HomeMy WebLinkAbout27 - CalPERS Pension Plan Update & Payment AlternativeCITY OF
F NEWPORT REACH
City Council Staff Report
November 25, 2014
Agenda Item No. 27
TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL
FROM: Dan Matusiewicz, Finance Director — (949) 644 -3123,
dmatusiewicz@newportbeachca.gov
PREPARED BY: Dan Matusiewicz, Finance Director
PHONE: (949) 644 -3123
TITLE: CalPERS Pension Plan Update and Payment Alternative Recommendation
ABSTRACT:
On November 17, 2014, the Finance Committee met and received an update on the latest CalPERS
actuarial valuation, reviewed an analysis of alternative payment options and made a recommendation to
City Council to employ a "fresh start" to reset the amortization schedule of both City CaIPERS plans to a
19 -year amortization schedule. If approved, the fresh start would increase required contributions effective
fiscal year 2015 -16.
RECOMMENDATION:
Authorize the Finance Director to instruct CalPERs to employ a "fresh start" resetting the amortization of
the City's unfunded pension liability to 19 years for both the Safety and Miscellaneous pension plans.
FUNDING REQUIREMENTS:
There would be no immediate funding requirement in fiscal year 2014 -15 but expect the required funding
contribution will increase approximately $6.6 million in fiscal year 2015 -16 and a total of approximately $23
million over the next five fiscal years as indicated in the incremental payment projection in Attachment A of
this report.
DISCUSSION:
Background:
The City of Newport Beach's pensions are pre- funded, as opposed to pay -as- you -go retirement systems
like Social Security. In pre- funded systems, the employer and employee make contributions into a
pension trust each year, over the course of an employee's working life. That money is invested and
earnings on these funds are re- invested. By the time the employee reaches retirement, the accumulated
assets in the trust are available to pay benefits. The objective of course, is to accumulate sufficient assets
to pay the benefits over the remainder of the employee's life. To meet this objective, a pension plan should
receive contributions in accordance with an actuarially based funding policy. The actuarially determinedP7 -1
pension funding plan determines exactly how much the employer and employee should contribute each
year to ensure that the benefits being earned will be securely funded in a systematic fashion.
Plan assets come from three distinct sources including employee contributions, employer contributions
and investment income. See Figure 1, "Funding a Pension Plan," Attachment A.
Because actuarial assumptions are for the long term, demographic and economic assumptions can vary
from actual experience. There are many moving parts such as mortality experience (how long retirees
live, for example), retirement rates, disability incidences, salary growth, investment returns and more. An
actuarial plan valuation is therefore prepared each year to true -up contributions levels to better match
actual experience.
Discussion:
The most recent actuarial report presents the results of the June 30, 2013 California Public Employees'
Retirement System (Cal PERS) valuation of both the Miscellaneous and the Public Safety Plans for the
City of Newport Beach. The date of the valuation - June 30, 2013 - is noteworthy in that it is now 16 1/2
months in arrears, but it is also the best formal information we have. This report sets the fiscal year 2015-
16 required contribution rates.
Changes Impacting the Valuation Results
On April 17, 2013, the California Public Employees' Retirement System (CaIPERS) Board of
Administration adopted new amortization and smoothing policies. The change became effective with the
current valuation (June 30, 2013) that sets the 2015 -16 contribution rates. With this change, CalPERS now
employs an amortization and smoothing policy that will pay for all gains and losses over a fixed 30 -year
period with the increases or decreases in the rate spread directly over a 5 -year period. Prior to this
change, CalPERS employed an amortization and smoothing policy which spread investment returns over
a 15 -year period with experience gains and losses paid for over a rolling 30 -year period. This policy
resulted in a negative amortization of the City's unfunded liability (e.g., the unfunded liability would
continue to grow year after year under the previous policy).
The former rate smoothing policy also employed the use of an Actuarial Value of Assets (AVA)
methodology to set contribution rates. The AVA represented a moving average, of sorts, intended to
smooth out the everyday ups and downs of the market. While the AVA was known to reduce rate volatility,
it also tended to understate the long term funding risk in extreme market conditions. The AVA
methodology lagged significantly behind the Market Value of Assets (MVA). During the course of the
recession, the AVA strayed so far from the MVA, it became clear that the AVA was no longer a viable or
responsible option. Despite recent positive investment returns, the elimination of the AVA, created an
asset adjustment (and in increase in unfunded liability) of nearly $80 million.
Chart 1, "Asset Value History," in Attachment A, depicts the two asset values over time and the gap that
was created during the past recession.
