***PSPRS Members: A first look at how the Arizona Legislature is proposing to reform PSPRS ***

Here is the draft legislative proposal for PSPRS pension reform that was posted to the Fraternal Order of Police website.  It is interesting that it says it is not for distribution, so I posted it verbatim here with format changes to fit this website.  I have not had a chance to digest it yet, but hopefully we can all figure out what it all means, but just remember that this is not final and nothing official, as far as I know, has come from the Arizona Legislature.  I would be interested in everyone's opinions.

DRAFT 5.0—FOR LEGISLATIVE & PFFA REVIEW TO ENSURE INCLUSION OF ALL CONCEPTS

CONFIDENTIAL: not for distribution, publication or attribution December 15, 2015

PSPRS Pension Reform Framework

Agreement Framework Language

The State of Arizona, the Professional Fire Fighters of Arizona, Arizona Highway Patrol Association, and the Phoenix Law Enforcement Association have engaged in policy discussions concerning reforms to the Public Safety Personnel Retirement System (PSPRS). The parties have reached the below framework for a tentative agreement on both retroactive and prospective reforms. It is understood that this agreement framework is subject to formalization through the development of state legislation and a subsequent voter initiative.

A.        The current Tier 1 and Tier 2 retirement plans will be modified as follows:

  1. PBI / COLA Reform:

a.         For all Tier 1 and Tier 2 members, the existing Permanent Benefit Increase (PBI) structure shall be eliminated and replaced with

a Cost of Living Adjustment (COLA) that is:

i) A compounding COLA based on regional CPI (annual change in the U.S. Bureau of Labor Statistics CPI-U for Phoenix-Mesa, AZ), with a cap of 2%

ii) Actuarially accounted for in advance as part of normal cost determination

iii) In the first year of retirement, the COLA will be prorated based on the date of retirement

b.         The above COLA provision shall be included as a severable element in the proposed enacting legislation and shall be effectuated upon passage of a separate voter-approved constitutional amendment approving a one-time opening of the Pension Clause in the Arizona State Constitution.

  2.       Defined-Contribution Plan for Tier 2 participants hired between January 1, 2012 and December 31, 2016:

Catch-Up Provision: In order to achieve equity between employees hired prior to January 1, 2012 (who have a deferred retirement option plan available to them), employees hired in the new Tier 3 retirement (who have a defined contribution (DC) component, as described in the following Section B), and employees hired between January 1, 2012 and the effective date of Tier 3 benefits (Tier “2b” members, who have neither the option of the DROPor DC plan), a defined contribution account will be established for Tier 2b members not enrolled in Social Security with the following contribution rates:

a.         For a member hired in 2012, a required employer contribution of 4% of the member’s regular compensation and a required contribution by the member of a minimum of 3% of that member’s regular compensation for seven (7) years, after which point the employer and employee contributions to the Tier 2 defined contribution plan are shared equally at 50/50 at the same rates as Tier 3, Option 1 (PSPRS Tier 3 Hybrid).

b.         For a member hired in 2013, a required employer contribution of 4% of the member’s regular compensation and a required contribution by the member of a minimum of 3% of that member’s regular compensation for six (6) years, after which point the employer and employee contributions to the Tier 2 defined contribution plan are shared equally at 50/50 at the same rates as Tier 3, Option 1 (PSPRS Tier 3 Hybrid).

c.          For a member hired in 2014, a required employer contribution of 4% of the member’s regular compensation and a required contribution by the member of a minimum of 3% of that member’s regular compensation for five (5) years, after which point the employer and employee contributions to the Tier 2 defined contribution plan are shared equally at 50/50 at the same rates as Tier 3, Option 1 (PSPRS Tier 3 Hybrid).

d.         For a member hired in 2015, a required employer contribution of 4% of the member’s regular compensation and a required contribution by the member of a minimum of 3% of that member’s regular compensation for four (4) years, after which point the employer and employee contributions to the Tier 2 defined contribution plan are shared equally at 50/50 at the same rates as Tier 3, Option 1 (PSPRS Tier 3 Hybrid).

e.                     For a member hired in 2016, a required employer contribution of 4% of the member’s regular compensation and a required contribution by the member of a minimum of 3% of that member’s regular compensation for three (3) years, after which point the employer and employee contributions to the Tier 2 defined contribution plan are shared equally at 50/50 at the same rates as Tier 3, Option 1 (PSPRS Tier 3 Hybrid).

f. A member is fully vested in the defined-contribution plan after 10 years of service, with employer contributions vesting at a rate of 10% per year, with the exception of a disability retirement, in which case there would be immediate 100% vesting.

Tier 2 participants hired between January 1, 2012 and December 31, 2016 will not be eligible for this benefit if, for any reason, these members become eligible for a DROP or similar benefit. If deemed ineligible, all employer contributions made pursuant to this catch-up provision must refunded to the employer.

B.        All employees hired on or after January 1, 2017, shall have the option of electing, within 90 days of employment, to participate in either the Tier 3 Hybrid retirement plan or the Tier 3 Defined Contribution plan. Members who do not make an affirmative election will be placed in the Defined Contribution plan, as  described below.

