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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, April 26, 2018

PSPRS investment returns through February 2018 with a recommendation to the Arizona Legislature on how to better oversee PSPRS

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 through February 2018, the eighth month of the current fiscal year (FY), with the past four FY end 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%
6/30/2017 0.22% 12.48% 0.90% 18.51%

7/31/2017 0.83% 0.83% 1.89% 1.89%
8/31/2017 1.06% 1.91% 0.19% 2.08%
9/30/2017 0.80% 2.72% 2.44% 4.57%
10/31/2017 0.64% 3.38% 2.18% 6.85%
11/30/2017 1.28% 4.70% 3.04% 10.10%
12/31/2017 0.66% 5.39% 1.00% 11.20%
1/31/2018 2.35% 7.86% 5.27% 17.06%
2/28/2018 -1.37% 6.38% -3.69% 12.74%

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

We finally have data from February 2018, which was an extremely volatile month for the markets with the Russell 3000 losing 3.69%, versus a loss of 1.37% for PSPRS.  This means PSPRS suffered only 37.13% of the monthly loss of the Russell 3000.  On the other hand, PSPRS only captured 44.60% of the gain in January 2018.  In the latest information provided by the Arizona State Retirement System (ASRS), ASRS' fiscal YTD return through April 17, 2018 is about 9.0%.  PSPRS' Cancer Insurance Plan (CIP) has earned 6.42%, net of fees, fiscal YTD.  The Russell 3000 had another loss of about 2.5% for the month of March 2018, and as of April 25, 2018, the Russell 3000 is up about 1% for the month of April with two trading days left.  It will be a close call whether PSPRS achieves its assumed rate of return (ARR) of 7.4% by the end of June.

For the fiscal YTD, PSPRS has captured almost exactly 50% of the gains of the Russell 3000.  This once again fits PSPRS' pattern of returning 50-60% of the Russell 3000.  At this capture rate, the Russell 3000 must earn between 12.33% and 14.80% in order for PSPRS to earn 7.4%.  PSPRS' actuaries are recommending that PSPRS lower this rate to 7.3% based on an experience study from last year.  Tier 3 members have an ARR of 7.0%.  Any decrease in the ARR will increase current liabilities as investment earnings going forward will be lower, which means contribution rates for Tier 1 and Tier 2 members will have to increase.  This will cause an increase in employer contributions as Tier 1 and Tier 2 members' contribution rates are fixed at 7.65% and 11.65%, respectively.

There was a bill that was attempting to tie PSPRS' ARR to the 3-year rolling average of the 20-year treasury constant maturity rate.  The bill would have forced PSPRS to adopt an ARR that was not more than 2% higher than this rate.  PSPRS would have been forced to drop the ARR 0.25% every year until that target was reached.  Fortunately, this bill was amended, and the language was changed to limit PSPRS from raising its ARR unless PSPRS was at least 80% funded.  This original bill was foolish, as it would have forced PSPRS to drop its ARR down to somewhere around 5%, which would have devastated every employer in the state and hit Tier 3 employees in the defined benefit pension especially hard.  These Tier 3 employees are required to split normal costs and unfunded liabilities 50/50 with employers, and once the ARR dropped below 7%, they would see increases in their pension contributions.  There is no way that this could have worked.

