Performance audit and sunset review, Arizona State Retirement System

              Performance Audit and Sunset Review
Arizona State
Retirement System
Performance Audit Division
Debra K. Davenport
Auditor General
SEPTEMBER • 2005
REPORT NO. 05 – 09
A REPORT
TO THE
ARIZONA LEGISLATURE
The Auditor General is appointed by the Joint Legislative Audit Committee, a bipartisan committee composed of five senators
and five representatives. Her mission is to provide independent and impartial information and specific recommendations to
improve the operations of state and local government entities. To this end, she provides financial audits and accounting services
to the State and political subdivisions, investigates possible misuse of public monies, and conducts performance audits of
school districts, state agencies, and the programs they administer.
The Joint Legislative Audit Committee
Senator Robert Blendu, Chair Representative Laura Knaperek, Vice Chair
Senator Carolyn Allen Representative Tom Boone
Senator Gabrielle Giffords Representative Ted Downing
Senator John Huppenthal Representative Pete Rios
Senator Harry Mitchell Representative Steve Yarbrough
Senator Ken Bennett (ex-officio) Representative Jim Weiers (ex-officio)
Audit Staff
Melanie Chesney, Director
Lisa Eddy, Manager and Contact Person
Chris Horton
Nate Martinez-Wayman
Michael Nickelsburg
Copies of the Auditor General’s reports are free.
You may request them by contacting us at:
Office of the Auditor General
2910 N. 44th Street, Suite 410 • Phoenix, AZ 85018 • (602) 553-0333
Additionally, many of our reports can be found in electronic format at:
www.auditorgen.state.az.us
2910 NORTH 44th STREET • SUITE 410 • PHOENIX, ARIZONA 85018 • (602) 553-0333 • FAX (602) 553-0051
DEBRA K. DAVENPORT, CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
WILLIAM THOMSON
DEPUTY AUDITOR GENERAL
September 14, 2005
Members of the Arizona Legislature
The Honorable Janet Napolitano, Governor
Mr. Paul Matson, Director
Arizona State Retirement System
Transmitted herewith is a report of the Auditor General, A Performance Audit and Sunset Review
of the Arizona State Retirement System (ASRS). This report is in response to a November 20,
2002, resolution of the Joint Legislative Audit Committee. The performance audit was conducted
as part of the sunset review process prescribed in Arizona Revised Statutes §41-2951 et seq. I am
also transmitting with this report a copy of the Report Highlights for this audit to provide a quick
summary for your convenience.
As outlined in its response, ASRS agrees with all of the findings and plans to implement all of the
recommendations.
My staff and I will be pleased to discuss or clarify items in the report.
This report will be released to the public on September 15, 2005.
Sincerely,
Debbie Davenport
Auditor General
Enclosure
Services:
The Arizona State Retirement System (ASRS) provides pension, disability, survivor, and retiree
health insurance benefits, and educational services for most public sector employers in Arizona,
including state universities, community colleges, public school districts, local and county govern-ments,
and the State of Arizona. As of June 30, 2005, ASRS had over 400,000 members, includ-ing
nearly 70,000 retirees. ASRS provides these services through four different programs:
􀁺􇩍 Member Services comprises the Member Services,
Financial Services, and Information Services
Divisions. These divisions are responsible for the core
functions of ASRS including the calculation, disburse-ment,
and coordination of retirement, retiree health
insurance, disability, and survivor benefits as well as
refunds of member contributions. Member Services
also responds to telephone, Internet, and in-person
inquiries and provides educational services to mem-bers
throughout the State.
􀁺􇩉 Investment Management is responsible for oversee-ing
the investment of ASRS Retirement Fund (Fund)
assets. ASRS manages 30 percent of the Fund inter-nally
and monitors the rest of the Fund’s external
management.
􀁺􇩁 Administration and Support comprises the various
administrative functions needed to support the
agency. Its responsibilities include human resources,
budgeting, internal auditing, and legal counsel.
􀁺􇩉 Information Technology Plan is a business plan con-taining
the development of the Public Employee
Retiree Information System (PERIS), Internet
Applications development, implementation of an
Electronic Document Imaging Management System
(EDIMS), and ongoing maintenance and upgrades to
telephone and network technology.
Facilities and equipment:
ASRS owns two buildings: the 3300 Tower in Phoenix where
ASRS’ main offices are located, and the building where its
Tucson offices are located. The 3300 Tower is a 360,000-
square foot office building worth $23.2 million. The building
that ASRS owns in Tucson has nearly 53,000 square feet and
is worth $2.8 million. ASRS also owns typical office and call
center equipment.
PROGRAM FACT SHEET
Arizona State Retirement System
Investment
Management—8 FTE
(1 vacancy) Information Technology
Plan—18 FTE
(3 vacancies)
Administration and
Support—33 FTE
(2 vacancies)
Member
Services—138 FTE
(17 vacancies)
Program revenue:
$23.9 million (fiscal year 2005, estimated)
Program staffing:
197 FTEs as of June 30, 2005 (including 23 vacancies)
Office of the Auditor General
$20
$21
$22
$23
$24
$25
$26
$27
$28
$29
$30
FY 2003 FY 2004 FY 2005 (est.)
Millions
ASRS board members:
ASRS is overseen by a board of directors that consists of nine members appointed by the
Governor and confirmed by the Senate. Of the nine board members, four members must have
substantial experience in economics, finance, or investment.
􀁺􇩆 Five of the board members must be ASRS members and must include an educator, a
retired member, and employees of the State and a political subdivision.
􀁺􇩆 Four other members must represent the public and cannot be ASRS members.
Vision:
“For the benefit of our members, the Arizona State Retirement System will be a leading state
benefit plan administrator in the areas of:
􀁺􇩃 Core Member Services
􀁺􇩆 Funded Status
􀁺􇩉 Investment Performance
􀁺􇩏 Operational Effectiveness
This will be accomplished while keeping program benefits and associated costs relatively
aligned and maintaining actuarial and fiscal integrity.”
Adequacy of goals and performance measures:
ASRS has 18 goals and 111 performance measures for its 4 programs. A review of ASRS’ mis-sion,
goals, and performance measures indicates that they align with each other. ASRS includes
all recognized performance measures: input, output, efficiency, and quality. The performance
measures also cover areas central to ASRS’ mission such as the timeliness and accuracy of
refund calculations and payments, call center operations, and the performance of investments.
While ASRS’ internal strategic plan includes goals for the time it takes to pay a new retiree his or
her first check and for that first check’s accuracy, it does not have externally reported perform-ance
measures in these areas. Since these are critical functions, ASRS should consider includ-ing
measures of the timeliness and accuracy of its initial retirement benefit payments.
Source: Auditor General staff compilation of unaudited information obtained from the Arizona Financial Information System (AFIS) Accounting
Event Transaction File for the years ended June 30, 2003 and 2004; agency-prepared financial estimates for the year ended June 30,
2005; Arizona Revised Statutes; and other information provided by ASRS.
State of Arizona
The Office of the Auditor General has conducted a performance audit and sunset
review of the Arizona State Retirement System (ASRS) pursuant to a November 20,
2002, resolution of the Joint Legislative Audit Committee. This audit was conducted
as part of the sunset review process prescribed in Arizona Revised Statutes (A.R.S.)
§41-2951 et seq.
Established in 1953, ASRS contributes toward members’ long-term financial security
by providing retirement, disability, survivor, and retiree health insurance benefits.
ASRS is also responsible for managing the investments of its $22 billion trust fund.
Finally, ASRS disseminates information to retirees, members, and employers through
its call center, walk-in service centers, retirement seminars, and Director’s Outreach
meetings, and through various communication mediums such as its Web site, its
semi-annual newsletter, and a yearly benefit statement sent to nonretired ASRS
members. As of June 30, 2005, ASRS had over 400,000 members, including nearly
70,000 retirees.
ASRS’ investment management generally appropriate
(see pages 9 through 19)
ASRS is generally managing its investments appropriately. ASRS invests its $22
billion trust fund in four types of asset classes: domestic equities, which are stocks
in American companies; international equities, which are stocks in international
companies; fixed-income instruments such as bonds; and real estate. ASRS’ mix of
investments is set primarily through a long-term investment approach called strategic
asset allocation. The ASRS Board (Board) implements this approach by setting a
percentage of total fund assets that each class will hold. The Board complements its
long-term asset allocation approach with a short-term approach called tactical asset
allocation, which focuses on taking advantage of changing conditions in the
economy to achieve more immediate investment returns. Auditors reviewed the
investment approaches of four other public funds and found that each fund was
similar to the ASRS in its use of both long-term and short-term investment
approaches.
Office of the Auditor General
SUMMARY
page i
As of March 31, 2005, ASRS had exceeded its overall investment goal of a rate of
return averaging 8 percent a year over a 10-year period, but its greater reliance on
domestic equities means that the rate of return is driven substantially by the stock
market’s performance. As of March 31, 2005, ASRS devoted approximately 56
percent of its assets to domestic equities, above other pension funds’ average of
44.5 percent. According to ASRS, it has a higher allocation to domestic equities
because this asset class produces higher long-term returns than those of other asset
classes. Measured over 1-, 3-, and 5-year periods ending March 31, 2005, ASRS’
rate of return is lower than 8 percent, reflecting the major decreases in domestic
equity prices that occurred during these periods. Conversely, for the 10-year period
ending March 31, 2005, which includes increases in the price of domestic equities,
ASRS performs better in relation to other public pension systems than it does for the
1-, 3- and 5-year periods ending on the same date.
ASRS is just beginning to invest in real estate. In August 2003, the Board approved
the allocation of 6 percent of its total assets to be invested in real estate. Since that
time, ASRS has laid the groundwork for such investments, hiring a real estate
investment consulting firm and an internal real estate investment manager, and
designing and adopting a real estate investment program. ASRS has also hired
some law firms to provide legal advice and selected some investment management
firms for its first round of real estate investments. ASRS plans to invest primarily in
high-quality, existing properties that can provide an immediate source of rental
income, but will also invest in properties that offer a higher potential for return. ASRS
plans to further diversify by investing in real estate nation-wide and in a variety of
property types, primarily office buildings, retail establishments, industrial complexes,
and multi-family housing.
In 2006, the Board plans to formally review ASRS’ asset allocation policy and
evaluate the appropriateness of its investments in relation to a desired balance of
investment risk and return. As part of its review, the Board plans to consider whether
to invest in alternate asset classes such as private equities, venture capital, and
hedge funds, in which some other public pension funds have already invested. While
each of these asset classes has a significant risk level, they also have potential to
yield higher returns than ASRS’ current asset classes.
ASRS should improve its performance in paying some
benefits (see pages 21 through 31)
ASRS should improve the timeliness and accuracy of annuity payments to new
retirees, as well as the timeliness of its payments of members’ refunded
contributions. While ASRS has an internal goal of sending new retirees their first
annuity check within 60 days of retirement, a 2005 national study found that a
State of Arizona
page ii
majority of retirees in systems similar to ASRS are being paid within 30 days.1
However, none of the checks that were sent to new retirees between July 1, 2003 and
January 31, 2005, were sent in 30 or fewer days from an individual’s retirement date.
Instead, most of the checks were sent between 31 and 60 days after retirement, and
approximately 25 percent of new retirees during this period did not receive an initial
annuity check for more than 60 days after their retirement. This delay could have
serious consequences for retirees who are counting on the annuity check as a major
source of income.
Auditors found that multiple factors contributed to delays in the issuance of annuity
checks, including ASRS’ practices of waiting for employers to verify a new retiree’s
final payroll information, manually calculating benefits, and issuing annuity checks
only once per month, as well as a temporary surge in the backlog of service
purchase requests. ASRS has an automated benefit calculation system to replace
manual calculations and has succeeded in reducing the backlog of members’
requests to purchase service credits.
In contrast to the timeliness of paying new retiree annuities, ASRS has had more
success in effectively identifying annuities with inaccurate amounts. ASRS has an
internal control process, called “final audit,” that reviews the calculation of new
retirees’ benefits. In a random sample of 48 cases, auditors found that the internal
audit process identified all the inaccuracies in the cases. Moreover, many of the
inaccuracies involved very small amounts, generally under $10 per month. Two
contributing factors to the inaccuracies were the manual calculation of complex
salary information and the inadequate procedures provided to staff who perform the
calculations. ASRS should continue to take action to improve performance in these
areas.
ASRS could also improve its timeliness in making refunds of eligible contributions to
members who leave the retirement system. ASRS has an internal goal of paying
these refunds within 45 business days of the member’s request. However, auditors’
review of all refunds processed from July 1, 2004 through December 31, 2004, found
that ASRS was meeting its 45-day goal only about 50 percent of the time. While
refund recipients may not rely on the payments for their primary income, these
members could be experiencing urgent financial hardships and thus may need this
money. Two factors appear to have contributed to the lack of timeliness in paying
refunds. First, ASRS has a backlog of service audits, which are reviews of a
member’s contribution history that ASRS requires before making refund payments.
