Nick Ponder Pension Policy Analyst PSPRS Update, MASTER Nick Ponder Pension Policy Analyst

Snapshot of PSPRS Established in 1968 the legislature established a single plan for public safety personnel called PSPRS to pool investments, provide relatively equal benefits between employers, and simplicity in transferring from one employer to another Reforms in 2011 and 2016 created three tiers of benefits, by enrollment date: Tier 1: 1968 – 12/31/2011 (7.65% employee rat) Tier 2: 01/01/2012 – 06/30/2017 (11.65% employee rate) Tier 3: 07/01/2017 forward (50/50 shared contributions and risk pool for employers w/ < 250 employees)

History of PSPRS Under Tiers 1 & 2 of the PSPRS system each employer has its own funded status and its own contribution rate(s), plan aggregate funded rate is 46%

Permanent Benefit Increase (PBI) In 1986 the PSPRS plan was funded in excess of 100% Retirees were not receiving an increase in their monthly retirement benefits Unions approached the legislature to receive an annual adjustment to the retiree benefit and to equalize disparity between urban and rural pensions Negotiations resulted in the PBI rather than a traditional COLA PBI takes any investment earnings in excess of 9% and gives ½ of the excess to retirees by way of an increase to their monthly pension based on the average PSPRS benefit Capped annual payments requiring anything exceeding cap to be rolled to subsequent year

½ Earnings above 9%...

PBI Disbursement Cap PBI Annual Cap Yr1 Yr2 Yr3 Yr4 Yr5 Yr6

PBI Under the Microscope Fiscal Year Investment Return Monthly PBI (in $) Statewide Aggregate Funded Status 2000 12.31% 87.37 124.7% 2001 -16.86% 93.24 129.9% 2002 -15.07% 98.17 113.0% 2003 6.67% 102.53 100.9% 2004 14.97% 111.90 92.4% 2005 9.11% 116.82 82.1% 2006 8.30% 121.76 77.0% 2007 17.05% 127.06 66.4% 2008 -7.27% 134.34 66.5% 2009 -17.73% 138.66 68.2% 2010 13.47% 146.74 65.8% 2011 17.37% 152.84 61.9% 2012 -0.79% 159.13 58.6% 2013 10.64% 121.19 57.1% 2014 13.28% 65.20 50.4% 2015 3.68% 0.00 49.0% 2016 0.60% 46.0% 2017 11.85% 45.3%

PBI Disproportionately Impacted Rural Employers Average Monthly Pension $4,300 X 4% PBI Increase $172 Rural PD Retiree Pension $3,000 PBI % Increase for Rural Pension 5.7% Urban Retiree Pension $5,600 % Increase for Urban Pension 3.07%

PBI Disproportionately Impacted Rural Employers Year Rural PD Phoenix PD 2000 $17,000 $32,500 2016 $40,500 $58,800 $ Increase $23,500 $26,300 % Increase 138% 81%

Is there a “healthy” funded status? There has been significant public debate regarding what is an acceptable funded status for pension plans The number circulating publicly over the last couple decades has been 80% Some argue 100% or more is the only acceptable funded status while others indicate an amount as low as 70% is acceptable We must first separate public from private pensions What is the inherent difference between a corporation and a city? IS IT THAT EASY?

Is there a “healthy” funded status?

Is there a “healthy” funded status? There has been significant public debate regarding what is an acceptable funded status for pension plans The number circulating publicly over the last couple decades has been 80% Some argue 100% or more is the only acceptable funded status while others indicate an amount as low as 70% is acceptable We must first separate public from private pensions What is the inherent difference between a corporation and a city? IS IT THAT EASY? NO! We cannot just look at funded status in a silo!

