State public safety unions and PSPRS pension reform: Sending Monopoly® players to a poker game and a chess match

We have already discussed how the sellout of the next generation of firefighters and law enforcement will be accomplished.  The more important question is why.  Why would the leaders of the state’s public safety unions be so willing, even eager it seems, to throw the next generation under the bus?  Shouldn’t there have been fraternal and paternal instincts to protect the next generation, to leave them more than we had, rather than burden them with all the financial sacrifice?  I am perplexed as to why the ostensible guardians of the firefighter and law enforcement legacies would acquiesce to such a betrayal.

Is it simply senior members just looking out for themselves?  Maybe.  The deal public safety union leaders negotiated ensures that Tier 1 and Tier 2a members sacrifice nothing while placing all the costs of the deal on Tier 2b and Tier 3 members, in particular.  Yet if you listen to the rhetoric from the union leaders, particularly Bryan Jeffries, president of the Professional Fire Fighters of Arizona (PFFA), you would think that everything was great and everyone made out the same.   Of course, he had the same attitude last year when he was trying to sell everyone on an even worse plan crafted by the PFFA.

If we take union leaders at their word that they really believe this PSPRS pension “reform” is good and fair for all tiers, what could explain their self-delusion?  Let’s start by looking at the union mentality.  If you have never been to a union meeting, it is an interesting experience to see how they portray the world.  When it comes to wages and benefits, especially those already in place, there is always some bogeyman lurking out there trying to take them away.  If we aren’t vigilant, some politician, some political party, or some special interest group or think tank will take away everything we’ve earned.  Here in Arizona, their favorite bogeymen is the Goldwater Institute.

I suppose this does some good as a method to rally the troops and keep them united and paying dues.  For an organization like the PFFA, which is not really a union but a lobbying organization funded by union locals to advocate for them on the state level, it helps them to characterize themselves as necessary warriors against the hostile forces allied against the state’s firefighters.  This may be a noble image, but it is a fiction as the PFFA and all the other state-level unions are just negotiators and deal-makers, who define success by acquisition and maintenance of benefits.  These are the benchmarks by which they assess themselves, not the long-term consequences of their “accomplishments,” much less the ethics of them.

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The state-level public safety union leaders are Monopoly® players.  Monopoly® starts as a game of acquisition – properties, railroads, utilities, but as the game progresses, the maintenance of assets becomes just as important.  The inability to maintain assets is the surest way to accelerate one’s eventual departure from the game.  Monopoly® is the game Mr. Jeffries and the other state union leaders have played for years, achieving their version of success, trying to acquire as much as possible; sustainability be damned.  It is the game they are playing now, and as such, they can call the PSPRS reform deal they negotiated a “victory,” since they are maintaining what they have; future generations be damned.  Unfortunately, it appears that this is the only game they know how to play.

On the other side, the Arizona legislature had the foresight to involve in the negotiations Reason Foundation, an organization that knows that Monopoly® is not the real games being played here.  Reason Foundation knew the real games being played were poker and chess.  Reason Foundation did not have to be Phil Helmuth to beat the state-level unions at poker.  Anyone could have detected their tell, one so obvious that the union leaders may as well have flipped their hole cards over for Reason Foundation to see.  The tell was the ridiculous PSPRS reform plan that the PFFA was trying to peddle last year.  This horrible plan of intergenerational theft showed that the PFFA and at least some of the law enforcement unions were concerned only about senior members in Tiers 1 and 2a.  This told Reason Foundation that the state-level unions were willing to sacrifice Tier 2b and 3 members' benefits in order to protect the benefits of senior members.   Senior members just had to accept a change the permanent benefit increase (PBI) formula, which is not really a sacrifice since PSPRS has neither the ability nor inclination to generate excess returns that could trigger future PBI's.  Reason Foundation may have allowed the state-level unions to win a hand or two, but they cleaned them out in the end.

Reason Foundation bested the state-level unions in chess as well.  It was funny to see Mr. Jeffries and Will Buvidas, the law enforcement union representative, talk about how they were pleasantly surprised with Reason Foundation and how easy they were to work with.  This brings to mind the adage that if you look around the poker table and can’t tell who the sucker is, it’s you.  I suppose if you were not even aware that you gave up your whole negotiating position before the poker game even started, you probably would think that Reason Foundation was easy to work with.