Second, staff who process refund requests must use multiple systems to access all
necessary data. ASRS plans to integrate these systems in 2006.
1 This benchmarking study was performed by Cost Effectiveness Measurement, Inc., a private company that annually
surveys public retirement systems and provides the compiled data to the participating systems. In the 2005 report
referenced here, the company grouped retirement systems into peer groups based on their number of active and retired
members.
Office of the Auditor General
page iii
ASRS should monitor and assess its plan for improving
call center performance (see pages 33 through 39)
ASRS may need to revise its plan to improve response times at its call center. ASRS
responds to telephone and e-mail inquiries from the public through its call center.
Beginning in June 2004, the call center’s customer service began to worsen, as
measured by the amount of time callers spent on hold and how many callers hung
up before receiving help. Apparently, several factors contributed to this decline,
including an increase in incoming calls and a decrease in the number of agents
available to answer phones. In response, ASRS increased the number of FTE agents
assigned to the call center from 14 to 24, and began hiring the additional staff in July
2005.
Auditors’ review of ASRS’ plan to hire additional call center agents, as well as call
center performance data, indicated that it adds more staff than necessary to manage
call volumes. As its baseline for projecting future call volumes, ASRS used an
unusually high period of call volume. In addition, others’ analysis of the industry
model that ASRS used to determine the staff increase indicated that the model has
a tendency to overestimate the staff number required to achieve performance goals.
Auditors’ analysis of the plan and the call center’s data suggests that 5 or fewer
additional FTEs would be required to meet ASRS’ performance goals. ASRS should
continue to monitor call center performance and, if actual experience supports this
analysis, ASRS should redeploy extra staff to areas needing additional assistance.
Other Pertinent Information (see pages 41 through 45)
While “the Plan” the Legislature created in 1971 covers most of ASRS’ 400,000
members, of which nearly 70,000 are retired, about 300 nonretired members and
1,800 members decided not to switch to the Plan and are still covered under an
earlier program, referred to as “the System.” ASRS has determined that, as System
membership declines, it will likely face significant problems ensuring that liabilities
and assets remain adequately balanced. Since many active System members will
soon be eligible for retirement, ASRS could stabilize the relationship between assets
and liabilities by adopting a more conservative investment philosophy for the System.
However, ASRS believes that this would likely result in a reduction of System
members’ benefits.
ASRS has studied this matter and concluded that the most practical alternative
presently available is to transfer liabilities and assets from the System to the newer
plan. However, this option would require additional study and legislation to determine
the proper balance between the interests of System members and those who are
State of Arizona
page iv
already covered under the newer plan. ASRS is going to develop a plan that it hopes
to complete by the end of 2005 that will address remaining questions about this
option.
Followup to 1994 sunset review (see pages 47 through
50)
This report follows up on several issues examined in a 1994 performance audit and
sunset review of ASRS (Report No. 94-3). The 1994 audit warned that conditions that
had kept contribution rates low were unlikely to continue. Contribution rates have
since risen from 2.0 percent in fiscal year 2003 to 6.9 percent in fiscal year 2006 and
are projected to reach 8.6 percent in fiscal year 2007. The recent higher contribution
rates were brought on by several factors, including low rates of return on investments
from 1999 through 2002, increases in benefits, and changes to actuarial
assumptions, including mortality rates. As of June 30, 2004, the Plan’s pension fund
and Plan and System health benefit funds had assets equal to 91.2 percent of
liabilities.
The previous audit also identified the fact that ASRS could reduce management
costs by internally managing more assets. According to ASRS, its Investment
Management Division now internally manages approximately 30 percent of its
assets. Additionally, the 1994 report examined the development of ASRS’ new
computer system. The audit found that ASRS had problems in implementing this
system due to poor planning, inexperienced management and programmers, and
failures to include users in development. Since the 1994 audit, several parts of the
system have been completed, but further development remained somewhat in flux.
ASRS had some concerns about the integration of its financial systems. After an
internal review and with the assistance of a consultant, ASRS decided to continue
developing its own IT systems.
Finally, the 1994 audit recommended restructuring the long-term disability program
by using other state agencies to provide services, thereby saving an estimated
$250,000 per year. ASRS continues to have a contractor provide these services as it
does not believe that the State has a program that can offer all of the current LTD
program’s services at an equal or lower cost.
Office of the Auditor General
page v
State of Arizona
page vi
Office of the Auditor General
TABLE OF CONTENTS
continued
page vii
1
9
9
12
14
18
19
21
21
22
27
29
31
33
33
33
37
39
Introduction & Background
Finding 1: ASRS’ investment management generally
appropriate
ASRS invests for long-term while addressing short-term needs
ASRS’ investment returns closely related to domestic stock market
performance
ASRS has developed real estate investment plan
Other potential asset areas
Recommendations
Finding 2: ASRS should improve its performance in
paying some benefits
ASRS pays benefits to members
ASRS should improve timeliness of new retiree payments
ASRS should improve accuracy of initial new retiree payments
ASRS should improve timeliness of refund payments
Recommendations
Finding 3: ASRS should monitor and assess its plan
for improving call center performance
ASRS call center assists members
Call center performance has worsened
Performance improvement plan likely calls for too many staff
Recommendations
State of Arizona
TABLE OF CONTENTS
page viii
Other Pertinent Information
History and structure of the System
Forthcoming problems identified
Potential System changes
Followup To 1994 Sunset Review
Sunset Factors
Agency Response
Tables:
1 Arizona State Retirement System Administration
Schedule of Revenues and Expenses, in Thousands
Years Ended or Ending June 30, 2003, 2004, and 2005
(Unaudited)
2 Total ASRS Asset Allocation
as of March 31, 2005
3 Total Investment Returns
Compared To 8 Percent Goal and SAA
As of March 31, 2005
4 Investment Performance Compared To
Other Public Pension Funds by Reporting Agency
Periods Ending March 31, 2005
5 ASRS Investment Return Percentages
Compared To Asset Class Benchmarks
Periods Ending March 31, 2005
6 Pensions and Refunded Contributions Paid
Fiscal Years 2000 through 2004
41
41
42
43
47
51
5
11
13
13
14
22
continued
Office of the Auditor General
TABLE OF CONTENTS
page ix
concluded
23
29
11
14
16
34
35
35
48
Tables:
7 Time Frame for Paying New Retirees
July 2003 through January 2005
8 Time Frame for Paying Refund Contributions
July 2004 through December 2004
Figures:
1 Global Tactical Asset Allocation (GTAA)
Actual Program Asset Allocation
As of March 31, 2005
2 Annual Return Rates for ASRS Compared To
Dow Jones Wilshire 5000
Calendar Years 1995 through 2004
3 ASRS Real Estate
Investment Strategy
4 Average Answer Rate
January 2003 through May 2005
5 ASRS Average Wait Times, in Minutes
January 2003 through May 2005
6 Member Satisfaction for Call Center Timeliness
January 2004 through March 2005
7 Member Contribution Rate
Fiscal Years 1986 through 2007
State of Arizona
page x
The Office of the Auditor General has conducted a performance audit and sunset
review of the Arizona State Retirement System (ASRS) pursuant to a November 20,
2002, resolution of the Joint Legislative Audit Committee. This audit was conducted
as part of the sunset review process prescribed in Arizona Revised Statutes (A.R.S.)
§41-2951 et seq.
History and purpose
Established in 1953, ASRS is responsible for contributing
toward members’ long-term financial security by providing
retirement, disability, survivor, and retiree health insurance
benefits; and by counseling and disseminating information to
members. Active teachers, who had been covered by various
other pension plans dating back to 1912, voted to join ASRS
in 1954, and transferred to ASRS on January 1, 1955.
Retirement benefits under ASRS are provided under two
different programs—an older program referred to as the
“System” and a newer program referred to as the “Plan.” The
System was the retirement program in place in Arizona from
1953 until 1971. It is a hybrid defined-contribution/defined-benefit
plan. Members and their employers contribute a set
amount annually to retirement accounts. Upon retirement,
members receive guaranteed payments from their accounts and may also receive
payments for returns on investment above the assumed rate of return. In 1970, the
Legislature passed a law to enact the current Arizona State Retirement System
Defined Benefit Plan, or the Plan, if 70 percent or more of state employees and
teachers voted to transfer to the new plan. More than 80 percent of eligible members
voted for the Plan and most political subdivisions subsequently voted to join.
However, the System is still in place for nearly 300 active members and
approximately 1,800 retired members who are receiving benefits. (See Other
Pertinent Information on pages 41 through 45 for more information.)
Office of the Auditor General
INTRODUCTION
& BACKGROUND
page 1
Defined Contribution Plan—A retirement plan
offering a benefit that depends on the total
contributions made by the employer and the
employee and on the investment returns
earned by those contributions. Employees
generally bear the investment risk.
Defined Benefit Plan—A retirement plan that
promises to pay a certain amount for the
member’s life, usually based on the number
of years of service and on the average salary
in the period before retirement. Employers
generally bear all investment risk.
ASRS provides pension, survivor, disability, and retiree health insurance benefits, and
educational services for most public sector employers in Arizona, including state
universities, community colleges, public school districts, local and county
governments, and the State of Arizona. As of June 30, 2004, there were more than
400,000 members in ASRS, of whom nearly 70,000 are retired.
ASRS’ member benefits
A formula set in statute calculates ASRS plan members’ benefits, which can be paid
to members upon retirement in a variety of ways. (Benefits for System members are
explained in the Other Pertinent Information section, pages 41 through 45.) Members’
and employers’ contributions pay for benefits. The contribution rate for employees is
set at 6.9 percent of compensation for fiscal year 2006 and will increase to 8.6
percent in fiscal year 2007.
The average monthly compensation is equal to the member’s highest average salary
paid over 36 or 60 consecutive months during the last 10 years of credited service.1
Credited service is determined from the period of employment during which the
employee was a member making the required contributions to the Plan, plus any
other service purchased (see below for a discussion of service purchase). The
Service Multiplier is a graded multiplier determined by years of credited service.
Service purchase—If a member previously worked for the federal government,
another state, or a state’s political subdivision, the member can buy credit, called
service purchase, for this time by paying ASRS an amount equal to the benefit
derived. This amount of time is then added to the member’s service time for the
purposes of calculating benefits upon retirement. Legislation passed in 2004
required members to purchase prior service at the actuarial present value starting in
August of 2004 instead of the past value they had been using. Additionally, as
allowed by law, ASRS started charging members 8 percent interest in July 2004 when
paying for service purchases through a payroll deduction agreement.
1 The number of years used to determine average monthly compensation varies depending on when a member began
service with the participating employer. For members beginning service in 1984, the average monthly compensation is
determined by taking the highest average monthly compensation for 36 months of consecutive service during the last
120 months of credited service. Members who began service prior to 1984 may instead choose to use the average
monthly compensation as determined by taking the highest average monthly compensation for 60 months of consecutive
credited service during the last 120 months of credited service, including lump sum payments of vacation and other pay
at the time of termination.
State of Arizona
page 2
Benefit Calculation—The Plan pays retirement benefits determined by a
formula set in statute:
Monthly Retirement Benefit = Average Monthly Compensation
X Total Credited Service Time X Service Multiplier
Years of
Service
Service
Multiplier
0.1—19.99 2.10%
20.0—24.99 2.15%
25.0—29.99 2.20%
30.0+ 2.30%
The volume of requests to purchase service increased significantly in June 2004 and
contributed to a significant backlog of requests waiting to be completed. The spike
in requests occurred because the changes that went into effect that summer
increased the costs of purchasing service. Members submitted requests before the
changes took effect in order to save themselves money. This backlog reached a high
of over 9,000 in September 2004; however, the agency created a special team to
reduce the backlog of open requests. As of July 21, 2005, ASRS had reduced the
backlog to 201 outstanding service purchase requests that had not been completed
within ASRS’ time frame goal.
Benefit payment options—There are several options for how members can
receive their retirement benefits. Members can choose to receive a life annuity, life
annuity with a period certain, life annuity with a partial lump sum payment, or a joint
and survivor annuity.
􀁺􇩔 The life annuity option pays the highest monthly benefit of all the options, but
does not guarantee benefits for the member’s beneficiary after the member’s
death.
􀁺􇨠 The life annuity with period certain options pays a reduced lifetime benefit to a
member, but guarantees a minimum number of payments. If the member dies
before the guaranteed number of payments are made, the member’s
beneficiary receives the remaining payments.
􀁺􇩔 The joint and survivor annuity has three options that pay a reduced benefit to a
member. Upon the member’s death, the member’s beneficiary receives a life-long
monthly benefit at one of the three chosen percentages. Because the ASRS
pays a benefit for the rest of the member’s life and then the beneficiary’s life after
the member’s death, the monthly benefit amount lowers.