1. Option 1 (PSPRS Tier 3 Hybrid)

A new PSPRS Tier 3 Hybrid retirement plan for Police and Fire employees that includes the following elements:

a. Defined-Benefit Pension:

Defined-benefit pension benefit based upon years of credited service at retirement or termination, calculated as the member’s final average compensation times the number of whole and fractional years of credited service times the following:

i) 2.50% if the member has at least 25.00 years of

 credited service.

ii) 2.25% if the member has at least 22.00 years of credited service but not more than 24.99 years of credited service.

iii) 2.00% if the member has at least 19.00 years of credited service but not more than 21.99 years of credited service.

iv) 1.75% if the member has at least 17.00 years of credited service but not more than 18.99 years of credited service.

v) 1.50% if the member has at least 15.00 years of credited service but not more than 16.99 years of credited service.

b. Defined-Contribution Plan for Non-Social Security

Employers:

Those Tier 3 Hybrid Plan members not enrolled in Social Security,shall be provided with a defined-contribution plan with contributions consisting of:

i) A required employer contribution of 3% of the 

member’s regular pay; and

ii) A required contribution by the member of a minimum of 3% of that member’s regular pay. Employees may elect to increase the employee’s contribution up to the annual limits established by the IRS.

iii) A member is fully vested in the defined-contribution plan after 10 years of service, with employer contributions vesting at a rate of 10% per year, with the exception of a disability retirement, in which case there would be immediate 100% vesting.

c. Equal Cost Sharing

i) Employers and Tier 3 Hybrid Plan employees shall equally share all normal costs, future unfunded liability amortization costs, and administrative costs on a 50/50 basis.

ii) There shall be no caps on employer or employee

contribution rates.

iii) All Tier 3 Hybrid Plan normal costs, unfunded liability amortization costs, and administrative costs shall be calculated on the basis of just Tier 3 in isolation from all other PSPRS tiers and shall not be construed to include any normal costs, unfunded liability amortization costs, and administrative costs associated with any other PSPRS tier.

iv) Pursuant to the above, members enrolled in the Tier 3 Hybrid Plan will only be contributing to any future unfundedliabilities on the obligations of the participants in the Tier 3 Hybrid Plan and no other PSPRS tier.

d. Cost of Living Adjustment

i) Compounding COLA based on regional CPI (annual change in the U.S. Bureau of Labor Statistics CPI-U for Phoenix-Mesa, AZ), with cap of 2.0%, unless the funded ratio of the plan falls below 90%. In years the plan falls below this funding threshold, the cap will be adjusted as follows:

(1) If funded ratio of the plan (per the most recent actuarial valuation) is between 80-89.99%., the cap is reduced to 1.5%

(2) If funded ratio of the plan (per the most recent actuarial valuation) is between 70-79.99%., the cap is reduced to 1.0%

(3) No COLA will be issued in any year in which the funded ratio of the plan (per the most recent actuarial valuation) is below 70%

ii) COLAs begin the first calendar year after the retiree reaches the 7th anniversary of their retirement date (or at age 60 regardless of whether the 7 year delay was met)

e. Minimum Benefit Eligibility Age

i) The minimum benefit eligibility age for an unreduced pension benefit will be age 55, with 25 years of credited service.

ii) The minimum benefit eligibility age for an actuarially equivalent pension benefit will be age 52.5, with 25 years of credited service.

f. 80% cap

i) The maximum pension benefit will be 80% of an employee's final average salary (same as Tier 2 status quo =2.5% x 32 years of credited service)

g. Final Average Salary Determination

i) Five-year final average salary is defined as five consecutive years within the last 20 completed years of credited service that yield the highest average.

ii) Overtime earned and credited towards final average salary is counted as pensionable that is subject to the employee/employer contribution rate.

iii) Note: FLSA pay is not considered overtime (56 hour standard work-week  for firefighters).

h. Cap on Pensionable Pay

i) Beginning on January 1, 2017, the annual compensation of each member taken into account for purposes of the system shall not exceed $110,000.

ii) To account for inflation, PSPRS will calculate and publish (via a report to  the legislature) the growth in salary scales annually, and the Pensionable Salary Cap will be indexed every three years in order to maintain pace with inflation, in the following manner:

(1) The cap will increase by the percentage increase in average of the pay scale for active employees below the rank of Police Sergeant and Fire Captain.

(2) In determining the adjustment to the cap, the percentage increase in average pay scale will be calculated as weighted by employer’s payroll relative percentage of total payroll. For example, consider a plan with two employers: in a given year Phoenix represents 70% of total payroll in the plan and Peoria represents 30%. If from one year to the next Phoenix’s pay scale for active employees below the rank of Police Sergeant and Fire Captain increases 2% and Peoria’s increases 10%, a weighted average would mean increasing the cap 4.4%; ((2%*70%)+(10%*30%)) = 4.4%.

i. Vesting

i) Defined-Benefit Vesting: A member is fully vested in the defined-benefit pension component of the Tier 3 Hybrid after 15 years of service

ii) Defined-Contribution Vesting: A member participating in the Non-Social Security defined-contribution component of the Tier 3 Hybrid plan is fully vested in the defined contribution plan after 10 years of service, with employer contributions vesting at a rate of 10% per year, with the exception of a disability retirement, in which case there would be immediate 100% vesting.

j. Lateral Hires

i) Employees may change employment between member agencies, retaining all benefits earned and with no negative impacts to their future benefit accrual, as long as there is no separation of service greater than 180 days. Approved leaves of absences consistent with existing leave policies are not

subject to the 180-day period. Each employing agency will be individually  responsible to liabilities accrued during the employee’s tenure of service with that respective agency.

