1. PSPRS: On Track to Financial Sustainability with Retirement Security with one exception Dave Wells, Ph.D. Research Director Grand Canyon Institute

2. Pensions get bad press these days Spiking in Phoenix Underfunded Future Liabilities Rising fiscal burden for municipalities GrandCanyonInstitute.org 2

3. Solution? Replace Pensions (Defined Benefit) with 401(k) Defined Contribution Plans That’s what Prop. 487 in Phoenix does GrandCanyonInstitute.org 3

4. How much do you need to save to retire? If you want to purchase an annuity that gives you $30,000 a year (plus perhaps $20-30,000 a year from Social Security) How much do you need to save? Most Americans think $200,000 is what they’ll need Those age 55-64, Center for Retirement Research found median savings $120K, enough to buy an annuity paying $7,000 a year. GrandCanyonInstitute.org 4 >$500,000

5. Not so fast on the 401(k) solution Defined Contribution Plans have higher overhead costs and lower returns For many Americans defined contribution plans do not lead to sufficient retirement security And you can’t take a magic wand and make future underfunded liabilities of existing pensions disappear…in fact, eliminating defined benefit plans for new employees might make the situation worse. GrandCanyonInstitute.org 5

6. Pensions-if managed well Best return on the taxpayer dollar AND best return for retirement security Takes the worry out of retirement for employees You can’t live too long (and run out of savings) You don’t have to worry about an economic downturn ruining your retirement But the private sector doesn’t have them Will Intel exist in 50 years? – Can’t say for sure. What about the City of Phoenix in 50 years? – Pretty darn certain YES GrandCanyonInstitute.org 6

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9. Best Practices Fund the Annual Retirement Contribution (ARC) Fully GrandCanyonInstitute.org 9

10. Best Practices Risk Sharing Between Employer and Employee ASRS model with 50-50 contribution share PSPRS placed all the risk on the employer – Employee rate fixed: 7.65% – Employer the rest of the ARC 2000: Normal Costs 17.41% – Employee Contribution 7.65% – Employer Pays 9.76% – But Pensions “overfunded” so employer reduced to 5.29% – GCI Recommends in this scenario—Employer still pay 9.76% GrandCanyonInstitute.org 10

11. PSPRS by 2011 2011: Normal Cost 19.16% – Employees still paying 7.65% – Employer share: 11.51% – BUT now system underfunded so Employer share now jumps to 20.89% 2003 to 2014 Employer Rates – 2003: 3.75% (GCI argues too low) – 2014: 31.03% (making this higher) – IF PSPRS from 1997-2005 paid the HIGHER of Normal Costs or the ARC, PSPRS would have 15% MORE ASSETS TODAY. – Employee Rates due to SB1609 (in 2011) have gone up to 11.05% (eventually peak at 11.65%--the added part going to pay down unfunded accrued liabilities) GrandCanyonInstitute.org 11

12. PSPRS has improved risk-sharing Employees now contribute 11.05% Will peak at 11.65% (or 1/3 of total contribution- whichever is less) This is under litigation, however. Currently Employees paying about 1/3 of the cost Problem not Normal Costs-that hasn’t changed much Problem is unfunded accrued liability (more on that later) GrandCanyonInstitute.org 12

13. Best Practices Cost of Living Adjustments Granted Responsibly – Problem for PSPRS – By statute half of any year’s earnings above the assumed rate of return went into a benefit increase fund—regardless of funding level of PSPRS. (so if 9% assumed return and actual return 10%, then 0.5% went into a benefit increase fund-and as long as that fund had money it established permanent benefit increases) – So PSPRS granting pension benefit increases of 4% at same time funding status dropping well below 80%. GrandCanyonInstitute.org 13

14. SB1609 (2011) fixed it…but Required 10.5% return in prior year – No benefit increase if PSPRS funded <60% – +2% if PSPRS funded 60-79% – +4% if PSPRS funded 80%+ – If this formula had been in place since 1997-PSPRS would have 17% MORE ASSETS! BUT AZ Supreme Court decision in Fields tossed this out earlier this year citing 1998 voter approved amendment to AZ Constitution So back to the original problem GrandCanyonInstitute.org 14

15. Best Practices Anti-Spiking Measures in Place Yes – Now rely on 60 best months for determining pension (more months mitigates any effort to push up later year salaries) – Unused sick or vacation pay not included – Phoenix did not appear to follow the latter part-but those added costs would only impact the City of Phoenix (PSPRS is really composite of many, many separate municipal funds) GrandCanyonInstitute.org 15

16. Best Practices Assumed Rates of Return Reasonable – Was problem for PSPRS—once as high as 9%. – Now Fixed with 7.85% – But fixing depressed funded ratio and raised contribution rates GrandCanyonInstitute.org 16

17. Normal Costs Well functioning plan has sets aside enough money to pay for their benefit when employee retires and will draw down that money in 30 or so years. I’m hired at age 35, retire at 65-can think I’m receiving my age 35 year contributions, 30 years later—relying on the return. That’s called Normal Costs GrandCanyonInstitute.org 17