􀁺􇨠 Members also have the option of taking a portion of their retirement income in a
lump sum payment equal to up to 36 months of the member’s calculated life
annuity benefit. The annuity amount is adjusted to a reduced amount to offset
the lump sum payment.
ASRS’ investments
As of March 31, 2005, ASRS had approximately $22 billion in assets, which are
invested in four major asset classes: domestic stocks, international stocks, fixed
income instruments, and real estate (see Table 1, page 5).1
1 This amount is the market value of ASRS assets.
Office of the Auditor General
page 3
Domestic stocks are publicly issued shares of American companies, such as
General Electric and Microsoft. International stocks are publicly traded shares of
companies such as Nestle’, Vodafone, and Mitsubishi that are from any country other
than the United States.1 Fixed income investments are investments that produce a
stream of revenue for ASRS, such as bonds. In 2003, ASRS also began
implementing its program for investing in real estate (see Finding 1, pages 9 through
19).
Organization and staffing
ASRS is overseen by a board of directors (Board) that consists of nine members
appointed by the Governor and confirmed by the Senate. Five of the board members
are required to be ASRS members and must include an educator, a retired member,
and employees of the State and a political subdivision. Four other members
represent the public and cannot be ASRS members. Of the nine board members,
four are to have substantial experience in economics, finance, or investment. The
Board is responsible for overseeing the administration of ASRS, setting investment
goals, objectives, and policies, allocating assets to meet the investment goals, and
reviewing the performance of the investment managers to ensure their attainment of
and adherence to the Board’s investment goals, objectives, and policies.
ASRS provides services through four programs. These four programs had 197 FTEs,
including 23 vacancies, as of June 30, 2005:
􀁺􇩍 Member Services (138 FTE, 17 vacant) comprises the Member Services,
Financial Services, and Information Services Divisions. These divisions are
responsible for the core functions of ASRS including the calculation,
disbursement, and coordination of retirement, retiree health insurance, disability,
and survivor benefits as well as refunds of member contributions. Member
Services also responds to telephone, Internet, and in-person inquiries and
provides educational services to members throughout the State.
􀁺􇩉 Investment Management (8 FTE, 1 vacant) is responsible for overseeing the
investment of ASRS Retirement Fund (Fund) assets. ASRS manages about 30
percent of the Fund internally and monitors the rest of the Fund’s external
management.
􀁺􇩁 Administration and Support (33 FTE, 2 vacant) comprises the various
administrative functions needed to support the agency. Its responsibilities
include human resources, budgeting, internal auditing, and legal counsel.
1 Nestle’ is a food and beverage company headquartered in Switzerland. Vodafone is mobile telecommunications
company headquartered in Great Britain. Mitsubishi, headquartered in Japan, is a holding company overseeing all the
operations of several subsidiaries.
State of Arizona
page 4
􀁺􇩔 The Information Technology Plan (18 FTE, 3 vacant) is a business plan
containing the development of the Public Employee Retiree Information System
(PERIS), Internet applications development, implementation of an Electronic
Document Imaging Management System (EDIMS), and ongoing maintenance
and upgrades to telephone and network technology.
Budget
Table 1 shows ASRS’ actual revenues and expenditures for fiscal years 2003 and
2004, and estimated revenues and expenditures for fiscal year 2005. Funds for
ASRS’ operating costs are appropriated by the Legislature from the State Retirement
Pension Fund, which consists of member and employer contributions, member
purchases of service credit, and investment income. In fiscal year 2005, estimated
administrative expenditures were $23.9 million; an estimated $6.3 million of this was
spent on professional and outside services, which includes expenses for computer
support, audit, consulting and legal fees, and actuary and benefit consulting.
Office of the Auditor General
page 5
Table 1: Arizona State Retirement System Administration
Schedule of Revenues and Expenses, in Thousands
Years Ended June 30, 2003, 2004, and 2005
(Unaudited)
2003 2004 2005
(Actual) (Actual) (Estimated)
Revenues:
State Retirement Pension Fund 1 $24,182 $26,834 $23,907
Administrative expenses:
Personal services and related benefits $8,788 $10,487 $10,885
Professional and outside services 6,823 11,234 6,342
Other operating 8,571 5,113 6,680
Total expenditures $24,182 $26,834 $23,907
1 Amount is the portion of the State Retirement Pension Fund paying for the agency operations. The
Fund’s revenue primarily consists of member and employer contributions, member purchases of
service credit, and investment income.
Source: Auditor General staff analysis of the Arizona State Retirement System Comprehensive
Annual Financial Report for the years ended June 30, 2003 and 2004, and agency-prepared
estimates for the year ended June 30, 2005 (actual 2005 amounts were not available at the
time of this report).
Scope and methodology
This audit focused on the management of the Retirement System Trust Fund,
aspects of ASRS’ customer service, and the System. This report presents three
findings and associated recommendations, as follows:
􀁺􇩁 ASRS has managed its investments reasonably through appropriate use of
asset allocation approaches and through development and implementation of a
plan to guide its real estate investments (see Finding 1, pages 9 through 19).
􀁺􇩁 ASRS needs to improve the timeliness of benefits paid to new retirees and
members choosing to withdraw their funds and the accuracy of benefits paid to
new retirees (see Finding 2, pages 21 through 31).
􀁺􇩁 ASRS needs to monitor and assess its plan to improve the performance of its
call center (see Finding 3, pages 33 through 39).
In addition, the report presents information about the financial status, outlook, and
possible changes to the previous retirement program, the System, that was in place
in Arizona from 1953 to 1971 (see pages 41 through 45), follow-up information
related to recommendations made in the previous sunset audit, which was issued in
1994 (see pages 47 through 50), and information related to the 12 sunset factors
defined in A.R.S.§41-2954 (see pages 51 through 58).
Several methods were used to study the issues addressed in this audit. Methods
used in all areas included interviews with agency management and staff and other
stakeholders, including national retirement associations. Auditors also reviewed
Arizona Revised Statutes, the Arizona Administrative Code, and ASRS’ policy and
procedure handbook. In addition, the following methods were used in reviewing each
specific area:
􀁺􇩉 Investment management—To determine the reasonableness of ASRS’
investment management, auditors primarily compared ASRS’ approach with
practices used in similar organizations and the industry in general. To learn
Arizona’s system, auditors interviewed ASRS staff, including its executive
director, chief investment officer (CIO), and attorney general representative, as
well as outside consultants. Auditors also interviewed several members of the
ASRS Board, including members of the Board’s Investment Committee and
Real Estate Committee. To gather comparative information, auditors interviewed
(1) the Chief Investment Officers of the Kentucky Retirement Systems, the Illinois
Teacher’s Retirement System, the Maryland State Retirement and Pension
System, and the Texas Permanent School Fund,1 (2) a staff member from the
Government Finance Officer’s Association (GFOA) who is familiar with pension
plans and an investment consultant who advises GFOA’s Committee on
1 These states were selected based on ASRS’ recommendation that these retirement funds most closely resembled ASRS.
State of Arizona
page 6
Retirement and Benefits Administration; (3) a pension consultant with an
academic background; and (4) the research director for the National
Association of State Retirement Administrators. In addition to conducting
interviews, auditors reviewed information from the Government Finance Officers
Association regarding asset allocation. Further, auditors reviewed various
documents produced by ASRS related to its investment performance, such as
its Market Value Report, and documents produced by ASRS’ investment
consultant related to asset allocation and investment performance.
As part of their work on investment management, auditors also reviewed ASRS’ real
estate investment program and the procurement information related to the ASRS’
real estate consultant and legal counsel. Finally, auditors attended meetings of the
ASRS Board and the Board’s Investment Committee, including a strategic analysis
session held on April 23, 2005.
􀁺􇨠 To evaluate the timeliness and accuracy of benefits paid to new retirees, auditors
interviewed ASRS staff and reviewed ASRS documents such as training
materials. Auditors assessed ASRS’ performance in this area by obtaining and
evaluating several data components, including:
􀂄􈑉 Information from ASRS’ primary data system, PERIS, on the received and
paid dates for all refund requests received from July 2004 through
December 2004.
􀂄􈑐 PERIS data for all new retiree requests received from July 2003 through
January 2005, including data fields such as received, retirement, and
approved dates.
􀂄􈑍 Master paper records of 48 randomly selected retirement files processed
between July 2004 and January 2005.
􀂄􈑔 Ten randomly selected benefit estimates performed between January 2003
and December 2004.
To gain an understanding of members’ concerns, auditors reviewed all
complaint letters from ASRS members between May and December 2004, as
well as the results of the monthly member satisfaction surveys conducted by an
outside vendor from January 2004 through March 2005. Finally, auditors
reviewed ASRS’ tracking and reporting mechanisms for the service purchase
and service audit functions to verify backlogs in those areas.
Office of the Auditor General
page 7
􀁺􇨠 To evaluate the performance of the ASRS call center, auditors reviewed data
from the call center’s software management system, CMS Supervisor, on all
calls received from January 2003 through May 2005. The data consisted of
several factors, including call volume, number of calls answered, and average
amount of time each caller spent on hold and speaking to an agent. To evaluate
why members call ASRS, auditors reviewed the data stored in the agency’s
“call-reason” tracking system, Cognos, for all calls received from October 2003
through February 2005. Auditors also reviewed personnel data from ASRS’
human resources data system, ASDERS, for all call center agents employed in
the call center from January 2003 through February 2005, in order to evaluate
shifts in experience levels. Auditors also interviewed staff with other state
pension systems to compare performance and strategies among similar
systems.1 Finally, auditors evaluated the quantitative model used to project call
center staffing needs by conducting a literature review.
􀁺􇩔 To gather information about the System, auditors reviewed actuarial valuations
of the System for fiscal years 2003 and 2004, and an internal agency report, and
interviewed agency management as well as ASRS’ contracted actuary.
􀁺􇩉 Information used in the Introduction and Background was collected from the
ASRS Comprehensive Annual Financial Report for the year ended June 30, 2004;
interviews with the contracted actuary, the ASRS Member Handbook; the Arizona
Master List of State Government Programs for fiscal years 2003-2005; previous
Office of the Auditor General audit reports; and other unaudited agency
documents.
The audit was performed in accordance with government auditing standards. All
members of the audit team are also members of ASRS. Government auditing
standards allow auditors to audit a pension plan of which they are members provided
the auditors have no control over the management of the plan, including investments
and benefits, and that membership in the plan is a benefit open to other auditors in
equivalent positions in the same organization. Both of these conditions were met for
this audit.
The Auditor General and staff express appreciation to the ASRS director and staff for
their cooperation and assistance throughout the audit.
1 These states include Iowa, Illinois, Ohio, Oregon, South Carolina, Virginia, and Washington. These states were identified
as ASRS’ peer retirement systems by Cost Effectiveness Measurement, Inc. as part of their Defined Benefit Administration
Benchmarking Analysis from March 2005.
State of Arizona
page 8
ASRS’ investment management generally
appropriate
ASRS is generally managing its investments appropriately. Auditors reviewed the
investment approaches of four other public pension funds and found that each fund
was similar to the ASRS in its use of both long-term and short-term investment
approaches. Relative to most other public pension funds, however, the Board’s
investment approach is more weighted toward investing in domestic equities. Over
the past 10 years, the Board has been able to exceed its target rate of return of 8
percent a year, though investment returns were much lower during the years that
broad domestic equity indexes dropped. The Board decided to further diversify its
investment portfolio to include real estate as an investment area in the summer of
2003. In 2006, the Board plans to formally review ASRS’ asset allocation policy and
consider different assets for investment, including privately issued equities and
hedge funds.
ASRS invests for long-term while addressing short-term
needs
ASRS’ assets are invested by the Board primarily through a long-term investment
approach called strategic asset allocation. Additionally, the Board allows itself the
flexibility to adapt to changing market conditions through an approach called tactical
asset allocation. Other state pension funds reviewed by auditors also used a blend
of strategic and tactical asset allocation.
Board primarily uses strategic asset allocation—The Board’s primary
approach to investing its assets is called strategic asset allocation. Strategic asset
allocation is an investment approach used to generate steady, positive returns for as
long as is necessary to pay liabilities, such as the monthly benefits paid to retirees.
The Board has decided that meeting these obligations requires ASRS to achieve an
Strategic asset
allocation attempts to
achieve steady long-term
returns.
Office of the Auditor General
FINDING 1
page 9
8 percent rate of return on its total investment portfolio. This portfolio consists of four
classes of assets: domestic equities, international equities, fixed-income instruments
such as bonds, and most recently, real estate.
