October 9, 2018
On the November general election ballot voters will have the opportunity to vote on Proposition 125. This is a bipartisan measure that will put the Correctional Officers Retirement Plan and the Elected Officials Retirement Plan back on a sustainable path while still keeping the promises made to retirees and giving them the tools to plan for the future. Below are some facts about Proposition 125:
Q: What is Proposition 125?
A: Prop 125 is the follow-up measure to Proposition 124, a 2016 ballot referendum that passed with overwhelming support that reformed the pension increase formula for Arizona police officers and firefighters in the Public Safety Personnel Retirement System (PSPRS). Proposition 125, which was a bipartisan measure that was unanimously approved by the Arizona State Legislature, would apply the same changes for retirees of the Corrections Officer Retirement Plan (CORP) and the Elected Officials Retirement Plan (EORP). These changes will put the pension plans back on a sustainable path while ensuring the promises made to retirees are kept.
Q: Does Proposition 125 do anything else?
A: No. Retirement benefits for CORP and EORP members are protected by the state constitution and all funds associated with these retirement plans are not impacted in any way. Proposition 125 does not divert any money to any other government agencies or projects. All Proposition 125 does is change the way increases to CORP and EORP retiree pensions are calculated.
Q: How does Proposition 125 work?
A: Like PSPRS’s Prop 124 from 2016, Prop 125 replaces the flawed permanent benefit increase (PBI) formula that is currently used to calculate increases paid to retirees with a true cost of living adjustment (COLA) for CORP and EORP retirees. This COLA will be based on the annual Consumer Price Index for the Phoenix-Mesa region that is released each year by the U.S. Department of Labor. Under Prop 125, the COLA payments are capped at 2 percent each year.
Q: How are CORP and EORP retiree pension increases currently calculated?
A: Currently, pension increases for the CORP and EORP plans are based on the returns on investments managed by PSPRS (which includes CORP and EORP). Under existing law, half of all annual investment returns above 9 percent are used to generate pension increases for CORP. In EORP, all annual investment returns above 9 percent are used to generate pension increases for retirees. These increases, known as Permanent Benefit Increases or PBIs, can range from a small fraction to 4 percent. Amounts in excess of the cap are distributed to retirees in subsequent years, regardless of investment returns or the overall health of the pension system.
Q: Why should the PBI be replaced with a COLA (cost-of-living-adjustment)?
A: The PBI has proven to be a flawed formula that has contributed to a sharp and alarming decline in the financial health of PSPRS pension plans. The formula siphoned off positive returns in the years where the plans performed well and stored those funds that were excess of the amount needed for the annual PBI payments to retirees in a separate account. Therefore, even in years of large investment losses due to the 2001 Dot.com crash and the market crash caused by the Great Recession in 2008, payments were being paid out to retirees increasing the liabilities of the system. Then, even in years of good returns, the money was being directed out of the underlying system making it hard to recover from the economic downturns. The PBI formula has also been proven to have a disproportionately negative impact on rural communities, which accrue additional expenses that outpace economic growth and hiring.
The PSPRS Board of Trustees endorses Prop 125, as they did with Prop 124 in 2016, because replacing this PBI formula with a true COLA will help get the PSPRS plans back on a path for financial success and health. It is important that the pension plans are sustainable to ensure pensions are there when our public servants retire. The Board of Trustees believes that the COLA-based increase in Prop 125 will provide retirees with consistent and meaningful increases while making PSPRS-managed retirement plans sustainable and affordable for employers and taxpayers.
Q: I am a CORP/EORP retiree on a fixed income. Would a COLA increase my pension more than the PBI?
A: That is difficult to predict as the COLA is based on inflation while the PBI is based on investment returns. This change will replace a conditional benefit that could possibly pay out a higher amount with a more guaranteed benefit that is capped at a slightly lower amount.
With very rare exceptions, the U.S. Department of Labor recognizes an inflation every year. This makes it very probable that a COLA will be implemented each year for retirees.
On the other hand, the investment-based PBIs are much harder to predict. The current assumed earnings rate (AER) of PSPRS is 7.3 percent. This means that investment returns are expected to average 7.3 percent a year over long periods of time, and that returns will exceed this level during some years and fall below in others. As a result, predicting when or how often investment returns will exceed 9 percent in order trigger a PBI – or how much a PBI will increase retirees’ pensions – is next to impossible.
The PSPRS Board of Trustees is most concerned with being able to meet the existing obligations to its retirees and active members and improving the overall health of PSPRS, CORP and EORP. Trustees believe that reforming the PBI mechanism is a key element of bringing long-term sustainability to the PSPRS-managed retirement plans.