18. PSPRS Until 2003, PSPRS assumed a 9% annual rate of return (ASRS assumed 8%). Hadn’t been a big problem 1971-2000, PSPRS met or exceeded expected return EVERY YEAR When Acknowledge 9% is now too high, then that means you didn’t collect enough, so funding relative to accrued liabilities drops Therefore, need to make that up with higher contribution rates GrandCanyonInstitute.org 18

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20. GrandCanyonInstitute.org 20 Problem with this slide from Mr. McGee of Arnold Foundation: ASSUMES CURRENT RATES ARE PERMANENT. PENSION PLANS LOOK AT A 30 YEAR HORIZON NOT 1, 3 OR 5 YEARS

21. GrandCanyonInstitute.org 21 While future is not known—Pension Returns of 8% nominal are reasonable. If inflation 2%, then 5%+2%=7%

22. PSPRS now very well managed Part of lower returns for PSPRS also due to poor asset allocation – Caught up in real estate investments Today PSPRS one of the best managed assets in the country. – For instance in the 2008-2009 credit crisis, the current portfolio would have suffered only two-fifths of the losses of the portfolio at the time. – Compared to 50 public pension funds when measured in terms of the Sharpe ratio, which indicates whether a portfolio's returns are due to smart investment decisions or a result of excess risk, PSPRS has moved from being well below average to the 90 th percentile of top performers GrandCanyonInstitute.org 22

23. GrandCanyonInstitute.org 23 Table 1. Arizona Pension Funds MANY PSPRS PARTICIPANTS ALSO DO NOT QUALIFY FOR MEDICARE! Arizona State Retirement System (ASRS) Public Safety Personnel Retirement System (PSPRS) Corrections Officers Retirement Plan (CORP) Total for All Three Active Members 207,572 (p. 33) 18,436 (p. 84)14,580 (p. 82)240,588 Non-Active Vested 208,573 (p. 33) 1,442 (p. 84)1,463 (p. 82)211,478 DROP Members1,482 (p. 84)1,482 Retired Members (including beneficiaries) 122,257 (p. 33) 10,159 (p. 84)3,810 (p. 82)136,226 Employee Contribution10.9% (p. 151)9.55% (p. 83)8.41% (p. 81) Employer Contribution 10.25% (p. 151) 25.70% (p. 83)11.31% (p. 81) Average Annual Benefit $19,560 (p. 101) $49,571 (p. 86)$25,319 (p. 84)$21,959 Participates in Social Security YesPrimarily NoYes Assumed Rate of Return (2013) 8%7.85% Actuarial Value of Assets (billions) $28.9 (p. 53)$6.19 (p. 40)$1.56 (p. 40)$36.7 Unfunded Liabilities (billions) $9.5 (p. 53)$4.36 (p. 40)$0.677 (p. 40)$14.5 Funded Ratio75.3% (p. 53)58.7% (p. 40)69.7% (p. 40)71.6% Note. Page numbers in parenthesis indicate where within each source document information can be found. Sources Arizona State Retirement System (ASRS), 2013 Comprehensive Annual Financial Report for Fiscal Year Ended June 30, 2013, online at https://www.azasrs.gov/content/pdf/financials/2013_CAFR.pdf https://www.azasrs.gov/content/pdf/financials/2013_CAFR.pdf Public Safety Personnel Retirement System (PSPRS), 45th Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2013, online at http://www.psprs.com/Admin_Investments_and_Finance/CAFR2013/2013%20PSPRS%20FINAL%20131212.pdf http://www.psprs.com/Admin_Investments_and_Finance/CAFR2013/2013%20PSPRS%20FINAL%20131212.pdf Corrections Officers Retirement Plan (CORP), 27th Comprehensive Annual Financial Report for the Fiscal Year Ended June 30, 2013, online at http://www.psprs.com/Admin_Investments_and_Finance/CAFR2013/2013%20CORP%20FINAL%20131212.pdf http://www.psprs.com/Admin_Investments_and_Finance/CAFR2013/2013%20CORP%20FINAL%20131212.pdf

24. End Pensions? Transition Issues Pensions would gradually turn into just paying out to retirees Investments would need to be more liquid with less risk—thus lower returns Ability to meet unfunded liabilities diminishes – In Pennsylvania actuaries estimated a $40 billion increase in unfunded liabilities – In Minnesota estimated to cost state $2.8 billion GrandCanyonInstitute.org 24

25. PSPRS Summary Good: Always funds ARC fully Reasonable Rate of Return Assumption Decent Risk Sharing (but under litigation) Very well managed portfolio Needs Improvement Permanent Benefit Increases need to be reined in (post Fields decision) – A better formula would mean 17% more assets today Paying Higher of Normal Costs or the ARC – Not relevant now – Relevant when “overfunded”—would mean 15% more assets today Together had these reforms been in place PSPRS would have about 1/3 more assets today. GrandCanyonInstitute.org 25

26. Questions? Full paper at GrandCanyonInstitute.org Contact information: – Dave Wells, Ph.D. – Research Director – Grand Canyon Institute – dwells@azgci.org – (602) 595-1025 ext. 2 GrandCanyonInstitute.org 26