Arizona's PSPRS Dilemma

12 August 2017  
The History Behind Arizona's Public Safety Personnel Retirement System, How The Fund Was Hurt After Financial Downturns and How It Has Affected The Various Cities in Arizona.

Many cities in Arizona are facing an ever increasing unfunded liability burden due to the issues of the Public Safety Personnel Retirement System, which covers the pensions for police and firefighters, following two economic downturns and benefits promised for years before the downturns.

“Around 2000, PSPRS had more than enough money to cover the retirement of every one of it’s retirees as well as every one of it’s active members,” said PSPRS Communications Director Christian Palmer. “After that, we had two major economic disasters with the dot com crash in the early 2000s and the housing market crash in the 2007-2008 years."

“So that was really one of the key factors for causing a downfall with PSPRS,” Palmer continued.

Originally started in 1968 as a way to establish equal benefits across all Arizona public safety agencies, the system works by having employees and employers of each fund put money into the system and then the PSPRS board invests the money into traditional stocks and bonds as well as alternative investments.

The returns assist paying for the retirements of the various funds around the state for thousands of retirees.

Like many institutional investors, such as pensions, PSPRS suffered severe losses during the financial downturns.

These losses were made worse due in part to a perk known as the permanent benefit increase, which applied a flat dollar amount increase to every retiree in the system in years when PSPRS produced a positive return greater than 9 percent.

The permanent benefit increase, also know as PBI, also capped the amount of annual pension increases while excess cash carried over to following years. Palmer said Under this mechanism, the PBI delivered pension increases for 28 conseuctive years even in years even when the trust produced very little money.

“The PBI (permanent benefit increase) is the mother of unintended consequences, it was absolutely well intentioned,” Palmer said. “The whole intent was to increase the pension levels of those [rural/small town] retirees to bring their retirement on par with that in the urban areas. This actually created a disproportionate impact on the employers and that impact year by year slowly compounded and really presented quite a problem.”

“There was no way they (PBI framers) could have envisioned events like the dot com crash or the housing market crash or the mathematical problems the PBI would present years after,” Palmer continued.

As the market returns dropped, the contribution from PSPRS fell. However, the pensions are by law guaranteed to never lower so each municipality had to make up the difference.

“People have to understand, PSPRS is a state system,” Prescott Mayor Harry Oberg said. “It’s designed by the legislature. They did not give us, any of the municipalities, any opportunity for input on what we thought the benefits should be.

“They gave very lucrative benefits to police and fire and just told us to pay the bill,” Oberg continued.

In 2016, voters eliminated the permanent benefit increase and replaced it with a cost of living adjustment capped at 2%. The COLA is based on the average annual percentage change in the metropolitan Phoenix-Mesa consumer price index, but it will not exceed 2%. 

In addition, after years of lobbying following the tech bubble disaster, PSPRS was authorized under law to invest in alternative assets such as private equity, real assets and real estate funds. Palmer says these assets seek stable and safe returns to protect employers from unforeseen contribution rate increases that can come from highly volatile investment portfolios consisting of mostly publicly-traded stocks.

“The exact reason we have those in the portfolio is they lower the volatility because these are privately traded, privately acquired investments, and they are not susceptible to every peak and valley that the market is going to bring,” Palmer said. “On top of very high returns that they deliver, they also give a great amount of sustainability and they help buffer out what would otherwise be really terrible years for PSPRS.”

During the fiscal year, which ended May 30, 2017, PSPRS had an investment return of greater than 12 percent, which Palmer says shows the PSPRS portfolio can generate profits even with the investment strategy of avoiding losses. However it will take time for the changes to make a difference with the unfounded liability facing many cities in Arizona.

20% of Prescott’s general fund budget goes to the 78.4 million dollar unfunded liability. Meanwhile Bisbee, Arizona dedicates an even higher percentage to the payment of their $17 million unfunded liability and had make a variety of changes.

“PSPRS has greatly affected Bisbee,”said Bisbee Mayor David M. Smith. “A full 22% of our budget goes directly to PSPRS for our firefighters and police officers.

Over the last ten years, Smith said the workforce has been reduced along with library days being cut and the town’s pool being funded by the public or shut down completely. Smith says the town is not laying off police, rather, they are simply not replacing them.

“All of these quality of life situations, are directly impacted by this debt,” Smith said.

Considering the city’s sales tax is over 9% already, Smith doesn’t see a tax directed for the unfunded liability an option. He is very hesitant to go over ten percent and would have to judge the consensus of the population with a choice of bankruptcy or more taxes should no help come.

“Chapter 9 (bankruptcy) is in future for Bisbee,” Smith said. “If this were to continue and we don’t get relief, then there simply won’t be the money to pay this.”

Prescott, meanwhile, will be putting a proposition up to the voters with a hope to pay down the debt owed.

According to information about the proposition posted on the city’s official website, If passed, the city would adopt a sales tax of three-quarters of one percent starting on January 1st, 2018 and sunsetting on December 31st, 2027 or when the city’s PSPRS unfunded liability is 1.5 million or less.

“It is a very fair tax,” said Prop 443 Co-Chairman Cecelia Jemegan. “I tell people, if you buy a coffee at Starbucks it costs you $3. After this cost it will cost you $3.03. That’s just pennies for each one of us to have to give back to our community.”

Others think the functionality of PSPRS needs to be changed before dedicating a fix.

“It wasn’t Prescott that created the problem, it’s PSPRS, it’s the fund, it’s the benefits they gave out, it’s the bad investments that they made,” said former Prescott City Councilman and Advocate for No on Prop 443 Chris Kuknyo, who mentions the tax would take pressure of the state to fix the issue. “That’s where we need the fundamental change and that’s why we need our state guys on our side. My hope is that every city or town is struggling with this but no one is talking to each other. We need to talk with each other.”

The Arizona Representatives do have the PSPRS unfunded liability on their minds. Solutions are being thought up with an ADHOC Committee headed by representatives Noel Campbell and David Stringer made up stakeholders such as police and fire unions, various retiree representation groups and many other organizations looking for solutions.

“(There is) a lot of expertise to draw upon and we are going to bring all these groups together and we are going to be studying this problem,” Stringer said. “I want to be clear, at the end of the day, we will have very concrete specific proposals to present to the speaker of the house and house of representatives to begin the process of addressing PSPRS unfunded liability.”

While PSPRS integrates the new strategies and the ADHOC Committee comes up with a proposition in December, cities like Bisbee, Prescott and many others across the state are left to deal with the unfunded liability.

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