Title
Adoption of Resolution Authorizing Participation in the Public Agency Retirement Services (PARS) Post-Employment Benefits Trust to be Used for Prefunding of Pension and Other Post-Employment Benefits (OPEB) Obligations;
Recommendation to Appoint the City Manager or Her Designee as the City’s Plan Administrator for the Trust Program; Direct the City Manager to Execute All Necessary Agreements and Plan Documents Associated with Establishment of the New Trust; and Adopt a Pension Rate Stabilization Program and Other Post-Employment Benefits Funding Policy. (Finance 2410)
Body
To: Honorable Mayor and the City Council
From: Jill Keimach, City Manager
Re: Adoption of Resolution Authorizing Participation In the Public Agency Retirement Services (PARS) Post-Employment Benefits Trust to Be Used for Prefunding of Pension and Other Post-Employment Benefits (OPEB) Obligations;
Appoint the City Manager or Her Designee as the City’s Plan Administrator for the Trust Program;
Direct the City Manager to Execute All Necessary Agreements and Plan Documents Associated with Establishment of the New Trust; and
Adopt a Pension Rate Stabilization Program and Other Post-Employment Benefits Funding Policy
BACKGROUND
The City of Alameda in partnership with its employees have taken several steps during the last six years to manage and reduce its pension and Other Post-Employment Benefits (OPEB) liabilities and costs. These actions represent responsible financial management that have lowered the City’s annual pension costs and positioned the City to achieve savings into the future. The City and the employee associations negotiated, through collective bargaining, to share the cost of California Public Employee Retirement System (CalPERS) annual required contributions. Currently, public safety employees hired prior to January 2013 or after January 2013, as long as they became CalPERS members prior to that date, contribute 15% of their salary toward their retirement (which includes paying 6 percent of the city’s required contribution) and non-safety employees hired prior to January 2013 contribute 8.868% of their salary toward their retirement (which includes paying 1.868 percent of the city’s required contribution). In addition, during the last round of negotiations with the public safety associations, safety employees contribute 2% to 3% of the top step police officer or firefighter salary toward funding OPEB liability.
Employees hired after January 2013 that previously were not members of the CalPERS receive a lower pension benefit per the California Public Employees’ Pension Reform Act (PEPRA) signed by the Governor Brown in 2012. Under PEPRA, the contribution rates are equally shared between the employee and the employer. Public Safety employees hired under PEPRA contribute 10.75% of their salary towards their retirement and non-safety employees contribute 6.75% of their salary towards their retirement. Because these employees are new CalPERS members, they do not carry the burden of paying for the unfunded liability.
The concept of setting aside funds for long-term liabilities (pension and OPEB) was discussed in September 2015, when the City Council approved setting aside General Fund surplus funds accumulated over a period of two years. Reserves of $6 million were equally allocated to pension and OPEB liabilities ($3 million each). Staff recommends transferring these funds to an outside third party irrevocable trust, such that contributed funds can only be used for future CalPERS pension contributions or OPEB costs.
DISCUSSION
California Public Employee Retirement System (CalPERS)
The City’s CalPERS actuarial reports dated June 30, 2014, included an unfunded liability of $170.5 million with a funded level for the safety plan of 66.1% and non-safety plan of 81.5%. The most recent actuarial reports received in the fall 2015 for valuation date of June 30, 2015 included an unfunded liability of $203.7 million with funding levels at 62.7% for safety plan and 76.5% for non-safety plan. It is important to recognize that although the unfunded liability increased by $33.2 million during the one-year period, CalPERS actuarial reports have changed significantly in recent years with their Board changing demographic assumptions, implementing a smoothing feature and lowering the rate of return (ROR) on investments, all of which cause the unfunded liabilities to increase, which in turn drive the City’s required contributions higher.