When skilled players play chess, they do not think moves ahead like a supercomputer does.  This is simply beyond the capacity of the human brain.  Good chess players must study past games in order to develop the pattern recognition necessary to know where the best move is based on the current arrangement of the board.  This is similar to poker where the dealt cards are not looked at in isolation during each hand with bets made accordingly.  Good poker players know the odds a particular hand has of winning based on years of studying and playing against other good players.  It is only in narrow margins where true “play” occurs and the game is ultimately won or lost.  Likewise, chess has its end game where the match reaches the point where pattern recognition becomes less trustworthy and every individual decision become crucially important.  Concentration, skill, and avoiding errors are essential during the end game.

If we look at the state-level public safety unions, they showed themselves to be as incompetent at chess as they are at poker.  I do not know Reason Foundation’s exact position on PSPRS reform; they give us no tells.  However, organizationally, I think it is safe to say that they are not fans of public employer defined benefit (DB) plans and would prefer public employees to be in defined contribution (DC) plans that do not burden government and taxpayers with open-ended costs in perpetuity.  However, once they won the poker game, they focused on their end game.  They knew that the PFFA and the law enforcement unions would not go for a full replacement of the DB plan with a DC plan.  This would have been a fatal opening.  They, instead, like good chess players, focused on their end game.

This end game was directed at Tier 3 members.  With the inclusion of the 50/50 split of normal costs and a DC-only pension option, in which employees and employers would each contribute 9% of pay, they have put in place a mechanism to permanently end the PSPRS DB plan if it ever becomes financially unstable again.  In the future, newly hired Tier 3 PSPRS members will not want to pay the exorbitant employee contribution rate into the DB plan if PSPRS spins out of control like it has now.  They will simply join the DC-only plan, knowing that their max contribution will only be 9% with equal matching from their employer.  As ever increasing numbers of Tier 3 members opt into the DC-only plan, the DB plan will go into a death spiral.  If future PSPRS members choose to screw up their pension, despite the safeguards put in place, the poison pill put in place by Reason Foundation will ensure that the DB plan is permanently put to rest.

What was the end game of PFFA and the law enforcement unions?  They didn’t have one.  I don’t know if they were fooled by Reason Foundation or if they just didn’t care.  Either way this poison pill will be there, waiting to be used when necessary.

It is probably not a good idea to send Nicolo Falcone to negotiate against Gary Kasparov and Phil Ivey.  Who’s Nicolo Falcone, you ask?  He is the world Monopoly® champion.  Yeah, I had to look him up.   While I am sure it takes a certain skill to win that championship (as I am sure it does to win the rock-paper-scissors championship), the game is still more about timing and luck.  The other games involve skill, social intelligence, and a long-term outlook.  The PFFA and the law enforcement unions won the Monopoly® game because Reason Foundation let them and knew that that was the only game the unions believed they were playing.  Reason Foundation won the poker and chess games, the ones that really mattered, and now the next generation of firefighters and law enforcement will have to pay the price.

Side note:

While it appears that the PSPRS pension reform bill (SB 1428) has sailed through theArizona Senate, it still does not appear to be a certainty to appear on the May 2016 ballot.  There seems to be some issues among Arizona House members and the Arizona Police Association.  SB 1428’s proponents seem to be dead set on rushing this through—it must be signed by the Governor by February 15, 2016 in order to appear on the May ballot.  Otherwise, it will have to wait until the general election in November 2016.  We have to ask ourselves why this has to rushed through if implementation will not begin for over a year. Stay tuned.

Selling the PSPRS sellout: How union leader are shafting the next generation of firefighters and law enforcement

If you would like to know what is actually in Senate Bill 1428 (SB 1428), you can find an 11-page fact sheet about it here.  For a video explanation from Bryan Jeffries, president of the Professional Fire Fighters of Arizona (PFFA), and Will Buvidas, treasurer/chief negotiator of the Phoenix Law Enforcement Association (PLEA), you can go to this nearly one-hour video presentation.  The presentation is also available at the PFFA website, but it appears to work better at the PLEA link.  Readers can read the fact sheet for themselves, but I wanted to focus on the presentation.

