November 2010 – Day 8: Arizona Pension Reform
Pension reform a difficult task
Craig Harris – The Arizona Republic – Nov 2010
There is no debate among high-ranking elected officials: Arizona’s six public-pension systems are in trouble as they consume an ever-growing portion of public money to improve their financial health.
Yet there is little consensus about how to fix them, and there has been little political resolve to tackle such an explosive issue because it could involve tampering with pensions for hundreds of thousands of current and future retirees who feel the current benefits were earned and promised to them.
The Arizona Legislature’s incoming House speaker and Senate president said lawmakers can go only so far to slow the rate of growth for the state’s pension systems, which an Arizona Republic analysis found cost taxpayers $1.39 billion last year, a 448 percent increase from a decade ago.
These rising taxpayer costs, coming at a time when state and local governments have cut services to balance their budgets, have been driven in part by the pension trusts’ investment losses during the market downturn but also by ongoing pension-benefit improvements and efforts to hold down costs for employees themselves.
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The upward trend in taxpayer costs is expected to continue for at least the next few years.
The key to reversing it is getting voters to repeal a 1998 provision in the Arizona Constitution, lawmakers say.
The provision’s language, which was overwhelmingly approved by voters, says: “Membership in a public retirement system is a contractual relationship . . . and public retirement system benefits shall not be diminished or impaired.”
Trimming benefit payouts would allow lawmakers to lower publicly funded contributions to those systems. But that change may be difficult, they say, because of the strong influence on the Legislature of Arizona’s 363,000 state and local public employees.
“It’s time we get serious about reforming the public-pension systems,” said House Speaker Kirk Adams, R-Mesa. “But if we are going to have any fundamental change, the voters will have to get involved.”
Adams said he would work to get the Legislature to have voters in 2012 change the state Constitution, which prohibits benefits from being diminished for those in the public-pension systems. Adams said he has yet to get support from the Republican-controlled Senate or Gov. Jan Brewer, a fellow Republican.
In 1998, the intent of the measure was to protect public-pension trust funds, which had surpluses at the time, from being raided by lawmakers in the event of lean budget times. Since then, the pensions have not been touched by lawmakers.
Lawmakers in 2001 enhanced benefits for the Arizona State Retirement System, the largest public-pension plan in the state, by changing the formulas to allow workers larger pensions.
“When things were good, they (lawmakers) were overly generous,” said incoming Senate President Russell Pearce, R-Mesa. “No one looked at the future impact. . . . We need to look at things now and decide what we can afford.”
Pearce himself benefits from three Arizona public-pension systems. He has eight years of service as a state and county government administrator in the ASRS system. He has about 10 years of service and growing in the Elected Officials’ Retirement Plan, and since 1991 he has received a pension from the Public Safety Personnel Retirement System for his time as a sheriff’s deputy.
Currently, Pearce’s annual public-safety pension is $47,957, according to records.
Pearce said he would favor eliminating the Elected Officials’ Retirement Plan because he believes people should not be given the wrong reasons to run for office.
Governments are taking steps to rein in public-pension benefits when they have become a budget burden.
A handful of states are considering going to 401(k)-style systems in which employees simply set aside their own retirement funds over time, with those funds earning income as investments.
The issue is defined-benefit plans. Nearly all states, including Arizona, have them for public employees. Under such systems, pensions are based on an employee’s ending salary, years of service and a fixed percentage rate that is multiplied by the other two factors.
Typically, those plans require employers (taxpayers) and employees to contribute to a trust fund, which can grow through investments. The trust then pays lifetime annuities, and in many of those systems, including some in Arizona, pensions have been boosted by cost-of-living increases that outpaced inflation. If the market falters, the amount of pension payments to retirees is still guaranteed, and contributions from still-working employees or from public employers, or both, are increased to cover investment losses.
In a significant indication of change, six newly elected governors in Alabama, Nevada, Pennsylvania, Tennessee, Wisconsin and Rhode Island have suggested that they want to amend their states’ pension systems to 401(k) plans similar to the private sector’s, said Stephen Fehr, a pension expert for the Pew Center on the States. The center is a non-profit policy-advocating group.
“They want to shift away from guaranteed pensions,” Fehr said.
Even in states with strong labor unions, such as California and Illinois, action has been taken, Fehr noted.
Voters in eight of nine California cities and counties approved measures during the recent election to cut public-pension benefits. In addition, Fehr said, more than 40 suburban communities in Chicago approved a ballot question that called on the Illinois Legislature to reduce benefits for future state workers.
