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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...

Thursday, September 29, 2016

If you're an employer, how do you stop PSPRS from destroying your budget?

In the coming years, we can probably expect to see more and more pieces like this one by Prescott Mayor Harry Oberg, Yes, the State's PSPRS debt can be solved, which appeared in Prescott's The Daily Courier on July 28, 2016.  I find Mayor Oberg's editorial quite interesting, not because of what it actually says, but what can be read between the lines.

If we look at his proposals for eliminating PSPRS' debt, they are all, to varying degrees, non-starters with most falling into the "rich relative(s)" solution that can only work as long as there is actually some entity available that can play that role.  The City of Detroit was only "saved" because contributions obtained from charitable foundations, the Detroit Institute of Arts (a city-owned museum with an art collection valued in the billions), and Michigan's taxpayers were used for to pay for the $800 million "Grand Bargain" that helped limit cuts to pensions and city services.  As far as I know, we have only Arizona taxpayers on which to rely for contributions.

Mayor Oberg offers five suggestions to generally eliminate PSPRS' debt and Prescott's more specifically:

1. "Pool the assets and debt of all Tier 3 PSPRS employees."  As it stands now, only assets are pooled for investment reasons, while every employer has its PSPRS liabilities calculated individually.  This proposal sounds good, but it is a horrible idea.  As with any financial proposal, we should remember basic economics and look at potential unintended consequences.  This proposal will incentivize irresponsible behavior by employers and public safety employees, yet spread the cost to all employers and taxpayers, regardless of how judiciously they manage themselves.  Shouldn't we first ask why there already exists such a disparity in contribution rates between various state employers?  The answer is obviously that some employers and public safety employees have been irresponsible with their finances over the years, despite the fact that they could see their PSPRS liabilities inexorably growing.  Why would expect better behavior if we hide individual irresponsibility in one large debt pool?  Most likely, this will incentivize bad behavior by even those who are inclined to act responsibly.

2. "Add one cent to the state sales tax for a specified period of years until the state PSPRS debt is 80% funded."  Do we need to say any more than we already said about the first proposal?  Mayor Oberg wants to punish everyone in the state for the excesses of individual employers and their public safety employees.  This would include taxpayers who pay for private fire protection or donate to and work at volunteer fire departments.  This seems unlikely to be approved by Arizona voters, and it is especially hypocritical for someone opposed to any increase in Prescott's local sales tax for the same purpose to propose a similar measure for the entire state.

3. "Create a revolving fund similar to the state’s Water Infrastructure Finance Authority of Arizona (WIFA) to allow immediate payment of debt and establish a repayment bond at 2-3 percent." I am perplexed at this fascination politicians have with pension bonds, as if they were some form of free lunch.  Pension bonds are one of the worst things a government can do and act only to postone a permanent solution to pension underfunding.  They remove the immediacy of the pension problem, which also removes the impetus towards the necessary financial discipline that had been missing in the first place.  Pension problems will continue and underfunding will not decrease, and governments end up with the same pension liabilities and pension bond debt.

4. "Obtain state legislative authority to increase the city property tax (with a cap) to a level which will sustain police and fire operations and pay."  Of all Mayor Oberg's suggestions, this is the only one I can see as feasible since both costs and revenue will stay local.  However, money is fungible, and the mayor and council will still be in charge of the budget.  How do they assure taxpayers that they are actually paying down Prescott's PSPRS liability, rather than using the increased tax revenue for other things?  Taxpayers in Prescott already rejected a sales tax increase for this very same purpose, so why would they trust the mayor and council any more with enhanced property tax revenue?

