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Home My WebLink AboutSS1 - Evaluation of Pension Funds - PowerPointEVALUATION OF PENSION SURPLUS FUND OPTIONS, INCLUDING A SECTION 115 TRUST January 27, 2026 City Council • Background • Statutory & Regulatory Framework • Section 115 Pension Trusts: Overview and Key Considerations • Independent Subject -Matter Experts in Public Sector Investment Strategies and Institutional Asset Management • Next Steps and Decision Points Q�EWPp�T c441FORN`P 2 • Evaluate whether pension surplus funds above the CaIPERS required contributions should be redirected into alternative investment options, such as a Section 115 Trust. • Study session requested by Council Members Weber and Weigand on 12/9/25 (Al item). Q�EWPp�T c441FORN`P 3 • As of June 30, 2024, the City's funded status was 75.9% with an unfunded accrued liability (UAL) of $313 million. • The preliminary pro ection for June 30, 2025 reflects strong investment performance (12.1% return for PY 24/25), bringing the funded status to 82.4% and the liability down to $235 million. • Each year the UAL is adjusted based on whether CalPERS meets its expected rate of return (6.8%) and changes in actuarial assumptions, such as updates to mortality rates reflecting longer life expectancies. June 30, - - 30, June - 30, 30, r June 020 02025* - Unfunded $333 million $223 million $348 million $341 million $313 million $235 million Liability Funded 69.2 % 79.3 % 70.9% 72.5% 75.9% 82.4% Percentage Investment 4.7 % 21.3 % -7.5% 6.1 % 9.5% 12.1 % Retu rn ��EWPORj * Projected CqG/FORNP CalPERS Portfolio Composition and Risk Management CalPERS targets a 6.8 percent assumed rate of return over the long term. The portfolio em loys leverage (approximately percent), a strategy that increases return exposure but also magnifies market risk, volatility, and potential losses. Environmental Social and Governance (SSG) considerations are integrated into the investment decision -making process and may influence long-term performance and risk characteristics. Q��WPO�T CqG/FORN�P Asset Class Allocation • The City's strategy is reviewed annually. • The Finance Committee reviewed this strategy in November 2025 and recommended: • Targeting a 95% funded status • Continuing to commit $45 million per year toward UAL reduction • If the City continues to make $45 million in annual contributions until reaching 95% funded in 2031, it will still need to pay the legally required amounts, which means the City is projected to reach 100% funded in 2033. � SEW PAR e� Cql FOR $40 — $35 , 94.4% r $30 92.2% 96.6% 89.8% $25 87.5% c $20 85.2% 84.2% $15 $10 $5 $0 2025-26 2026-27 2027-28 2028-29 2029-30 2030-31 2031-32 Q�EWPORT CqG/FORN�P 2032-33 2033-34 � Estimated Minimum Required UAL Payment Estimated Funded Status% 100.0% 100% 2034-35 t Projected to Reach 100% Funded. Final UAL Payment of $6.7M. 90% 80% $50 $45 $40 $35 $30 / a 86.3% $25 84.2% $20 $15 $10 $5 $0 }� 94.3% ¢x 91.7% {Sx o 89.0 /o 97.0% 2025-26 2026-27 2027-28 2028-29 2029-30 2030-31 2031-32 Estimated Minimum Required UAL Payment oAdditional Discretionary Payments (ADPs) PO CqG/FORN�P 100.00/C 100% 2032-33 2033-34 Estimated Funded Status% 1 Projected to Reach 100% Funded 90% 80% STATUTORY & REGULATORY FRAMEWORK Marcus Wu, Partner Pillsbury Winthrop Shaw Pittman LLP California Law Governing Public Agency Investments • California Government Code §§ 53600-53609 applies to City treasury and general fund dollars, including funds set aside for pension contributions. • These rules apply regardless of funded status or cash surplus. Permitted Investments • Cash, U.S. Treasury securities, and other high -quality fixed -income investments Prohibited / Restricted Investments • Equities, private investment managers, or alternative investment strategies Key Takeaway Surplus pension dollars that remain in