Correction to the last post about PSPRS retiree representation

Thank you to the reader who pointed this out.  There is a PSPRS retiree on the ten-member PSPRS advisory committee.  Here is the relevant passage from SB 1428:

BEGINNING JANUARY 1, 2017, THE PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM ADVISORY COMMITTEE IS ESTABLISHED AND SHALL SERVE AS A LIAISON BETWEEN THE BOARD AND THE MEMBERS AND EMPLOYERS OF THE SYSTEM.  THE COMMITTEE SHALL BE APPOINTED BY THE CHAIRPERSON OF THE BOARD FROM NAMES SUBMITTED TO THE CHAIRPERSON BY ASSOCIATIONS REPRESENTING LAW ENFORCEMENT, FIREFIGHTERS, STATE GOVERNMENT, COUNTIES, CITIES AND TOWNS AND TRIBAL GOVERNMENTS.  THE COMMITTEE SHALL SELECT A CHAIRPERSON FROM AMONG ITS MEMBERS EACH CALENDAR YEAR.  THE COMMITTEE SHALL CONSIST OF THE FOLLOWING TEN MEMBERS:

1.  A MEMBER WHO IS A LAW ENFORCEMENT OFFICER.

2.  A MEMBER WHO IS A FIREFIGHTER.

3.  A MEMBER OF THE ELECTED OFFICIALS' RETIREMENT PLAN.

4.  A MEMBER OF THE CORRECTIONS OFFICER RETIREMENT PLAN.

5.  A RETIREE FROM THE PUBLIC SAFETY PERSONNEL RETIREMENT SYSTEM.

6.  A REPRESENTATIVE FROM A CITY OR TOWN IN THIS STATE.

7.  A REPRESENTATIVE FROM A COUNTY IN THIS STATE.

8.  A REPRESENTATIVE FROM A FIRE DISTRICT IN THIS STATE.

9.  A REPRESENTATIVE FROM A STATE EMPLOYER.

10.  A REPRESENTATIVE FROM A TRIBAL GOVERNMENT LOCATED IN THIS STATE

I apologize for this error and should have read the text of the bill, not just the fact sheet.  Regardless, it is still vitally important that retirees get representation on the Board of Trustees since they will be outnumbered 9-1 by government and active employees on the advisory committee, and the advisory committee members will submitted by "associations of representing law enforcement, firefighters, state government, counties, cities, and towns and tribal governments," organizations that will overwhelming favor active members.  This will further help stack the advisory committee against retirees.

PSPRS retirees: Find your voice and protect yourselves before it's too late

While it is already too late for anything to be done about SB 1428, the PSPRS reform bill already signed by Arizona Governor Doug Ducey, or the May 2016 referendum to change the COLA formula, there is one crucial reform that needs to be implemented and is still possible to accomplish, even at this late date.

It is imperative that retirees get representation on the PSPRS Board of Trustees and the new advisory committee.  This is to prevent a repeat of PSPRS’ past efforts to consciously work against the interests of retirees.  The current PSPRS Board of Trustees seemed to see no problem when PSPRS Chief Investment Officer (CIO) Ryan Parham wrote in this article, "The truth about PSPRS investment performance," in the December 18, 2014 Arizona Capitol Times:

PSPRS wants its retirees to enjoy increases, but we are incentivized to seek lower returns in the range of 9 percent to maximize earnings that can be applied to cover – and hopefully reduce – unfunded liabilities.

Mr. Parham publicly admitted that PSPRS was trying to keep its returns under 9% to avoid paying permanent benefit increases (PBI’s) to retirees.  His confession actually served two purposes: it gave PSPRS cover for its lackluster investment returns and made it look like the under-performance was serving a higher purpose.  Call me crazy but shouldn’t the Chief INVESTMENT Officer be trying to make investments that earn as much money as possible for PSPRS, regardless of the consequences to the underlying fund, and does anybody really believe that PSPRS’ investment staff can target their investment strategy to earn precisely within the sweet spot between their expected rate of return of 7.5% and the 9% threshold that triggered PBI’s?

