes down to the five members of the Arizona Supreme Court-appointed panel, but the information provided gives some interesting points to discuss.

We should start off by saying that Mr. Hall seems likely to win his case (with a key caveat that we will talk about later) on SB 1609's changes to the COLA formulation for the same reason that Mr. Fields won.  Per Pension Litigation Tracker, there are three main constitutional issues in Hall and Fields:
  1. The Contracts Clause in Article II, §25 of the Arizona Constitution which states, "No bill of attainder, ex-post-facto law, or law impairing the obligations of a contract, shall ever be enacted."
  2. The Pension Protection Clause in Article XXIX, §1(C) of the Arizona Constitution which states, "Membership in a public retirement system is a contractual relationship that is subject to Article II, §25, and public retirement system benefits shall not be diminished or impaired.”
  3. The Yeazell v. Copins (1965) Arizona Supreme Court decision, "which held that a public employee’s interest in his retirement pension is a contractual one that vests at the outset of employment; and, the employee has a vested right to continued membership in the retirement pension plan 'under the same rules and regulations existing at the time of his employment.'"
You can read the full Fields decision here, but the Pension Clause was the main justification for deciding in Mr. Fields' favor.  The Court held that the COLA was a "benefit" as commonly understood and was in place at the time of Mr. Fields' retirement, so it could not "diminished or impaired."  The defendants argued that since there are conditions under which the Contracts Clause can be violated and the Pension Clause references the Contracts Clause it was permissible to impair and diminish benefits in certain cases.  The Court dismissed this by concluding that the Pension Clause actually gave extra and specific protection to pension benefits, otherwise there would have been no reason to add it to the Constitution.

This was a slam dunk for Mr. Fields, but the Hall case gets much more interesting for all of us who were active PSPRS members when SB 1609 went into effect if we consider two issues that the retired Mr. Fields did not have to worry about: vesting statutes and the increase in employee contribution rates.

The Hall case has raised the issue of when an EORP member fully vests.  Maricopa County Superior Court Judge Douglas Rayes initially ruled in favor of Mr. Hall, declaring both the original COLA formulation and lower contribution rates were pension benefits that could not be "diminished or impaired," but he excluded from this decision anyone hired after 2000, citing the 2000 EORP vesting statute which states that EORP members do not fully vest until they apply for benefits.  Judge Rayes later reconsidered this decision and concluded that it applied to all EORP members, regardless of when they joined EORP.

This is interesting because it shows a small crack in the wall that protects pension benefits, particularly for PSPRS members.  In March 2013, this judge initially agreed with EORP's contention that the vesting statue was "part of any contractual relationship created when post-2000 EORP members began their employment," and "it is clear under Yeazell that the terms of an employee's contract incorporate the statutes on the books at the time."  He reconsidered this decision in July 2013 and better clarified exactly what "vesting" means.  However, Judge Rayes, who seemed fairly sympathetic to the plaintiff's case, did initially find this common ground with the defendants.  Both EORP and CORP, the corrections officers' plan, having vesting statutes that date back to only 2000.  PSPRS's vesting statute dates all the way back to 1983!  Does this carry more weight since it goes back further?  Is there some precedent between 1983 and 2000 in which the vesting statue was used to impair benefits that could be used to justify impairing them now?  We will have to see, but this is the caveat I mentioned earlier that could affect PSPRS members if the panel interprets the PSPRS vesting statute as Judge Rayes initially did.  It could mean that the change in the COLA formulation could be found to be constitutional for the overwhelming majority of us.

The second issue of employee contribution rates is even more interesting.  In his March 2013 judgement, Judge Rayes states, "Plaintiffs argue that the 1998 Formula and 7% contribution rate are 'public retirement system benefits'.  The Court agrees.  Although Plaintiffs are not entitled to receive their retirement benefits until they are employed the required number of years, they are nevertheless legally vested in the formula under which their benefits are calculated."  The defendants argued that "the contribution rate is the price paid by the employee for the benefit, not the benefit itself."  On a common sense reading, the defendants seem to have the more compelling argument since the contribution rate has no bearing on the calculation of the benefit.  Retirees will still have their retirement calculated the same way and receive the same COLA, regardless of how much they are required to pay into the system.  This seems to stretch the Pension Clause way beyond its intent.