So, how did we get here? Permanent Benefit Increase (1986) Good intentions gone bad – helping RURAL retirees No funding level requirement Year-to-year investment returns and the “bucket” Actuarial calculations did not contemplate the PBI, was using outdated life expectancy tables, historically assumed 9% return Global investment losses twice 2001-2002 “Dot.com” loss of $1.7 billion Funding level drop from 127% to 101% 2008-2009 “Great Recession” crunch By FY 2010 funding level drops to 66% DROP Failure of 2011 reforms due to lawsuits Demographic shifts 2000: 2.7 active members to 1 pension; 2016: 1.6 actives to 1 pension

Pension Reform – Round 1 Increased contribution rates SB1609 (2011) Increased contribution rates Barnes v. ASRS, Hall v. EORP, Parker v. PSPRS Reduced PBI formula for active and retired members Fields v. EORP (2014), Hall v. EORP Restricted Service Purchase Pendergast v. ASRS Capped employer contribution rates for EORP Fields v. EORP (2017) Established Tier 2 requiring employees to pay higher contribution rates and remain in the system longer before retirement On each of these reforms, except the creation of Tier 2, the courts struck down modifications ruling they were only applicable prospectively

League Task Force - Yardstick Yardstick Element Included in Tier 3? 1. Defined Benefit Plan 2. Free from Legal Challenge 3. New Statewide System 4. Plan Elements Full Pooling Equal Cost Sharing Circumstantial Pension Increases DC Supplement Those w/o Soc. Sec. 5. Governance Structure Board of Trustees Disability Boards

Pension Reform – Round 2 SB1428 (2016) Created a Tier 3 for public safety members Required employees to share equally in cost of pension, 50/50 contribution rate Greater age requirement before being eligible for retirement Different graded multiplier structure for maximizing pension benefits DB Pension = Avg. Salary × Years of service × Graded Multiplier Capped contributions on first $110,000 of salary Employee has option to join DB or DC plan Retiree must be retired 7 years or age 60 AND plan must be funded in excess of 70% for COLA’s to be awarded Required PSPRS to study risk pooling and consolidating local boards Changed make-up of PSPRS Board, granting more representation to taxpayer representatives

Round 2 (continued) Proposition 124 (2016) Struck the PBI from statute and replaced it w/ COLA capped @ 2% per year Voter approved amendment to the constitution permitting the transition from PBI to COLA Approved with > 70% public support More predictable for PSPRS and easier to prefund

Cost Savings Employees sharing equally in costs EE Contributions ER Contributions Investment Returns Employees sharing equally in costs Tier 1 Share: EE = 17%, ER = 83% of incoming funds Tier 2 Share: EE = 23.7%, ER = 76.3% of incoming funds Tier 3 Share: EE = 50%, ER = 50% of incoming funds

2017 Legislative Session SB1063 HB2485 Created a risk pool for employers w/ 250 or fewer police or fire employees Employers with 251 or more employees will be in a single employer plan HB2485 Granted PSPRS employers the permission to switch from a 20-year to a 30-year amortization period Alterations to the transfer statute, ensuring that new employer doesn’t pay for liabilities accrued in previous employment

League Task Force - Yardstick Yardstick Element Included in Tier 3? 1. Defined Benefit Plan 2. Free from Legal Challenge 3. New Statewide System 4. Plan Elements Full Pooling Equal Cost Sharing Circumstantial Pension Increases DC Supplement Those w/o Soc. Sec. 5. Governance Structure Board of Trustees Disability Board YES, default w/ option of DC YES, prospective YES, pools assets for all 230 plans PARTIAL, pooled for 250 EE’s or fewer YES, EE & ER share 50/50 in contributions YES, COLA paid based on funded % YES, 3% EE & ER contributions to DC plan PARTIAL, 4 labor, 4 taxpayer, 1 advisory committee TBD

2017 Actuarial Valuation PSPRS Fund returned 11.85%, but aggregate and individuals funded statuses went down…why? Actuarial Assumption Changes (pg. 2-3 of your valuation) Asset losses are smoothed over a 7 year period therefore all 1/7th of the 11.85% returns are realize this year and past poor performing years are also reflected; aggregate returns over past 7 years are 6.6% falling below the assumptions of 7.4% Due to the loss of the Hall case contribution rates for Tier 1 employees was lowered from 11.65% to 7.65%, also Tier 2 benefit structure was modified to align it more with Tier 3 Reduction in assumed rate of return from 7.5% to 7.4% Reduction in salary appreciation from 4% per year to 3.5% per year Updated mortality tables because people are living longer Updated retirement, withdrawal, and disability assumptions