Mr. Parham felt confident enough in his position to tell the world that PSPRS is deliberately lowballing its returns, and the PSPRS Board of Trustees, which includes a firefighter and law enforcement representatives, expressed no uneasiness or outrage about this.  Only in such an insular, dysfunctional, and arrogant organization as PSPRS could senior personnel fail to perform their most fundamental fiduciary duty, then have the audacity to claim that it is a calculated act of good management.  While I would be the first one to say that the excess earnings PBI model was horrible and needed to go, I would never even suggest that PSPRS purposely and spitefully diminish its own investment returns in order to deny retirees PBI's.  If producing greater-than-9% returns is truly harmful to PSPRS, prove it to me by actually earning those higher returns and show me hard evidence of its negative financial impact.  I suspect that if a retiree representative had been on the Board of Trustees he might have felt the same way, and there would been a few hard questions asked of Mr. Parham and his fellow Trustees like:

Aren’t we supposed to earn the highest return possible and let the legislature and voters change financially flawed laws and policies?

Can we even earn 9% with the low risk strategy we’ve put in place?

If we cannot earn 9% with your current strategy, why don’t we just admit this?

Aren’t we violating the Fields decision and the spirit of the law by intentionally holding down returns?

Why should retirees trust PSPRS if management and Trustees when we express displeasure about a bad policy through the infliction of financial pain on them?

Beginning in 2017, SB 1428 adds two more public safety members to the Board of Trustees and changes the makeup as follows:

a)      two members representing law enforcement, one of whom is  appointed by the President of  the  Senate  and  one  of  whom  is  appointed  by  the  Governor.  A  statewide  association representing  law  enforcement  shall  forward  at  least  three  nominees  for  each  position  to the  appointing  officer.    At  least  one  of  the  members  appointed  shall  be  an  elected  local board member;

b)      two  members  representing  firefighters,  one  of  whom  is  appointed  by  the  Speaker  of  the House  of  Representatives  and  one  of  whom  is  appointed  by  the  Governor.  A  statewide association  representing  firefighters  shall  forward  at  least  three  nominees  for  each position  to  the  appointing  officer.    At  least  one  of  the  members  appointed  shall  be  an elected local board member;

c)       three  members  representing  cities  and  towns  in this  state,  one  of  whom  is  appointed  by the  President  of  the  Senate,  one  of  whom  is  appointed  by  the  Speaker  of  the  House  of Representatives  and  one  of  whom  is   appointed  by  the  Governor.  An  association representing  cities  and  towns  shall  forward  at  least  three  nominees  for  each  position  to the  appointing  officer.  These  nominees  shall  represent  taxpayers  or  employers and  may not be members of PSPRS;

d)      one  member  representing  counties  in  this  state  who  is  appointed  by  the  Governor.  An association representing county supervisors in this state shall forward nominations to the Governor, providing at least three nominees for the position.  These  nominees shall represent taxpayers or employers and may not be members of PSPRS; and

e)      one member who is appointed by the Governor from a list of three nominees forwarded by the Board.  The Board shall select the nominees to forward to the governor from a list received from the advisory board of at least five nominees.

SB 1428 also creates a “PSPRS advisory committee” beginning in 2017 that will:

serve as a  liaison between  the  Board  and  the  members  and  employers  of  PSPRS.  The committee  shall  be appointed by the Chairman of the Board from names submitted by associations representing law  enforcement,  firefighters,  state  government,  counties,  cities  and  towns  and  tribal governments.

Do you notice anything missing from the board and committee?  There is not a single retiree representative in either group.  The state unions, government groups, and the Board itself will nominate members to the Board of Trustees, and they will be chosen by the Governor, Senate President, and or the Speaker of the House.  Retirees cannot even get representation on the advisory committee and have been completely shut out of any role in PSPRS oversight, despite the fact that retirees are the most reliant on PSPRS for their standard of living, especially now that COLA’s will be calculated on an individual’s own retirement benefit, instead of the average normal pension.