While Mr. Hall's lawyers also cited the Contract Clause and the Judicial Salary Clause, which prohibits decreases in a judge's salary during his term in office, to bolster his case, the precedent of Yeazell seems to make the strongest argument for the plaintiffs since it states that one is vested "under the same rules and regulations existing at the time of employment."  Yet all the past cases cited involve the conditions under which an employee can retire and how their post-employment benefits are calculated.  The cited cases all seem to involve a legislative change after someone joined the retirement system that alters the conditions of retirement or the calculation of post-employment benefits, not how much they paid for the benefits.  None of the cited cases seem to deal with an increase in the contribution rates of active employees, though Judge Rayes considered the contribution rate as a component of "retirement benefits," so this may be a new issue for the panel to decide. Do employees legally "vest" in the contribution rate that existed when they were hired?  Are contribution rates, or rather the lost income caused by increase over the initial rate, a "benefit" as opposed to a cost not unlike health insurance?

In its argument in Fields, EORP states this was not so.  They cited the 1992 case of Smith v. City of Phoenix, in which a city judge argued unsuccessfully that the salary structure under which he was hired, which by city statute kept his salary at 95% of superior court judges, was an enforceable contractual agreement.  The city changed the statute to hold city judges at their existing salary in advance of a pay raise for superior court judges, and Smith sued.  The Fields opinion says, "The court of appeals held that Smith had no contractual right to continued salary increases under the city ordinance, observing that his 'contract of employment' did not express 'that the method of calculating his salary would remain fixed throughout his term,'  and '[i]ndeed the fact that both parties knew his salary was established by a city ordinance, which was naturally subject to change by the city council, suggests just the opposite.'"  The Arizona Supreme Court dismissed the Smith case as irrelevant to Fields and wrote:
Assuming the case was correctly decided, we note that it reflects the general principle that statutory provisions do not create contractual rights . . .  But statutorily established retirement benefits are an exception to this rule . . . Under Yeazell, the right to a public pension on the terms promised vests upon acceptance of employment . . .  and "the State may not impair or abrogate that contract without offering consideration and obtaining consent of the employee
Mr. Fields was already retired when he sued EORP so the question of increased employee contributions was not germane to his case, yet EORP's use of Smith to bolster its case was interesting and seems likely to reappear when Hall is argued, where it would seem to be much more relevant.  All these statements are all very intriguing:
  • the method of calculating his salary would not be fixed throughout his term
  • assuming the case was correctly decided
  • statutory provisions do not create contractual rights
  • statutorily established retirement benefits are an exception to this rule
Yet we are still stuck without a definitive explanation as to if and how pension contribution rates fit under the umbrella of pension "benefits."  Only the opinions of those five judges matter.

Looking to other states that have tried to raise pension contribution rates, the general impression is favorable to do this legislatively, though among states with constitutional public pension protections, only the Michigan Supreme Court has so far upheld increases to existing employees' contribution rates.  Many of the cases are still being litigated, and others are being contested over different constitutional provisions.  Completed Supreme Court cases in Florida, Alabama, and New Hampshire all held that plaintiffs had no right to a fixed contribution rate, and for what its worth, the New Hampshire Supreme Court in its December 2014 decision cited the cases in Florida, Alabama, and Michigan as precedent.  Once again, we will have to see what those five judges think.

All this would seem to argue for the repeal of Article XXIX 1(C) of the Arizona Constitution so that public pension benefits do not get any extraordinary protection beyond any other contract.  Any pension "reform" that is financially adverse to a pension system member is a violation of Article II based on the precedent set in Yeazell.  Financially adverse pension reform is reneging on a contract established when the employee entered the pension system on hiring.  This was the case in 2011 with SB 1069 as it is now the case with the Professional Fire Fighters of Arizona's (PFFA) Operation Blue Falcon.  Under Article II and Yeazell, the PFFA's proposal is just as unconstitutional as SB 1609, if not in letter, certainly in spirit.  Furthermore, the PFFA "fix" is harmful to its own constituents and a worse plan than SB 1609.

Article XXIX 1(C) essentially makes pension reform impossible.  Even the PFFA's ridiculous proposal to amend Article XXIX via voter referendum will almost certainly face legal challenges under Article II and Yeazell.  The easiest thing to do is repeal Article XXIX 1(C) and allow the legislature to make reforms with input from all stakeholders, and we must accept that in probably every case there will be a lawsuit.  But without the special legal protections of Article XXIX 1(C), there might be a chance to get some reforms through that could incrementally fix the pension instead of dangerously trying to legislate via constitutional amendment.  The PFFA stated in 2011 that "No fix is needed for police, fire pension." Yet look where they are now.  The same lack of foresight they had back then infects them now.  If the PFFA sets a precedent now and "reforms" PSPRS by amending Article XXIX 1(C) and overriding Article II and Yeazell, what will stop some other group, perhaps one less friendly to public safety personnel, from amending it again in the future in a way that even the PFFA will not like.

Just something to think about, but regardless, we should all have a very interesting year ahead of us.  Stay tuned.