For CalPERS, one of the most critical assumptions in attaining its full funding goals is the ROR on its investments. Prior to December 2016, CalPERS’ annual ROR assumption was 7.5 percent. If the 7.5 percent rate of return is not realized, then contributions from employers and employees must increase. Unfortunately, the 7.5 percent ROR has not been achieved in the past two years (2.4 percent in FY 2015 and 0.6 percent in FY 2016) and the outlook from the investment community and actuaries for a 7.5 percent annual rate of return is increasingly pessimistic. As a result, effective December 2016, CalPERS’ Board approved a reduction in the ROR to be phased in over a three-year period. This most recent reduction has not been reflected in the 2015 actuarial reports. The ROR changes will be implemented as follows:
|
Fiscal Year |
Discount Rate |
|
FY 2018-19 |
7.375% |
|
FY 2019-20 |
7.25% |
|
FY 2020-21 |
7.00% |
The impact on the employer contribution rates as a result of the decreased discount rate is presented in the table below:
|
|
|
Change in CalPERS Rates |
|
Valuation Date |
Fiscal Year Impact |
Non-Safety Plans |
Safety Plans |
|
6/30/16 |
2018-19 |
2.25% - 3.75% |
2.5% - 4.25% |
|
6/30/17 |
2019-20 |
4.5% - 7.5% |
5% - 8.5% |
|
6/30/18 |
2020-21 |
11% - 18% |
12% - 20% |
|
6/30/19 |
2021-22 |
16% - 23% |
17% - 25% |
|
6/30/20 |
2022-23 |
21% - 28% |
22% - 30% |
|
6/30/21 |
2023-24 |
26% - 33% |
27% - 35% |
|
6/30/22 |
2024-25 |
31% - 43% |
32% - 45% |
The changes in the unfunded accrued liability (UAL) due to changes in actuarial assumptions are amortized over a fixed 20-year period with a 5-year ramp up at the beginning and a 5-year ramp down at the end of the amortization period. As a result of the ramp up and the effective date of the increase, it will be seven years until the full impact of the discount rate change is completely phased in.
Other Post-Employment Benefits
The City offers its public safety employees health care into retirement, referred to as Other Post-Employment Benefits (OPEB). Because of the continuing rise in the cost of healthcare, and the growing number of retirees, OPEB has become one of the greatest threats to the City’s financial stability. The City’s latest actuarial report prepared by Bartel and Associates valued the City’s OPEB liability at $113 million.
As such, in early 2014, an OPEB Trust was established with the Public Agency Retirement Services (PARS), with an initial deposit of $300,000. Contributing funds to a Trust, which allows an agency to accumulate funds for payment of a future liability, is a strategy widely held as being the most cost effective way of mitigating OPEB liability. These types of Trusts are protected and can only be used for OPEB payments. Additionally, as money is accumulated over time, the investment returns help fund the benefits and both the City and the employees can contribute.
At the time the initial Trust was created, City Council provided direction to begin discussions with the Public Safety Associations to develop solutions to this difficult problem. In April 2015, the City approved new contracts with its public safety employee associations that took a major step toward addressing the issue.
As reflected in the Memoranda of Understanding, the City agreed to establish a separate account in the existing OPEB Trust. Funds in the Trust would help pay for the OPEB obligations for those sworn employees in the Fire and Police Departments who contribute into the Trust and retire after January 1, 2019. The January 2019 date was established to ensure at least 3 years of contributions were made before benefits could be drawn upon.
As outlined in the Memoranda of Understanding, the City made an initial deposit of $5.25 million dollars into the Public Safety portion of the Trust and agreed to deposit an additional $250,000 each year for ten years. Employee contributions were based on date of hire. Those safety employees hired prior June 2011 who have spousal health coverage into retirement contribute 4% of a police officer’s base salary into the Trust and those employees that are hired after June 2011 who no longer have spousal health coverage once they retire, contribute 2% of their salary to a supplemental retirement plan, which includes a health care savings plan, and 2% toward the Trust, for a total contribution of 4% of base salary. These contributions are in addition to their contributions toward their pension.
As of December 31, 2016, the City’s accumulated assets set aside in the OPEB Trust amounted to $6.388 million, setting the funding level at 5.6%.
Combined OPEB/Pension Trust
Unfunded retirement liabilities and the inevitable CalPERS contribution rate increases are serious problems that are not unique to Alameda. In response to this growing issue, a number of proactive agencies are establishing not only OPEB Trusts, but Pension Rate Stabilization Program (PRSP) Trusts. To date, the most widely adopted PRSP for governmental agencies has been a plan sponsored by PARS.
As outlined above, the City has an existing irrevocable OPEB trust with PARS to help fund its retiree health benefits. Today’s action proposes to set up a new combination irrevocable Trust to replace the existing OPEB Trust, with one that will have two accounts. One account will be for the existing OPEB assets that have been contributed since 2014 (as well as future contributions) and the other account will be for prefunding pension liabilities. Exhibit 1 is the IRS Private Letter Ruling that verifies the tax-exempt status of the PARS combination trust program.