Earlier this year, 21 states took action to reduce their pension liabilities, Fehr said. Arizona was one of those. Lawmakers required those in ASRS hired after July 1, 2011, to work a few years longer to draw their pensions. The Arizona Legislature also modified the calculation to determine pension benefits for new hires. The changes do not affect current ASRS members or retirees.
To retire with full benefits, incoming ASRS members, state and local government workers and teachers now will have to obtain 85 points (calculated by combining age and years of service) rather than the previous 80. And the amount of their annual pensions will be based on their average annual wage during their last five years of employment rather than their last three
years. That change is expected to lower starting pensions slightly.
Pearce and Adams said those changes were only modest reforms, and it took four years for Arizona lawmakers to approve them.
“Misery loves company because every state and the federal government have similar issues with their public-pension systems,” Adams said. “We shouldn’t have a system where taxpayers are paying into a 401(k) system and receiving Social Security, but public employees are receiving benefits that are far better than what the private sector is getting.”
Even those receiving Social Security, which is a defined-benefit plan, are not guaranteed cost-of-living increases, as is the case in some of Arizona’s public-pension plans.
In 2011, for the second straight year, Social Security benefits will remain flat because the inflation rate that would trigger cost-of-living raises is so low.
Calls for change
While there is talk nationally about moving public-pension systems to 401(k)-style programs, only Alaska and Michigan have adopted them as their primary plans, Fehr said.
In a 401(k) or defined-contribution plan, an individual invests money from a paycheck and may have a matching contribution from an employer going into an investment account. However, unlike in a defined-benefit plan, the employee is not guaranteed a specific annual pension at retirement. Instead, the employee gets whatever proceeds are in the investment account.
That investment account increases or decreases in value over time, depending on the financial markets.
The Arizona Chamber of Commerce and Industry, which has a strong lobby at the Legislature that focuses on government spending and accountability, wants Arizona to adopt a 401(k)-style system because proponents say it is less costly than a defined-benefit plan.
“Our focus is whether this type of pension, a defined-benefit system, is right for the future,” said Suzanne Taylor, the chamber’s senior vice president of public policy. “Our question is whether this system is sustainable and whether we should be moving new employees to what’s in the private sector. . . . We haven’t had a crisis so far, but we don’t want to have one.”
Taylor said it would be nearly impossible to change to such a system for current public employees and retirees because of guarantees afforded them in the state Constitution. Politically and legally, she said, it would be easier to make changes for future employees.
But if the state immediately ended defined-benefit plans and moved to 401(k) systems, a significant new problem would develop, said ASRS Director Paul Matson. Matson said ASRS and Arizona’s other systems are underfunded, and additional contributions are needed from both current and new employees and their employers to cover those deficits. If future employees were to be taken out of that equation, costs for current members and their employers to erase the trust deficits would skyrocket.
Nonetheless, Adams and Pearce suggested it is time for Arizona to move to a two-tiered public-pension system in which pension benefits are scaled back for new employees.
Plans in the works
Matson strongly advocates for the current defined-benefit plan, saying it provides better financial security for its retirees, making them less dependent on other government services. Matson also believes the ASRS plan is sustainable without significant reform.
Matson, however, favors changes for those who retire from the ASRS system and then return to work for an ASRS employer. When these employees take a “double dip,” neither they nor their employers contribute to the ASRS trust when they return to work. Opponents of the practice say it hurts the trust’s stability and is unfair to other ASRS members whose contribution rates must go up to offset the lack of contributions from working retirees.
Matson plans to ask the Legislature to create an alternative contribution rate paid by employers of double-dippers. Employees who have retired and returned to work would not be asked to contribute under Matson’s plan.
The Republic found that double-dipping by more than 900 educators in Maricopa County is costing ASRS at least $8.6 million in lost contributions this year.
Jim Hacking, director of the state’s pension system for public-safety officers, said he plans to meet with members of his plan in December to make recommendations for legislative changes.
The Public Safety Personnel Retirement System is the most underfunded in the state, and taxpayer-subsidized contributions from public employers are nearly three times the contributions made by police and firefighters from their own paychecks.
Hacking said the current program providing annual cost-of-living increases and deferred-retirement incentives that include large lump-sum payouts needs to be fixed.
“It’s our plan to do everything we can so the plan is restored to a state of good financial health,” Hacking said.
Gov. Brewer vowed to work with pension managers and the Legislature to restore the health of the public-pension systems. “There are concerns whether the (pension) systems are sustainable and if they are fair going into the future,” Brewer said. “We need to sit down and vet the systems at the Legislature.”
The price of inaction could be far greater than what it already has cost Arizona taxpayers.
“Given the situation across the country, we have pension systems that are going bankrupt all over,” the governor said. “We don’t want to find ourselves in that situation, and we are going to have to address the issues.”
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