Defined Contribution and Retirement Study Committee

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ARIZONA STATE LEGISLATURE

Fiftieth Legislature – First Regular Session

DEFINED CONTRIBUTION AND RETIREMENT STUDY COMMITTEE

Minutes of Interim Meeting

Tuesday, December 13, 2011

House Hearing Room 1 -- 3:00 p.m.

Chairman Ducey called the meeting to order at 3:04 p.m. and attendance was noted by the secretary.

Members Present

Honorable Doug Ducey, Chairman Lauren Kingry

Senator Linda Gray Alan Maguire

Senator Steve Yarbrough Scott Smith

David K. Byers Brian Tobin

Members Absent

Senator Jack Jackson Jr. Representative Chad Campbell

Honorable Beth Ford Representative Justin Olson

Representative David Stevens

Chairman Ducey thanked the Members for their time, commitment and dedication. He said the information presented so far has been educational and part of the information-gathering process so the Committee can do a thorough job of completing the five tasks that are required (Attachment 1). The Committee’s objective is to protect the pension program and system, along with benefits, for existing and future retirees.

Review and follow-up on any questions from the previous meeting

Mark Swenson, Deputy Treasurer, reviewed a handout, Review and Follow Up
December 13, 2011 (Attachment 2) containing responses to questions on the following items:

Legacy Defined Benefit Costs in Other States
Summary of Funded Status (Arizona State Retirement System [ASRS], Public Safety Personnel Retirement System [PSPRS], Corrections Officer Retirement Plan [CORP] and Elected Officials’ Retirement Plan [EORP])
Follow-up on Salary Spiking (ASRS) (the same data will be requested from 240 plus employers in the PSPRS, which may require a letter signed by Chairman Ducey)
Multi-Employer Plan Consolidation
Disability Claim History (PSPRS and CORP) (there is not enough data to compare disability claims from larger PSPRS employers with smaller employers, which staff will work on for the next meeting, as well as finding out the cost of individual local disability boards)

Chairman Ducey thanked the staff for doing a thorough job in obtaining the data.

Mr. Byers indicated that it would be helpful to know the percentage of denied disability claims and whether it makes a difference if a local or professional board makes the determination.

In response to questions, Mr. Swenson acknowledged that the State of Michigan will continue to fund and pick up costs for retirees and employees that remain in the Defined Benefit (DB) plan until there is no longer any participation; however, staff is researching to determine if any existing percentage of payroll of new employees is being set aside to cover the costs.

Mr. Maguire stated that he is surprised by the number of follow-up items because he was not aware that information was needed. He made the following points:

According to testimony and the mathematics presented, there is no cost savings from conversion of a DB structure to a Defined Contribution (DC) structure.
The savings, or lower cost to employers and employees in current and future contribution amounts, occurs only because of lower benefit levels, not the conversion.
DB plans that rely on self-directed investment decisions by employees will almost definitely have lower long-term investment rates of return, resulting in lower post-retirement benefits that likely will be inadequate for retirees.
Conversion from a DB to a DC structure does not eliminate liability for current benefits accruing or prior accumulative unfunded liability.
Arizona public employee retirement systems are structurally and financially different than most public retirement plans in other states, therefore, any national comparisons have little or no relevance to Arizona and are frequently misleading.
Most private sector DC plans have lowered the current contribution amounts, and consequently, lowered the benefit levels, resulting in lower post-retirement income levels that will generally be inadequate for retirees; therefore, comparing private systems has little or no relevance to the Arizona public retirement systems and is misleading.
There is an underfunded situation in Arizona because the Legislature proposed and enacted benefit increases in the systems over the objection and advice of knowledgeable people.
There has been a chronic underperformance of investment portfolios in Arizona relative to the assumed rate of return, which the Members could consider studying.
The Legislature, in order to benefit the General Fund, allowed the contribution rates to become artificially low for a long period of time, which resulted in underfunding, in combination with the other factors.
With regard to the PSPRS, a major contributing factor has been the post-retirement benefit adjustment, which is something else the Committee could study.

Mr. Maguire submitted that the information presented could have been taken from a sample of recent retirees. He has heard from multiple employers asking him what is going on at the state because the message is being sent to hundreds of thousands of public employees in Arizona that the retirement plans are at risk when they should not be at risk.

