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Originally published Sunday, July 16, 2017 at 06:04a.m.

Editor’s note — This is the first in a series of articles looking into the financial woes of the Public Safety Personnel Retirement System (PSPRS), and Proposition 443, the City of Prescott’s sales-tax-increase measure that will be on the Aug. 29 primary ballot.

The first wave hit in 2001-02 with the “dot.com” crash. Soon after, Arizona’s public-safety pension fund was battered again by another, even larger, wave with the 2008-09 “great recession.”

Couple that with the Public Safety Personnel Retirement System’s state-mandated annual 4-percent pension increases, and PSPRS officials say the funding levels faced the “perfect storm” throughout the early 2000s.

The result: The statewide pension fund, which manages $9.1 billion in assets, currently is less than half-funded for its expected pension costs. Information from PSPRS shows the “aggregate funding level” at 49 percent.

These financial issues among others have resulted in massive liabilities for individual employers such as the City of Prescott. The city currently has an “unfunded liability” for its PSPRS pensions of $78 million to $80 million.

In recent years, that growing liability has caused the city’s annual payment to PSPRS to skyrocket (totaling $7.8 million in the current fiscal year), even as the unfunded liability is expected to continue to increase.

Experts say the problems with PSPRS stem from a combination of unique challenges, worldwide financial issues, and, in some cases, questionable financial decisions.

PBI – ‘Good intentions gone bad’

Prescott’s police and fire pensions help to illustrate the fund’s plight: In 2000, pensions for retired Prescott firefighters and their surviving spouses averaged $24,268 per year. By 2016, the average annual pension had grown to $50,908.

Likewise, annual pensions for retired Prescott police officers and their beneficiaries jumped from $23,745 in 2000 to $45,798 in 2016.

Despite the two major economic downturns in the first decade of the 2000s, during which PSPRS investments lost billions, pensions to individual retirees continued to rise – largely through the state-mandated Permanent Benefit Increase (PBI) program.

Indeed, PSPRS officials cite the PBI as the main contributor to the pension fund’s current woes.

Christian Palmer, communications director for PSPRS, said the PBI program dates back to the 1980s and the state Legislature’s attempt to equalize pensions for rural and urban firefighters and police officers.

“The whole reason for it was because they wanted to help rural Arizona – the rural police and firefighters,” Palmer said of the implementation of the PBI. “Chances are that their salary was lower, and as a result their pension was lower.”

For instance, in Bisbee, the average pension in 2000 was $17,280, considerably lower than the state average of $29,503. By 2016, Bisbee’s average pension had grown to $37,591 – more than double the 2000 amount – while the state average had grown to $52,342.

The increases came from a special PBI account, which grew during years of high investment returns. The state law required any PSPRS investment returns of more than 9 percent to go into the PBI “bucket,” Palmer said, from which the pension increases were paid – at a rate of 4 percent of the average pension.

That meant that in 2001, when PSPRS had a minus-16.86-percent investment return, its retirees got a $93.24-per-month raise. Then in 2002, when the fund’s investment return was minus-15.07 percent, retirees got another monthly increase – of $98.17 – which was added onto their previous PBI increases. That continued throughout the early 2000s, including the positive investment years of 2003 through 2007, when pensions grew by $102 to $127 per month.

Then, in 2009, when PSPRS’s investment return was minus-17.73 percent, retirees earned a $138.66 month increase. The upward trend continued through 2012’s minus-0.79-percent investment return, when retirees received a $159-per-month raise. The increases began tapering off in 2013, when retirees received a $121-per-month increase, and then, a $65-per-month increase in 2014, and zero increases in 2015 and 2016.

Palmer explained that because of double-digit investment returns in the 1980s and 1990s, and some years of the 2000s, “the PBI became almost a permanent fixture.”

That served to siphon off the buffer that normally would have allowed the fund to weather the bad years.

“PBI was the real killer of the PSPRS funding level and overall financial health,” Palmer said.

The PBI program has since gone away with Proposition 124, approved by voters in 2016, which replaced the 4-percent increases with cost-of-living increases, based on the Consumer Price Index, and capped at 2 percent.

Magnified real estate impacts

Compounding the PSPRS’s asset losses during the housing crash of 2008 and 2009 was the system’s heavy investment in real estate.

An April 2017 online message to PSPRS members and employees stated: “PSPRS, in the early 2000s, and before any of the current staff, board, or consultants were around, invested heavily in Arizona real estate, buying undeveloped land in the hope of building projects like golf-course anchored new communities and retail facilities.”

So, when the housing market crashed – hitting especially hard in Arizona – the pension fund was especially vulnerable, said Ryan Parham, the chief investment officers for PSPRS.

He noted that PSPRS’s real-estate holdings included office buildings, retail centers, master-planned communities, and other residential-type properties – mostly in Arizona, and heavily centered in the Phoenix area.

PSPRS’s real-estate investments go back 20 years or so, and ultimately totaled a value of about $700 million, Parham said, adding that the holdings represented about 8 to 10 percent of PSPRS’s assets at the time.

When the crash hit in 2007, 2008, and 2009, Parham said values of many of the real estate properties dropped by 40 to 70 percent.

Because of a lack of buyers at the time, Parham said, if PSPRS had tried to sell the properties, the system may have recovered as little as 10 cents on the dollar.

Rather than engaging in a “fire sale,” PSPRS opted to try to stabilize the assets, Parham said. To help deal with those “legacy” real estate investments, PSPRS hired Desert Troon to manage the properties.

Over time, Parham said about 70 percent of the legacy properties have been sold – some at about 78 or 79 cents on the dollar of the original investments. Decisions on when to sell are based on current offers, as well as whether the proceeds could be better re-invested in higher-performing assets.

Currently, Parham said PSPRS has about 10 percent of its assets invested in real estate, largely in co-mingled funds that have 10 to 20 institutional investors – an approach that he said is “more diversified.”

Shifting demographics

Along with the massive investment-asset losses that PSPRS suffered in the two financial crashes of the early 2000s, the fund also is dealing with a related impact: A shifting demographic.

As local governments were feeling the pinch of the 2008-09 recession, they were imposing hiring freezes, and laying off employees.

Statewide, that led to a significant shift in the ratio of active employees to retirees. In 2000, PSPRS had 2.7 active members per pension; by 2016, that had dropped to 1.6 active employee for every pension.

In Prescott, the shift was even more dramatic. Actuarial numbers show that Prescott Fire had 52 active firefighters in the system in 2000, and 29 pensions. By 2016, the fire department had 49 active employees and 65 retirees and beneficiaries.

The Prescott Police Department had 58 active employees in 2000, and 30 retirees and beneficiaries. By 2016, there were 57 actives and 62 retirees and beneficiaries.

When Prescott Mayor Harry Oberg appeared before the state Legislature’s ad hoc committee on the PSPRS in Flagstaff in late June, he emphasized the significant staff reductions that the city had made in response to the recession, as well as to the rising annual costs of PSPRS.

In 2009, and again in late 2015, for instance, the city eliminated and/or froze a number of positions in the police and fire departments.

Follow Cindy Barks on Twitter @Cindy_Barks. Reach her at 928-445-3333, ext. 2034, or cbarks@prescottaz.com.

(Watch for future installments of this series on: PSPRS reform efforts; details of the Proposition 443 sales tax; opposition views; and what happens if the sales tax measure fails.)