Pension Sustainability: Arizona

Analysis of Arizona's policies

As of June 30, 2009, the most recent date for which an actuarial valuation is available, Arizona's pension system for teachers is 79 percent funded and has a 30-year amortization period. This means that if the plan earns its assumed rate of return and maintains current contribution rates, it would take the state 30 years to pay off its unfunded liabilities. While its amortization period meets regulatory benchmarks, Arizona's funding level is just below the conventionally recommended minimum funding level of 80 percent. The state's system is just short of being financially sustainable according to actuarial benchmarks.

In addition, Arizona commits excessive resources toward its teachers' retirement system. The current employer contribution rate of 10.10 percent and employee contribution rate of 11.39 percent are each too high, in light of the fact that local districts and teachers must also contribute 6.2 percent to Social Security. The rate is determined according to statutory requirements, which mandate that the employer contribution rate must equal the cost to fund this year's expenses (the normal cost) plus any amount needed to amortize any unfunded liabilities over a 30-year period. While these rates allow the state to pay off liabilities within 30 years, it does so at great cost, precluding Arizona from spending those funds on other, more immediate means to retain talented teachers.

Citation

Arizona State Retirement System, Comprehensive Annual Financial Report https://www.azasrs.gov/content/pdf/financials/2010_CAFR.pdf Arizona State Retirement System Contribution Rates https://www.azasrs.gov/web/ContributionRates.do

Recommendations for Arizona

Ensure that the pension system is financially sustainable.
The state would be better off if its system was over 95 percent funded to allow more protection during financial downturns. However, Arizona should consider ways to improve its funding level without raising the contributions of school districts and teachers. In fact, the state should work to decrease contributions. Committing excessive resources to pension benefits can negatively affect teacher recruitment and retention. Improving funding levels necessitates, in part, systemic changes in the state's pension system. Goals 4-G and 4-I provide suggestions for pension system structures that are both sustainable and fair.

State response to our analysis

Arizona maintained that the Arizona Constitution (Article XXIX, Section 1.A.) requires retirement benefits to be funded with contributions and investment earnings using actuarial methods and assumptions that are consistent with generally accepted actuarial standards. Accordingly, the funded status of the Arizona State Retirement System (ASRS) will gradually improve due to the actuarial assumptions in place and therefore continue to keep the ASRS financially sustainable.

The state asserted that systemic changes have been proposed by the ASRS to the legislature since 2003. Collectively, these changes are expected to reduce the total contribution rate by over 3 percent and reduce long term liabilities by $5 to $7 billion. A legislative study committee has also been created to analyze the public pension plans in Arizona and to consider more suggestions.

Further, Arizona stated that the ASRS has exceeded its annual rate of return expectation (8 percent) in 20 of the past 30 years. During that time, members and employers benefited from contribution rates as low as 2 percent. The ASRS was well over 100 percent funded when the downturn began in 2001. Of the 10 years where the expectation was not met, five have occurred in the last decade. 

In Arizona, public employers have always made their actuarially required contributions as required by the constitution, which has kept the ASRS in relatively good financial condition. The ASRS, along with many other pension plans, mitigates contribution rate volatility by "smoothing" its investment returns over a 10-year period. 

Last word

NCTQ maintains that Arizona's funding ratio is slightly below suggested benchmarks and commends the state for maintaining a 30-year amortization period. However, this analysis shows that the contributions necessary to fund a system of this format place a considerable burden on teachers and school districts.