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

2. 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)

3. 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%

4. 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

5. ½ Earnings above 9%...

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

7. 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%

8. 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%

9. 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%

10. 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?

11. Is there a “healthy” funded status?

12. 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!

13. 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
“Dot.com” loss of $1.7 billion
Funding level drop from 127% to 101%
“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

14. 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

15. 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

16. 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

17. Round 2 (continued) Proposition 124 (2016)
Struck the PBI from statute and replaced it w/ COLA 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

18. 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

19. 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

20. 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

21. 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

22. PSPRS LOCAL BOARDS, DISABILITY IMPACTS

23. 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

24. Current: 230 Local Boards

25. 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

26. 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

27. Cortex: 45 Local Boards

28. 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

29. 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.

30. League: 17 Local Boards, 1 Medical Board

31. Employer Recommended Practices

32. 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

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

34. 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.

35. 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

36. 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.

37. 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

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

39. 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)

40. 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.

41. The Employer Recommended Practices Are . . .

42. 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

43. 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

44. 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)

45. 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

46. 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

47. 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

48. 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

49. 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

50. 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.

51. 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?

52. 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

53. 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…”

54. 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

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

56. Questions? @AZCities 602-258-5786 1820 W. Washington St.
Phoenix, AZ 85007
@AZCities