The doubling of the representation of public safety unions on the Board of Trustees will not help retirees, and it is actually designed to help increase the influence of the state unions, the same ones that are shafting the next generation of firefighters and law enforcement.  As far as I know, the two public safety Trustees did nothing to speak up for retirees when Mr. Parham announced that PSPRS was trying to keep returns under 9%.  Will adding two more public safety Trustees make this situation any better?

Let’s contrast this to the Arizona State Retirement System (ASRS).  Among ASRS’ nine board members are four public representatives, two with experience in the private investment management industry, an economics professor, and the president of the Arizona Tax Research Association, and a retiree representative.  The other four ASRS board members represent state employees, political subdivisions, educators, and members at large.  Four of PSPRS’ nine-member board will be made up of public safety with another member picked by the Board of Trustees itself.  So ASRS has four neutral board members and a retiree representative, while PSPRS will essentially have a nearly built-in majority of state public safety union members.  For an example of how things already work, the current PSPRS Board of Trustees is chaired by Brian Tobin, the former president of the Professional Fire Fighters of Arizona.  If you are a retiree, think about what will happen when you add two more public safety union representatives to the two already there, and those four have a hand in nominating a fifth.  Do you think retirees will get treated any better in the future than they have been recently?  If high inflation eats up the purchasing power of retirees, who will be there to speak for them?  No one.

Once again, it is vitally important that retirees work to get one, but ideally two, representatives on the PSPRS Board of Trustees.  Instead of the public safety unions stacking the Board with two more members, a law enforcement and a firefighter retiree representative should be given those spots.  Otherwise, retirees will again be at the mercy of others that have only their own selfish interests at heart.  Why would we not want to follow the example of the only properly functioning state pension system, ASRS, instead of repeating past mistakes of our failed system.  The only way for PSPRS retirees to protect their interests is to have representation on the PSPRS Board of Trustees.  I don’t know if this can be accomplished, but we will never know if retirees don’t try to lobby their legislators, Speaker of the Arizona House David Gowan, Arizona Senate President Andy Biggs, or Governor Doug Ducey.  This is probably the only chance retirees will have to defend themselves.  I hope they take it for all our sake.

PSPRS investment returns through December 2015

The following table shows PSPRS' investment returns, gross of fees*, versus the Russell 3000 for December 2015, the sixth 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%

There is usually about a two-month lag in PSPRS reporting its investment returns.   PSPRS suffered 23.67% and 35.00% of the Russell 3000's losses in August and September, respectively, and suffered 46.34% of the Russell 3000's loss in December.  With half the fiscal year gone, PSPRS has a little over 60% of the loss of the Russell 3000, which is in the 55-60% range seen in the past two fiscal years, though this is 60% of a loss, rather than gains.

The Russell 3000 lost about 5.5% in January 2016, so it will be interesting to see if these patterns of monthly returns continues.  Based on the year so far, I would expect PSPRS to show a loss of about 1.25% in January 2016, and its fiscal YTD loss to be only about 30% of the Russell 3000.  With three trading day left in the month, February 2016 is down 0.92%, but the markets have been so volatile that 1-2% swings are not unusual.  Regardless, PSPRS will still have a loss at the end of February with only four months left to try and get into the black.

* 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.

PSPRS members: Watch the oral arguments before the special panel of judges deciding the Hall case

If you would like to view the oral arguments before the special panel of judges in the Hall case, you can find the video here.  The video is from February 18, 2016 and lasts about 55 minutes.  For more about the legal issues and arguments in the Hall case, see this post, "What the Hall is going on?  Legal issues surrounding the Hall and Parker cases against EORP and PSPRS" from July 2015.

Neither side in the case dealt with the COLA issue, which should be decided for the plaintiffs under the same reasoning as the Fields case, and will be a dead issue soon anyway when the May referendum is approved and permanently changes the COLA formula.  All the arguments and questions from the judges dealt with the constitutionality of raising employee contribution rates.  The attorneys' arguments are interesting, as are the judges' questions, but there seems to be no clear indication how this case will be decided or how each judge will vote.