Including a pension component to the Trust will benefit the City in three notable ways. First, assets placed into the pension account will earn a greater return over time than where they are currently invested in the Local Agency Investment Fund (LAIF). The funds will earn a return closer to that earned by CalPERS, but unlike the funds that have been forwarded to CalPERS, these funds will be controlled by the City, including establishing the risk tolerance level. Second, the Pension Rate Stabilization assets can be used to pay CalPERS annual employer required contributions at the City’s discretion, which will help cushion the financial impact of the expected sharp increases in rates. Finally, rating agencies perceive prefunding into a Trust more favorably than earmarking funds within the City’s pooled cash and investments.
As an alternative approach, the City might consider making additional advance contributions to CalPERS instead of establishing a separate Trust with PARS. In this instance, CalPERS would amortize additional funds the City chooses to contribute over 30 years, causing very little immediate impact on the reduction of annual contribution rate. The proposed Trust with PARS allows annual contributions, and accumulated assets will help the City offset its pension liabilities.
If the City Council does not authorize the PARS pension trust and chooses not to make additional contributions to CalPERS, the funds will remain reserved in the General Fund to be used for paying future pension costs. These reserves will not be applied to the Net Pension Liability presented in the City’s future financial statements and will earn a much lower rate of return.
Funding Policy
In an effort to address the City’s unfunded liabilities, staff has proposed a funding policy (Exhibit 2) for City Council approval that establishes requirements for annual contributions as well as withdrawal of funds as follows:
• Annual Contributions will be shared among all City Funds proportionate with the number of employees allocated to these funds in any given year;
• The minimum contributions each year will be $250,000 to the Pension component of the Trust and $100,000 to the OPEB component of the Trust;
• Starting in FY 2016-17, the City shall transfer any unspent funds from the 1079/1082 closed Pension Plans to the Pension component of the Trust. Each year thereafter, the City shall contribute at least as much as the year prior of the unspent funds plus any additional available funds. Available funds arise due to passing of participants in Plans;
• Annual contributions from Successor Agency and Alameda Municipal Power shall be deposited to the OPEB Miscellaneous/Safety (Pre 1-1-2019) account of the Trust;
• If financial conditions warrant, and until such time as the OPEB Unfunded Actuarial Accrued Liability (UAAL) is fully amortized, the City will make additional contributions to the OPEB account of the Trust to further pay down the UAAL;
• Annual withdrawals will be limited to 10% or less of CalPERS annual required contributions (ARC) for City’s pension payments and no more than the actual ARC for the City’s OPEB payments;
• When the General Fund Police or Fire Departments project budgetary operating savings, the City shall make an additional contribution into the OPEB Safety (Post 1-1-19) account of the Trust of no less than 10% of the projected budgetary operating savings.
The City will pay fees to PARS for administration of the trust fund and to Highmark Capital for investment of the plan assets based on the amount of funds under management and according to a sliding scale outlined in the Administrative Services Agreement (Exhibit 3). The fee structure is the same structure that is currently in place with the OPEB Trust that was established in 2014. The fees will be netted against interest earnings in the Trust. Fees will be determined based on the combined assets of the OPEB and Pension accounts which will result in lower fees as assets build.
FINANCIAL IMPACT
This action does not require an appropriation at this time. However, the City has funds which have been reserved in the General Fund for pension and OPEB liabilities. If approved tonight, the staff will come back to the City Council to request approval for appropriation of these funds for deposit into the proposed Trust fund.
MUNICIPAL CODE/POLICY DOCUMENT CROSSREFERENCE
This action is in conformance with the Alameda Municipal Code and all policy documents.
ENVIRONMENTAL REVIEW
This activity is not a project and is exempt from the California Environmental Quality Act (CEQA) pursuant to section 15378 (b)(4) of the CEQA Guidelines, because it involves governmental fiscal activities, which does not involve any commitment to any specific project which may result in a potentially significant physical impact on the environment.
RECOMMENDATION
Adopt a Resolution authorizing participation in the Public Agency Retirement Services (PARS) Post-Employment Benefits Trust to be used for prefunding of pension and other post-employment benefits (OPEB) obligations;
Appoint the City Manager or her designee as the City’s Plan Administrator for the trust program;
Direct the City Manager to execute all necessary agreements and plan documents associated with establishment of the new trust; and
Adopt the Pension Rate Stabilization Program and Other Post-Employment Benefits Funding Policy.
Respectfully submitted,
Elena Adair, Finance Director
Exhibits:
1. IRS Private Letter Ruling
2. Pension and OPEB Funding Policy
3. Administrative Services Agreement between the City and PARS
4. Trust Agreement
5. Adoption Agreement