2. Option 2 (PSPRS Tier 3 Defined-Contribution Plan)

a. Tier 3 Defined Contribution Plan members shall be provided with a defined-contribution plan with contributions consisting of:

i) A required employer contribution of 9% of the member’s regular pay; and

ii) A required contribution by the member of a minimum of 9% of that member’s regular pay. Employees may elect to increase the employee’s contribution up to the annual limits established by the IRS.

iii) A member is fully vested in the defined-contribution plan after 10 years of service, with employer contributions vesting at a rate of 10% per year, with the exception of a disability retirement, in which case there would be immediate 100% vesting.

b. [ALL PARTIES ARE AGREE THAT WE NEED TO DETERMINE APPROACH FOR HANDLING DISABILITY FOR DC TIER MEMBERS—REASON FOUNDATION IS RESEARCHING OPTIONS]

C. PSPRS Governance Reforms

1.         The appointment and composition of the PSPRS Board of Trustees will reflect the cost-sharing/risk-sharing of the Tier 3 retirement formula.

2.         OTHER REFORMS TBD, currently in development by PSPRS Governance Reform Working Group

D. Miscellaneous Additional Reforms

1.         All new hires after January 1, 2017 shall be required to make a positive and irrevocable election between either the Tier 3 Hybrid Plan or Tier 3 Defined Contribution Plan within 90 days of employment. Any employee failing to make an election within 90 will be deemed to have elected the Tier 3 Defined Contribution Plan

2.         At no time will any PSPRS employer’s annual payment to PSPRS be less than their share of actuarially determined normal cost. No credits against normal cost shall be factored in to annual employer contributions.

3.         At no time will any PSPRS employee’s contributions to PSPRS be less than their share of actuarially determined normal cost. No credits against normal cost shall be factored in to employee contributions.

4.         This proposal requires that for existing Tier 1 and Tier 2 employees, the member contribution rate will be applied only to pensionable pay for those remaining in the current tiers, while the total employer contribution rate (normal cost, plus unfunded liability costs) will be applied to total pensionable pay of employees in all tiers.

5.         For all Defined-Contribution benefits described above, reasonable safeguards will be placed upon the accounts to ensure adequate long-term financial security. Such safeguards are, but not limited to, prohibitions on borrowing against assets, prohibition on day trading activities, limited quantity of funds to invest in, options available for target-date funds and automatic rebalancing, member education, and advice lines.

6.         Any future benefit increase shall be fully paid in the year of enactment and cannot be amortized over any period of years. The cost of the benefit should be calculated using a risk-free rate of return, using the Ten-Year Treasury Constant Maturity rate, for both the discount rate and the expected rate of return on assets, and the plan actuary should calculate the cost of the benefits using a mortality table published the year the benefit change is adopted (not an older table with adjustments made up to the present year).

E. APPENDIX

1.         For the proposes of actuarially modeling these changes, Reason Foundation is using the assumptions of the plan, plus the following additional assumptions outside the plan:

2.         5% of Tier 3 members will select the Tier 3 Defined Contribution Plan annually.

3.         65% of members are in plans that do not offer Social Security, and thus 65% of Tier 2 and Tier 3 members qualify for the 3% employer contribution rate to a DC plan.

4.         For the proposes of measuring the cost/savings, and changes to employer risks:

5.         The PSPRS baseline should include the costs of the current PBI design (up to 4%) in the calculation of baseline normal cost.

6.         Nothing about the proposed changes should be constructed as closing the plan or changing the amortization schedule. Changes to current employee benefits are only related to reducing the COLA to a maximum of 2% and adding a defined-contribution “catch-up provision” for employees hired after January 1, 2012, as described in Section A(2) above. Changes to future employee benefits involve a change to the defined-benefit multiplier design, benefit eligibility, COLA benefits having a 7-year waiting period (or until age 60) before they begin, and an employee option to select a 100% definedcontribution-only plan. Changes to future hire employer costs change the employer percentage paid on any future Tier 3 unfunded liability amortization costs (reducing it to a 50/50 share with employees), but not the amortization schedule itself.

7.         For the purposes of measuring changes to benefits:

8.         Projections of current benefits offered to benefits under the proposed changes should include Social Security benefits for eligible employees, whether calculating projected annuities or replacement rates.

9.         Projections of the value of defined-contribution funds should assume a rate of return 50 basis points below the plan’s expected rate of return, i.e. a 7% rate of return for the defined-contribution under the current plan assumptions.