If the Arizona Legislature wants to impose more control over  PSPRS, it should start by giving another state agency, such as the Office of the State Treasurer or the Auditor General, the authority to select PSPRS' actuaries, pension consultants, and accountants.  We know that PSPRS' Board of Trustees and senior management cannot be trusted.  See this passage from The League of Arizona Cities and Towns PSPRS Task Force Report from August 2015:
It is also important to point that prior to FY 2015-16, the cost of the PBI (permanent benefit increase) was not included in the employer contribution rate. Excluding the PBI from the calculation effectively underestimated the normal cost of the pension plan, causing it to manifest itself in the unfunded liability. This issue was identified by PSPRS actuaries several years ago, but the PSPRS Board did not take action to address it. (boldface mine)
Despite this, the PSPRS Board of Trustees is still allowed to contract for these services.  It would be far better if the actuaries, consultants, and accountants were reliant on another state agency to award these contracts.  Their work would be more independent and not influenced by concerns over continued business with PSPRS, if they shined a negative light on the Board or senior management. Their reports and recommendations would also circulate outside of PSPRS for review and analysis.  The PSPRS Board and senior management would then be under pressure to adopt the recommendations of these independent companies or justify to the Arizona Legislature why they cannot.  If PSPRS repeatedly ignored the recommendations without justification, the Legislature or Governor could make personnel changes at PSPRS or pass legislation to force good policies.  This would be a good first step in holding PSPRS accountable.

* 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, 0.63% in FY 2016, and 11.85% in FY 2017.

Wednesday, April 11, 2018

Let's get ready to rumble! Will we see Round 3 of Fields v. EORP, and how would it affect PSPRS members?

As some of you may have noticed, posts are getting less frequent here.  There simply isn't as much going on now that the Fields and Hall cases have been settled, or at least, as it relates to issues that concern most PSPRS members.  Understandably, most PSPRS members want information about things that will affect their own finances, particularly anything that might change current wages or monthly retirement checks.  So just as I was starting to consider closing up shop, PSPRS sent this out:
Referendum headed to ballot
Arizona voters will be asked to reform the permanent benefit increase formula for retired members of the Elected Officials Retirement Plan and the Corrections Officers Retirement Plan. This question will be wrapped into one referendum appearing on the November 2018 ballot.

The reforms to pension increases for CORP and EORP largely mirror those included in Prop 124, which voters passed in May 2016 to replace the permanent benefit increase (PBI) for public safety retirees with a cost-of-living-adjustment model.

The PBI reform to CORP was included in Senate Bill 1442, which was signed into law last year and created additional benefit reforms. The legislation impacting EORP, House Bill 2545, was signed into law this week by Governor Doug Ducey.

As was the case with Prop 124, the changes to CORP and EORP require subsequent voter approval to amend the state constitution to adjust the retiree benefit structure. 

The replacement of the permanent benefit increase (PBI) for CORP and EORP retirees is supported by the PSPRS Board of Trustees due to the urgency to bring stability and sustainability to PSPRS-managed retirement plans. Reform related legislation passed through the state Legislature with unanimous votes or overwhelmingly majorities.

Employers and those interested are strongly encouraged to read all reform legislation related to PSPRS-managed retirement plans. This email is not intended to provide details on all pending or proposed reforms.
The Arizona Legislature is going to try and change how the Elected Officials' Retirement Plan (EORP) and Corrections Officers Retirement Plans (CORP) pay post-retirement benefit increases via a voter referendum in the 2018 general election.  EORP and CORP still use a permanent benefit increase (PBI) system similar to what PSPRS had for Tier 1 members prior to the passage of Proposition 124 in May 2016, which replaced PSPRS' old PBI formula with a capped 2% cost of living allowance (COLA) that is based on the inflation rate in the Phoenix-Mesa area.  PSPRS' COLA applies to ALL PSPRS members, regardless of tier, though Tier 3 members have additional restricions on the payment of their COLA's.

For Tier 1 CORP members (retired before July 1, 2011), half of any annual investment earnings over 9% go into a reserve fund that is used exclusively to pay PBI's of up to 4% of the average normal benefit.  For Tier 2 CORP members (retired July 1, 2011 or later, a sliding scale is used to pay the PBI.  The scale is based on the funded ratio of CORP.  Tier 2 members can get a PBI from 2-4% based on the funded ratio between 60-80%.  You can read more about the PBI's in the CORP Member Handbook.  For EORP members, the PBI rules are the virtually the same.  EORP members are not designated by tiers (tiers are for the little people, apparently) but are broken into in two groups with the same cutoff date as CORP members.  The only major difference I see in the EORP Member Handbook is that the EORP PBI's are based on a member's individual benefit, not the average normal benefit. which makes sense since there is wide range in salaries among EORP members.