The presentation is more interesting because it includes participants in the reform negotiations.  It is done in the manner of a late-night infomercial, including what appear to be planted questions from the audience.  Anyone who reads this blog knows that I have been quite critical of the PFFA's reform efforts.  Nothing in this video has done anything to change my opinion that they have quite shamelessly dumped the costs of senior members' excesses on a future generation.  Law enforcement personnel can make their own judgment about Mr. Buvidas, although I do not know how universally he speaks for all of Arizona's law enforcement personnel.

Here are several points from the video presentation:

1. There are actually four tiers:

• Tier 1 is anyone with 20 years of credited service as of December 31, 2011.
• Tier 2a is anyone in PSPRS but with less than 20 years of credited service as of December 31, 2011.
• Tier 2b is anyone hired between January 1, 2012 and June 30, 2017.
• Tier 3 is anyone hired after June 30, 2017.

I had considered all Tier 1 members to be those hired before January 1, 2012.  The only difference between Tier1 and Tier 2a members is whether members' contributions to PSPRS while in the DROP are not paid at all (Tier 1) or paid and later refunded (Tier 2a).  Going forward, it is important to remember how the tiers are broken down.

2. During the presentation, they mention that one of the causes of PSPRS' problems is an "unrealistic expected rate of return" (ERR).  They state that it should actually be closer to 5%, instead of the current 7.5%.  They estimate that PSPRS has less than a 50% likelihood of reaching 7.5% over the next 30 years.  PSPRS, just a few years ago, had an ERR of 9.0%, and PSPRS just dropped its ERR from 7.85% to 7.50% this fiscal year.  Once again, going forward, this point will be important to remember when we consider this reform proposal.

3. The presenters actually praised Reason Foundation, a libertarian organization, for its participation in the process.  This is perhaps the greatest irony in all this.  Both Mr. Jeffries and Mr. Buvidas expressed their apprehension about working with Reason Foundation but found them easy to work with.  The sad truth is that Reason Foundation was fairer to union members than the union leaders themselves.  Mr. Jeffries spent last year going round the state blithely trying to sell his plan of intergenerational theft to union members.  Yet an outside organization, dedicated to small government, comes in with a better plan that takes better care of union members than the members' own representatives.  This is an especially shameful spectacle on the part of the PFFA, an organization that was denying any reform was necessary in 2011, promoting a generational wealth transfer last year, and is now on board with a completely different plan.  A model of leadership the PFFA isn't.

4. Future COLA's will be based on an individual's actual benefit amount, not the average normal pension benefit.  In fiscal year (FY) 2015, the average normal pension was $54,974/year or about $4,581/month.  With a $4,581/month pension, a 2% increase would mean a $92/month compounding increase; $3,500/month would be $70/month; $5,500/month would be an additional $120/month.  Over 20 years, the compound effect of 2% annual COLA's will raise our $3,500/month benefit about $1,599/month, our $4,581.month benefit about $2,093/month, and our$5,500/month about $2,512/month.  Under the current system, all members get the same COLA, based on the average normal pension benefit, regardless of their individual benefit amount.  This was especially helpful for those receiving disability and survivor pension, which tend to be smaller than most normal pensions.  Readers can decide for themselves how they feel about this.

However, this is another incentive to spike one's pension since it will pay this extra dividend in retirement as well.  The pensionable income cap for Tier 3 members will make this more difficult for them to take advantage of this, but it is left wide open for Tiers 1, 2a, and 2b.

5. The replacement of the deferred retirement option plan (DROP) with a defined contribution (DC) pension is blatantly unfair to Tier 2b and Tier 3 members.  The DC pension was a sop thrown at those members to protect the DROP for Tier 1 and Tier 2a members.  That the DROP is bad policy is without question; that is why it was ended in 2012.  Yet rather than accept the same conditions they are imposing on future workers the union leaders protected senior members by preserving the DROP.

It is difficult to make straight comparisons of the DROP versus the new DC plan.  However, I used Bankrate.com's calculators to figure out the final DC benefit for someone who earned $75,000/year for 25 years.  Obviously, this would not happen, as wages would grow over the years, but it is a simple way to have someone double his salary over a 25-year period.  It would also be more favorable to the employee than if we started at $50,000/year and incrementally increased annual salary to $100,000 in year 25.

A monthly contribution of $375, 6% (3% apiece from the employer and employee) of $6,250/month or $75,000/year, would produce a final benefit at 5% annual interest, compounded monthly, of $223,320.  The employee would have contributed $56,250 over the 25 years for a net gain, including the employer's $56,250 contribution, of $167,070.  Not bad, but let's compare it to the DROP.

