Arizona's largest pension fund will require 200,000 members to pay more
Arizona's public-safety pension system faces financial peril because of poor investments and generous retirement benefits. (Wochit)
More than 200,000 teachers, state-government workers and other public-sector employees in Arizona will need to make modestly higher payroll contributions into their pension system.
That could even continue for several years into the future, all because of diminished long-term expectations for the stock market and economy.
The Arizona State Retirement System, the state's largest public pension fund, has reduced its long-term outlook, citing modest expected long-term economic growth that makes big investment gains less likely.
Pension funds face long-term obligations: The Arizona pension fund (and others like it) pay retirement income and health benefits to members, mainly after they stop working. The Arizona fund currently distributes about $3.3 billion annually.
Funding starts with worker and employer contributions: Pension funds receive payroll contributions made by both workers and their employers; in the case of the Arizona State Retirement System, these include cities, towns, counties, school districts, public universities, community colleges and the state government. For the Arizona fund, contributions total about $2.2 billion annually.
Investment returns make up the rest. Pension funds receive an important boost from the income and gains generated by their investments, which typically include a mix of stocks, bonds, real estate, commodities and other assets.
Changes in investment outlooks can alter the need for higher or lower contributions: When a fund's management cuts its outlook for expected investment returns, actuarial standards require the pensionsystem to increase its valuation of future obligations. This can require workers and employers to ante up more money in the form of payroll contributions.
That's what is happening with the Arizona State Retirement System and its 209,000 active members and more than 700 government employers.
The initial increase of 0.3 percent commences with the start of the Arizona pension fund's new fiscal year in July. Someone earning $50,000, for example, will have another $150 deducted from pay annually for this purpose.
Government entities and school systems will make similar contributions on behalf of workers. The person's employer also would pay $150, as contributions are split 50-50.
The Arizona State Retirement System has benefited significantly from the economic recovery since 2009 and the stock market's nine-year rally, notwithstanding the market hiccup in recent weeks. The pension fund topped $40 billion in portfolio assets in mid-January for the first time ever.
But the investment gains realized in recent years aren't likely to continue, at least at the same rate, amid economic growth that remains modest from a long-term perspective. Consequently, the fund is scaling down its projections for future returns.
The fund's management team hasn't turned negative or bearish on the stock market, but big spurts in the past have been followed by cooling-off periods.
"We think the level of the stock market is about right," said Paul Matson, executive director of the pension fund, in a January interview that he affirmed this month. "We think (stock prices) will continue to grow but not at the same rate as in the past few years."
Hikes are rare, but more are possible
Adjustments like this don't happen frequently. From 1981 to 1984, the ASRS assumed it would generate annual investment returns averaging 7 percent. In 1985, it bumped that up to 8 percent. The outlook remained at that level until the latest reduction to 7.5 percent.
When pension funds reduce investment expectations, accounting rules require them to increase estimated future liabilities, which can result in higher contributions by employees and employers who belong to a system.
The Arizona constitution requires public pension plans to follow funding methods and assumptions that are consistent with generally accepted actuarial standards.
Steve Ramos, a retired teacher who monitors the Arizona State Retirement System on behalf of the Arizona Education Association, said he suspects many current employees aren't happy about needing to pay more into the pension plan.
"But ask a recently retired AEA member if they are glad the state made them pay into the ASRS system during their careers (and) the answer would almost certainly be 'yes,'" he said.
Ramos said he feels the contribution hike is justified and appreciates that the increases will be gradual.
"The plan provides for a smooth transition to higher contribution rates over a reasonable period," he said, adding that gradual increases help employees better predict their take-home pay and plan accordingly.
A spokeswoman for the Arizona Education Association, which represents teachers, said she hasn't heard of widespread dissatisfaction with the contribution increase.
Aiming for 7.5 percent
Public-sector pension funds must estimate future obligations, including retirement and health-insurance costs payable to members years down the road. They adjust or "discount" these future obligations by a rate that reflects expected investment results.
Other public-sector pension funds around the nation similarly have lowered their expected returns — to an average 7.4 percent from 8 percent, reflecting reduced investment forecasts ahead.
Even though the Arizona fund generated an average annual return of 9.7 percent from its inception in July 1975 through June 2017 (the most recent numbers available), Matson said that's probably "on the high side" going forward. The fund's management bases its forecast on 30-year outlooks.
Matson said he's neutral on the prospects for most stock markets except for those in Europe, where he feels stocks generally are attractive given rising economic growth. He noted that European shares sell at cheaper price/earnings ratios and other valuation measures compared to those in the U.S.
He's slightly negative or bearish for global bond markets, given the likelihood of rising interest rates, which typically lead to lower bond prices.
Interest rates have pushed upward in recent weeks to a point where the 10-year Treasury note now yields around 3 percent. The Arizona pension fund has complemented its bond-market investments by making more loans directly to small corporations.
The fund continues to hold a broadly balanced mix of investments, including 58 percent of portfolio assets in U.S. and global stocks, plus 25 percent in bonds and direct loans. Most of the rest is invested in real estate and commodities.
Current total contribution rates for pension, health and long-term care are 11.5 percent, per employee and employer, rising to 11.8 percent at midyear.
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The non-profit watchdog Truth in Accounting gave Phoenix and Mesa "D" grades for their financial health. The national group cited pension debt as a key factor.