On March 23, 2018 the Arizona Republic published this editorial by PSPRS Board of Trustees Chairman Brian Tobin about the dire state of EORP.  While I do not want to get into what Mr. Tobin had to say in his editorial, we should note the complete cluelessness and utter lack of credibility of a public servant who will walk away with nearly $1 million in his first year of retirement telling taxpayers that they need to pony up more money to pay for a broken pension system.

It might be tempting for PSPRS members to say what is good for the goose is good for the gander, especially when it involves the benefits of "elected officials."  However, the 2017 consolidated annual financial report (CAFR) shows the average annual PSPRS service pension is higher than the average annual EORP service pension ($56,232 vs $54,860), while CORP's average annual service pension is only $28,977.  So even if you have no sympathy for retired politicians and judges, many of whom had other sources of income during their working lives and shorter careers in public service, we should not forget that CORP members will be especially hard hit by a change in their PBI's.  No CORP member is getting rich off PBI's, and in fact, the average active CORP member's salary is lower than the average benefit of PSPRS and EORP retirees. This might be something PSPRS members should  keep in mind when it comes to fill out our ballots in November.  The PSPRS press release states that both CORP and EORP will be covered under a single referendum, rather than separately, cynically assuming that voters will want to punish "elected officials" more than they want to help retired corrections officers.

If I had to predict, the referendum changing EORP and CORP's post-retirement increases from a PBI to a COLA will pass.  I cannot see any organized opposition from EORP members (There are just not enough of them.), and I have never seen CORP members (Are they even unionized?) flexing any financial or political muscle in Arizona.  I do not expect much to happen between now and November 6, 2018, but if the referendum passes, that's when I suspect things will really start to heat up because standing on the sidelines is EORP's arch-nemesis, retired Maricopa County Superior Court Judge Kenneth Fields.  His successful challenge to SB 1609 in 2011 was over the very issue of alteration of the PBI formula.  He also won another case against EORP in 2017 over how much employers were required to pay in contributions.  EORP currently has a fixed employer contribution rate that is grossly inadequate to fund the pension.

The curious thing about this is that EORP must be funded.  It makes no sense for Legislature could not set a fixed employer contribution rate and deliberately starve it of funding.  The obligation to retirees would not disappear because the state refused to make employers pay the necessary contributions.  EORP's defined benefit pension will have to be funded until the last member or survivor dies, and for some perspective, see this story.  So what was the purpose of setting a fixed employer contribution rate that is only half or one-fourth of what is needed?  I do not like conspiracy theories, but what else could it be but to force EORP into such a financial crisis that a radical change would be required.  For instance, maybe something like changing EORP's PBI to a capped COLA like PSPRS?  The Legislature tried to change the PBI's less radically in 2011, and Judge Fields beat them in court.  He beat them again last year.  If we can all see how this was set up, an experienced attorney and retired judge surely can, and I am sure that Judge Fields knew all along what the Legislature was trying to do.

Will we see round three in Kenneth Fields v. EORP?  I suspect so.  This is a man who has won a case against Maricopa County over retaliation by former Sheriff Joe Arpaio and the former County Attorney.  He also attempted to force former PSPRS Administrator James Hacking to attend remedial classes in the role of a public fiduciary.  We have previously discussed the constitutionality of changing PSPRS' PBI formula, and if you are not familiar with the issues, you can see this post, "Was it constitutional for Proposition 124 to replace PSPRS' permanent benefit increases with a capped 2% COLA?"  Long story short is that changing the PBI unilaterally, even if by voter referendum, appears to violate the contract clauses of both the Arizona and US Constitution, assuming the contract clauses trump Article 29 of the Arizona Constitution.