PSPRS LOCAL BOARDS, DISABILITY IMPACTS

Current Disability Process By statute (ARS §38-847) each employer under PSPRS is required to have a Local Board with a primary task of that Local Board being the adjudication of disability claims Member applies for disability and provides relevant medical docs to local board Local board reviews application and determines whether to order an Independent Medical Examination (IME) Local board orders IME and provides information to medical board Medical board completes IME report and submits recommendation to local board Local board approves (or denies) medical board recommendation and submits report to PSPRS PSPRS reviews documentation for approval and, if approved, authorizes disability payments

Current: 230 Local Boards

Issues with Current Process Some employers are very active in their local board process while others are not Apart from medical board review, which some employers have little familiarity with due to the infrequency of these occurrences, there are typically no other medical professionals involved in the process Creates additional bureaucracy Despite all the apparent fail-safe measures in the stated process there are wide discrepancies in disability rates by employer Governance-related training varies greatly by local board

Cortex Recommendation 3 Alternatives: Maintain current structure of 230+ local boards Have one unified local board for the entire state Establish individual local boards based on county and maintain local boards for employers w/ > 250 employees Recommendation was to maintain Local Board structure for all employers w/ more than 250 employees Establish an additional 27 Local Boards (separate boards for police and fire) along county lines and 1 state Local Board Total Local Boards = 45 Board membership is unclear but seems to consist of 3 non-members

Cortex: 45 Local Boards

Analysis While total disability rates are relatively low there are some high rates of disability on an individual employer level This analysis is consistent with the analysis from Cortex which indicates there are inconsistencies in governance, education, and determinations at the Local Board level There is weak correlation between average age by employer and rates of disability The PSPRS Board and Local Boards are, typically, not medical professionals Based on risk pooling outlined in SB1063 the current structure is antiquated and could present issues if left unchanged

League Recommendation 1 Medical Board for employers in the risk pool while non-pooled employers would maintain their Local Boards or opt-in to the singular pooled Medical Board Medical decisions made by medical professionals Independent Medical Examiner (IME) receives medical documents, employer incident report, any additional relevant information IME meets with the claimant after review of prior medical history and performs own evaluation, creates IME recommendation Establish a 3 person Medical Board of licensed doctors who will review IME recommendation and make final determination Local Board may still have a role in pre-employment screening and evaluation, etc.

League: 17 Local Boards, 1 Medical Board

Employer Recommended Practices

Two Key Steps What is the financial condition of our plan? How can we improve the financial condition of our plan? Increase Assets Decrease Liabilities

Actuary 101 Unfunded Liability Funded Status (Funded Ratio) Pension Funding Formula

Unfunded Liability Market Value of Assets are the assets as of TODAY! Future liabilities are discounted to a present value estimate using the assumed rate of return as the discount rate. The difference is the over funded or unfunded liability.

Unfunded liability (debt) PSPRS Liabilities are Not Pooled (256 plans) Unfunded Liabilities have been Earned and Cannot be Diminished or Impaired Pension Clause and Field’s Decision The Amount and Timing of Your Contribution Directly Impacts the Funded Status of Your Plan A More Appropriate Term for Unfunded Liabilities is Debt

Know your numbers! Actual liability What the numbers are AND how the numbers are calculated. Actual liability Changing the yearly multiplier changes the actual pension amount to be paid in the future. Cost of Living (PBI) increases pension payments. Estimated liability Changing the assumed rate of return changes the estimated present value of the liabilities and the funded status, but not the actual pension.

Funded status (funded ratio) Market Value Assets Liabilities (present value) Identifies the Assets Available to Fund the Liabilities (in Today’s Dollars) Goal: 100% Funded or Greater

Pension funding equation C + I = B + E Contributions Interest Benefits Expenses

Contributions have 2 components: Normal Cost: Annual Cost of Pension Benefits “Earned” in the Current Year Estimated based on Actuarial Assumptions Their Assumptions are probably NOT your Assumptions! Unfunded Liability: Cumulative Effect of Previous Normal Costs not funded Straight line amortization (currently 19 yrs)

How much of your contribution relates to unfunded liabilities? Town of Paradise Valley FY 15-16 Rate Amount Normal Cost 12% $0.4M Amortization of Unfunded Liabilities* 60% $1.7M Total Contribution 72% $2.1M * Represents 83% of the Contribution Rate and Amount.

