Despite a fairly positive report on the stability of the Arizona State Retirement System (ASRS) earlier this year, a major business group with no direct involvement in the fund is expressing serious concern.
The Arizona Chamber of Commerce and Industry, none of whose member firms has employees enrolled in a public pension plan, is calling for a major overhaul of ASRS to radically change how benefits are calculated for future retirees.
A 2010 report by the nonprofit Pew Charitable Trusts hailed Arizona as “a national leader in managing its long-term liabilities for both pensions and retiree health care and other benefits.” Pew labeled ASRS a “solid performer,” one of 16 plans to receive that distinction.
Glenn Hamer, president and CEO of the chamber, says the state’s four major public pension programs, including ASRS which is by far the biggest, enjoyed a cumulative $4.7 billion surplus at the turn of the century.
“Since that time, however, asset growth has been unable to keep pace with the liability growth caused by a number of factors, including an expanding government workforce, rising salaries and legislative action that increased benefit levels,” Hamer says. “As a result, the $4.7 billion surplus has become a $10.4 billion deficit.”
The chamber used 2000 as a baseline indicator, even though the nation was coming off one of the longest, most aggressive economic boom eras in the history, because that was when ASRS reached its peak, with a surplus of $3.6 billion. The four plans had a cumulative $4.7 billion surplus.
“We wanted to look at how we got from that point to the current situation with a $10.3 billion deficit,” Hamer explains.
Hamer says the chamber’s concern over the health of the state retirement system is business-related. The chamber doesn’t want to see Arizona go the way of many other states, whose public pensions have created a major burden on state budgets, Hamer says. For example, California diverted $3 billion to pension costs from other programs in fiscal year 2010.
“As governments are forced to direct funds to creaking pension systems, funds are diverted away from core government functions,” Hamer says. “And when government functions go unfunded, it’s the taxpayer who will increasingly be called upon to increase government revenues, creating an environment where economic recovery will continue to stall.”
Hamer notes that Pew warned of a cumulative $1 trillion public pension gap for plans across the country.
“Arizona was recognized as a top performer among the states analyzed by Pew researchers. However, recognizing a state with a $10.4 billion funding shortfall as a top performer underscores the structural challenges facing public pensions nationwide,” Hamer says.
Indeed, the Pew report notes that ASRS is funded at about 80 percent of its total pension liability, which Pew states is at the minimum benchmark that the U.S. Government Accountability Office says is preferred by experts. Pew went on to state that because Arizona has accounted for the underfunding and increased contributions by employees and employers effective July 1, the concern is lessened.
Contribution rates are expected to continue to increase annually for members and employers for the next several years. The July 1 hike boosted the pension contribution rate to 9.6 percent from 9 percent.
Those increases, while designed to keep ASRS adequately funded, get to the heart of the chamber’s concerns.
Public employees earn constitutionally guaranteed retirement benefits even though the costs associated with those benefits continue to rise and the state’s budget continues to track in deficit. That means the state will have to divert more money to the retirement system to keep it solvent.
“These long-term pension funding challenges have significant short-term implications,” Hamer said. “During fiscal year 2009 — one of the toughest budget years in Arizona history — state and local governments contributed $1.3 billion to the state’s retirement plans. Of this contribution, over
$400 million was dedicated to closing the funding gap. This was $400 million of additional budget flexibility that would have been available if not for the unfunded liability.”
Hamer says state and local budget officials should get used to the prospect of paying down pension debt. The chamber recommends that the state should keep taxpayers apprised of pension liability by including a line item in state and local budgets that reflects the size of the annual pension contribution, and listing an alternative-funding calculation that uses investment-return assumptions that are required of private-sector pension plans.
A second, more far-reaching recommendation targets the growth of future liabilities. Recognizing steps taken by the Legislature this year — raising the retirement age, adjusting the average salary calculation and eliminating employer-contribution refunds for future ASRS enrollees — the chamber says that’s not enough.
“Ultimately,” Hamer says, “the only way to completely eliminate future liability growth is by closing the defined-benefit plans to new enrollment and transitioning new employees to a defined-contribution plan.”
But, Paul Matson, ASRS director, is adamantly opposed to shifting to a defined-contribution plan from the existing defined-benefit plan.
As defined-benefit plans, 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. Whereas, a defined-contribution plan 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 perform.
Matson says defined-contribution plans are generally more expensive, with lower rates of return and higher administrative fees. With a defined-benefit plan, the individual can calculate with accuracy what the benefit will be upon retirement.
Each year, ASRS publishes a Comprehensive Annual Financial Report, following industry standards set forth by the Government Finance Officers Association of the United States and Canada. The report includes the funded status of the retirement plan in two forms: using the actuarial value of assets, and using the market value of assets, Matson says.
For setting contribution rates, the ASRS uses the actuarial value of assets, which smoothes fund gains and losses over a rolling 10-year period. “This method is consistent with actuarial and accounting standards, results in a contribution rate that is smoother through time, is easier to budget for, and is more equitable between generations,” Matson says.
Market value of assets provide a better fiscal snapshot of a plan, Matson says.
“To use market value of assets to determine annual contribution rates would cause significant swings in contribution rates, thus creating short-term budgeting problems and a less-equitable plan structure,” he says.
Bolstering the ASRS position of stability, Matson says ASRS paid out $2.1 billion in fiscal 2009, but received contributions of $1.67 billion from employees and employers. What’s more, ASRS has a pot of money totaling $24.4 billion backing up future obligations, down from $25 billion a few months ago. Even so, he says the fund is solid for generations to come.
Hamer says the concern is not that the pension plans will go broke. “Arizona has proven itself to be a reliable contributor,” he says. “But the money used to make the contributions is no longer available for other uses.”
“Historically, generous retirement benefits to government employees have been justified by lower compensation levels compared to a comparable private sector position,” Hamer says. “In light of the growing evidence that public sector employees are now compensated as well or better than those with similar skills and education levels in the private sector, it seems reasonable for them to receive comparable retirement benefits as well.”