Thanks to a new state law, the Oro Valley Town Council has until the end of June to approve a plan to pay $22.8 million in pension liabilities for police over the next 18 years.
The Public Safety Personnel Retirement System unfunded liability is the amount of money needed to cover the pensions of local law enforcement officers and firefighters that exceeds a city or town’s current assets. It’s a debt spread out over a set number of years, similar to a home mortgage.
Arizona’s PSPRS was founded in 1968. It’s a state entity responsible for collecting contributions and managing the retirement accounts of each individual, as well as the overall investments and distribution of the funds.
Public pension systems receive funding from three sources: employee contributions, employer contributions and returns on investments.
There are three different tiers in the pension system. Tier 1 covers the public safety officials that have been around the longest. They contribute about 7.65 percent of their salaries to the system, while the city or town covers the rest of the actuarial amount. Tier 2 has officials that pay 11.65 percent of their salaries, and Tier 3 consists of new officers who pay 50 percent.
Advocates for the pension system say that training new recruits on a regular basis reduces overall productivity, so it is not in the best interest of these departments to see a high turnover rate. According to the National Public Pension Coalition, pensions are designed to “promote long-term commitment to the profession,” with benefits increasing the longer an employee stays in the system.
But years of neglecting future costs have put governments across the country in bind. Last year, Gov. Doug Ducey signed a law requiring Arizona jurisdictions to come up with a plan to stabilize Arizona’s public-safety pensions.
“The faster you pay it off, the less money you’re going to end up spending in the long run,” said Christian Palmer, communications director for PSPRS. “We have a lot of municipalities taking a close look at what options they have on an individual basis.”
Certain municipalities, such as Prescott, have established temporary sales tax increases, which take “tremendous bites” out of their unfunded liabilities, according to Palmer. He said local governments are making tough decisions during this budget season, deciding which revenue streams can be utilized to pay their unfunded liabilities.
Oro Valley’s unfunded liability is about 61 percent funded, which means the town has saved $6 out of every $10 needed for all police officers to retire. Going forward, the town council has a few different options to address this ongoing cost.
The town currently pays about $3 million for its minimum annually required contribution, which is based on a 38 percent contribution rate set by a PSPRS actuarial analysis. Palmer said this rate is slightly above the average.
Stacey Lemos, Oro Valley’s chief financial officer, said the town has the ability to contribute more on a voluntary basis. Lump sum payments toward the unfunded liability are one such possibility, which has been addressed in Town Manager Mary Jacob’s recommended budget.
Jacobs recommends using $500,000 of sales tax revenue from the Oro Valley Marketplace. At the May 15 council meeting, councilmember Bill Rodman expressed disagreement with using the money for that purpose.
The previous town council established a policy that allocated any year-end excess dollars in the general fund that accumulated over the 25 percent contingency reserve requirement toward capital funding and paying down the PSPRS unfunded liability.
At the May 22 study session, council member Josh Nicholson suggested paying off the unfunded liability in full using bonds. Lemos said this is a route that other jurisdictions have taken, using “pension obligation bonds” to acquire a fixed interest rate over 20 years.
This would be a much different route than paying directly into the PSPRS, which has seen significant increases in unfunded liabilities across the state over the last two decades.
However, Lemos said she hasn’t done enough research into the pros and cons of it to make a recommendation to the council.
A moving target
The volatility of PSPRS has prompted critics to point fingers at those who manage the system, claiming mismanagement of public dollars. In 2013, Oro Valley’s contribution rate was 18.7 percent of the police department’s payroll, compared to today’s 38 percent. Representatives from PSPRS attribute the increases to a handful of events.
Palmer said the primary reason behind the increase was the 2008 financial market crash, which had an “incredible impact” in reducing the value of the PSPRS assets.
“This was a global financial disaster,” he said.
Secondly, up until 2016, PSPRS had a pension benefit increase formula dictated by state law that was unsustainable financially.
“If we earned more than 9 percent, they took some of that investment, and they gave it out as permanent benefit increases to the retirees,” said Phil Coleman, an employer relationship manager with PSPRS. “So they took one-time money and turned that into compounding benefits for our retirees … So what happened is when we had really good years, we lost money.”
Arizona voters passed a 2016 proposition that changed the formula to make it more sustainable for long-term viability.
Around the same time, PSPRS lost two lawsuits that were filed in response to pension reform in previous years, with judges ruling that the state can’t change a person’s retirement benefits after they have been hired.
Palmer said that caused a significant burden, since PSPRS was required to refund about a quarter of a billion dollars, which negatively affected cities and towns’ unfunded liabilities.
In addition, the assumed earnings rate calculated by PSPRS has seen a decrease over the last few years as they update their actuarial tables. Palmer said a decrease from 7.85 to 7.3 percent makes a big difference, because they are dealing with long-term expenses.
“The statistics we’ve seen has shown that the assumed interest rate on earnings has not been met for a long time,” Budget and Finance Commissioner James Beasley said at the study session. “So we’re dealing with a moving target here.”
Lemos said the actuarial analyses have also shown a change in mortality assumptions. With people now living longer into retirement, pension liabilities have increased over time.
According to the most recent US Census survey on public pensions, more than 25 million people in the U.S. were affiliated with a public pension in 2016 as either a member or a beneficiary. Total contributions have been increasing nationwide.
The deadline to address funding for the PSPRS unfunded liability comes just after the town council called for the addition of eight new police officers over two years. Town staff is currently working to identify options for funding their salaries and related equipment costs.
Lemos said that overall, adding the new officers have a neutral impact on the unfunded liability because the actuarial analysis accounts for a growth in payroll.
“It depends on if these new officers are brand new to the system, they go into the Tier 3 benefit level and for that level they are required to work longer before they receive a pension and the town’s contribution is less than lateral transfers from other agencies in the system,” she said.
The town will hold a public meeting on the upcoming PSPRS funding policy June 19.