There was no firm date on when a decision will be reached, though the plaintiffs' attorney asked that the panel decide the case itself and not send it back to a lower court for reconsideration.  I believe from the past that the only notice that the case has been settled is a 24-hour advance warning that a decision will be announced the next day.  We will be stuck waiting until then.

PSPRS reform signed into law: The betrayal of the future generation is complete (with a chance of poetic justice for those that betrayed them)

Governor Doug Ducey signed the PSPRS pension reform legislation into law on February 16, 2016, so the sellout of the next generation of firefighters and law enforcement is complete.  The point man for this betrayal, Bryan Jeffries, president of the Professional Fire Fighters of Arizona (PFFA), states in this  article, Arizona pension reform is signed by Gov. Doug Ducey, but voters will have a say, by Craig Harris in the February 17, 2016 Arizona Republic, that his organization is "all in."  That's funny.  I must have missed the election that all us voted in to approve this.

This is all pretty much a done deal.  I don't anticipate any organized resistance to the referendum in May that will change the COLA formula.  All that's left to do is to make sure the next generation of PSPRS members understands how our generation left them to pay the tab for our excesses.  The only unresolved issue is the Hall case, which will be argued before the special five-judge panel that was created after the sitting justices on the Arizona Supreme Court recused themselves from the case because they had a personal stake in the case.  The five judges named to the panel have no stake in the Hall case, having been placed on the bench after the new defined contribution pension replaced the defined benefit pension in the Elected Officials' Retirement Plan (EORP).  There is a separate case by PSPRS members that is active, but since it involves the same issues, it is not being heard as the results of Hall will carry over.

There was a little extra drama surrounding the Hall case over the past week when the plaintiffs tried to force the recusal of Clint Bolick, the new Arizona Supreme Court justice, from the case.  Justice Bolick replaced Pinal County Superior Court Judge Karl Eppich as a member of the panel.  Justice Bolick formerly was the vice-president of litigation for the Goldwater Institute.  This February 16, 2016 Arizona Republic article by Craig Harris, Ex-Goldwater lawyer-turned-justice to hear pension case, says this about Justice Bolick:

Bolick, in December 2010, was quoted by The Arizona Republic as saying proposed legislative changes to PSPRS could be made without running afoul of the Constitution or contract law. That very issue is now before the Supreme Court judicial panel. The Goldwater Institute also was a major supporter of the 2011 law that required judges and others in PSPRS to pay more for their benefits.

You can read more about the recusal effort here.  (You will have to choose "Active civil cases" then search for "Hall" with you browser's find tool.)  Arizona Republic columnist Laurie Roberts also has a piece here.  I am certain that the plaintiffs will win on the COLA issue in their case, but this will be a hollow victory that will last only until the May election when the new 2% maximum COLA will likely win approval from the voters and make the constitutional issue of altering the COLA formula moot.  The more interesting issue will be how the judges rule on the change in contribution rates.

The Hall plaintiffs, which by extension is all of us who were already PSPRS members when SB 1609 went into effect in 2011, are also contesting the change in employee contribution rates.  For PSPRS members, the employee contribution rate increased incrementally from 7.65% to the current rate of 11.65%.  A plaintiff victory would mean refunds of any contributions of over 7.65% paid by Tier 1 and Tier 2a PSPRS members, and it would be the final slap in the face to Tier 2b and Tier 3 PSPRS members.

A plaintiff victory would lower the fixed contribution rate of Tier 1 and Tier 2a members 4% to less than the rate of Tier 2b, who will still be stuck with the fixed 11.65% rate, and Tier 3 members, who will have a variable rate that is being estimated at 9% but will likely be higher.  It's not enough that nearly all the sacrifice is being heaped on Tier 3 members.  They will have to work 25 years, have no DROP, have a cap on pensionable earnings, cannot collect full benefits until 55 years of age, have a COLA based on PSPRS' funded ratio which is not collectible for seven years or when the member turns 60 years old, have to split the normal cost 50/50 with employers, and have previous generations' unfunded liabilities limiting their employers' abilities to offer better wages and benefits.  Now it is possible that Tier 1 and Tier 2a members will get big refunds and further add to the unfunded liabilities that will affect the finances and quality of life of Tier 2b and Tier 3 members and their families for years to come.

