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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...

Tuesday, July 19, 2016

They'll fail but you'll pay: The financial injustice in PSPRS' new service purchase policy

I would like to share the following email about service purchases that I received several weeks ago, just in case any active PSPRS members did not receive it.  It is reproduced verbatim, except for contact information for the author:

Dear Brothers and Sisters:
Brothers and Sisters, many of you have discovered that the PSPRS has raised its service purchase rates.  We have fielded many of your phone calls and we have responded by communicating these issues directly with PSPRS staff and we requested that they re visit this issue.  The good news is that they have agreed.  Brian Moore from Local 493 put together a great article clarifying what PSPRS has agreed to do.  Thank you Brian for providing this information.  

By Brian Moore, Vice-President Local 493 Healthcare and Member Benefits Elected Member, City of Phoenix PSPRS Fire Pension Board

Last year and without notice, PSPRS changed the manner in which it calculated the cost for service purchases of Rural Metro and out of state service time. A number of Arizona Fire Fighters had planned to make service purchases last year and were shocked to find that the change made by PSPRS resulted in a cost increase of 60% or more depending on the member’s years of service, salary and age. Also affected were many Arizona police officers working. Many of these experienced officers came to Arizona after being recruited by cities and towns during the police officer shortage that existed statewide in the late 90’s and early 2000’s when the economy was booming. All of those affected had been planning to make purchases when they had close to 20 years of service and were rightfully upset when the change was made without any advanced notification.

A little history is necessary to understand the problem that developed. To entice out of state police officers to relocate to Arizona, PSPRS statutes were amended to allow police officers and firefighters to “buy” unlimited amounts of previously served time in other states. In the mid 2000’s, PSPRS statutes were amended again to allow purchase of Rural Metro service credit for those who later began working for a fire district or municipal department that was covered under PSPRS. Purchases of up to a maximum of 4 years of military service had always been allowed as had unlimited years of prior service that was credited in the Arizona State Retirement System (ASRS) and the Corrections Officer Retirement Program (CORP).

The infamous Senate Bill1609 passed in 2011 change a number of provisions of service purchases. It changed the requirements to 10 years of membership in PSPRS before any purchases could be made and limited out of state and Rural Metro service purchases to 5 years max no matter how many prior years one might have. The law changed again in 2012 to allow out of state and Rural Metro purchases after 5 years of PSPRS membership but Military service purchase still required 10 years of service. Laws pertaining to purchasing prior service in any of the Arizona plans- ASRS, COPERS, CORP or City of Tucson Retirement plan remained unchanged.

Then in April of 2015 and because of another obscure change in state law, PSPRS began using a much lower discount rate to determine the cost of Rural Metro and out of state service credit. No other service purchases were affected. The discount rate is the rate used by pension plans to discount the cost of future liability for these service purchases to present value and takes into account the short-term risk of not meeting the assumed rate of return. The main reason for the cost increase was because the new discount rate was around 4% instead of the previous discount rate which was equal to the assumed earnings rate of the PSPRS fund which was 7.5%.

Because the change was without notice and created a significant hardship to many folks who had been playing by the rules, Local 493 leadership, PFFA representatives and the police unions went to PSPRS and the legislature to get the discount rate changed back to what it was prior to April 2015. These efforts led to House Bill 2019 that was passed by the legislature and signed by Governor Ducey in April of this year. The law takes effect on or about August 6th since the effective date is 90 days after the legislature adjourns. Some of the main provisions of HB 2019 are as follows:

The discount rate will change to equal the assumed rate of return set by the PSPRS Board of Trustees for the fund which will be 7.4% on July 1st of this year. This TEMPORARY discount rate change will LOWER the cost of service credit purchase substantially. 
This special purchase provision is TEMPORARY and will be in effect until July 1st, 2017 at which time the discount rate WILL CHANGE and become an amount equal to the yield of a 10 Year Treasury Bill plus 2% (meaning the discount rate would be about 4% right now) and thus purchases WILL COST SUBSTANTIALLY MORE after that time.
Military service will be able to be purchased after 5 years of membership in PSPRS instead of 10 years. (New provision)
Payment plans will be available using “after tax dollars”. This is a new provision. Service purchases can still be made by transferring 401(a) and 457 assets but those must be used for lump sum purchases.
After July 1st, 2017, ALL TYPES of service purchases will be calculated using the lower 10 Year T Bill plus 2% discount rate. This will dramatically INCREASE the cost for military, ASRS, COPERS, Red Shirt time, Rural Metro, out of state time etc. You might want to consider making any service purchases prior to 7/1/17 or at least look at the cost differences- even if you do not have 20 years of service. (New provision)
Remember that in order to purchase prior military, Rural Metro or out of state service, you must have 5 years of membership or service credit in PSPRS. Other service purchases/transfers do not require a 5 year wait.