The Board implements a strategic asset allocation approach by setting policy targets
for each asset class. A policy target is the percentage of fund assets that is invested
in a specific asset class. The Board determines these targets based on which
combination of policy targets will best balance achieving an 8 percent rate of return
with maintaining an acceptable level of risk. One of the Board’s investment
consultants performs an analysis of various policy targets to help the Board assess
which are best for each asset class. This analysis considers such factors as the
expected investment return for each asset class, the risk associated with each asset
class, correlations among asset classes, and whether any new asset classes should
be added to the funds portfolio. Additionally, the investment consultant helps the
Board decide how much of its assets should be actively managed or overseen by an
investment manager, and how much should be passively managed or tied to the
performance of a financial index. The consultant performs this analysis by assessing
historical returns from investment managers and factors in the current economic
climate, such as interest rates, inflation, and corporate profitability. ASRS reports that
its investment staff work with the consultant in developing each of the foregoing
analyses and recommendations.
According to the ASRS director, the Board reviews its strategic asset allocation every
3 years, and the next asset-allocation review is scheduled in 2006. During its review
in 2003, the Board reviewed its policy targets and the possible inclusion of new asset
classes. Auditors’ review indicated that strategic asset allocation reviews could
reasonably occur every 2-5 years. Consequently, ASRS’ 3-year allocation review time
frame is reasonable.
Board adapts to changing market conditions through tactical asset
allocation—In addition to strategic asset allocation, the Board uses tactical asset
allocation, which focuses on taking advantage of changing conditions in the
economy to achieve more-immediate investment results as a complement to its
long-term asset allocation strategy. These short-term results can help to increase
investment returns beyond those projected under the strategic asset allocation.
The Board uses tactical asset allocation in two ways. First, ASRS has a program,
called Global Tactical Asset Allocation (GTAA), in which the Board has dedicated
about 10 percent of its assets. Within the GTAA program, assets are distributed
among three of the four asset classes; the GTAA program does not include
investments in real estate (see Figure 1, page 11). The GTAA program uses external
money managers to invest ASRS’ funds to generate a return on investments above
what is expected under the basic strategic asset allocation. For example, one ASRS
A policy target is the
percentage of fund
assets that is invested in
a specific asset class.
Tactical asset
allocation attempts to
achieve returns over
the short term.
State of Arizona
page 10
The GTAA program is
designed to achieve a
higher return than
ASRS’ investments as
a whole.
GTAA manager’s goal is 3 percentage points higher
than the total ASRS benchmark.1 Both GTAA
managers use sophisticated investment strategies,
such as investing in futures, to add value to their
portfolios.
Separate from the GTAA program, ASRS also uses
tactical asset allocation by using the ranges set by
the Board in its strategic asset allocation to move
above or below the Board’s policy targets (see Table
2). These ranges allow ASRS to hold more of an
asset if it is performing well or less of an asset if it is
performing poorly. For example, if the market value of
ASRS’ domestic equities increases relative to other
asset classes, then the percentage of assets held in
domestic equities also increases. In this case, ASRS
would not want to reduce the amount of assets in a
strongly performing asset class just to ensure that it
always stays at the policy target. ASRS can use each
range fully or not at all.
Blending of strategic and tactical asset allocation a common
practice—The blended use of strategic asset allocation and tactical asset
allocation is generally accepted as the appropriate way of governing investment
decisions for public pension funds. Auditors
interviewed Chief Investment Officers (CIOs) at
four state pension funds, and all reported that
their fund primarily used strategic asset
allocation.2 One CIO stated that it makes sense
for funds with long-term liabilities to invest for
the long term. Another CIO stated that strategic
asset allocation allows the fund to better keep
their investment in-line with their liabilities.3
Similar to ASRS, these funds also used tactical
asset allocation. For example, like ASRS, these
funds allow ranges around the policy targets.
One CIO stated that this allows his fund the
flexibility to sell some of an asset if it needs
funds to pay benefits.
1 According to the ASRS, its total benchmark for the GTAA program is a hybrid of different benchmarks, with 56 percent
coming from the domestic equity benchmark, 28 percent from the domestic fixed income benchmark, and 16 percent
from the international equity benchmark.
2 The four funds are the Illinois Teacher’s Retirement System, the Kentucky Retirement Systems, the Maryland State
Retirement and Pension System, and the Texas Permanent School Fund. According to ASRS, these funds are similar in
size to ASRS and have a similar level of investment in different asset areas.
3 Funds with higher liabilities may need higher investment returns, which can be obtained through riskier investments such
as public equities or alternative investments such as private equities.
Office of the Auditor General
page 11
Figure 1: Global Tactical Asset Allocation (GTAA)
Actual Program Asset Allocation
As of March 31, 2005
Source: Auditor General staff analysis of the unaudited Arizona State
Retirement System Market Value Report as of March 31, 2005.
International
Equities
21.3%
Fixed
Income
26.1%
Domestic
Equities
52.6%
Table 2: Total ASRS Asset Allocation
As of March 31, 2005
Asset Classes
Target
Percentage
Percentage
Ranges
Actual
Percentage
Domestic equities 53% +/-5% 55.9%
International equities 15 +/-5 18.1
Fixed income 26 +/-5 25.9
Real estate1 6 +/-2 0.1
1 Investment in the real estate asset class is in the process of being implemented (see page
14).
Source: Auditor General staff analysis of unaudited portions of ASRS’ Comprehensive Annual
Financial Report for Fiscal Year 2004 and the unaudited Arizona State Retirement
System Market Value Report as of March 31, 2005.
ASRS’ investment returns closely related to domestic
stock market performance
ASRS’ total investment returns over the last 10 years are strongly correlated with
ASRS’ returns on its investments in domestic equities. ASRS’ current 56 percent level
of investment in domestic equities is considerably higher than the 44.5 percent level
reported for public pension funds as a whole. Consequently, during periods of poor
performance by domestic equities, ASRS total investment returns are lower than in
years of good performance by domestic equities. However, for the 10-year period
from April 1, 1995 to March 31, 2005, ASRS’ investment performance has exceeded
the actuarial rate of return.1
ASRS allocation to domestic equities is higher than many other
public pensions—The ASRS Board has decided to allocate the majority of its
assets to domestic equities, and its investment in domestic equities is considerably
higher than the average of many other public pension funds. According to ASRS,
ASRS invests heavily in domestic equities because this asset class produces long-term
returns that are generally higher than those of other asset classes. In addition,
ASRS has also focused on public markets, which typically have lower investment
management fees. The policy targets for domestic equities call for ASRS to have
equity investment of 53 percent; however, when accounting for the ranges around the
policy targets this percentage can be higher. As of March 31, 2005, ASRS had
invested 56 percent of its assets in domestic equities. In March 2005, an investment
advisory firm released a report that compared funding levels and asset allocations of
125 public pension funds. This report stated that the average combined allocation to
domestic equities for the 125 public pension funds was 44.5 percent.
Investment in equities affects ASRS investment returns compared to
benchmarks—The performance of ASRS’ investments is generally correlated with
the performance of its domestic equities. Consequently, ASRS’ performance
compared to major benchmarks is also correlated with the performance of its
domestic equities. According to the ASRS director, ASRS uses several methods to
measure its total investment returns. Four of the main benchmarks are as follows:
􀁺􇩔 The 8 percent rate of return actuarial goal set by the Board.
􀁺􇩔 The Strategic Asset Allocation (SAA) benchmark is a combined benchmark that
measures the performance of ASRS’ four asset classes. The performance of
each of these classes is weighted in the SAA benchmark according to their
policy target as approved by the Board.
ASRS invests most of its
assets in domestic
equities.
1 ASRS assumes an 8 percent rate of return, called the actuarial rate of return, on its investments when determining what
its contribution rate should be. ASRS does not need to have an 8 percent return every year, but wants to achieve this
return over a period of years. According to ASRS’ consulting actuary, the ASRS is currently assessing returns over a 5-
year period to see if they are at 8 percent. However, beginning in 2007, ASRS will use periods that grow by 1 year annually
until 2012. Beginning in 2012, ASRS will begin using a rolling 10-year period to determine how closely its actual rate of
return matches the actuarial rate of return.
State of Arizona
page 12
􀁺􇩂 Benchmarks for investment performance in each of the asset areas, such as the
S&P 500 index, which serves as the benchmark for domestic equities. The
Board adopts these benchmarks after discussion with its investment consultant
and with ASRS’ internal investment staff.
􀁺􇨠 Investment returns relative to those of other public pension plans.
Auditors found that, over the longer term, ASRS has been achieving its desired
overall rate of return, while short-term results have been more mixed and have been
generally reflective of changes in the stock market. When assessing ASRS
investment returns, auditors reviewed investment returns over the following periods:
1 year, 3 years, 5 years, and 10 years. Specifically, auditors found that ASRS’
investment returns were higher than 8 percent, the actuarial rate of return, for the 10-
year period, but not for the 1-, 3-, and 5-year periods (see Table 3). Similarly, ASRS’
returns versus other pension plans were higher over the past year and the past 10
years than they were over the past 3- and 5-year periods (see
Table 4). However, ASRS generally surpassed its own
investment benchmarks for each of the four time periods
reviewed (see Table 5, page 14). The ASRS also surpassed
its SAA benchmark for the four time periods reviewed (see
Table 3).
These returns are all in-line with expectations that, since
ASRS has invested approximately 56 percent of its assets in
Over the period from
1995 to 2004, ASRS’
investment returns
exceeded its actuarial
goal of 8 percent.
Office of the Auditor General
page 13
Table 3: Total Investment Returns
Compared To 8 Percent Goal and SAA
As of March 31, 2005
Percentage
Returns
Percentage
Comparison To
Actuarial Goal
Percentage
Comparison
To SAA
1 year 6.7% -1.3% +0.1%
3 years 6.2 -1.8 +0.5
5 years 1.6 -6.4 +0.9
10 years 10.0 +2.0 +1.3
Source: Auditor General staff analysis of unaudited Pension Plan
Presentation Report First Quarter 2005 prepared by Mercer
Consulting and unaudited strategic asset allocation benchmark
information provided by ASRS.
Table 4: Investment Performance Compared To
Other Public Pension Funds by Reporting Agency
Periods Ending March 31, 20051
Years
Reporting Agency
1 3 5 10
Russell/Mellon Public Funds
Number 61 57 52 39
Median return 7.7% 7.6% 3.5% 9.6%
Percentile2 72 86 93 34
Wilshire Public Funds
Number 77 74 73 58
Median return 7.0% 6.7% 3.0% 9.5%
Percentile 50 73 77 37
Callan Associates Public Funds
Number 86 81 75 52
Median return 6.8% 6.9% 3.3% 9.3%
Percentile 49 72 88 23
1 Each of these three reporting agencies ranks pension fund performance within different groups of pension funds. As a
result, the performance of ASRS is somewhat different for each reporting group.
2 For each reporting agency, percentile refers to the relationship of ASRS returns to the returns of other funds reported.
Percentile is listed on a scale from 1 to 100 with 1 being the best.
Source: Auditor General staff analysis of unaudited Pension Plan Presentation Report First Quarter 2005 prepared by
Mercer Consulting.
domestic equities, ASRS’ total investment returns will be
strongly correlated with the price of those equities (see
Figure 2). Based on information provided by ASRS, during
the period from 1995-1999, stock prices, as expressed in
broad markets such as the Wilshire 5000, rose significantly,
which positively correlated with ASRS’ returns from the
same period. However, beginning in 2000, stock prices
declined dramatically from the highs of the late 1990s. This
decline is mirrored in ASRS’ returns over the 5-year period
from 2000-2004 and the 3-year period 2002-2004, which
are lower than ASRS’ 10-year returns from 1995-2004.
Additionally, ASRS’ returns from 2004 are down, which
coincides with a decline in stock prices for that year.
ASRS has developed real estate
investment plan
The ASRS Board approved investment in real estate in
August 2003, correcting what one board member called an “investment deficiency.”
The ASRS Board approved the allocation of 6 percent of its total assets to investment
in real estate, taking 4 percent of fixed income investments and 2 percent of
international equity investments to fund the real estate investments. Since that time,
ASRS has developed a real estate investment
program to guide the process. This program
set out the main areas in which ASRS’ real
estate investment will occur. In addition to
developing an investment program, ASRS
has also laid the groundwork for
implementing and maintaining the program.
Real estate investment plan
provides various methods of
diversification—In addition to using real
estate as a method of diversifying its overall
investments, ASRS plans to diversify within its
real estate investment program as well (see
Figure 3, page 16). It plans to achieve this
diversity in three main ways:
State of Arizona
page 14
Table 5: ASRS Investment Return Percentages
Compared To Asset Class Benchmarks1
Periods Ending March 31, 2005
Years
1 3 5 10
ASRS Domestic equity 7.5% 4.2% -1.4% 11.4%
S&P 500 6.7 2.7 -3.2 10.8
ASRS Fixed income 1.3 6.0 7.2 7.4
Lehman Brothers
Aggregate Bond
1.1 6.0 7.1 7.1
ASRS International equity 12.9 11.1 0.5 7.7
Morgan Stanley–EAFE2 15.5 12.1 -0.8 5.7
1 Benchmarks are shaded.
2 EAFE stands for Europe, Australia, Far East.
Source: Auditor General staff analysis of unaudited Pension Plan Presentation
Report First Quarter 2005 prepared by Mercer Consulting and unaudited
10-year return data provided by ASRS and compiled by Mercer.
