Ugly Numbers & Underfunding: Pension Reform Needed

The Arizona public safety pension is watched on the national stage-

A Strange Story and Weak Numbers: PSPRS of Arizona

Tuesday, May 6, 2014- Meditation Money Management Blog

By Andrew Silton, JD, MA

Retired Chief Investment Advisor to the $68 billion North Carolina Treasurer, also formerly with Deutsche Bank Real Estate Opportunity Fund 1 and Legg Mason Asset Management

I began working on this post because of an unusual lawsuit in which a money manager is suing former employees of a public pension plan. That doesn’t happen too often. In fact, I’ve never seen this before. However, curiosity led me to look at a pension plan where ugly numbers overwhelm a strange story. After several hours of looking at the issues facing the Public Safety Personnel Retirement System (PSPRS) of Arizona, I’ve got a headache. I can only imagine what it’s like for the trustees and professionals overseeing the $7.8 billion plan.

The Numbers

For starters, the plan is only 57% funded as of last June.[1] Ten years ago it was 95% funded.   Undoubtedly the reality is even worse, since public fund accounting tends to understate a pension’s liabilities. This grim picture is made even worse by the fact that employees and employers contributed 9.6% and 27.2% of salaries just to keep the plan going.[2] A decade ago, employees and employers only contributed 7.7% apiece. In other words, it now takes 36.8% of employee salaries to meet the pension’s current obligations. Imagine what it’s like for the government entities that have to come up with these sharply increasing contributions.

As point of reference for folks who are concerned about the North Carolina Teachers’ and State Employees’ Retirement System. North Carolina is 94% funded (down from 108% a decade ago) and the employee and employer contribution rates are 6% and 8.3%[3], respectively. Ten years ago, the contribution rates were 6% and 0.8%[4], respectively.[5]

At PSPRS, the assumed rate of return is 7.85% versus 9% a decade ago.[6] In North Carolina, the assumed rate of return is 7.25%[7] versus 7.25% ten years ago[8]. What does this mean? Arizona is assuming that its assets will grow at 7.85% over the long run, while North Carolina assumes that will increase more slowly. If the assumption proves to be overly optimistic, the pension’s shortfall is very likely to increase. Conversely, if the assets grow more quickly, the pension’s deficit is likely to shrink (unless benefits are enhanced or the liabilities increase faster than assumed).

Two final notes on the numbers: the PSPRS’s allocation to alternative investments is about 58% of assets and the investment returns are reported to the board of trustees on a gross (before fee) basis. Obviously, the net returns have to be much lower. Even so, the gross returns have generally underperformed the pension’s benchmark and have failed to meet the actuarial assumption by 2.3% per year for the last decade.[9] While North Carolina has a small hill to climb in keeping its pension properly funded, PSPRS of Arizona is staring up at a cliff.

The Story

The large public records request made by SEANC and the report issued by Benchmark Financial are trivial in comparison to the complicated situation facing PSPRS of Arizona. In fact, I’m not sure I can summarize it properly because there’s no agreement on the basic facts. As you’ll see, there are lawsuits and allegations of impropriety flying all over the place. Pity the poor police officers and firefighters who are worried about their pensions.

The PSPRS has a strategic relationship with a firm called Desert Troon. For the past twenty years, Desert Troon has managed a couple of Arizona-based real estate portfolios for PSRPS worth about $450 million. This arrangement bears some resemblance to North Carolina’s Innovation Fund managed by Grosvenor in that PSPRS exercises quite a bit of control over the investment activities of the Desert Troon (DT) portfolios. However, any further resemblance quickly disappears because the DT portfolios are caught up in controversy.

As you might imagine, Arizona real estate didn’t fare to well during the great recession. As a result, the DT portfolios came under a great deal of pressure. As best I can tell, these real estate assets weren’t subject to the same reporting requirements as regular funds.[10] Apparently a valuation dispute broke out between several members of the staff and the CIO. It got so bad that the employees, including the general counsel, resigned; the accusations flew. The employees claimed that the DT portfolios were grossly overvalued in order to pay the CIO his bonus. They claimed they were threatened when they tried to raise the valuation issues. In recent days, a sexual harassment claim has been added to the story.[11] Various Arizona agencies and the FBI were brought in to investigate the charges and countercharges.

Meanwhile the trustees and CIO claim that the charges were wholly unfounded. They sued one of the employees because he took a host of documents with him when he resigned. Various news organizations started digging into the story, presumably because they talked to or received documents from the whistleblowers. In the most recent development, Desert Troon has sued the four whistleblowers for making false public statements that have allegedly hurt their ability to gain new business.[12]

It’s hard to say who is right or wrong in this dispute. However, the PSPRS of Arizona has a much bigger problem than the Desert Troon controversy, and it is in the numbers. Stay tuned.


[1] , page 81.

[2] Ibid, page 83.

[3], page 1.

[4] The rate was tiny because the plan was still fully funded.

[5], page 114.

[6] PSPRS Annual Report, page 86.

[7] NC Actuarial Report, page 12.

[8] NC CAFR 2004, page 124.

[9] at page 7.




Posted by Andy Silton, JD, MA


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