However, in this whole shameless spectacle, there is some potential for a bit of poetic justice.  A loss by the plaintiffs on the constitutionality of raising employee contribution rates would open the door for the legislature to raise the rates for Tier 1 and Tier 2a (and Tier 2b) members anytime they deemed it necessary and appropriate.  There would no longer be a "fixed" employee contribution rate.  This could someday be an issue if there is another financial crisis or prolonged market downturn.  The PFFA and law enforcement union negotiators acquiesced so timidly to Reason Foundation's plan because they believed it would protect Tier 1 and Tier 2a members, like themselves, from having to make any of the sacrifices they so freely placed on Tier 2b and Tier 3 members.  Wouldn't it be funny if Justice Bolick, former litigator for Reason Foundation's kindred spirit in Arizona, the Goldwater Institute, provided the tie-breaking vote against the Hall plaintiffs?

Oral arguments in the Hall case will be made tomorrow, February 18, 2016.

The big question looming over PSPRS reform : What will the expected rate of return be in the future?

They say the devil is the details, so let us look at a detail of the PSPRS reform proposal that may not be getting enough attention.  If you watched the video presentation by the union representatives or read the Reason Foundation Powerpoint, you see a point made about PSPRS’ expected rate of return (ERR).  While most discussion has, understandably, been about specific changes that affect us individually, we would be remiss if we did not point out how the ERR has and will continue to have an outsized effect on all of us.

The ERR is what PSPRS assumes (or expects) it will earn on its investments, and it is sometimes referred to as the assumed rate of return.  There are many factors that actuaries must use to calculate normal costs and unfunded accrued actuarial liabilities, such as wage inflation, mortality rates, membership, and ERR.  Of all these, ERR is probably the easiest for laypeople like us to understand since we can relate to it in our daily lives.  If we go to the ever-useful Bankrate.com and use their savings goal calculator, we can illustrate this quite easily.  If we set a goal of a half million dollars in savings after 25 years at an ERR of 5.0%, compounded monthly, we would have to save about $840 per month for that 25 years.  If we keep everything else the same but change the interest rate to 7.5%, compounded monthly, we would only have to save about $570 per month for 25 years.  Even raising the interest rate 0.25% to 5.25%, would mean that you would drop the monthly savings amount $31 from $840 to $809, which saves $9,300 over 25 years.  If this additional $32 per month was invested at the 5.25% rate, you would have $519,000 saved up instead of $500,000.

So we can see how important the ERR is for the pension.  The lower your ERR, the higher your contributions will have to be, and vice-versa.  Using the same figures from the last paragraph, returning only 5.0% on your savings when your ERR was 7.5% will leave you about $160,000 short of your half million dollar goal because your monthly contribution rate was too low.  You contributed for the 7.5% ERR but earned at the actual rate of 5.0%.  This is PSPRS’ problem.  Employer and employee contribution rates were based for many years on an ERR they failed to actually earn, and like our examples, this produced a shortage.  However, unlike our examples, this is not a saver who just failed to reach a goal.  PSPRS was accruing a liability to its members and had to earn that money.  We also should remember that, not too long ago, PSPRS’ ERR was all the way up to 9.0%.  It has been dropping over the past few years, and currently stands at 7.5%.

PSPRS has changed its investment policy to be more risk-averse, and consequently will be unlikely to earn 7.5%.  The past two fiscal years PSPRS earned 55-60% of the Russell 3000, so in order to earn 7.5% the Russell 3000 would need to earn 12.5-13.6%, which would be very difficult to do over a long period if PSPRS stays with its current investment strategy.  The Russell 3000 would need to earn 8.0-9.33% in order for PSPRS to earn 5.0%, which would still be difficult but much more realistic under the current strategy.