'95 '96 '97 '98 '99 '00 '01 '02 '03 '04
Annual Return Rates
Figure 2: Annual Return Rates for ASRS Compared To
Dow Jones Wilshire 5000
Calendar Years 1995 through 2004
Source: Auditor General staff analysis of unaudited information provided by ASRS that was gathered
by Russell/Mellon and Mercer.
-30%
-20%
-10%
0%
10%
20%
30%
40%
ASRS Dow Jones Wilshire 5000
􀁺􇩉 Investing in Core and Non-Core Assets—ASRS plans to invest in two main
property areas, called Core and non-Core. Core assets will represent the
majority of its real estate assets. Core assets are high-quality existing properties
that are already substantially leased and producing a generally stable stream of
income. The real estate investment program sets a policy target for the Core
asset area of 70 percent, with an allowable range of 10 percent above or below
this weight. Non-Core assets include existing properties that are of lower quality,
or are not substantially leased. Non-Core assets are riskier investments than
Core assets. The higher risk of non-Core assets means that there is a higher
likelihood of negative returns on non-Core assets than on Core assets. However,
the higher risk also means that non-Core assets offer a higher potential for return
than Core assets. The real estate investment program sets a policy target for the
non-Core asset area of 30 percent, with an allowable range of 10 percent above
or below this weight.
􀁺􇩉 Investing in Different Property Types—ASRS plans to further diversify its real
estate assets by investing in four main property types. ASRS plans to invest in
property types that include office buildings, industrial facilities, retail facilities,
and multi-family structures, such as apartments. The real estate investment
program sets different policy targets and allowable ranges for the different
property types. The property type that can receive the largest amount of assets
is office properties, in which the policy target is 30 percent and the allowable
range is 15 percent above or below. The other major property types have policy
targets at either 20 or 25 percent, and allowable ranges of 10 percent above or
below. ASRS may also invest up to 10 percent of assets in other types of
properties, such as public storage facilities or manufactured housing.
􀁺􇩉 Investing throughout the Country—ASRS also plans to diversify its real estate
investments by spreading its assets over four main geographic areas. The real
estate program divides the United States into four areas—the West, South, East,
and Midwest. Within each of the areas, the program sets a policy target of 25
percent and has allowable ranges of 20 percent above or below. According to
ASRS’ real estate consulting firm, these relatively large allowable ranges give
ASRS needed flexibility to focus resources on areas where ASRS has
determined it is most likely to capitalize on favorable market conditions.
ASRS making progress toward implementation of the Real Estate
Program—ASRS has hired outside advisors and an internal real estate investment
expert, but has not yet signed contracts with real estate investment managers.The
first part of the real estate investment program was added in December 2003, when
ASRS hired its real estate consulting firm. In this role, ASRS’ consulting firm assists
ASRS in monitoring the performance of real estate investment managers and
determining appropriate areas for investment. Shortly after hiring the consulting firm,
ASRS hired an internal real estate portfolio manager. This staff member worked with
the consulting firm and the CIO to design the real estate program. ASRS has also
Office of the Auditor General
page 15
Most real estate
investments will be
in Core assets.
ASRS can make
heavier investments
in regions with
favorable real estate
conditions.
State of Arizona
page 16
ASRS Real Estate
Investment Strategy
ASRS plans to allocate approximately 6 percent of its total assets to
investment in real estate. This 6 percent investment will be diversified across
different areas:
􀁺􇩃 Core (lower risk) and non-Core (higher risk) investments
􀁺􇩔 Type of property
􀁺􇩐 Property location
For example, if the ASRS bought an office building in Phoenix that had most of
its space leased and was producing a generally stable stream of income, this
building would count as a Core investment, as an Office property investment,
and as an investment in the West.
Within each of these three areas, the Board has set specific policy targets and
an allowable range around each of the targets.
Core/Non-Core
Policy Targets
Core 70%
Non-Core 30%
Range +/-10%
Type of Property
Policy Targets
Property Location
Policy Targets
East 25%
Midwest 25%
South 25%
West 25%
Range +/-20%
Figure 3:
Source: Auditor General staff analysis of ASRS Real Estate Investment Program.
Office 30%
Range +/-15%
Other 5%
Range +/-5%
Retail 25%
Industrial 20%
Multi-family 20%
Range +/-10%
hired four legal firms to handle duties such as drafting and negotiating contracts,
providing legal opinions on issues related to the real estate investment program, and
helping to structure investments so as to minimize liability to the State.
ASRS has selected three managers that it plans to use for the first round of real estate
investments. However, as of May 26, 2005, these managers have not yet signed
contracts with ASRS. According to an ASRS official, a major obstacle for these
managers is contract conditions regarding liability insurance that Arizona’s state
procurement regulations mandate, but are not considered standard for the real
estate investment industry. ASRS is working with its real estate consulting firm and
real estate legal counsel to draft contracts that satisfy both state requirements and
the potential real estate managers. These external investment managers will be able
to start making investments as soon as they sign their contracts. According to ASRS,
once the managers sign their contracts, they will have up to 3 years to fully invest all
monies that are available to them. This time frame allows managers to hold out for
investments that are more likely to yield a good return.
ASRS real estate investment policies and procedures not yet
implemented—While it has made progress in implementing the real estate
investment program, ASRS has not yet approved its real estate investment policies
and procedures. A draft version of the policies and procedures has been created, but
as of April 2005, ASRS’ Real Estate Committee was still in the process of reviewing
them. These policies and procedures, which cover such issues as who has authority
to sign contracts for ASRS with investment managers and who has the authority to
release funds that these managers can invest, are appropriate for a fund that is just
beginning to invest in real estate. Since the first investments are anticipated to occur
very soon, the Real Estate Committee should adopt its currently drafted policies and
procedures as soon as possible.
In addition to adopting its draft real estate investment policies and procedures, ASRS
could develop additional policies and procedures. Auditors compared ASRS’ draft
version to policies and procedures developed by the California Public Employee
Retirement System (CalPERS) and the Illinois State Board of Investment (ISBI), and
determined that there were additional policies and procedures that the ASRS could
develop. Specifically, CalPERS’ procedures include specific criteria for potential
investment properties, and ISBI’s procedures include the roles and responsibilities of
their investment advisor, which is similar to ASRS’ real estate investment consulting
firm. ASRS should use procedures developed by other state pension plans to help
guide its future development of real estate investment policy and procedures.
Office of the Auditor General
page 17
ASRS has selected
three real estate
managers, but has not
yet signed contracts
with them.
Other potential asset areas
While the ASRS has recently diversified its investments by adding the real estate
asset class, there still are other asset classes available for investment. According to
the ASRS director, in its next asset allocation review in 2006, the Board may discuss
whether or not to invest in new asset areas, such as private equity, venture capital, or
hedge funds. Some other public pension funds have already invested in these asset
classes:
􀁺􇩐 Private equity—Private equities are shares of equities issued by companies that
are not publicly traded. One common way of investing in private equity is
through a partnership. A partnership is formed by a general partner, who has
experience in private equity investing. The general partner sells interest in the
partnership to financial investors, such as the ASRS, who become limited
partners. Limited partners provide financing when the general partner identifies
investment opportunities. Private equities offer a potentially higher return than
the publicly traded equities in which ASRS currently invests. Higher private
equity returns could be an important source of new revenues if a Mercer
representative’s prediction of lower-than-8-percent returns for equities over the
next 10 years proves true. Further, ASRS would not be the only fund that invests
in private equities. State pension funds in California, Illinois, Virginia, and
Colorado are among the public pension funds that have already invested in
private equities.1
There are also significant risks associated with private equities. Because private
equities are issued by companies that are not publicly traded, these companies
are not subject to the same level of regulation by the federal Securities and
Exchange Commission. Consequently, information about these private
companies is not as readily available as information about public companies.
For example, many private companies do not issue annual reports or discuss
their performance or financial condition.
􀁺􇩖 Venture capital—Venture capital is a form of private equity in which investors
provide financing for business ideas at the early stages of their development.
Venture capital offers a potentially higher rate of return than some other areas of
private equity investment, according to an investment manager familiar with it.
Additionally, other public pension funds have already made venture capital
investments.2 However, venture capital investments also involve a higher risk,
and therefore the returns from venture capital investments are uncertain. Further,
successful venture capital investments could take years to provide a positive
return.
In 2006, the Board may
consider other possible
asset areas.
1 These funds include the California Public Employees Retirement System, the Illinois Teachers’ Retirement System, the
Virginia Retirement System, and the Colorado Public Employees Retirement Association.
2 Two of these funds are the Florida State Board of Administration and the Massachusetts Pension Reserves Investment
Management Board, which both invest pension assets for funds in their respective states.
State of Arizona
page 18
Private equities offer a
higher possible return
than public equities.
􀁺􇩈 Hedge funds—Hedge funds are managed fund pools, similar to mutual funds.
However, unlike mutual funds, whose investments are limited, hedge funds can
invest in any asset, even professional sports franchises.1 According to a
representative from an alternative investment evaluation and marketing firm,
there are approximately 7,000 hedge funds available, although the actual
number is unknown. Like private equity and venture capital, hedge funds offer
the potential to achieve higher returns than are realized with publicly traded
equities. Additionally, several state pension plans have already invested in
hedge funds.2
According to some investment experts, however, there are also some significant
disadvantages to investing in hedge funds. One concern about hedge funds
relates to the benchmarks for hedge fund performance. Reporting to these
benchmarks is optional, and there is a coincidence between the poor
performance of a hedge fund and its lack of reporting to a benchmark. As a
result, the data regarding the overall performance of hedge funds is skewed.
Another concern is that hedge fund managers can charge very high fees for
their services, including a percentage of the investment gains. Some hedge fund
managers may charge 20 percent or more of investment gains.3 This could
significantly reduce the amount that ASRS would realize from any positive hedge
fund returns.
Recommendations:
1. The ASRS Real Estate Committee should adopt its draft policies and
procedures for investment in real estate.
2. ASRS should use procedures developed by other state pension plans to help
guide its future development of real estate investment procedures.
Hedge funds can invest
in any asset area.
1 BBC News. May 19, 2005. “Anti-Glazer fans vow ‘last stand’.” http://news.bbc.co.uk/1/hi/business/4562347.stm (May 25,
2005.)
2 These plans include the Alaska State Pension Investment Board, the California Public Employees’ Retirement System,
the State of Michigan Retirement Systems, the Pennsylvania State Employees’ Retirement System, and the Virginia
Retirement System.
3 Litterman, Bob, Quantitative Resources Group, Goldman Sachs Asset Management. Modern Investment Management:
An Equilibrium Approach. Hoboken, N J.: John Wiley and Sons, Inc., 2003.
Office of the Auditor General
page 19
State of Arizona
page 20
Office of the Auditor General
page 21
ASRS should improve its performance in paying
some benefits
ASRS should improve the timeliness and accuracy of annuity payments to new
retirees, as well as the timeliness of refunded contribution payments to members.
While ASRS’ goal is to make an initial annuity payment to each new retiree within 60
calendar days, a 2005 national study found that a majority of retirees of systems
similar to ASRS are being paid within 30 days. In addition, while ASRS quality control
staff is appropriately identifying inaccuracies in new retirees’ annuities, the number of
errors made in calculating these annuities should be reduced. Finally, ASRS sends
out only half of members’ refunded contributions within its goal of 45 business days,
while more than 8 percent of members wait an additional month to receive their
refund payment. ASRS should continue to take action to improve its performance in
each of these areas.
ASRS pays benefits to members
ASRS provides several types of monetary benefits to its members, including
retirement annuities and contribution refunds. Annuities are paid to members upon
retirement, and can be continued to a survivor upon the member’s death. As
discussed in this report’s Introduction and Background section (see page 2), annuity
amounts are determined by several factors, including the member’s length of service
and salary history, and a graded multiplier set by statute. As illustrated in Table 6 (see
page 22), the amount of retirement annuities paid to members increased from
approximately $695 million in fiscal year 2000 to over $1.2 billion in fiscal year 2004.
This was an increase of nearly 80 percent in dollars paid out, while the volume of
retirees increased approximately 23 percent over the same period, reflecting an
increase in the average annuity amount.