A person in the DROP participates for only the last five years of work.  He either makes no member contributions like Tier 1 members or makes members contributions that are later refunded with interest when he leaves work for good.  Either way, he is not out any extra money, and in fact, is ahead since he ultimately keeps those member contributions.  Using the the same $75,000 salary, a Tier 2a member who enters the DROP after 20 years will receive a final benefit after five years of $203,053 at the current DROP interest rate of 3.1%.  A Tier 1 member would get $228,064 due to a higher interest rate of 7.5%.  Both will also save over $43000 in member contributions.  We can see that at least $80,000 more will accrue to the DROP member, who has to do absolutely nothing except join the DROP, versus the member in the DC plan, who has to pay into the plan his entire career.

This disparity between the DROP and DC plan is a factor of the DROP's bad financial math.  It cannot and will not work.  Yet the unions were not going to give it up in order to help other tiers or the long-term financial stability of PSPRS. The union leaders sold out younger members to protect an unsustainable benefit for senior members.

6. Tier 2b members can feel better about themselves since the union leaders are shafting Tier 3 members even worse than them.  Remember that Tier 2b members were hired after SB 1609 and are subject to its provisions, among which was a minimum of 25 years credited service and a minimum age of 52.5 years to draw benefits.  Tier 3 members have the same minimum 25 year's service but cannot draw benefits until they are 55.  Tier 3 members can still draw benefits at 52.5 years but must take a lower amount.

The unions like to point out how physically demanding firefighting and law enforcement are, but apparently this will not be the case in the future.  A young man or woman who joins a fire department or law enforcement agency at 25 should expect to work 30 years if he or she wants to get full benefits.  Pay no attention to that wear and tear on your body and mind, a Tier 1 or Tier 2a person needs you to keep working longer than they were required to.

7. I mentioned in point 2 about the ERR and how we needed to keep it in mind going forward.  Here is where it becomes relevant. The presentation states that Tier 3 members will only be responsible for 50% of the normal cost of their tier only.  The presenters estimate that the normal cost will be 18% for Tier 3, which means Tier 3 members should expect only a 9% member contribution.  Sounds good, but what ERR did they use?

Is this 9% member contribution rate based on the current 7.5% ERR or the 5% ERR the presenters said was more realistic and sustainable?  If it is based on 7.5%, Tier 3 members should not expect that 9% employee rate to last since the ERR will eventually have to be lowered to 5%.  The lower the ERR, the more contributions will need to be made, and half of any increase will have to come from Tier 3 members' own pockets.  No one can know for sure what the employee rate will be until we know what the ERR is going to be.

The presenters also say that Tier 3 members are not responsible for prior pension system debt, but this is not a corporate spin-off.  Employers are still responsible for their pension debt until it is paid off.  This will have financial consequences in other ways that may not be seen in the normal cost. Mr Jeffries and Mr. Buvidas are right that Tier 3 members are not responsible for prior pension system debt, but they will be paying for it in the form of lower wages and benefits, longer careers, greater call loads, and less safe working conditions.

8. Probably my favorite part of the presentation of was Mr. Jeffries talking about how he had difficulty with the 50/50 split of normal costs between employers and employees.  Yet he brings up a point that we have discussed before, which is that a 50/50 split keeps employees aware of the health of their pension.  The absurd part of Mr. Jeffries comments was how he recommends that the next generation be more "vigilant" in watching out for the health of PSPRS!

What?  Wasn't that the job of the PFFA, PLEA, FOP, AHPA, et al?  I do not know the role of Mr. Jeffries or Mr. Buvidas in our current situation, so I am not calling them out specifically, but they represent organizations that have been anything but vigilant about PSPRS.  In fact, they seem to have represented the worst aspects of human nature: greed, selfishness, short-sightedness, arrogance, and just plain stupidity.  It is the height of hypocrisy to advocate this selfish and greedy plan while admonishing the future victims of your greed to be more vigilant about the system you screwed up.

9. But wait, there's even more for Tier 3 members.  Their COLA's will be on sliding scale that lowers the percentage of their COLA based on the funded level of PSPRS.  Furthermore, they will not be able to receive COLA's until 7 year after they have retired or turn 60 years old.  Why is this good for Tier 3 members but no one else?

