SR - - CALPERS PENSION LIABILITY FUNDING STRATEGY UPDATE�pP ORa.
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AGENDA ITEM
October 13, 2015
TO: Honorable Mayor and
Members of the City Council
THRU: Rick Otto
City Manager
FROM: William M. Kolbov� x4v--
Finance Director
ReviewedNerified B
City Manager
Finance Director
To Be Presented By: Will Kolbow
Cons Calendar _
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Plan/Environ
1. SUBJECT 7:71
Ca1PERS Pension Liability — Funding Strategy Update
2. SUMMARY
The City offers a defined benefit pension plan to its safety and civilian employees, respectively,
through the California Public Employees Retirement System (Ca1PERS). In recent years, the
unfunded pension liability (the difference between benefits earned and the assets accumulated to
pay the benefits) has risen to as high as $224.5 million in 2009 and, as of June 30, 2013 (the
latest valuation date), sits at $190.2 million. Staff has reviewed several options to address this
liability and is seeking feedback on proposed strategies that will allow the City to pay down the
liability within CalPERS' expected timeframe or sooner.
3. RECOMMENDED ACTIONS
Receive and file.
4. FISCAL IMPACT
None.
5. STRATEGIC PLAN GO
2. Be a fiscally health community.
a. Expend fiscal resources responsibly.
6. GENERAL PLAN IMPLEMENTATION
Not applicable.
ITEM _�. a 1 10/13/2015
7. DISCUSSION and BACKGROUND
Ca1PERS Benefits Provided by the City
The City provides retirement benefits to its employees through CalPERS. All full -time and
certain part-time employees are eligible to receive benefits through CalPERS. The City has a
safety pension plan for its sworn firefighters and police officers, and a miscellaneous plan for all
other eligible employees. These plans provide defined benefits to covered employees upon
retirement from the CalPERS system.
The safety plan formula is 3% @ 50 for employees that were CalPERS members before January
1, 2013 ( "classic members "). This means that, upon retirement at the age of 50, employees
receive 3% of their final year's compensation for every year that they worked and were covered
by the system. For example, a firefighter that retires from the City with 25 years of would
receive a pension of 75% (25 times 3 percent) of their final year's compensation. Those safety
members hired on or after January 1, 2013, and have had not previously been a member of
CalPERS receive a formula of 2.7% @ 57, as a result of the Public Employee Pension Reform
Act ( PEPRA) of 2013.
The miscellaneous plan formula for "classic members" is 2.7% @ 55. The formula for PEPRA
miscellaneous plan members is 2% @ 62.
Fundine of Retirement Benefits
All contracting agencies of CalPERS are required to fund their pension plan benefits as they are
earned by employees. This ensures that, along with accumulated investment earnings on
contributions, there are sufficient funds set aside for the benefits earned by employees upon their
retirement. According to CalPERS, investment earnings pay about two - thirds of total benefits
earned, while employer (City) contributions pay 21% of benefits and employees pay 12 %.
Contributions by both the employees and the City are calculated on a percentage of payroll. The
contribution rate for employees varies based on the plan that they are enrolled in and whether
they are a classic or PEPRA member. Classic safety employees contribute 9% of pensionable
income, while PEPRA safety members pay 12% of pensionable income. Classic miscellaneous
employees contribute 8% of pensionable income and PEPRA miscellaneous members contribute
6.75 %.
The City contributions are actuarially determined by CalPERS. The City pays a portion of the
normal cost, which is the portion of pension the employee earned for that same period's work,
and pays for all shortfalls in the pension plan, also known as unfunded liability contributions.
For example, in FY 2014 -15, the City's contributions were 33.320% and 22.568% of pensionable
compensation for the safety and miscellaneous plans, respectively. For the safety plan, this
consisted of 17.775% for normal costs and 15.545% toward the City's unfunded liability. For
the miscellaneous plan, the rates were 9.974% and 12.594% for normal costs and unfunded
liability, respectively.
ITEM 2 10/13/2015
Unfunded Liability
An unfunded liability can occur when actual results do not agree with actuarial assumptions. For
example, actuaries must estimate how long people receiving pensions will live and, therefore,
draw benefits. If, on average, pensioners exceed these estimates, they will receive more benefits
than the actuaries had anticipated.
Another major factor in determining how much money must be set aside is the rate of return on
investments, also known as the discount rate. When investment earnings do not meet
expectations, a liability is created and additional contributions are necessary to make up the
difference.
Pension liabilities have fluctuated greatly over the past fifteen years. In 1999, the City's pension
liability was negative and, as a result, the City's contribution rate for both plans was zero. Under
PEPRA, however, City contributions cannot fall below the normal cost contribution in the future.