FINDING 2
State of Arizona
page 22
As Table 6 also shows, the amount of refund payments has decreased since fiscal
year 2000, falling from over $70 million to just over $36 million in fiscal year 2004,
while the volume has decreased by 35 percent. Refunds are available to members
who terminate employment with a participating employer prior to retirement. Upon
termination and prior to retirement, members may choose to request a “refund” of
their retirement contributions to ASRS, and receive these funds directly or roll them
over to a qualified retirement account. Members are not required to request a refund
of their contributions, and instead can leave them with ASRS until they are eligible for
retirement. The amount of the refund payment is the total contributions paid by the
member during his or her employment, as well as the interest earned on those
contributions. If a member has more than 5 years of service, the refund payment will
also include a percentage of contributions paid by his or her employer, beginning at
25 percent for 5 years of service and rising to 100 percent for 10 or more years of
service.
ASRS should improve timeliness of new retiree payments
While ASRS is largely meeting its goal for paying annuities to new retirees within 60
calendar days of retirement, it is not paying any new retirees within 30 days, as many
of its peer systems are able to do. There are several factors contributing to
challenges in paying annuities to new retirees on a timely basis, including employer
payroll verification, calculation of the annuity amount, a single monthly payment date,
and a prior backlog in service purchases.1 ASRS is already taking action to address
each of these factors and should continue to ensure its technology-based solutions
for this area are implemented by the end of calendar year 2006.
ASRS is taking action to
improve timeliness.
1 Active ASRS members may purchase certain types of credited service (including military service, other public service
employment, and time spent on a leave of absence from an ASRS employer) that will be included in calculating their
retirement annuity.
Table 6: Pensions and Refunded Contributions Paid
Fiscal Years 2000 through 2004
Fiscal Year
Number of
Retirees
Pensions Paid
in Thousands
Number of
Refund Recipients
Refunded
Contributions Paid
in Thousands
2000 55,959 $ 695,426 7,845 $70,755
2001 58,580 809,133 7,457 98,535
2002 60,951 924,172 6,041 42,765
2003 64,114 1,067,481 5,155 35,976
2004 68,560 1,238,966 5,125 36,212
Source: Auditor General staff analysis of ASRS data, as reported in the ASRS annual audited financial statement for
fiscal year 2004 and as provided by ASRS’ Senior Management Analyst.
ASRS is not timely in initiating annuities for new retirees—ASRS is
generally having success in meeting its goal of paying annuities to new retirees within
60 days after retirement. However, a 2005 national study showed that retirement
systems similar to ASRS disbursed initial annuity payments to an average of 75
percent of their new retirees within 30 days of the members’
final employment paycheck.1 As illustrated in Table 7, from
July 2003 through January 2005, ASRS did not pay any of its
new retirees within 30 days. ASRS is paying approximately 74
percent of its new retirees within its goal, but more than a
quarter are not receiving their first annuity check for at least 2
months after retiring. In the worst cases, several members
waited more than 6 months to receive their first annuity
payment.
While ASRS generally is meeting its goal of paying new
retirees within 60 days, it is important that it improve its
performance in this area. The timely delivery of these
payments is crucial for many retired members. If a new retiree
is relying on his or her ASRS annuity payment as a primary
source of income in retirement, any delays in initiating these
payments could seriously impact their financial situation. In
one case a member had to wait more than 7 months after her retirement date to
receive her first annuity check, while her service purchase transaction and partial
lump sum distribution were being completed. Additionally, an incorrect partial lump
sum amount was paid to her, which required an additional 2 months to correct. ASRS
reports that it issues hardship advances in some cases.
Several factors contribute to delays in paying new retirees—Several
factors contribute to the challenges in paying new retiree benefits in a timely fashion.
ASRS should continue its efforts to address these factors, and should consider
adopting new strategies to further enhance efficiency of processing new retirees.
Specifically:
􀁺􇩅 Employer payroll verification—ASRS currently waits for employers to report and
verify final payroll information for members employed within the past 3 years
before calculating and paying annuity benefits, and an ASRS supervisor
indicates that this is a primary cause for delays in issuing new retiree annuities.
This final payroll information determines the member’s total service credit and
could change his or her highest average monthly salary, both key factors in
calculating the member’s retirement annuity amount. An ASRS supervisor also
states that waiting for this information can add as much as several weeks to the
processing of a member’s retirement application when employers do not
provide the verification in a timely fashion. For example, if an employer does not
1 This benchmarking study was performed by Cost Effectiveness Measurement, Inc., a private company that annually
surveys public retirement systems and provides the compiled data to the participating systems. In the 2005 report
referenced here, the company grouped retirement systems into peer groups based on their number of active and retired
members.
Office of the Auditor General
page 23
Table 7: Time Frame for Paying New Retirees
July 2003 through January 2005
Calendar Days
Number of
New Retirees
Percentage
of Total
30 or less - -
31–45 3,619 49.8%
46–60 1,773 24.4
61 or more 1,870 25.8
Totals 7,262 100.0%
Source: Auditor General staff analysis of data from all
retirement applications received and processed by
ASRS from July 1, 2003 through January 31, 2005.
State of Arizona
page 24
submit the verification form for a member by ASRS’ deadline each month, that
member’s annuity payment cannot be processed until the following month.
In contrast, many of ASRS’ peers have been able to pay their new retirees more
quickly, and have initiated retirement annuities prior to receiving employer
verification. For example, the South Carolina Retirement System reported to
auditors that it pays annuities to nearly 90 percent of its new retirees within 30
days of retirement, while the Illinois Municipal Employees Retirement Fund
noted in an interview with the auditors that its members wait an average of only
18 days after retirement before receiving their first annuity payment. Both
retirement systems stated that they do not wait for a verification of the final
payroll data from the members’ employers before initiating annuity payments.
Following this practice used by these other states would not appear to create a
pattern of substantial errors in ASRS’ initial payments. Although the payroll
information for ASRS members available at the time of their retirement may be
different from the information that is later verified from the employer, auditors’
analysis of a sample indicated that it differs only slightly. This sample of ten
benefit estimates, which were performed between January 1, 2003 and
December 31, 2004, by ASRS staff prior to the member’s retirement,
demonstrated that monthly annuity amounts based on the data available at
retirement differed by less than 2 percent from those calculated after the
employer verification.
ASRS has initiated action on this issue. By the end of calendar year 2006, ASRS
intends to fully incorporate the processing of new retirees into PERIS, its
computer system.1 Once this occurs, ASRS will implement its goal of paying
new retirees within 10 days, and will no longer wait for employer payroll
verification before initiating annuity payments. According to ASRS management,
until processing new retirees is automated, initiating annuities based on
estimates would require staff to process each new retiree’s file twice instead of
once, placing too large a burden on staff resources. ASRS should ensure
project completion by December 2006 to reduce the amount of time new
retirees wait for their first annuity payment.
􀁺􇩍 Manual calculation of highest average monthly salary (AMS)—This process, a
key step in determining a member’s annuity amount, can be time-consuming
and cause delays in issuing members’ initial annuity checks. ASRS staff review
the final 10 years’ payroll history for each member to identify the 3 or 5 years
encompassing their highest salaries, depending on whether the member began
service before or after 1984. Staff must then examine the data from each pay
period within those years to manually calculate the highest AMS. As payroll data
prior to 1999 is not available in the current data system, this task involves
Benefit estimates
differed by less than 2
percent from finalized
annuities.
1 ASRS’ main data system is its Public Employee Retirement Information System (PERIS), which is used to store and
manage data on all ASRS members.
accessing data available only on microfiche or in archived files for many
members. An ASRS supervisor reported that this can take several days if
another staff group is using the file.
ASRS reported that it has addressed this issue by designing an automated
process for calculating the AMS. According to ASRS, this automated calculation
was implemented in new retiree processing in July 2005 and will also be
included in the overall automation of the new retiree functions scheduled to be
incorporated into its computer system in 2006. ASRS is also in the process of
converting all of its old data currently stored in paper and microfiche format to
an electronic imaged format, to be available for viewing directly through the
computer system. ASRS reported that this process is also scheduled to be
completed by June 2006. ASRS should ensure that it completes these projects
to decrease the amount of time new retirees wait for their first annuity payment.
􀁺􇨠 Single monthly payment date—ASRS currently issues, through its custodial
bank, all annuity payments for new retirees only once each month. As illustrated
in the text box below, members’ initial annuities are paid within a wide range of
timeliness, depending on the specific retirement date selected by the member.
For example, a member retiring on September 1 would be scheduled to receive
the first check in 36 days, while a member retiring on September 2 would wait
at least 67 days for the first check.
As reported in a 2005 national study, several other state retirement systems are
able to pay their new retirees more quickly, and auditors confirmed that some
pursue a different strategy than ASRS.1 For example, both the Washington State
Department of Retirement Systems and the South Carolina Retirement System
reported to auditors that they use two pay dates each month for issuing annuity
payments to new retirees. As a result, both of these systems initiate annuities to
new retirees within 30 days of retirement.
While ASRS believes that scheduling two payment dates each month is not
possible until the process is automated, auditors concluded that it may be
Office of the Auditor General
page 25
A new retiree selecting a retirement date between August 2 and September 1 of 2005 will be
processed in September, while a member retiring on September 2 will be processed in
October. The scheduled payment date for the first set of applications is October 7, while the
payment date for the September 2 retiree will be November 8, as illustrated below.
Retirement
Date
Payment
Date
Number of Days To
Receive First Payment
8/2 10/7 66
9/1 10/7 36
9/2 11/8 67
1 This benchmarking study was performed by Cost Effectiveness Measurement, Inc.
possible earlier. ASRS indicated that establishing multiple pay dates per month
could occur only after the new retiree process is fully automated, which is
scheduled to happen by the end of calendar year 2006. One component of the
planned automation is a “disbursement engine” that will capture and distribute
payment data, and that will provide flexibility to the payment scheduling process
that ASRS states it currently lacks. According to ASRS management, this
automation is necessary for it to schedule two payments per month because all
of its current manual processes are built on a single monthly payment model,
and that increasing payment frequency would involve redesigning the process.
Management also indicated that this would delay the automation of the new
retiree process scheduled to be completed next year.
However, auditors’ review of the process suggested that establishing two
annuity payment dates per month may be possible using the existing
processes, and may not involve a significant redirection of existing resources.
Auditors concluded that adding a second payment date approximately 1 week
after the existing payment date for new retirees would not create any new
manual processes. Additionally, ASRS has determined that paying annuities
more than once each month would not incur additional charges from its
custodial bank. ASRS should study the cost of implementing a second monthly
pay date for new retirees’ annuities, weighing any potential impact upon
currently scheduled IT projects against the benefit of reducing new retirees’ wait
times for receiving annuity payments.
􀁺􇩓 Service purchase backlog—For some members who were attempting to
purchase additional service before or at retirement, a backlog in processing
service purchase requests caused delays in processing their retirement
applications and in sending the members’ first annuity checks. Many members’
retirement applications could not be processed until their service purchase
transactions were completed. For example, several members who waited more
than 6 months to receive their first annuity checks were delayed due to their
request to receive their benefits in a lump sum form to pay for their service
purchase transactions. According to ASRS records, a significant backlog
developed in the summer of 2004 in completing service purchase requests (see
Introduction and Background, pages 2 through 3). By September 2004, the
number of requests awaiting processing had reached over 9,000.
ASRS successfully implemented a plan to reduce this backlog. Recognizing the
negative impact the backlog was having on several areas within ASRS,
management formed a special team in November 2004 dedicated to reducing
the backlog. This team was composed of member services and financial
services staff members and focused on issuing cost invoices to members,
which is the first step in replying to a service purchase request. This team was
State of Arizona
page 26
Establishing two annuity
payments per month
may be possible using
existing processes.
Office of the Auditor General
page 27
in place until March 2005, and by the end of that month, the backlog had been
reduced to just over 1,000 requests. As of July 21, 2005, the backlog had been
further reduced to 201 requests that had not been processed within ASRS’ time
frame goal.
ASRS should improve accuracy of initial new retiree
payments
In contrast to the timeliness of paying new retiree annuities, ASRS has had more
success in effectively identifying annuities with inaccurate amounts through its
internal control process. However, auditors’ review found several errors committed
during the processing of new retirees. There appear to be two primary factors
causing these inaccuracies, and ASRS should continue to take action to address
them.
ASRS identifying annuities with inaccurate amounts—ASRS has a “final
audit” process that effectively verifies the accuracy of all new annuities approximately
3 months after a member’s retirement. This process reviews each new retiree’s file to
determine if the annuity amount requires an adjustment due to a change of
information since the member’s retirement or an error in the initial retirement
processing. For example, an employer could submit a revised payroll verification
form after a member has retired if it had posted incorrect contribution amounts on
behalf of the member. Also, the staff who initially processed the new retiree
application could have made an error in calculating the member’s highest average
monthly salary or length of service.