PSPRS representatives have told me that they will not be updating the service purchase website and online service purchase calculator or even providing specific details until the effective date of the law which is on or around August 6th. In the meantime, you can check what the higher cost is now and then around August 6th when the updated calculator is posted, recalculate your cost to see the difference. The web address for PSPRS is www.psprs.com . Click on the “Public Safety” link at the top of the page and this will take you to the Public Safety page.

This is my personal summary of the legislation and only intended as a general overview. This summary is based upon conversations with the PSPRS lobbyist and PSPRS Service Purchase staff. Please refer to PSPRS and HB2019 for specific details and information. PSPRS will be providing more information in the near future. I know this is pretty lengthy (omitted) if you have any questions or require any additional information.
We hope this information will be helpful to you. Stay safe out there, one and all.

Bryan Jeffries
Professional Fire Fighters of Arizona
The gist of this is that any active PSPRS member who wants to purchase service time will need to do it before July 1, 2017 or he or she will have to pay significantly more.  How much higher? I went here to see the cost difference between the old and new rates.  I calculated a service purchase estimate for myself of three years at 20 years of service (with an average high three-year salary of $75,000) under the old higher discount rate and the new lower discount rate and found a difference of about $28,500 in cost--$65,161 versus $84,475.  This amounts to a 29.6% increase in the cost of the service purchase for me.  The estimate will vary depending each member's own date of birth, service time, and average salary.

Several points need to be made here.  The first is that we can once again see the utter cluelessness and naivete of the Professional Fire Fighters of Arizona (PFFA) and the other state public safety unions.  The PFFA's appeasement of the Arizona Legislature over the last year or so apparently has no limits.  The oddly triumphal tone of PFFA President Bryan Jeffries' message shows this.  He considers this a victory?  A year-long reprieve?  The hundreds of thousands of dollars this will cost public safety members over the years seems not to register any alarm or outrage with him or any of the other state union leaders.  I guess Mr. Jeffries and the other leaders were too busy giving away member benefits through the front door to notice the stuff being taken out the back door.

This brings us to my next point.  If we go to the PFFA's "Leadership" page, we see listed a Director of Legislative Affairs, a Political Director, a Director of Government Affairs, and two Staff Representatives.  I assume the law enforcement unions have similar men and women on their staffs.  These individuals, whose job it is to stay abreast of changes that affect PSPRS members, could not head off this change to the service purchase policy?  The only purpose of the PFFA and other state public safety unions is to lobby the Arizona Legislature and protect member benefits at the state level, and yet they allow this to happen?  What about all the political capital they should have gotten by working with State Senator Debbie Lesko and others in the Arizona Legislature during their sellout of future PSPRS members?  Once again, I guess the Legislature figured if the state public safety unions were so willing to sell out their own members, why not help themselves to a few more member benefits as well.

This brings us to the transparency-challenged leaders of PSPRS.  While I never expect much from the PSPRS administration, they can always surprise us with their arrogance.  Mr. Moore writes that PSPRS ". . . will not be updating the service purchase website and online service purchase calculator or even providing specific details until the effective date of the law which is on or around August 6th."  Well, that's a very service-focused attitude by the PSPRS administration.  They will tell us about the thousands of dollars in cost increases to PSPRS members when they are good and ready!

While it is easy to focus on the ineptitude and indifference of the state public safety unions and PSPRS administration, we should not miss the most important point that needs to be made here.  Mr. Moore wrote:
The discount rate is the rate used by pension plans to discount the cost of future liability for these service purchases to present value and takes into account the short-term risk of not meeting the assumed rate of return. The main reason for the cost increase was because the new discount rate was around 4% instead of the previous discount rate which was equal to the assumed earnings rate of the PSPRS fund which was 7.5%.
I have placed in italics the critical part of this passage.  So PSPRS will extract from the member a higher service purchase payment due to "the short-term risk of not meeting the assumed rate of return." This implies that a member is doing something similar to buying an individual annuity, rather than contributing to the combined investments managed by PSPRS, which has no short-term horizon.  Furthermore, a PSPRS member who buys service time is likely to have an investment period of 20 years or more for the purchase price he pays.  Does PSPRS consider 20, 25, 30 years short-term?  Why does a member buying service time at 45, 50, or 55 years old with a life expectancy of 75 years or older have to bear the cost of short-term failures to meet the assumed rate of return (ARR)?