The Employer Recommended Practices Are . . .

Think credit cards… Your current balance is $300. Making the minimum payments you will pay a total of $697 in interest. Making the minimum payments you will pay off the balance in 37 years. The Actuarially Required Contribution (ARC) is only an Estimate – The Minimum Amount

Employer recommended practices Budget Contributions for DROP Members Prepay Your Budgeted Contribution Review Local Board Practices Prepare a Comprehensive Study Payoff Unfunded Liability (Debt) Earlier Create a Pension Funding Policy

Budget contributions for DROP members ER Contributions Have Been Budgeted Since Hire and Get Put Back In Once Replacement EE is Hired When an employee enters DROP, the unfunded pension liability DOES NOT go away. The resulting decreased contributions are NOT a savings. (Think total $’s and %’s)

Prepay your Budgeted contribution July 1st Results in Two Outcomes Increases Your Investment Income Even if the pension investments do not earn the assumed rate of return, the investment returns over time will be higher than those of local governments. Reduces Your Unfunded Liability

Review local board practices Employer Board Appointments Local Board Members: 5 ER Appointments: 3 Mayor/Designee is Chair Staff and/or Citizens May Establish Your Own Qualifications EE Appointments: 2

Review local board practices (continued) Hire Outside, Independent Legal Counsel Require Board Polices and Procedures Pre-Existing Conditions at Hire Disability Retirements Disability Retirements for EEs with Less Than 20 Years of Service have an Adverse Financial Impact on Your Plan Workers’ Compensation is a Key Indicator

Review local board practices (concluded) Create a Structure to Encourage Relationship with Elected Officials Annual Joint Meeting to Discuss Financial Status, Census Changes, etc. Staff Appropriately Manager, Finance, HR - Critical

Prepare a comprehensive study “A Movie”: Establishes a Baseline Annual Valuation Report is a “Picture” Where are You in the Pension Life Cycle? Young Today, Mature Tomorrow… Reconstructs Your Current Financial Condition

Prepare a comprehensive study (concluded) Provides Census Information Ratio of Actives to Retirees Turnover Rates given DROP, Staffing Levels Identifies ER Specific Practices Final Salary Components (e.g. Spiking) Impact of Lateral Hires Their assumptions are probably not your assumptions.

Payoff unfunded liability (DEBT) earlier Sooner Is Fairer Currently Being Paid Off Over 19: $21M Unfunded Now; $49M Final Cost Treat and Manage as Any Other Debt “Hard vs. Soft” is Incorrect Policy Question: What is the Best Way to Reduce or Eliminate this Debt?

6. Payoff unfunded liability (DEBT) earlier (concluded) Options to Reduce or Eliminate: Use Positive Variances from Operating Budget Use Reserves Issue Debt for Projects You Were Planning to Pay Cash For Add a New Line Item to Your Budget to Make an Additional Payment

7. Create a pension funding policy A Comprehensive Document with the Objective of Ensuring Financial Resources Exist to Fund Pension Obligations Accounting Standard Requirement: Recognized as Debt Engages Elected Officials Avoids or Fixes “Kicking the Can Down the Road” “If that, then this…”

7. Create a pension funding policy (concluded) Policy Components Define Funded Status Goal EX: Not Less Than 80% However, 80% is continuing the generational shift Define Annual Contribution Amount EX: Contribution Not Greater Than 10% of Operating Expenses Define Actuary Assumptions (Yours, not thiers) Identify Roles and Responsibilities

Use the market cycle to evaluate your funded status Market Cycle (Asset Value) Funded Status A

Questions? @AZCities 602-258-5786 1820 W. Washington St. Phoenix, AZ 85007 nponder@azleague.org www.azleague.org @AZCities 602-258-5786