Chairman Ducey indicated that neither he nor any member of the Board of Investment asked for this task, but he plans to conduct a thorough analysis of the first item outlined in the charge of the Committee (Attachment 1), with no predetermined path.

Mr. Maguire submitted that much of that analysis was recently done by both of the major retirement systems in Arizona. This issue has been addressed at least three or four times and the numbers always come out the same. This is not a complicated analysis but it is being dragged on much more comprehensively than is needed. He asked that the interim report include his statements, especially the fact that it has been learned that there are no cost savings from DB to DC conversions; there are cost savings from benefit reductions.

Mr. Byers said he is not sure what the spiking data tells the Committee and questioned why it is necessary to ask so many PSPRS employers for more data. Mr. Swenson answered that according to various newspaper articles about retirement issues, there is a perception that overtime is a prime reason for spiking, but ASRS data shows that is not the case. The only purpose of obtaining data from PSPRS is to see if the data is consistent in response to questions Members asked publicly and privately.

Mr. Maguire submitted that can be accomplished by reviewing data from a randomly-selected sample of recent retirees. The problem is caused by changes in compensation at the end of a career and it is potentially more likely in some of the public safety-related systems than in the ASRS, although it has happened in both.

Mr. Byers agreed, stating that sending a letter may cause PSPRS employers to do work that is not useful or helpful. Spiking has been reviewed in ASRS and there have not been any signs of systematic strategic spiking; there may only be a few individuals, even in the school districts.

Mr. Swenson replied that perhaps a subset of PSPRS can be reviewed. Charges 3 and 5 (Attachment 1) may also be done with a subset, as well as the cost of the local disability board system from a sampling methodology.

Mr. Tobin opined that more information on spiking is not needed. Chairman Ducey indicated that he prefers that staff over-analyze since the Committee is trying to protect billions of dollars in the pension program. The Committee was tasked by the Legislature, and staff in his office and legislators can limit what is studied, but if any Member wants follow-up on any of the five charges, the requested information should be provided.

Senator Gray stated that the second charge of the Committee relates to merging the funds. The draft interim report (Attachment 3) states that the Legislature addressed this in 2009 by allowing ASRS to offer a consolidated plan on a voluntary basis for each school district and charter school to participate.

Pat Kline, Assistant Director, External Affairs, Arizona State Retirement System (ASRS), advised that legislation allowed ASRS to offer a program. As far as the intent to have a consolidated program for employers, ASRS offered it alongside of or in replacement of whatever the employer currently offered. Most employers offered it alongside what is currently offered. It has not been offered as a sole program, probably for political reasons.

Mr. Maguire stated that all of the school districts are in a consolidated DB plan already so there was no option to consolidate; the only option dealt with the additional benefit, which is like a health insurance benefit in the sense that the employee makes a decision to participate in the program, and there is not the same transference of monies between jurisdictions as in consolidation of a DB plan. Mr. Kline agreed that it is an “apples and oranges” comparison.

Presentation on survey of private sector defined benefit versus defined contribution coverage in Arizona

Chairman Ducey noted that SB1609 - retirement systems; plans; plan design (Laws 2011, Chapter 357) tasks the Committee with examining public and private DC plans in other states, including plan designs.

Kevin Donnellan, Legislative Liaison, State Treasurer’s Office, indicated that staff conducted an informal survey to better understand what types of plans private sector companies in Arizona offer to employees. He reviewed the survey results, Arizona Private Sector DC vs. DB Retirement Plan Survey Results December 13, 2011 (Attachment 4).

Mr. Maguire noted that the section on DC plans indicates that employer contribution rates vary from zero up to six percent matching, which would imply a twelve percent payment to the future retirement benefit for those employees and would be a very low rate of post-retirement income. The data shows that DC plans have lower post-retirement benefits than typical DB plans.

Senator Gray noted that employees in the PSPRS do not pay into Social Security like employees in the other retirement plans, which makes a big difference when comparisons are made.

Mr. Swenson added that by law all private employers pay into Social Security, but public and religious employers can opt out of Social Security. Staff has been compiling data to rank states by contribution level for those with Social Security and those without.

Mr. Maguire said in ranking systems, only normal costs should be included, which is a valid comparison between systems. The total contribution rate is distorted by amortization of the unfunded liability, which reflects many other choices.

