Arizona’s recent
project to improve the solvency of its public safety pension
plan is a notable fiscal achievement. With the passage of
Senate Bill 1428, the state legislature has moved to slash the
volatility of new hire contribution rates for local government
employers by 50%, while simultaneously reducing the total
forecasted accrued liabilities of the pension plan as a whole by
more than a third over the next three decades.
The same pension reform effort installs a less expensive, more
sustainable new tier of benefits and fixes a structurally unsound
system for post-retirement benefit adjustments that was threatening
the solvency of the plan.
And perhaps most notably, the pension reform package earned the
endorsement of many public safety labor unions statewide because it
is also providing secure retirement benefits for current and future
employees.
The ideal public sector pension reform always includes reducing
taxpayer exposure to risk, ensuring the cost for government
employers is affordable and stable, and providing sustainable and
secure retirement for current and future employees. But rarely does
a pension reform effort accomplish all of these in one multifaceted
package, as Arizona has done with the reform to its Public Safety
Personnel Retirement System (PSPRS).
The details behind the Arizona SB1428 pension reform effort are
worth considering in detail, particularly changes to the
affordability of benefits, the volatility in employer costs for
benefits, and the post-retirement adjustment of benefits.
Affordability of Pension Benefits
Arizona’s reform creates a new, more affordable tier of benefits
for police, fire and other hazardous duty personnel hired on or
after July 1, 2017. New public safety hires into PSPRS will be
offered a choice between a Defined Contribution Only Plan
and a Defined Benefit Hybrid Plan.
The Defined Contribution Only Plan offers employees a
tax-deferred, professionally managed, portable 401(a) account with
a menu of investment options to select from, based on risk
tolerance and retirement goals. Under this option employers and
employees each contribute 9% of compensation (i.e., monthly pay
checks), creating one of the most attractive public safety
retirement options in the country.
The Defined Benefit Hybrid Plan offers employees a traditional
pension benefit based upon years of credited service at retirement
or termination, the member’s final average compensation, and a
defined benefit multiplier. This is similar to the existing defined
benefit plan, but with several key differences that improve
affordability:
(1) New Multiplier Formula: New employees who work for
at least 15 years will receive a benefit multiplier of 1.5%, with
the multiplier stepping up every two to three years. New employees
who work a full career of 25 years will receive a 2.5% multiplier,
which is equivalent to the benefit provided to current employees
and retirees. (See our full
analysis of the PSPRS reform for the complete schedule.)
(2) Pensionable Pay Cap: Compensation that can be
considered for determining a pension benefit will be capped at
$110,000 for new hires, as compared to the cap for current hires of
$265,000. The cap can increase every three years at the same rate
as the change in the upper limit of pay scales (salary ranges) for
public safety positions during the same period-estimated to be 1%
average annual growth.
(3) 50/50 Cost Sharing: All normal costs,
administrative costs, and any potential unfunded liability
amortization payments for new hire benefits will be split evenly.
Currently, employees have a fixed contribution rate and taxpayers
bear all the risk of unfunded liabilities.
(4) Retirement Eligibility: New employees will be able
to retire at any age, with their benefit based on years of service
to that point, but they won’t be eligible to start receiving their
benefits until age 55, compared to 52.5 years old currently.
Employees can elect to have their benefits start at age 52.5, but
the benefit will be an actuarially equivalent amount, as if
payments started at age 55 (i.e. the monthly amount will be
reduced). Collectively, this means that assets will remain in the
plan longer to earn investment returns.
(5) COLA Charge Included in Normal Cost and Linked to Funded
Status: Retirement benefits are eligible for a cost-of-living
adjustment (COLA) up to 2% based on local rates of inflation, and
the costs of providing this benefit will be included in normal
cost, effectively pre-funding the benefit. This contrasts with the
Permanent Benefit Increase (PBI) scheme in which benefit increases
were not prefunded (see below for our full critique)