10. Governance reform is all about the who, not the how many.  The presenters make a point of how now that there is a 50/50 split in normal costs there should also be more equal representation on the PSPRS Board of Trustees.  Perhaps, but look at what has happened recently with PSPRS.  Ryan Parham, PSPRS' chief investment officer, came out publicly with what amounted to an admission that PSPRS was deliberately trying to lowball its investment returns so as not to pay COLA's.  I believe that this is a cover story for an investment team that is unable to earn the ERR  PSPRS' returns are so low because its investment strategy does not work.  Nonetheless, the fiduciary duty of the chief investment officer is to earn returns.  That's it, and if he is not trying to do this, he is failing PSPRS and its members.  Yet, Mr. Parham's admission passed without protest, despite there being a fire and a law enforcement representative on the Board of Trustees.

If PSPRS had a retiree representative who could have taken issue with this, maybe there would have been an issue.  Stacking PSPRS' Board of Trustees will do no good if they act like the current Board of Trustees and follow the lead of PSPRS' staff rather than acting as watchdogs.  The League of Arizona's Cities and Towns wants a Board made up of experts that will be able to understand what PSPRS' staff is doing, not more narrow constituents with a political agenda.  That sounds like a better idea.

10. The Hall case could add an interesting twist to all this.  If the case is decided in favor of the plaintiffs and Tier 1 and Tier 2a members are to return to a member contribution rate of 7.65%, they will be due a refund and have a lower rate than either Tier 2b or Tier 3 members.  If Tier 3 members do have a 9% rate, they will have a lower rate than Tier 2b members, who came on before them but are legislatively required to pay 11.65%.  It does not appear that anyone is saying what will happen if the Hall plaintiffs win.  Will the legislature force them into equal cost sharing or drop them back down to 7.65%?

11. The final point I would like to make is that this will likely be the last reform for PSPRS.  This is definitely not because it is such a great plan.  It is because in it are planted the seeds of PSPRS' own destruction.  Whether consciously or unconsciously, the union leaders have acquiesced to a poison pill policy for Tier 3 members.  While there are important safeguards, like equal sharing of normal costs and immediate payment of any benefit increases, to dissuade Tier 3 members from destroying PSPRS again, you cannot count out the selfishness and greed of people, who will always be looking to get something for nothing.

By including a DC-only option for Tier 3 members, PSPRS will have in place a mechanism to wind PSPRS down if it goes off the rails again.  In the future, if PSPRS becomes grossly underfunded again, new hires will likely opt into the DC-only plan, slowly robbing the DB plan of members and funding.  This will cause a downward spiral that will eventually lead to the end of the DB plan.  Did the union leaders who agreed to this know this or were they snookered by Reason Foundation into accepting this?

If you are a Tier 1 or Tier 2a member, you have nothing to be unhappy about, if you care only about your own benefits.  The only thing you will be giving up is the old COLA formulation, which is virtually worthless since PSPRS' investment staff has neither the inclination nor the ability to earn its ERR, much less the 9% threshold that would trigger COLA's.  If you care about fairness and shared sacrifice with your future fire and law enforcement brothers and sisters, you are probably uneasy about this "reform" plan.  Tier 2b and Tier 3, in particular, are being forced to pay for the retirements we did not properly fund ourselves.  That is a disgrace.

The union leaders will tell you that it will all be good, but we have seen this plan change several times over the past five years.  I do not believe that they know what they are doing.  All they know is that they, as senior personnel, do not want to give up anything and will use all their power to protect what they have.  For heaven's sake, the PFFA plan they were selling all last year was worse than what we have now.  We actually have to be thankful that Reason Foundation got involved in this process!

Senior members (Tier 1and Tier 2a) are giving up NOTHING in this "reform," and the sacrifice will all be borne by the most vulnerable members in Tier 2b and Tier 3.  The realist in all of us can accept that this is how our union leaders do business, after all they're just self-interested human beings like everyone else.  But the realist in all of us doesn't have to buy the fiction that this "reform" is equal, fair, or ethical.  It's a sellout, plain and simple, no matter what Bryan Jeffries and Will Buvidas say.  To paraphrase Groucho Marx, are you gonna believe them or your own eyes?

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.

***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.