Mr. Byers noted that most DC plans charge a 2.5 to 3 percent fee to employees, which is not always obvious. A DC plan could probably be created with reasonable costs, but many brokers charge huge fees and employees and teachers lose that money.

Chairman Ducey said that is a good point that should be followed up.

Motion to delegate to the State Treasurer’s Office selection of consultants and entering into agreements for actuarial studies and related work

Chairman Ducey indicated that the motion will fulfill the first charge relating to the feasibility and cost of transferring existing members of the public retirement system. SB1609 provided the Treasurer’s Office with an appropriation to hire the necessary resources.

Mr. Maguire said he believes that was part of the analysis done last year in anticipation of the Legislature’s work on reforming the system, which included costs associated with closing the plans. He has seen the same information from ASRS that is somewhat outdated, but if it was recently updated, perhaps it could be presented to the Committee. He pointed out that the state already has DB and DC plans in place for most public employees even though it is not called a DC plan, but a deferred compensation plan. It may be appropriate to see if it makes sense to convert existing DC plans over time to a system like the DC plan in Utah.

Chairman Ducey asked if the legislators will accept a study conducted before the bill was passed, although that is not how he reads the charge to the Committee.

Mr. Swenson indicated that an independent actuary would be found to confirm the integrity of data already in existence for ASRS and PSPRS, not to replicate the actuarial data.

The Members discussed whether or not to contract with an actuary, raising the following points:

A second actuary audits the main actuary every five years, which is expensive.
The Legislature hired an auditor to audit both systems several years ago.
An analysis was done by PSPRS on the cost of closing the DB plan, which ASRS has probably done as well.
If a new actuary is contracted, much of the money will be used by the new actuary to become knowledgeable about the retirement systems.
If there is no cost savings to transfer to a DC plan, but there is a cost to close down existing DB plans, the answer to the charge is that it is not feasible.

Mr. Maguire submitted that discussion about a lower benefit level for public employees going forward would be valid, and if the Committee decided on a lower benefit level, it can be looked at in the context of a DB or DC plan. The cost of closing the system is merely the difference between current liabilities and current assets, which is the unfunded liability that has to be paid off over time.

Chairman Ducey said he appreciates the comments, but no one has suggested lowering or diminishing benefit plans; there has only been discussion about the cost of transfer and feasibility. If actuarial studies exist, those should be presented to the Committee.

Mr. Byers speculated that many legislators believe a DC plan is cheaper, so the charges of the Committee are based upon a false premise. Part of the Committee’s responsibility is to inform legislators that it is not cheaper.

Senator Gray commented that she prefers not to spend the appropriation on another actuarial study.

Mr. Byers said he would like staff to provide a presentation on the cost to close the systems, which is what will be done by shifting to a DC plan, as well as the cost to create a DC plan.

Chairman Ducey stated that the motion will be postponed until the next meeting.

Senator Gray stated that there is no opportunity for spiking by teachers. She said she would like to know more about policies on spiking in the different public safety entities rather than actual numbers, which Chairman Ducey indicated will be provided at the next meeting.
Mr. Tobin noted that SB1609 changes the average pension calculation from three years to
five years, so spiking has been addressed in most cases.

Mr. Smith related that some spiking will be seen in the Arizona Department of Administration personnel system with employees who accumulate annual leave that is cashed out upon retirement. That is probably good because there would be huge productivity losses if people begin using annual leave as retirement nears. Mr. Byers pointed out that annual leave in the ASRS cannot be cashed out upon retirement unless the employee was hired before 1984, to which Mr. Smith agreed.

Senator Gray stated that City of Phoenix law enforcement employees can cash out annual leave, which counts as spiking. Mr. Tobin agreed but indicated that there are thresholds in order for those payouts to occur and, in most cases, employees must have hundreds of hours already accumulated.

Discussion and approval of study committee interim report

Chairman Ducey noted that a draft report (Attachment 3) was sent to each Member containing a summary of what the Members reviewed to date. He acknowledged that Mr. Maguire would like his comments included in the report. He said he will add his own comments on what the Committee is studying as specifically charged in SB1609.

Mr. Tobin moved the interim report submitted by Chairman Ducey to the floor for discussion.

Mr. Swenson noted that the draft interim report contains some grammatical errors.

Chairman Ducey called for a motion to approve the interim report with grammatical corrections and inclusion of his and Mr. Maguire’s comments.

