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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 1, 2016

A brief analysis of the PSPRS pension reform framework before the big reveal this week

If you have not had a chance to look at the PSPRS Pension Reform Framework, it is available in the previous post or at the Arizona Fraternal Order of Police website.  We have to remember that this is just the framework that was apparently agreed to by the State of Arizona, the Professional Fire Fighters of Arizona (PFFA), the Arizona Highway Patrol Association, and the Phoenix Law Enforcement Association "for a tentative agreement on both retroactive and prospective reforms" to PSPRS.  I thought it was odd that the League of Arizona Cities and Towns was not at the table.  Perhaps they deferred to the State as their representative, which would be a mistake in my opinion, but they already generated their own "yardstick" for reform, which did seem to have some influence on this framework.  The most surprising thing is the influence the Reason Foundation seems to have had on the framework.

Here are my takeaways from the PSPRS Pension Reform Framework:

1. Cutting the cost of living allowance (COLA) / permanent benefit increase (PBI) Gordian knot:
The simple proposal is to limit the COLA to the lower of 2% or the local consumer price index (CPI).  This amount will be included in the normal cost and not be reliant on excess investment returns, which is good since those currently managing PSPRS have neither the desire nor the ability to earn the expected rate of return (ERR), much less anything over it.  The contempt PSPRS' management and Board of Trustees seems to have for retirees since the Fields case is nearly palpable.  In retrospect, it may have been better if retirees had accepted the SB 1609 COLA reforms back in 2011.
As it says in the framework, this is the only portion of the framework that will need to go to the voters, possibly in May 2016, since it is the only retroactive change, affecting those retired or active now. 
2. Public safety unions are shafting their future coworkers (again):
I have written quite a bit about the PFFA's attempts at intergenerational theft.  Fortunately, their worst proposal, to fund retiree COLA's out of active member's contributions is not included in the framework.  It was disgraceful for the PFFA to have even considered such a blatantly unfair proposal that would have benefitted only those close to retirement and would have placed a permanent financial burden on the most junior employees.
The new tier created in this framework will be quite different from what exists now, but I would like to highlight two changes.  The first is that there is no Deferred Retirement Option Plan (DROP) or rebranded program like the PFFA's inflation protection program.  The DROP is not available to anyone hired in 2012 or later, so it is not available to Tier 2 or Tier 3 members.  It does remain in place for Tier 1 members hired before 2012.  I had hoped that the DROP would be eliminated completely for all tiers since it was a bad program that was neither necessary nor financial sound.
The other change is that Tier 3 members will now have an inflation-adjusted cap on their pensionable earnings.  This cap will start at $110,000 per year.  There is no cap for Tier 1 or Tier 2 members. There are also a stricter formula for paying retiree COLA's to Tier 3 members.
When we look at these changes, we see the more selfish tendencies of those leading the public safety unions.  When we look at any policy affecting the financial status of the pension, the only valid question should be: is the benefit promised being adequately funded to meet the future liability created?  In the case of the DROP and pension spiking, the answer is emphatically negative.  Otherwise, we would maintain the DROP for all tiers and have no need to cap pensionable income.
The changes for Tier 3 members tells us that the DROP is not cost-neutral and pension spiking is a serious problem.  Yet rather than acknowledge that the DROP and pension spiking are money-for-nothing schemes that hurt PSPRS and accept their portion of shared sacrifice that would come with equal treatment of all tiers, the public safety unions have decided to do what they normally do and protect senior members at the expense of junior members.  All unions members are equal, but senior union members are more equal than others.
3. Mandatory deferred compensation for anyone hired after 2011:
While I like the idea of employers contributing to a defined contribution (DC) account  for PSPRS members, is it really something that can be mandated from the state onto local employers?  Likewise, how can you require individual employees to contribute to a DC plan?  These seem to be questions of collective bargaining by union locals.  Finally, wouldn't it be easier to require new hires to simply participate in Social Security since this "third leg" of retirement income already exists?  Mandating a DC plan does not solve the "third leg" problem, and instead, only forces employers and employees to participate in the "second leg."  The only way to get the "third leg" is through Social Security.  Of course, employees and employers would each have to contribute 6.2% of the employee's income to Social Security, which is 2.2-3.2% more than the proposed mandatory DC plan.  Perhaps this scared them away from the Social Security option, but regardless, employees will get only a small benefit, the 3-4% employer contribution, and not a "third leg" on their retirement stool.
4. Flexibility in employment/retirement for Tier 3 members:
This is probably the most interesting change to PSPRS.  Tier 3 members will have the option of retiring after as little as 15 years at a lower multiplier of 1.5% per year of service on a sliding scale all the way up to the 2.5% per year of service if they stay 25 years or more.  Tier 3 members can even forgo any defined benefit pension for an exclusively DC pension.  This DC pension would require 9% contributions apiece from the employer and employee, and the choice would be irrevocable once made.
These options will make Tier 3 members, especially those that choose the exclusive DC plan, less tied to PSPRS or the state of Arizona for employment.
5. Tier 3 members will split costs 50/50 with employers:
This is a big change that will act as a governor on the sort of reckless and greedy pension enhancements that got PSPRS into its current mess.  Assuming that actuaries are giving honest cost projections of future benefit increases, Tier 3 members will have a good idea whether the proposals of their union leaders are workable.  Tier 3 members should immediately know the cost of a benefit increase because the cost should appear in their current contribution rate.  No longer will unrealistic estimates be used to raise benefits that are unsustainable with the cost pushed somewhere into the future when it will be someone else's problem.  If you want a benefit, you will have to pay for it now and convince those that will have to pay for that it really benefits all members, not just those close to retirement.
6. What about the Hall case:
Oral arguments in the Hall case are scheduled in just two and half weeks on February 18, 2016.  We have already discussed how the COLA question will almost certainly be decided in favor of the plaintiffs, under the same reasoning as the Fields case.  This will be a short-lived victory for the Hall (and Fields) plaintiffs since the COLA formulation will be changed to a maximum 2% annual COLA, assuming voters agree to it in a referendum.  Furthermore, it seems like PSPRS' crack investment staff will be lucky to end the year in the black, much less earn 9% on its investments, so there will be no PBI next fiscal year, regardless of the referendum.
The more compelling question is what of the contribution rate increase.  The second issue in the Hall case is whether it was constitutional to raise the employee contribution rate for Tier 1 members from 7.65% to 11.65%.  This increase was done incrementally over the past several years.  I believe the plaintiffs will lose this argument, but what if they win?  This means that thousands of Tier 1 members should be due a refund of excess contributions.
However, this is all dependent on when the special panel issues its decision in Hall, how it is interpreted by the legislature and the panel, and whether or not a permanent increase can be retroactively mandated in a referendum.  Say the panel issues a decision in March that SB 1609 unconstitutionally raised employee contribution rates for Tier 1 employees.  Shouldn't PSPRS have to immediately refund members' millions in excess contributions?  Knowing PSPRS they will drag their feet and do everything they can to not pay it out in hopes that a retroactive mechanism can be crafted to keep the money.  It will be interesting to see how this all plays out.
7. How much influence did Reason Foundation have on the framework:
If you go to the Fraternal Order of Police link, you will see another link to a Reason Foundation Powerpoint (and I owe thanks to the reader who first pointed this document out to me).  According to the Powerpoint:
Reason Foundation provided education, policy options, and actuarial support for all stakeholders, and facilitated consensus amongst stakeholders on conceptual design and reform framework
If you do not know about this organization, their website states:
Reason Foundation advances a free society by developing, applying, and promoting libertarian principles, including individual liberty, free markets, and the rule of law.
Some people have a problem with Reason Foundation because they share beliefs with both the Goldwater Institute and the Koch brothers (David Koch is a Reason Foundation trustee), two groups Arizona's public unions love to hate.  Their presence at the stakeholder meetings must have been like a turd in a punchbowl.
Oddly, though, they seem to have had an outsized influence on the framework.  Other than the 2% COLA proposal, it seems that the PFFA had little to no influence on the framework.  The law enforcement unions seem to have sat around much of the past year until finally piggy-backing on to the PFFA's reform proposal.  The radical changes proposed for Tier 3 members seems to all have come from Reason Foundation, within several of the guidelines proposed by the League of Arizona's Cities and Towns.
While I am glad that the PFFA's lousy proposal was not implemented, it seems like neither they nor the law enforcement unions had much to do with the plan for Tier 3 members.  It seems like they could have at least gotten them a COLA formula that was more like those for Tier 1 and Tier 2 members.  Maybe they were happy that they got to keep most of what they wanted for their senior members and did not really care what happened to people not even on the job yet.
According to this January 31, 2016 story, "Major overhaul to police, fire pension plan this AZ Senate Monday," by Bob Christie of the Associated Press, the plan is supposed to finally be revealed in the Arizona Senate today.  Hopefully, we will see more specifics in this big reveal.


  1. So, our current "brothers and sisters," threw their future and retired brothers and sisters under the bus! Nice job... With your DROP and spiking...

  2. So, our current brothers and sisters threw the new hires and even retirees under the bus, to salvage their a unethical DROP and spiking activities! Nice...

  3. Thank you for your comments. That pretty much sums it up. Let the devil take the hindmost since I already got mine.


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