the City's general fund are legally constrained to low -risk, fixed -income investments. Q�EWPORT AAAAR c441FORN`P 10 What is a Pension/OPEB Section 115 Trust? • An irrevocable, tax-exempt trust under IRC Section 115 • Established solely to fund pension and/or OPEB liabilities • Assets are no longer considered City funds Investment Authority • California Government Code investment restrictions do not apply • Governed by CA Constitution, Article 16, Section 17 • Assets may be invested in any prudent, diversified strategy Governance & Fiduciary Safeguards • Fiduciary duties of loyalty, prudence, and diversification apply • Best practices include: • Formal investment policy • Oversight committee to manage Trust investments SEW PO e� Cq</ FO RNP SECTION 115 PENSION TRUSTS: OVERVIEW AND KEY CONSIDERATIONS ADOPTION OF SECTION 115 PENSION TRUSTS BY ORANGE COUNTY CITIES m 9% 7r� emed 5l :Shuster Not -Established 9� 35/ Established 65% PARS 77% • Rate Stabilization: Helps smooth pension contribution volatility by allowing Section 115 Trust assets to offset unexpected increases driven by investment return volatility in CalPERS-managed assets. • Diversification: Enables the City to diversify pension assets across a separate investment portfolio with a different asset mix than CalPERS. • Local Control: Provides the City with direct control over contributions, disbursements, and investment decisions, including the ability to tailor risk and asset allocation to local priorities and market conditions. � SEW PAR e� Cql FOR INDEPENDENT SUBJECT -MATTER EXPERTS IN PUBLIC SECTOR INVESTMENT STRATEGIES AND INSTITUTIONAL ASSET MANAGEMENT: PUBLIC AGENCY RETIREMENT SERVICES (PARS) & PFM ASSET MANAGEMENT 15 • PARS, headquartered in Newport Beach, was the first provider nationwide to receive an IRS Private Letter Ruling for Section 115 pension and OPEB trusts. • PARS administers over 2,000 plans for over 1,100 public agencies, overseeing $8.3 billion in Section 115 trust assets. • PARS utilizes PFM for investment management services. • The City currently has a PARS -administered OPEB Trust with approximately $50 million dedicated to retiree medical benefits, which is fully funded. • The OPEB Trust includes $5 million in excess funds that are available to be drawn down and could be used to fund a Pension Trust. JS Large Cap Equity 8.6% 17.1 % 28.5% 34.2% 42.8% JS Small Cap Equity 0.5% 0.9% 1.5% 1.8% 2.3% nt'I Developed Equity 3.40% 6.8% 11.3% 13.5% 16.9% :merging Market Equity 1.1% 2.3% 3.8% 4.5% 5.6% EITs 0.8% 1.5% 2.5% 3.0% 3.8% isted Infrastructure 0.8% 1.5% 2.5% 3.0% 3.8% ore Bonds 76.8% 63.0% 44.5% 35.0% 21.3% igh Yield Bonds 6.3% 5.0% 3.5% 3.0% 1.8% Five investment strategy options are available, each with defined ranges for equity, fixed income, and cash. The Balanced and Capital Appreciation strategies provide equity exposure similar to CalPERS. A customized strategy can also be created. Q��WPO�T c441FORN`P Annualized Returns, Net of Fees* As of June 30, 2025 ml�m Long -Term Expected Returns, Net of Fees* * PARS and PFM have a tiered pricing structure that becomes more cost-effective as assets under management increase. The combined cost for trust management by PARS and investment management by PFM is 28 basis points when factoring in both the OPEB and Pension Trust assets. 18 NEXT STEPS & DECISION POINTS • Does the City Council concur with the Finance Committee's recommendation to target a 95% funded status, continuing to commit $45 million per year toward the pension liability? • Should an Internal Revenue Code Section 115 Pension Trust be established and funded from the $5 million surplus in the OPEB Trust? • Does the City Council wish to make additional contributions to the Section 115 Pension Trust beyond the initial funding, or would the Council prefer to revisit this in one year? � SEW PAR e� Cql FOR 20