5. "Specifically for Prescott, consider providing pension funding for all the families of the deceased Granite Mountain Hot Shots (GMHS) covered under PSPRS."  I am not completely sure how much Mayor Oberg wants from the state.  He mentions a $5 million payment already paid by the state to cover the pension obligations of the six full-time Prescott firefighters that were part of the GMHS.  I believe he is saying that he wants more to cover those six firefighters' pensions.  I believe he is also implying that the state should also help with the pension obligations of the three seasonal GMHS firefighters who were retroactively awarded PSPRS pensions by the Prescott PSPRS fire board.  He bases these claims on the fact that the GMHS were ordered onto state trust land by the state forestry division.  I do not know the details of the agreements between the City of Prescott and the state forestry division when it came to fighting wildfires, but I would assume that if there was any potential that the state was legally liable for any of the pension obligations, Prescott would already be pursuing this in the courts.  Mayor Oberg is free to make any claim he wants based on compassion, but the choice to staff a hot shot team with all the attendant financial risks for such a small city was Prescott's, not the state of Arizona's.  And while I am not making any statement about the morality of retroactively awarding PSPRS pensions to the seasonal employees of the GMHS, this entirely local decision was made knowing that it had huge financial consequences for the City of Prescott.  Fortunately, there were other programs that helped the families, but Prescott should not expect the state to bear the costs of its decisions.

All these proposals, except possibly for one, are not realistic.  None of them solve the underlying problem for Prescott or any of the other 256 public safety employers.  Mayor Oberg hints at it, but he never comes out and says what that underlying problem is: pension costs fall fully on local entities, though the local entities do not control the pension benefits.  Would Mayor Oberg accept it if Prescott city workers negotiated their wages, health insurance premiums, or vacation accruals with the state legislature?  I would think not.  Yet this is exactly what happens with public safety pension benefits.  The state legislature, which has nothing to lose, negotiates pension benefits with state public safety unions, which have everything to gain, while the local entities have to pay for whatever they agree to.

This most recent pension reform was a perfect example.  The League of Arizona Cities and Towns offered a "yardstick" for pension reform, but as far as I know they played no part after that, despite the fact that they had the most at stake.  Fortunately for the League, the state public safety unions were too busy protecting the benefits of senior members and betraying the next generation of public safety personnel to realize that they set the PSPRS defined benefit pension on the path to extinction, so local entities will make out in the long run.  However, this does not mean that that the legislature and the state public safety unions will not continue to play the same game they have always played.

I hope Mayor Oberg and other local elected officials realize that any enhancement to pensions become permanent via the Arizona Constitution's Article 29, unless changed via a vote of the state electorate (ala Proposition 124 in May 2016).  I suspect that the process of reintroducing harmful policies and unsustainable benefits is already in the works.  If Mayor Oberg wants to do something to help his city, he and other local elected officials should reassert their authority over their own budgets and get more proactively involved in the crafting of state pension statutes.  This strategy will be more ethical, more successful, and certainly more dignified, than begging the state for money.

Thursday, September 22, 2016

PSPRS investment returns through July 2016 (with further evidence that PSPRS' investment strategy is failing)

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through July 2016, the first month of the current fiscal year (FY), with the FY end 2014, 2015, and 2016 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%
6/30/2016 -0.32% 1.06% 0.21% 2.14%

7/31/2016 1.62% 1.62% 3.97% 3.97%

There is usually about a two-month lag in PSPRS reporting its investment returns.

First off, we should note that PSPRS' final return for FY 2016 was 0.63%, meaning that they paid 0.43% in fees, so they did not pay more in overall investment fees than they earned, though PSPRS did pay more in fees than they earned in four of the ten asset classes .  Also, for comparison, the Arizona State Retirement System (ASRS), at a 0.50% annual return, earned even less than PSPRS in FY 2016.  However, ASRS is still handily beating PSPRS over the long run in annualized returns:

1 year  3 year 5  Year 10 Year
PSPRS 0.63% 5.71% 5.40% 4.45%
PSPRS CIP 1.79% 6.24% 5.49% 5.69%
ASRS 0.50% 7.10% 7.10% 6.00%

This again brings back to the central issue with PSPRS.  PSPRS has better comparative returns only when overall market returns are low, and as PSPRS' investment staff theorizes, when returns are negative.  As can be seen in the comparison with ASRS, this performance will not be successful in the long-term, unless PSPRS drops its expected rate of return (ERR).  PSPRS dropped their ERR 0.10% again for the current FY from 7.5% to 7.4%.  ASRS is still maintaining a 8.0% ERR.  If we look at the past three years, PSPRS earned 13.28%, 3.68%, and 0.63% over FY 2014, 2015, and 2016, respectively.  ASRS earned 18.6%, 3.2%, and 0.50% over the same there respective FY's.  That additional 5.3% earned in FY 2014 makes a big difference in the three-year annualized return, more than making up for the lower returns ASRS had in the next two FY's.