The operating principle that is supposed to be used with ERR’s is that your ERR is supposed to reflect the likelihood of paying off the debt.  If you are buying a junk bond that has a high chance of default, you should expect a high rate of return.  If you are investing for a public pension, which theoretically is an “undiminishable” and “unimpairable” obligation, you should have a rate that is as close to risk-free as possible.  Public pension obligations must be paid under any circumstances, and whatever you invest in should have as close to a guaranteed return as possible.  The risk-free rate has traditionally been the rate on some type of US Treasury bill.

So if PSPRS’ ERR is too high, what should it be?  4%, 5%, 6%?  Regardless, any lowering of the ERR will have major consequences, yet there seems to be no guidance as to what the ERR will be in the future.  When PSPRS dropped its ERR 0.35% from 7.85% to 7.5%, it raised the aggregate employer contribution rate 3%.  What would a decrease of 2.5% do?  This is why it is so important to know what the ERR will be in the near future.  A drop in the ERR will increase the unfunded liability for Tiers 1, 2a, and 2b overnight and will burden employers with even more costs since PSPRS members in these tiers have a fixed contribution rate. 

For Tier 3 members, this will have an even bigger effect on them since they have to split normal costs 50/50 with employers.  If normal costs go up 3%, Tier 3 members will have to pay an additional 1.5% out of their paychecks into PSPRS.  This is why we should all be asking what ERR was used to get the 18% normal cost for Tier 3 members.  In the video presentation, Bryan Jeffries and Will Buvidas gave this as the projected normal cost rate, meaning employees would have to only pay a 9% contribution rate.  If the 7.5% ERR was used, this is an inaccurate rate if PSPRS is planning to move to a lower ERR in the near future, which they almost certainly will have to do since PSPRS cannot earn 7.5% with its current investment strategy.

Furthermore, as we mentioned earlier, lowering the ERR will increase the unfunded liabilities on the other three tiers.  This increased unfunded liability will have to be paid by employers, who will have to find the funds in their already overstretched budgets.  Where do we think these funds will come from?  Even worse for Tier 3 members, this unfunded liability will likely take decades to pay down, so long after most Tier 1 and 2a members are retired, Tier 3 members will still feel the effects of that unfunded liability, a legacy from one generation to another, a gift that will keep on taking.

The only potential good news for Tier 3 members would be an increase in inflation.  PSPRS is a debtor to all its members, and debtors like inflation.  An increase in inflation would mean an increase in the risk-free rate with a corresponding increase in returns on all of PSPRS’ riskier investments.  PSPRS could actually earn more than its ERR without taking on additional risk.  Tier 3 members would see their contribution rates go down as PSPRS earned more and, if their union locals are on the ball, wage increases to keep up with inflation.  PSPRS’ improving finances would also lower its unfunded liability and decrease costs to employers still paying off legacy debt incurred from other tiers.  This would be in addition to a decreased employer contribution rate, which might make employers more amenable to paying raises to their employees.

As we discussed in the last post, retirees will find no benefits in inflation.  They will be stuck with a fixed COLA rate as the dollars they are paid can buy less each year and their standard of living slides.  Raising the COLA will be difficult since it will require another voter referendum to change it.  However, who do you think will be in charge of the firefighter and law enforcement unions then, as retirees go hat in hand to ask them for help.  Hopefully, Tier 3 members will be in a forgiving mood if that day ever comes.

As in so many cases with PSPRS, we see incentives misaligned.  We have retirees competing with active workers competing with people who aren’t even on the job yet.  If an independent board with retiree representation could determine COLA’s on a yearly basis, this might be avoided.  When Inflation reduced the unfunded liability of retired tiers, it could free up funding for higher COLA’s, while still allowing active Tier 3 members to benefit.  Everyone pulling in the same direction for the betterment of all, what a concept!  This almost sounds like something a—what is the word I’m thinking of—oh yeah, a UNION should do.