Mr. Maguire related that he will abstain from voting because he did not find the report in the documents he received.

Question was called on the motion to approve the interim report with grammatical corrections and inclusion of comments by Chairman Ducey and Mr. Maguire. The motion carried by a vote of 5 ayes, 1 nay and
1 abstaining.

Public Testimony

Chairman Ducey said that regardless of comments from Members of the Committee, he has no preconceived notion of what should or should not be done to the pension system. His role is to protect the benefits for people who earned the pension, are currently retired or will be retiring in the future.

Byron Schlomach, Economist, Goldwater Institute, in regard to Mr. Maguire’s comments regarding uncertainty, said that given the seriousness with which the lawyers at
Goldwater Institute take contract rights, he is not sure the Members would not have to worry about a lawsuit if the Committee begins tampering with current retiree benefits. As to current employees, a constitutional provision limits the Legislature’s degree of freedom. He added that the DB system pits employees and retirees against taxpayers. It does cost to move to a DC system, limited to only new employees, but that is because the system is as much cash flow as it is an investment system.

Virginia Brant, representing self, stated that she appreciates the ASRS system. If existing actuaries can provide the information the Committee needs, she does not know why extra money should be spent.

Joe Carter, All Arizona School Retirees Association, stated that cost savings are realized from benefit reduction, not necessarily from the type of plan. Paul Matson from ASRS stated in his presentation that the current average pension is slightly under $20,000. There have been articles in the newspaper about individuals taking home six-figure pensions, but those must be anomalies or the average pension would be much higher. He suggested that as the Committee discusses reduction of benefits, the Members look at the average and perhaps medium pensions for retirees in the systems, but keep in mind that people have planned on the pensions, in most cases, for decades.

Sigrid T. Whitman, All Arizona School Retirees Association, submitted comments that were read by Chairman Ducey indicating that she supports the ASRS DB plan. She noted that employees formerly paid a contribution rate of 50 percent, which has been raised to 53 percent. The DB plan provides security, in addition to Social Security, for retirees. It would be very costly to convert to a DC plan.

Tim Hill, President, Professional Fire Fighters of Arizona, testified that the PSPRS is basically the totality of retirement security for fire fighters who do not receive Social Security. Fire fighters hired before 1986 will never receive Medicare, and those who will receive Medicare will not be eligible for many years, which causes an enormous financial burden when the members retire. The cost of closing the system, which affects the feasibility of transferring to a DC system for existing and future members, was answered by actuaries when SB1609 was passed. The Committee is charged with studying the feasibility not automatically contracting with an actuary; however, the money is available if it is needed.

Mr. Hill remarked that the cost-of-living adjustment has been eliminated for most retirees with nothing to help employees keep up with increased costs for health insurance and Medicare. The employee contribution rate was increased and, as Mr. Tobin mentioned, spiking has been resolved by the fact that a five-year salary period is now evaluated rather than three years so someone would have to work many hours of overtime to impact the final pension calculation.

Mr. Hill added that it would be helpful to those affected by proposed changes if Committee information is posted online so people are more prepared to discuss any impacts.

Chairman Ducey related that documents the Committee is reviewing will be posted on the website for complete clarity and transparency. He thanked the Members for attending and the people who testified. He stated that the next meeting will be held in 2012 and his assistant will contact the Members with potential dates.

Mr. Maguire made the following remarks:

· It would be useful for the Committee to discuss the definition of compensation and its components in the Arizona retirement systems in a historical context.

· Any further discussion about consolidation of the public safety system should be limited to consolidation of administration and disability terminations.

· The Members should discuss DC systems, particularly in the private sector, the contribution rates, computed future retirement income and how much lower it is than the DB plans currently offered.

· The Committee has an obligation to help the Legislature understand the subjects that are part of its charge.

He added that he is aware that Chairman Ducey did not ask for this task, but he has done an excellent job of chairing the Committee in a fair and balanced manner.

Without objection, the meeting adjourned at 5:04 p.m.

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Linda Taylor, Committee Secretary

December 21, 2011

(Original minutes, attachments and audio on file in the Chief Clerk’s Office; video archives available at http://www.azleg.gov)

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DEFINED CONTRIBUTION AND

RETIREMENT STUDY COMMITTEE

December 13, 2011

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