 If we look at the three, five, and ten year annualized returns, we see that PSPRS earned 51.30%, 46.55%, and 60.13% of the Russell 3000's three, five, and ten year annualized returns, respectively.  Over the same periods, ASRS earned 63.79%, 61.20%, and 81.08% of the Russell 3000's annualized returns, respectively.  Keep in mind that the ten year annualized period includes the worst of the market downturn in 2008-09, so includes both ends of the market spectrum.  ASRS clearly has a better investment policy than PSPRS.  More telling is that even PSPRS' Cancer Insurance Plan (CIP), which has a simple portfolio that invests roughly 50% in equities, 45% in bonds, and 5% in commodities, earned more than PSPRS over the same annualized periods.  PSPRS does not have to look enviously at ASRS for a sign that something is amiss with its investment strategy; they need only look within their own offices at the CIP.

At some point in time, PSPRS will have to start earning returns that more closely approach the broader market or lower its ERR.  Can someone at PSPRS please tell PSPRS Chief Investment Officer Ryan Parham that Proposition 124 passed back in the spring and COLA's are now limited to 2% or the regional consumer price index and will be included in contributions as part of the normal cost?  Mr. Parham doesn't need to lowball returns any longer and can now invest in a manner that will produce the higher returns he boasted PSPRS was capable of earning.  Is it too much to ask that PSPRS earn its ERR over the long run, especially if they actually try to do so, or are they just waiting for inflation to do the job for them?

 * 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% in FY 2014, 3.68% in FY 2015, and 0.63% in FY 2016.

Saturday, September 10, 2016

A 9/11 remembrance

Now that it has been 15 years since the terrorist attacks on 9/11/2001, it seems like a good time to revisit this passage from page 316 of  The 9/11 Commission Report:
The National Institute of Standards and Technology has provided a preliminary estimation that between 16,400 and 18,800 civilians were in the WTC complex as of 8:46 A.M. on September 11.  At most 2,152 individuals died at the WTC complex who were not (1) fire or police first responders, (2) security or fire safety personnel of the WTC or individual companies, (3) volunteer civilians who ran to the WTC after the planes' impact to help others, or (4) on the two planes that crashed into the Twin Towers.  Out of this total number of fatalities, we can account for the workplace location of 2,502 individuals, or 95.35 percent.  Of this number, 1,942 or 94.94 percent either worked or were supposed to attend a meeting at or above the respective impact zones of the Twin Towers; only 110, or 5.36 percent of those who died, worked below the impact zone.  While a given person's office location at the WTC does not definitively indicate where that individual died that morning or whether he or she could have evacuated, these data strongly suggest that the evacuation was a success for civilians below the impact zone. (italics mine)
Everyone can remember 9/11 as they choose.  If the funereal reading of names and ringing of bells is one's preference, that is fine.  I prefer to think of the incredible efforts of those WTC rescuers, professional and civilian alike, who accomplished a task under nearly impossible conditions on 9/11 and were able to save nearly everyone that could possibly be saved from the towers.  These rescuers were heroes not just because they died helping their fellow Americans, but because they succeeded at their mission.

Unfortunately, 9/11/2016 will likely see the spectacle of some NFL players refusing to stand during the playing of the national anthem.  This self-indulgent protest, led by a one-dimensional, injury-prone, second-string quarterback, makes the accomplishments of Jackie Robinson seem almost unbelievable.  This man, who bore so much both on and off the field while still being able to play baseball at the highest level (career slash line: .311/.409/.474), appears superhuman in comparison to the anthem sitters.  When any NFL player sits during the national anthem, it will make me appreciate the real heroism of Jackie Robinson even more.