Pre-Paying Pension Debt in Arizona
Overview of Key Terms
By Rushda Mustafa
Actuarial Value of Assets (AVA): The current value of all assets held/invested by a pension fund to generate returns and make benefit payments to retirees
Actuarially Accrued Liability (AAL): The value in today’s dollars of all future benefits payable to current and future retirees
Paying off unfunded pensions as soon as possible can save a municipality significant General Fund dollars. Pension bonds may be a tool to pre-fund employer contributions to the two state-wide retirement systems, the Public Safety Personnel Retirement System (PSPRS) and the Arizona State Retirement System (ASRS). As an allocated costs plan, PSPRS has benefited from over $1.9 billion in supplemental pre-payment contributions from participating employers since 2020. ASRS is in the process of launching a voluntary Contribution Pre-Funding Program (CPP) for employers to make supplemental contributions to the system in exchange for guaranteed offset credits. What Is Pension Debt, and How Is It Impacting Municipalities? Legacy unfunded pensions are a debt growing at the actuarial rate. Any unfunded portion of a pension liability represents a dollar that cannot be invested to grow like other plan assets. Thus, the opportunity cost of lost investment earnings becomes the “interest” that accrues on the unfunded liability (UAAL) every year it remains outstanding. An example is a debt growing at the actuarial rate that must be amortized. Because of the steep debt accrual (7% to 7.50%), even as municipalities continue making accelerating payments every year, they are not making significant headway in paying off the UAAL. In Arizona, municipalities participate in the Public Safety Personnel Retirement System (PSPRS) and Arizona State Retirement System (ASRS). PSPRS is an allocated costs plan – which means each employer has a distinct liability and payment profile – while ASRS is a pooled, cost-sharing plan, whereby all participating employers pay the same annual contribution rate into the System.
Funded Ratio: The ratio of AVA to AAL; 100% funding implies Assets = Liabilities Actuarial Rate: The assumed rate of return on a pension plan’s assets; typically between 7.00% to 7.50% Unfunded Actuarially Accrued Liability (UAAL): The difference between the AAL and AVA. The UAAL is a debt accruing at the Actuarial Rate. This debt has to be repaid by a municipality like any other loan (UAAL Payment) Pension Cost: The current year’s cost (Normal Cost) + Past accrued costs being amortized (UAAL Payment)
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