The final audit process appears to be correctly identifying inaccurate annuities, and
the inaccuracies generally appear to be minimal. Auditors’ analysis of a random
sample of 48 new retirees’ final audits conducted between July 2004 and January
2005 indicated that inaccuracies are being properly identified.1 Specifically:
􀁺􇩔 The analysis found that the final audit process appropriately identified
inaccuracies, or the lack thereof, in all 48 sampled files. Auditors selected and
verified the accuracy of 23 files for which the final audit confirmed the originally
calculated annuity amount. Of the 25 files selected because the final audit
identified a discrepancy in the annuity amount, 13 were caused either by a
subsequent change to the member’s information or a difference in the rounding
functions used by the new retiree and final audit processing spreadsheets. The
remaining 12 discrepancies were caused by an error made during the
processing of the member’s retirement application, 9 of which were made by
ASRS staff in manually selecting the appropriate pay periods to calculate the
The final audit process
correctly identifies
inaccuracies in
annuities, which are
generally minimal.
1 Auditors requested documents for a random sample of 50 new retirees, but documents for 2 of the sampled new retirees
could not be located.
ASRS successfully
addressed the service
purchase backlog.
member’s highest average monthly salary. Prior to auditors’ request for error rate
data, ASRS had not consistently tracked the number of errors made in
processing new retirees. Though ASRS staff began tracking this information
during the audit, a historical error rate cannot be calculated or verified.
􀁺􇨠 The differences in annuity amounts identified in the 25 sampled final audits that
contained discrepancies in the monthly annuity amount were less than 2 percent
for 22 of the files, ranging from $0.01 to $35.61, and were less than $10 for 21
of the 25 files. When ASRS identifies an inaccuracy, it corrects the annuity
amount for all future payments. It also adjusts the member’s next annuity
payment to address any underpayments and most overpayments since the
initial annuity payment.1
Two factors contribute to difficulties in determining correct annuity
amounts—Two primary factors appear to contribute to the challenges in
calculating accurate new retiree annuity amounts. ASRS should continue its efforts to
address these factors. Specifically:
􀁺􇨠 Manual calculation of highest average monthly salary (AMS)—ASRS staff
currently review the last 10 years of payroll history for each member to manually
calculate the highest AMS. Due to the complexities that can exist in a member’s
payroll history from such factors as gaps in employment and multiple pay period
frequencies, this process has led to some incorrect AMS calculations. For
example, the payroll history for teachers may include large “balance-of-contract”
payments and/or gaps in payroll periods, as many are paid on a 9-month
schedule, which can make it difficult to select the appropriate range of months
needed to comprise the required 3 or 5 years of salary history.
ASRS designed an automated function for calculating the AMS and reported
that it was implemented in new retiree processing in July 2005. Auditors
reviewed the methodology used in designing this new function and concluded
it was sound and adhered to statute.
􀁺􇩉 Inadequate procedural guidance—Auditors analyzed the official procedure
documents for the new retiree process and found these documents do not
provide sufficient guidance for staff in some areas of processing retirement
applications, including the calculation of the highest AMS. For example, payouts
of accumulated vacation time prior to a member’s retirement are not eligible to
be included in the calculation of the highest AMS for some members, but the
procedures do not state this. Also, the procedures do not provide instructions
on how to select the appropriate range of months in calculating the highest
AMS, given the complexities previously mentioned.
ASRS reported that it is in the process of developing revised procedures for the
new retiree process, including calculating the highest AMS, to ensure the
State of Arizona
page 28
1 Overpayments of $10 or more are billed to the member through ASRS’ accounts receivable department.
procedures correspond to current practices. ASRS stated that its new retiree
staff use a set of informal guidelines for the calculation of retirement annuities,
and ASRS intends to incorporate these guidelines into the official procedures.
Auditors reviewed these informal guidelines, and found they provide additional,
though still not complete, guidance for this process. An ASRS supervisor also
reported that once the automated function for calculating the highest AMS is
implemented, it will incorporate the revised process in the formal procedures
and will deliver training sessions to all appropriate staff. ASRS should ensure it
updates its official procedures and provides training sessions to new retiree staff
once this new function is operational.
ASRS should improve timeliness of refund payments
ASRS is not consistently meeting its time frame goals for paying requested refunds
to members terminating employment prior to retirement. It is meeting its goal of
paying these benefits within 45 business days for only half of all refund requests,
which can have significant negative impacts on affected members. Two primary
factors appear to contribute to these challenges, and ASRS should continue its
efforts to address these issues.
ASRS not consistently issuing refunds in a timely fashion—ASRS is not
consistently meeting its time frame goals for paying
refunds. According to ASRS’ strategic plan, ASRS
strives to make refund payments to members
within 45 business days of their request. However,
as illustrated by Table 8, it is meeting that deadline
for only approximately half of all refund requests.
While refund payment recipients may differ from
new retirees in that they are not relying on the
payments for their primary income, members who
forfeit their contributions could be experiencing
urgent financial hardships and thus may need this
money. In its member satisfaction surveys
conducted during calendar year 2004, the
timeliness of refund payments ranked the lowest
among the three main types of benefit payments
(retirement, refund, and survivor), with 26 percent of surveyed members reporting
they were dissatisfied with the amount of time it took to receive their refunded
contributions.
Office of the Auditor General
page 29
Informal guidelines
provide additional,
though incomplete,
guidance.
Table 8: Time Frame for Paying Refund Contributions
July 2004 through December 2004
Business Days
Months
Number of
Refunded
Contributions
Percentage
of Total
45 or less (internal goal) < 2 1,363 50.3%
46–60 2–3 1,122 41.4
61 or more > 3 228 8.4
Totals 2,173 100.0%
Source: Auditor General staff analysis of data from all refund requests
received and processed by ASRS from July 1, 2004 through
December 31, 2004.
Two factors contribute to delays in paying refunds—Two primary factors
appear to contribute to challenges with paying refunds in a timely fashion. ASRS
should continue in its efforts to address these factors. Specifically:
􀁺􇩓 Service audits—According to ASRS staff, it requires a service audit for every
member requesting a refund before a payment is issued. A service audit is a
confirmation of a member’s total service credit, done by examining the
member’s detailed contribution and service purchase history to ensure ASRS’
data system reflects the accurate service and salary figures. In October 2003,
ASRS implemented a service audit function in its computer system, which
automatically runs for all contribution data received after 1999, and all service
purchases initiated after May 2004. However, for members with data from earlier
times, the service audit must be completed manually, using data from paper or
microfiche files. ASRS reported that the service audits completed from
November 2003 through April 2005 took an average of 28 days to complete.
Despite this average, ASRS staff noted that some of these manual service audits
have taken more than 3 months to complete and that this is the primary cause
of delays in making refund payments. Auditors’ review of the time frame data for
paying refunds showed that of the six refunds that took at least 4 months to
complete, untimely service audits caused four of the delays. In one case, the
service audit was not completed until 128 days after the member submitted the
refund application, and the payment was issued 20 days after the completion of
the audit.
ASRS has a backlog of manual service audits that have been requested but not
yet completed. According to an ASRS staff member, one source of this backlog
was ASRS’ effort to reduce the backlog in service purchase requests, when
ASRS reassigned staff from service audits to service purchases. ASRS reported
that since it has effectively reduced the backlog of service purchase requests, it
has reassigned a nine-person member services staff team to focus on the
service audits that still require manual reviews. In the first month of the team’s
operation, ASRS reported that the backlog was reduced from over 3,500 to
2,322 pending service audits.
􀁺􇩍 Multiple data systems—ASRS still relies on its legacy computer system for
processing all refund payments. ASRS staff must look up information and enter
payment data in both the legacy system and its main computer system to
complete refund requests, which creates unnecessary delays and increases the
potential for data entry errors. ASRS reported that it has already begun work to
fully incorporate the refund function into its new computer system, and is
scheduled to finish the project by April 2006. ASRS should work to ensure it
finishes this project on time to reduce the amount of time members wait for their
refunded contributions.
State of Arizona
page 30
ASRS had reduced the
service audit backlog
from over 3,500 to 2,322
as of May 31, 2005.
Recommendations:
1. To improve the timeliness of paying new retiree annuities, ASRS should:
a. Complete the incorporation of the new retiree function into its main data
system by December 2006 to allow it to initialize annuities based on
currently available data instead of waiting for employer verification of final
payroll details.
b. Complete its ongoing project to convert members’ paper and microfiche
files to electronic images by June 2006.
c. Study the cost of implementing a second monthly pay date for new retirees’
annuities, weighing any potential impact upon currently scheduled IT
projects against the benefit of reducing new retirees’ wait times for receiving
annuity payments.
2. To improve the accuracy of paying new retiree annuities, ASRS should update
all procedure documents related to processing new retirees, and provide
training to its staff for the automated calculation of the highest average monthly
salary once this new function is operational.
3. To improve the timeliness of paying refunds, ASRS should complete its efforts to
fully incorporate this function into its main computer system by April 2006.
Office of the Auditor General
page 31
State of Arizona
page 32
ASRS should monitor and assess its plan for
improving call center performance
Revisions are likely needed in a plan ASRS developed to improve response times at
its call center. In June 2004, waiting times for callers began increasing substantially,
causing more callers to hang up before a customer service agent became available
to handle their call. The delays appear to have resulted from several factors, including
an increase in calls and a decrease in staff. ASRS’ plan to address the problem
called for adding substantially more staff. Auditors’ review of this plan, as well as call
center performance data, indicated that it is based on several faulty assumptions,
including projected call volumes and the number of staff required to answer those
calls. As a result, the plan may add more staff than will be needed to meet its
performance objectives for the call center.
ASRS call center assists members
In April 2002, ASRS established a centralized call center at its Phoenix office. While
ASRS had always responded to incoming telephone and e-mail inquiries from
members and the public, the agency chose to provide service through a dedicated
call center staff group. As of May 2005, the call center was staffed by 14 full-time
agents answering the phones, plus 2 supervisors. The call center uses industry-standard
software to manage and capture data on incoming calls and to record the
nature of the inquiries. The reasons members call include questions regarding health
insurance, benefit payment schedules and amounts, annual member statements,
service purchase transactions, and address changes.
Call center performance has worsened
Since June 2004, the ASRS call center has not met its goals for the percentage of
answered calls or the time a caller waits to talk to an agent, and member satisfaction
Office of the Auditor General
page 33
FINDING 3
State of Arizona
page 34
with the call center performance as measured by customer satisfaction surveys has
also declined. Several factors probably contributed to this situation. ASRS could
address one of the factors by exploring ways of gathering more data about the
specific reasons for members’ calls.
Answer rates and wait times have worsened—Since June 2004, the ASRS
call center’s customer service performance has fallen significantly. The agency
measures the quality of service provided to its members by the call center in several
ways, including the answer rate—the percentage of all incoming calls that agents
answer before members hang up—and the wait time—how long members wait on
hold before reaching an agent. The call center’s software package calculates and
tracks these measures. As illustrated by Figure 4, the call answer rate has worsened
significantly since June 2004. Prior to then, the call center answered an average of
94 percent of all calls, exceeding its goal of 90 percent. However, that average fell to
69 percent from June 2004 through May 2005.
Similarly, as illustrated by Figure 5 (see page 35), wait time performance has
worsened. While callers reached an agent in an average of 37 seconds before June
2004, again exceeding the goal of 60 seconds, they waited more than 5 minutes on
average from June 2004 through May 2005.
Callers are spending
more time on hold, and
the answer rate has
fallen.
Figure 4: Average Answer Rate 1
January 2003 through May 2005
1 Answer rate is the percentage of incoming calls answered by a call center agent before the caller hangs up.
Source: Auditor General staff analysis of data from ASRS' call center software package.
2003 2004 2005
0%
20%
40%
60%
80%
100%
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Answer Rate
Percent Answered Goal
Member satisfaction with
call center has
worsened—ASRS, through
an outside vendor, surveys a
sample of approximately 250
of its members each month to
ascertain their level of
satisfaction with many facets of
customer service, including the
call center. As illustrated in
Figure 6, the survey data for
calendar year 2004 shows a
growing level of dissatisfaction
with the performance of the call
center. While only 7 percent
and 6 percent of survey
respondents expressed
dissatisfaction with the
timeliness of answering calls in
the first and second quarters of
calendar year 2004, that
percentage rose to 10 percent
in the third quarter and 16
percent in the fourth. More
recently, the monthly surveys
for January and February 2005
reported 41 percent and 48
percent dissatisfaction rates
with the timeliness of
answering calls.
Several factors may be
contributing to low
performance—Multiple
factors are likely having a
negative impact on call center
performance. Since June
2004, the volume of incoming
calls has increased
significantly, the average
number of staff answering
phones has decreased, and
the amount of time required to
handle each call has
increased.