If PSPRS cannot earn its ARR over a 20-year or longer period, the failing is on PSPRS, not the individual members buying service time.  It is called an "assumed" rate of return for a reason.  It takes into consideration the long-term ups and downs of the markets to get an annualized rate that should hit that expected rate.  The justification for using this lower discount rate for service purchases makes no sense.  It is merely a form of extortion that will discourage members from buying service time at all.  PSPRS members do not control how much PSPRS earns over the long or short term ,the Board of Trustees and the PSPRS staff do.

By expecting PSPRS members to use a lower discount rate for service purchases, PSPRS is being indicted as either incompetent, deceptive, or some combination of both.  PSPRS assures us they can earn 7.5% (or 7.4% now) with their "nationally recognized" investment strategy, so forcing PSPRS members to pay more by using a lower discount rates indicates a high expectation of low earnings by PSPRS.  The PSPRS administration must feel no confidence in their own abilities or else they just don't care since I have not seen them come to their own defense and point out the unfairness of this new service purchase policy to PSPRS members.  In the end, I do not understand why, if the Governor and the Arizona Legislature have so little faith in the ability of the current PSPRS administration and Board of Trustees to earn the ARR, they don't get rid of them and bring in some people who can.

Sunday, July 3, 2016

PSPRS investment returns through April 2016

The following table shows PSPRS' investment returns, gross of fees, versus the Russell 3000 for April 2016, the tenth month of the current fiscal year (FY), with the fiscal year end 2014 and 2015 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%
6/30/2015 -0.73% 4.21% -1.67% 7.29%

7/31/2015 0.13% 0.13% 1.67% 1.67%
8/30/2015 -1.43% -1.31% -6.04% -4.47%
9/30/2015 -1.02% -2.31% -2.91% -7.25%
10/31/2015* 1.95% -0.36% 7.33% 0.08%
11/30/2015 0.37% 0.09% 0.55% 0.63%
12/31/2015 -0.95% -0.86% -2.05% -1.43%
1/31/2016 -1.41% -2.26% -5.42% -7.00%
2/29/2016* -0.35% -2.61% -0.52% -7.52%
3/31/2016 3.45% 0.84% 7.04% -0.48%
4/30/2016 0.64% 1.49% 0.62% 0.14%

PSPRS did not provide monthly investment returns for October 2015 or February 2016, and returns for those months are estimates based on the prior and following months' returns. There is usually about a two-month lag in PSPRS reporting its investment returns.

There is nothing new from last month.  PSPRS is still beating the Russell 3000 by about the same percentage it did last month, though the Russell 3000 did finally climb back into the black for the first time since November of last year.  The Russell 3000 returned 1.79% in May 2016 and 0.21% in June 2016; its fiscal year 2016 return was 2.14%.

As for the individual asset classes, we can still see that PSPRS' fiscal YTD returns are mostly driven by private equity and real estate.  Of the ten major categories, five have negative returns for the fiscal YTD.  Private equity has earned 12.89% and real estates has earned 7.95% in the fiscal YTD; the three other positive classes, fixed income, private credit, and real assets, have earned 3.22%, 3.75%, and 0.83%, respectively for the fiscal YTD.  Also, among the ten major asset classes, only three, non-US equity, private equity, and private credit, are surpassing their benchmarks for the fiscal YTD.

It will be interesting to see how the fiscal year ends for PSPRS.  Brexit turned out to be a non-event as to its effect on the Russell 3000.  We will have to wait until August to see if it had any effect on PSPRS' investments.  PSPRS' next Board of Trustees meeting is scheduled for July 20, 2016.

 * Returns, gross of fees, are used because PSPRS usually does not report returns, net of fees paid to outside agencies, except on the final report of the fiscal year.  Returns, gross of fees, are used in the table for consistency.  The past two years fees have reduced the final annual reported return by about a half percent.  Returns, net of fees, were 13.28% and 3.68% for fiscal years 2014 and 2015, respectively.