Even with a mind-numbing return on investment of minus 18 percent and a report suggesting that the Arizona State Retirement System is woefully underfunded, retirees and current employees banking on a stable pension check need not worry.
So says Paul Matson, ASRS director, who notes that the retirement system is sitting on a whopping $25.5 billion pot of money. Sitting on it may not be the proper description. Investing is what ASRS does with the money it receives from members and employers, besides paying benefits to roughly 100,000 retired state workers, teachers and others.
And those investments, over the life of the fund, have returned about 9 percent more money to the state each year. But what about the 18-percent drop in fiscal 2009, which ended last June 30? Not to worry, says Matson. That sharp decrease, triggered by a falling stock market, was more than offset by a 25.9 percent jump in assets during the 10 months that ended on April 15.
“That’s why we look at a longer period, not one year to the next,” he says.
Besides, while ASRS paid out $2.1 billion in fiscal 2009, it received contributions of $1.67 billion from employees and employers. At that rate, the fund is absolutely solid for several generations. Matson emphasizes the word “generations.”
In some years, the cash flow going in almost equals the cash flow going out, Matson says. “And we’ve got $25 billion backing up future obligations.”
But Matson isn’t satisfied with that.
Today ASRS is funded at 79 percent of liabilities, which means for every dollar to be paid out over the next several generations, the fund has 79 cents. Based on steadily increased contributions from employers and active members – not retirees – and an improving economy, Matson has set his sights on having ASRS 100 percent funded.
The last time ASRS was 100 percent funded was around 2000, but certain benefits were enhanced and the so-called “dot-com” bubble burst, leading to several poor investment years.
Jolted by a volatile stock market, the ASRS total fund reached approximately $25 billion in September 2008, plunged to $17 billion in March 2009, and now is right back up to $25 billion.
The rosy picture painted by Matson was backed up by a favorable assessment in February from the nonprofit Pew Charitable Trusts, and was challenged in March by a report from the watchdog Goldwater Institute.
The Pew report hailed Arizona as “a national leader in managing its long-term liabilities for both pensions and retiree health care and other benefits.” The report noted that ASRS was funded at about 80 percent of its total pension liability, which Pew states is “right at the minimum benchmark that the U.S. Government Accountability Office says is preferred by experts.”
The Pew report underscored a nationwide concern of funding for pension programs in general. Most pension plans, including Arizona, are showing an underfunded status. But, Pew reported, because Arizona has accounted for the underfunding and plans to increase contributions “earmarked to improve the funded status over time, the concern is lessened.”
Indeed, while Matson says ASRS members have no need to be concerned about the stability of the fund, a key step toward keeping ASRS healthy is that contribution rates will continue to increase annually for the next several years for active members and employers by 0.3 percent, or possibly 0.4 percent. Initially, the pension contribution rate will increase to 9.6 percent from 9 percent starting July 1.
For example, an employee earning $40,000 a year, the increased contribution will amount to about $130 a year, Matson says.
Matson barely had time to digest the Pew report when the Goldwater Institute accused Arizona officials of under-reporting funding shortfalls. “I’m wary of reports that come from an ideological perspective,” he says.
The Goldwater Institute report, authored by Andrew Biggs, a resident scholar at the American Enterprise Institute, says the accounting methods used by public employee pensions effectively ignore risk.
“These accounting methods, which are used by public pensions in Arizona and around the country, allow pension fund managers to assume that high returns can be earned through stocks and other investments without taking any market risk,” the report states. “As a result, the true market value of Arizona pension shortfalls that must be funded by taxpayers is understated by around half of what the pension funds have reported.”
The report examines ASRS, the Public Safety Personnel Retirement System (PSPRS), and the Corrections Officer Retirement Plan (CORP).
“If Arizona’s public pension liabilities were priced on a fully risk-adjusted market basis, which most financial economists believe is the best representation of costs to the taxpayer, these plans would be about 41 percent funded, versus the 77 percent level Arizona pension accounting statements report,” the Goldwater report states. “On a risk-adjusted basis, unfunded public pension liabilities would exceed $50 billion, roughly $8,300 per Arizonan, dwarfing the $10 billion funding shortfall the funds acknowledge.”
The Goldwater Institute recommended shifting public sector pension plans to defined-contribution plans instead of defined-benefit plans. Right now, Arizona pension plans pay benefits based on the individual’s earnings and the number of years of employment. They are funded equally by the employer and the member.
A defined-contribution plan, however, is similar to a 401K plan, in which benefits are determined by how much an individual contributes and how well investments chosen by the individual do.
Matson opposes shifting to a defined-contribution plan, saying such plans generally are more expensive, with lower rates of return and higher administrative fees. “The individual manages their own assets,” Matson says. “All the risk is with the individual.”
With a defined benefit plan, the individual can calculate with accuracy what the benefit will be upon retirement.
Additionally, the Goldwater report says the amount that government employees contribute from their paychecks into the pension funds should reflect market-risk calculations. “Employees would pay a more realistic share of the costs to provide their benefits when they retire,” the report states.
But Matson says under that proposal, short-term to medium-term contribution rates would become “almost unaffordable.” Later on, he says, rates would be cut dramatically, adding, “Our methods have a similar rate over a longer period.”
Even with the increased contributions and recovering stock market, the nearly 100,000 retirees will again see no hike in their monthly benefit. The last bump was in 2005. The permanent benefit increase is based on a formula using a 10-year average rate of return.
“I don’t expect an increase for the next several years,” Matson says.
Likewise, Matson doesn’t expect the Legislature – which has slashed programs and is facing monumental budget shortfalls for at least the next few years – to attempt to sweep money from the $25 billion ASRS. Even if lawmakers tried a politically unpopular move to get their hands on pension funds, Matson says it is unlikely that such action would stand up in the courts or under the terms of the state Constitution.
“The Constitution says the money is clearly in trust for the benefit of our members and cannot legally or otherwise be swept from the ASRS,” Matson says.
The relationship between the state and ASRS members is a contract under which benefits cannot be diminished, he says.
So while lawmakers are highly unlikely to cast covetous eyes on the ASRS, they did pass a key measure that should save the fund some money. H2389, which affects employees hired after July 1, 2011, changes the definition for normal retirement to 85 points (combination of age and years of employment) from 80 points. That means a person would have to work two-and-a-half more years to retire without having benefits reduced. The bill had strong bipartisan support in the Legislature and was signed by Gov. Jan Brewer on April 14.
A reason for the change, according to Matson, is that people are living longer and therefore drawing pension checks for a longer period. “It’s a recognition of greater longevity,” he says, and like other changes helps to mitigate planned contribution increases that impact members and employers, including state government and public schools.
Another aspect changes the method of determining benefits by averaging the salary for the five highest years out of 10 instead of the current three highest years out of 10. It targets the practice of some employees who are able to spike their salaries a year or two before retirement by taking on a second job or qualifying for a substantial amount of overtime.
“It smoothes out the earnings and mitigates the spiking of their salary,” Matson says.
Looking ahead with higher contribution rates for employees and employers, but no benefit increases for retirees, Matson says the economy has turned a corner.
“It’s definitely healthier than it has been for the last several years,” he says. “Unemployment and foreclosures seem to be stabilizing. Meanwhile, the stock market and bond market are very robust, beyond what most people have expected. Some of the riskiness is diminished.”