The recession of the early 2000s led to an unfunded liability of $65.6 million in 2003. By 2007,
strong returns led the pension plans to be fully funded once again. The Great Recession,
beginning in 2008, led the unfunded liability to reach $224.5 million in 2009. This peak in the
liability was perpetuated by a 24% loss in the CalPERS portfolio in FY 2008 -09.
CalPERS' valuations lag by three years due to the time it takes to gather and analyze data. The
rates that the City is paying for FY 2015 -16 were determined by the valuation dated June 30,
2013. The unfunded liability in the safety plan, as of June 30, 2013, was $115.3 million and the
miscellaneous plan unfunded liability was $74.9 million, for a total of $190.2 million. The safety
plan contains assets to cover 71.7% of benefits earned, while the miscellaneous plan holds 73.3%
of benefits earned.
Addressine the Unfunded Liability
While strong earnings in the past have led to the unfunded liability being reduced to zero, as
recently as 2007, investment earnings alone cannot be relied upon to make up funding shortfalls.
As such, additional contributions are necessary to pay down the liability. As these payments are
made, CalPERS charges 7.5% interest on the liability, which matches the discount rate it uses in
its assumptions. CalPERS has implemented policies to address the amortization of the unfunded
liability over a 30 -year period, with periods of ramping up contributions over a 5 -year period,
holding them steady for 20 years, then ramping the contributions down over the last 5 years of
the amortization period. The contributions are paid as a percentage of payroll. CalPERS makes
assumptions about what they predict pensionable payroll will be. However, since the recession,
actual pensionable payroll has been significantly less than CalPERS projected payroll, therefore
lowering the actual amount paid toward the unfunded liability. It is important to note that the
City's practice has always been to make the payments as a percentage of pensionable payroll
according to CalPERS requirements. By not paying the full dollar amount, the contribution rate
must increase in future years in order to keep the amortization period on track. This also
increases the interest costs on the liability as it is not being paid off as quickly as expected.
During the Council FY 2015 -16 budget study session on April 28, 2015, staff presented the
Council with several options for addressing the City's unfunded liability. These options included
ITEM 3 10/13/2015
establishing an irrevocable trust to fund future benefits, making one -time payments to CalPERS,
and shortening the amortization period (currently 30 years). While these options could have the
effect of lowering the liability at a quicker pace, it also exposes more assets to the CalPERS
investment portfolio that, by definition, must take greater risks than the City's investment policy
in order to meet its 7.5% rate of return target. As such, these may not be attractive options to the
City.
We have recently explored two additional options to ensure that the City is, at a minimum,
making the full amount CalPERS expects the City to pay. One option is to appropriate additional
funds in the Accrued Liability Fund, set aside for CalPERS, at the end of the year to make up any
shortfalls in unfunded liability payments made to CaIPERS. For example, in FY 2014 -15, the
City made all of its required contribution based on the percentage of payroll approach. However,
pensionable compensation was $7.1 million less than CalPERS had projected. This was due to
unfilled vacancies, as well as CalPERS' assumption that pensionable payroll will grow at a 3%
rate per year for the three years between the actuarial valuation date and the year the contribution
rates are in effect. Therefore, the City paid $1,043,828 less toward the unfunded liability than
CaIPERS had anticipated. This shortfall will be accounted for in future actuarial valuations and
will result in an additional increase to the unfunded rate. Additionally, CalPERS will charge
interest at 7.5% on that shortfall.
A second option would be to use the lump sum prepayment option available from CalPERS.
Similar to an early payment on a mortgage, the prepayment will allow a reduction in interest
payments for the fiscal year in which the prepayment is made. For example, if the City made the
prepayment for FY 2015 -16, the full payment would have been made in July in the amount of
$17,394,476. The payment would include both normal and unfunded liability costs for both
plans. If actual payroll and, consequently, CalPERS normal costs are lower than budgeted, the
excess amounts are credited against the unfunded liability. This could have the effect of
lowering unfunded contribution rates in future years and shortening the amortization period to
pay down the liability. Both of these additional options offer Council flexibility in funding,
whereas the other options discussed previously are essentially irreversible decisions. It is
important to note that this option is only available at the beginning of the fiscal year and the full
payment must be made with the first payroll of the fiscal year.
Conclusion
With funds available in the Accrued Liability Fund (specifically set aside for CalPERS purposes,
currently $5.2 million), staff will seek direction at mid -year from Council to consider a one -time
payment to CaIPERS in the amount of $1,043,828 in order to make up for the shortfall in the
unfunded liability payments from FY 2014 -15. This payment will consist of $746,461 to the
safety plan and $297,367 to the miscellaneous plan.
Secondly, staff will seek direction on the consideration of a shift in strategy to one of the two
funding strategies discussed above. These options could be further explored and discussed at
Budget Study Sessions for the FY 2016 -17 budget.
8. ATTACHMENTS
None.
ITEM 4 10/13/2015