I would suspect that this is the legal argument Judge Fields would take to overturn any changes to EORP's PBI made via referendum.  He will have a tougher audience this time around, since Governor Doug Ducey has appointed three new justices to the Arizona Supreme Court since his first lawsuit agains SB 1609, though I do not know how may would recuse themselves from the case due to a personal stake in the outcome.   However, this is a case that seems tailor-made for the US Supreme Court since it would affect every public pension system in the country.  I suspect that no matter who wins, the loser would appeal to the highest court in the land.

While I believe that the PBI is horrible financial policy and should be eliminated, based on my layman's understanding of contracts, the electorate simply cannot vote to unilaterally alter a contract except in very extraordinary circumstances, like bankruptcy or fraud, and you certainly cannot initiate a Sopranos-like bust out of a pension in order to create extraordinary circumstances.  Suppose we have another financial crisis, not even one as bad as in 2008-09, could the legislature or special interest group place a measure on the ballot that implemented across the board cuts to existing pensions or raise contribution rates 5% or 10%?  How would those be different than Proposition 124?  It appears that the Arizona Legislature has gotten a taste for legislating via referendum.

So possibly standing in the way of all this is one man.  Judge Fields seems to be a disappearing breed, a man willing to fight on principle.  Does anyone really believe that he cares about the financial losses he might suffer over changes to the PBI?  You have to already be a successful attorney to get a judgeship in the first place, and it appears he is still quite active in the legal field.  So his lawsuits have been fought strictly to hold the government accountable.  Most of us expect promises to be kept, especially financial ones to those who are no longer working, but there are not that many that are willing to fight so hard to make sure they are.  So CORP members can take a little heart, they could have a white knight coming to their rescue, but they will have to wait until after the election to see.

What does this mean for PSPRS members?  If the EORP referendum passes and Judge Fields or some other EORP member (EORP has a lot of lawyers among its membership) sues to overturn it, I have not doubt that a CORP member will also file his or her own lawsuit the same way PSPRS members piggy-backed onto the EORP lawsuits by Judge Fields and Judge Hall.  However, PSPRS member unions started all this referendum nonsense in the first place, and it will be two and a half years since Proposition 124 was passed with no challenge made to it constitutionality.  Is there a timely filing requirement or other legality that would prohibit a PSPRS member from again piggy-backing onto an EORP lawsuit?  I guess like CORP members we will have to wait and see.  If this does happen, we will have a very interesting few years ahead of us.

We cannot end without remarking on the contrast between Judge Kenneth Fields and our "leaders" in Arizona.  We had the flaccid negotiating of the Professional Fire Fighters of Arizona (PFFA) and law enforcement unions against the Arizona Legislature and Reason Foundation.  These crack artists of the deal were willing to give away everyone else's benefits as long as they kept their deferred retirement option plan (DROP).  (Who cares about retirees keeping up with inflation or protecting Tier 3 members' paychecks from contribution increases?!  We are going to fight to the end to make sure Brian Tobin gets that $817,398 payment when he retires!)  Speaking of Mr. Tobin, this is someone who will not even stand up to PSPRS' management, the very group that he and the other trustees are supposed to oversee.  How can we expect him to call out the Arizona Legislature for manufacturing a crisis in order to bring about a "constitutional" change to diminish and impair retirees' benefits.  Can't Mr. Tobin at least stand up for CORP members now that a manufactured crisis for EORP is engulfing them, the lowest paid retirees of all?  He and the other Trustees represent CORP members as well.   How is that EORP members have one man fighting so effectively for them, while PSPRS members are stuck with such a group of spineless, selfish, and shortsighted leaders?  Too foolish to know that they were opening a Pandora's Box of pension chaos when they supported Proposition 124, they now want to open the lid again and see what other havoc they can let loose.

There is more to talk here on pension chaos and havoc, but that will have to wait for another post.