Office of the Auditor General
page 35
Figure 5: Average Wait Times, in Minutes
January 2003 through May 2005
2004
Source: Auditor General staff analysis of data from ASRS' call center software package.
Goal Percent Answered
2003
0
2
4
6
8
10
12
14
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Apr.
May
Wait Time in Minutes
2005
Figure 6: Member Satisfaction for Call Center Timeliness
January 2004 through March 2005
2004 2005
Source: Auditor General staff analysis of data from the ASRS monthly member satisfaction surveys for
January 2004 through March 2005.
0%
20%
40%
60%
80%
100%
Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
Jan.
Feb.
Mar.
Member Satisfaction
􀁺􇨠 Call volume increased—Over the past year, ASRS experienced a large increase
in the number of incoming calls. Beginning in June 2004, the volume of
telephone inquiries received by the call center rose significantly, reaching a peak
of almost 30,000 in January 2005. While the average monthly number of
incoming calls from January 2003 through May 2004 was just over 16,000, the
average increased by 33 percent, to almost 22,000, from June 2004 through
May 2005.
According to ASRS, the rise in service purchase requests and subsequent
backlog that developed in the summer of 2004 (see Introduction and
Background, pages 2 through 3) is the primary cause for this increase in call
volume. However, the information available from the call center’s software
package is currently not detailed enough to determine if ASRS is correct in this
assumption. Auditors’ analysis of data from the call center’s software package
found that the nature of calls, as recorded by the agents immediately following
each call, has remained fairly stable throughout 2004 and 2005, and that calls
regarding service purchase have not significantly increased over this period.
However, ASRS management said that many of the calls recorded under other
reasons (for example, new retiree checks or refund payments) were indirectly
related to the service purchase backlog. The call center software currently has
no data for assessing these relationships. To better understand the reasons for
calls, and therefore project possible trends in call volumes, ASRS should explore
ways of more specifically tracking both the primary and secondary reasons for
incoming calls.
􀁺􇩎 Number of agents decreased—The number of agents at the call center
decreased over the same time period. Prior to June 2004, the call center had an
average of almost 11 agents answering the phones at any given time. From
June 2004 through May 2005, the average had fallen to below nine agents
answering the phones. ASRS management indicated that it has been difficult to
attract and maintain a sufficient number of staff in the call center. Auditors’
analysis of the staffing level during this period, as compared to the call volume
and answer rate, suggests that maintaining their full complement of agents
would have significantly mitigated the decrease in performance as call volume
rose.
􀁺􇩁 After-call work takes more time—Additionally, the time needed to finish up work
related to calls, after the call is over, has increased, though the amount of time
spent talking to the caller has remained fairly stable at an average of 4 minutes.
Prior to June 2004, agents had been taking less than a minute on average to
wrap up any call-related work after completing the call. From June 2004 through
May 2005, it took nearly 90 seconds on average to complete the same work.
This “after-call work” includes such activities as preparing requested forms to
send to members, recording the reason for and notes about the call, and
communicating with other ASRS staff to address callers’ concerns. While the
addition of 30 seconds is not a large amount of time for an individual call, that
State of Arizona
page 36
Call volume reached a
peak of 30,000 in
January 2005.
ASRS should more
specifically track
reasons for incoming
calls.
Office of the Auditor General
page 37
increase takes on greater magnitude when multiplied by the 10,000–17,000 calls
that ASRS answers each month. Auditors’ analysis suggests that this cumulative
increase accounts for almost one agent FTE’s time each month.
While agency management indicated this rise in after-call work was likely due to the
learning curve of newly hired staff and the increase in the number of newer staff,
auditors’ analysis of the call center’s staffing history did not find support for that
statement. Specifically, a review of the call center’s staffing history indicated that staff
experience levels appear to be very similar during the periods of January 2003–May
2004 and June 2004–February 2005. As a result, it does not appear that staff working
in the call center during the period of higher after-call work are less experienced than
before.
Performance improvement plan likely calls for too many staff
ASRS should monitor and assess its staffing plan intended to improve the call
center’s performance. Recognizing the worsening call center performance levels,
ASRS developed a plan to enhance performance by hiring 10 additional FTEs.
However, auditors’ review of the plan identified several deficiencies and suggested
that ASRS may not need 10 additional staff to meet its performance objectives.
Plan calls for 10 additional staff—ASRS recognized the decrease in its call
center performance, and used a model to develop a staffing plan to remedy the
situation. This plan calls for an increase in the number of call center agents from 14
to 24 FTEs, and sets a higher pay grade for the 10 additional FTEs. ASRS used a
quantitative model to determine the number of agents required to achieve its desired
service level of answering 80 percent of calls within 20 seconds.1 One component of
the model is call-volume projections, and ASRS based these projections on a 15
percent increase over the July to December 2004 call volume. Even though this
period had an abnormally high volume of calls when compared to previous 6-month
periods, ASRS projected the volume would continue to rise as service purchase
transactions were concluded and the number of new retirees rose.
In addition to adding new staff, ASRS also decided to change its staffing strategy
away from a reliance on staff provided by temporary personnel agencies to directly
hiring permanent, higher-pay-grade employees. The plan called for ASRS to hire the
10 additional FTEs as grade 19 employees, an increase costing approximately
$3,750 more per position than the existing grade 15 positions.2 ASRS allocated 10
1 ASRS used the “Erlang C” model in its staffing analysis. This model inputs projected call volume, desired answer rate
and wait time, and expected call length. It then uses a logarithmic function to calculate the number of agents required to
match the inputs. This model is widely used in call centers.
2 The available evidence does not clearly indicate the extent to which hiring staff at a higher pay grade will affect results.
ASRS officials indicated they have had some difficulty in retaining call center employees and would be able to provide
better service with higher-grade positions. While higher salary levels might encourage retention, neither ASRS’ monthly
member surveys nor its internal call center quality review process have identified problems with employees’ skills or
experience levels.
ASRS is shifting from
temporary to permanent
staff in the call center.
State of Arizona
page 38
of the new positions approved by the Legislature and Governor in its fiscal year 2006
budget to the call center.
Plan’s projections are likely overstated—While ASRS has already initiated its
plan to improve call center performance by hiring 10 additional FTEs, auditors’ review
of the plan and call center data suggests that ASRS may not need this number of
FTEs. Specifically, auditors’ analysis indicates that 5 or fewer agents should be
sufficient to meet ASRS’ performance goals for the call center. ASRS should monitor
its call volume to confirm this analysis; if it is shown to be accurate, ASRS should
redeploy any excess staff to other areas requiring assistance.
ASRS management indicated they would redeploy some of these 10 new FTEs to
other functions if fewer agents were needed in the call center. However, as of July
2005, other areas identified by ASRS appear to be performing adequately with the
current number of staff. For example, while the agency was struggling with issuing
cost letters for service purchases in 2004 within their performance goal, data from
mid-2005 shows they had improved and were able to issue the cost letters within
their goal of 40 business days. Additionally, ASRS reports that during 2005, it has
significantly reduced its backlog of service audits from nearly 4,000 to under 800.
Therefore, if staff are redeployed to other areas, ASRS should ensure those areas are
in need of assistance at that time.
Auditors identified two problems with the plan’s projections, one dealing with call
volumes, the other with the model used to develop the plan.
􀁺􇩆 First, the call volume ASRS used as the starting assumption for the quantitative
model’s projections was too high. The 6-month period (July–December 2004)
used as the base for the model reflected the highest call volume since ASRS
began tracking this type of data, and was nearly 30 percent higher than the
same period in 2003. While the agency believes that the service purchase
backlog was primarily responsible for this large increase in call volume, it also
believes that this volume will continue to rise as ASRS’ overall volume of services
provided to members increases. However, the call volume has already
decreased 40 percent from January to May 2005. Additionally, auditors’ analysis
of past call-volume trends found that the average increase over all other
comparable 6-month periods was less than 8 percent. These analyses suggest
that the ASRS’ call-volume projections were too high, and therefore fewer staff
could answer a lower expected volume of calls.
Additionally, the call center’s performance during previous peaks in call volume
does not support ASRS’ decision to hire 10 additional FTEs. Prior to the increase
in call volume beginning in June 2004, October 2003 had the highest volume in
any month since ASRS began measuring performance with its current software.
During October 2003, the call center answered over 92 percent of that month’s
22,287 calls with an average of 11 agents answering the phones. The staffing
assumptions used by ASRS management suggest that 14 FTEs would be
sufficient to have an average of 11 agents answering the phones at any given
time.1 Even if future call volumes were to meet ASRS’ projections of an average
of fewer than 25,000 calls each month, it is not reasonable to expect it would
require 24 FTEs to adequately answer these calls.
􀁺􇩓 Second, industry literature suggested the quantitative model used by the
agency has a tendency to overestimate the number of staff required to meet the
service level targets. For instance, the model assumes that all callers will wait on
hold indefinitely until an agent is available to answer their call. If some
percentage of callers hang up, the resulting volume of calls requiring an agent
response decreases, as does the number of staff required. ASRS established a
goal of answering at least 90 percent of incoming calls, acknowledging that
some callers will hang up before reaching an agent.
Recommendations:
1. To provide more accurate call volume projections to assist in future staffing
plans, ASRS should consider the feasibility of tracking both the primary and
secondary reasons for incoming calls.
2. If the call center is able to achieve its performance objectives with fewer staff
than required by the staffing plan, ASRS should redeploy any excess staff to
other areas requiring assistance.
Office of the Auditor General
page 39
1. According to the call center manager, the number of available agents, as tracked by the call center’s software package,
is generally lower than the number of FTE agents employed in the call center, due to such absences as vacations,
illnesses, daily breaks, and staff meetings.
State of Arizona
page 40
Auditors have compiled information about the financial status, outlook, and possible
changes to the previous retirement program known as the “System” that was in place
in Arizona from 1953 to 1971.1 As System membership continues to decline, ASRS
has determined that it will face problems ensuring that liabilities and assets remain
adequately balanced. Maintaining the status quo with the System would likely require
significant benefit cuts. In order to avoid this, ASRS has studied three options.
History and structure of the System
ASRS has existed in various forms since 1953 and has
operated the current pension plan since 1971. In 1953, the
Legislature created ASRS to provide retirement and other
benefits for state employees, including university faculty and
employees of the State’s political subdivisions. Active teachers
voted to join the ASRS in 1954 and transferred to ASRS on
January 1, 1955.
In 1970, the Legislature agreed to enact the current Arizona
State Retirement System Fixed Benefit Plan (Plan) if 70 percent
or more of state employees and teachers voted to transfer to
the new plan. More than 80 percent of members voted to
replace the System with the Plan, which became effective July
1, 1971. Most political subdivisions subsequently voted to join.
Since the transition to the Plan, System members have been
given several chances to switch over to the Plan, and many have
taken advantage of such opportunities. As of June 30, 2004, there were still about
2,100 System members, nearly 300 of whom were not retired. According to ASRS,
these members have likely chosen to stay in the System probably because it is
financially advantageous. As of June 30, 2004, the System had $544.7 million in
assets and $510.8 million in liabilities. ASRS invests System assets in equities,
bonds, and real estate, along with assets from the Plan.
Office of the Auditor General
OTHER PERTINENT
INFORMATION
page 41
1 Much of the information in this section of the report is based on findings and conclusions reached in a study conducted
for ASRS by its contracted actuary.
Defined Contribution Plan—A retirement plan
offering a benefit that depends on the total
contributions made by the employer and the
employee and on the investment returns
earned by those contributions. Employees
generally bear the investment risk.
Defined Benefit Plan—A retirement plan that
promises to pay a certain amount for a
member’s lifetime, usually based on the
number of years of service and on the average
salary in the period before retirement.
Employers generally bear all investment risk.
State of Arizona
page 42
The System is a retirement program that contains elements of both defined
contribution and defined benefit plans. Each member and employer contributes an
amount set by statute (currently 7 percent of the employee’s compensation) into the
member’s account, and interest on the balance (set at 8 percent since 1985) is
added as well. When System members retire, their account balance is converted into
a guaranteed annuity that then pays them a specified benefit amount on a monthly
basis. If investment income exceeds the assumed 8 percent rate of return before a
member retires, then he or she receives additional credits to the account, known as
supplemental credits. According to ASRS, the average unguaranteed portion of
nonretired members’ benefits is 59.9 percent. Upon a member’s retirement, these
supplemental credits are added to the guaranteed portion of benefits, but they are
not themselves guaranteed.1 Finally, any investment gains to the System’s
investments that occur after a member’s retirement are paid to retired members in
the form of a 13th check either in November or December.
Forthcoming problems identified
As System membership continues to decline, ASRS has determined that it will face
problems ensuring that liabilities and assets remain adequately balanced. In
addition, System administration will become increasingly inefficient. As a result,
ASRS believes that it will have to reduce benefits if it wants to e