ARIZONA STATE UNIVERSITY ex rel. ARIZONA BOARD OF REGENTS, a body corporate, Plaintiff/Appellant,
ARIZONA STATE RETIREMENT SYSTEM, a body corporate, Defendant/Appellee
Appeal from the Superior Court in Maricopa County. No. LC2012-000689-001. The Honorable Crane McClennen, Judge.
For Plaintiff/Appellant: Thomas L. Hudson, Eric M. Fraser, Osborn Maledon P.A., Phoenix.
For Plaintiff/Appellant: Lisa K. Hudson, Office of General Counsel, Arizona State University, Tempe.
For Defendant/Appellee: Jothi Beljan, Arizona Attorney General's Office, Phoenix.
Judge Patricia K. Norris delivered the opinion of the Court, in which Presiding Judge Margaret H. Downie and Judge Randall M. Howe joined.
¶1 The dispositive question in this appeal is whether Defendant/Appellee, the Arizona State Retirement System, was required to follow the rulemaking procedure set forth in Arizona's Administrative Procedure Act before enforcing a policy under which it charged Plaintiff/Appellant, Arizona State University, for an actuarial unfunded liability reportedly arising when 17 University employees retired. We hold that it was, and because the System failed to follow the rulemaking
procedure, the policy is invalid. Accordingly, we reverse and remand to the superior court for entry of an order directing the System to refund the improper charge, with interest thereon if and as authorized by law.
FACTS AND PROCEDURAL BACKGROUND
¶2 The System administers a trust fund which provides retirement and disability benefits in the form of periodic, or lump sum, pension payments to eligible employees of the state and participating political subdivision employers. Ariz. Rev. Stat. (" A.R.S." ) § § 38-711(13), -712, -727, -729, -757, -758, -760, -762 to -764 (2015). The employees, known as " members," may also elect to receive one of several health insurance supplemental benefits. A.R.S. § § 38-711(23), -783 (2015). Member and employer contributions fund the trust, along with interest on fund assets and investment returns. A.R.S. § § 38-718, -735 to -737 (2015). To monitor the trust's financial health, the System compares the assets it has accumulated to pay for members' earned benefits with the liabilities it owes for those benefits. See A.R.S. § 38-737(A). When liabilities owed for past service exceed assets accumulated to pay those liabilities, an unfunded actuarial accrued liability exists.
¶3 Each year, the System's actuary determines the contribution rates necessary to fund the System's present and future obligations to its members plus payments on any amortized unfunded actuarial accrued liability. A.R.S. § § 38-736, -737. In determining the contribution rates, the actuary relies on assumptions about members' expected benefit elections, payroll growth, retirement rates, mortality rates, interest rates, and investment returns. The System conducts empirical studies every five years to improve its assumptions. See A.R.S. § 38-714(G) (2015).
¶4 The System may incur an actuarial unfunded liability when an employer offers incentives to encourage its employee-members to retire. For example, when an employer increases a member's salary beyond System expectations in exchange for a promise to retire, that member's monthly pension, calculated using the increased salary, see A.R.S. § 38-711(5)(a)(ii)(b), -757 to -759 (2015), may likely exceed the amount the System expected to pay out to that member, thus resulting in an unfunded liability. A termination incentive program may also result in an unfunded liability by causing members to retire and collect benefits sooner and for longer than the System expected.
¶5 To address the financial impact of termination incentive programs, see Amended Senate Fact Sheet, H.B. 2052, 46 Leg., 2d Reg. Sess. (March 11, 2004), in 2004 the Legislature enacted A.R.S. § 38-749 (2015). 2004 Ariz. Sess. Laws, ch. 106, § 1 (2d Reg. Sess.). Under this statute, " [i]f a termination incentive program that is offered by an employer results in an actuarial unfunded liability" to the System, the employer must pay the System " the amount of the unfunded liability." A.R.S. § 38-749(A). The statute directs the System to " determine the amount of the unfunded liability in consultation with its actuary." Id. 
¶6 Although A.R.S. § 38-749 refers to an " actuarial unfunded liability," the statute does not explain how to determine when a termination incentive program results in an actuarial unfunded liability or how to calculate " the amount of the unfunded liability." To answer these questions, the System's executive staff discussed the statute with the System's actuary. They considered two methods of calculating the unfunded liability, one which would discount the charge to employers by the amount of additional benefits a member would have received if he or she had continued working instead of retiring and one which would not provide employers with this discount. As a result of these discussions, the System's executive staff adopted the first method and directed the System's actuary to draft the System's " Policy on Employer Early Termination Incentive Programs" to memorialize how the System would implement A.R.S. § 38-749.
¶7 The Policy requires employers to notify the System of all members who participate in a termination incentive program and to disclose their demographic and salary information, as well as their benefits elections. Using this information, the System's actuary calculates the present value, under System actuarial assumptions, of the member's future benefits as if he or she had not retired (" active liability" ) and the present value, under System actuarial assumptions, of the member's future ...