Key Valuation Results
Net of positive investment returns, annual contributions and benefit payments, the City's unfunded pension
liability decreased $17 million from $275 million to $258 million despite the $80 million adjustment
mentioned above. The components of the unfunded liability are displayed in Table 1, in Attachment A.
The accrued liability is the value of benefits earned to date by members currently in the plan. When a
plan's Market Value of Assets (MVA) is less than its Accrued Liability, the difference is the plan Unfunded
Liability. The "Normal Cost" represents the annual pension cost of service for the upcoming fiscal year for
active employees. If an Unfunded Liability exists, the plan will have to pay contributions exceeding the
normal cost of the plan to pay -down the Unfunded Actuarial Liability (UAL). This amount is associated
with past service periods and is due regardless of whether any further service credit is earned. Based on a
current attribution analysis of the UAL, 70% of the UAL is attributable to plan participants no longer
employed by the City.
Seventy percent (70 %) is an important statistic - it means, among other things, that current employees are
paying for the retirement costs of past employees. It also means that 70% of the UAL problem is set inP7 -2
stone, and untouchable, unless California laws change.
Utilizing the plan's assumed payroll growth of 3% and inclining payment schedules utilized by CalPERS,
we expect the total cost of the pension plans to increase as illustrated in Chart 2, "Total Cost Projection,"
Attachment A.
The chart above also demonstrates that the payment on the unfunded actuarial liability (UAL) represents
an increasing portion of the total cost of the pension plans. At the same time, normal pension costs will
remain relatively stable, especially with the existing 2nd and 3rd Tiers for new City employees.
Employee contributions are also expected to represent a larger percentage of the plan contributions based
on current labor contracts and currently exceed 50% of the normal plan costs as is demonstrated by the
Chart 3, "Normal Cost Projection," in Attachment A.
Impact of New Asset Smoothing Methodology
On April 9, 2013, the City Council approved a fresh start fixing the payment schedules to 21 years for
Miscellaneous and 26 for Safety. Two years later, our remaining amortization period should have been 19
years and 24 years for the respective plans. Unfortunately, the $80 million AVA adjustment was added to
our unfunded liability payment schedule to be amortized over a fixed 30 year period which will slow our
pension funding progress, in spite of our prior fresh start. On a weighted average basis, the remaining
amortization period is now 22.9 years for Miscellaneous and 25.7 years for Safety.
Options for Funding of the UAL Faster
It is the City's policy (See Reserve Policy F -2) to: 1) amortize the unfunded actuarial liability in accordance
with the actuary's funding recommendations; and 2) make effort at maintaining its UAL within a range that
is considered acceptable to actuarial standards. Our actuary indicates that an 80% funded ratio is a good
target, leaving room for market value adjustments in either direction. Policy F -2 further prescribes that the
City Council shall consider increasing the annual CaIPERS contribution should the UAL status fall below
acceptable actuarial standards.
The City has taken a number of actions to mitigate the rising costs including:
Establishing lower benefit formulas for new hires
Eliminating the Employer Paid Member Contribution (EPMC)
Having employees pay more of the pension costs
Reducing the number of staff by nearly 100 employees
Adopting a fixed and shorter amortization period of the unfunded liability
Investment returns have been promising as of late but are not likely to eliminate our unfunded liability
without further action. Significant savings will accrue to the City as the result of previous Council actions
but the current UAL will take more than two decades to fully be eliminated under the current payment
schedule.
A more immediate approach at addressing the escalating nature of UAL costs and to bring the City's
funded status higher than the current funded ratio of 65.8% is to accelerate our payments on the UAL,
similar to paying a mortgage or car payment quicker. Nearly two years ago, the City accelerated its UAL
payment schedule by increasing its payments to CalPERS. In doing so, the Council set a course to reduce
interest by $113 million over the next 30 years. As previously stated, the new asset smoothing policy
employs a 30 year fixed amortization with a 5 year ramp up. The 5 year ramp effectively defers the full
cost of the UAL over time. By paying the full amount sooner and shortening the amortization period, the
City can realize significant additional savings.
The City again has an opportunity to accelerate the payment of the UAL from the current 30 -year plan.
Staff evaluated various funding options to accelerate the repayment of the unfunded liability and achieve
significant plan savings. As directed by Chairman Henn, staff evaluated the option to repay both plans
over a fixed 19 -year, 15 -year and 10 -year periods as compared to the current schedule. Table 2,
"Unfunded Liability Payment Savings," in Attachment A, summarizes and compares the funding
27 -3
requirements and potential savings of year funding option.
Each of the scenario options will result in lower interest payments and greater long -term savings.
Expected incremental cash flows can be found on page 2 of Attachment B.
Current 30 -Year UAL Payment Plan (Current)
Under the current 30 -year plan presented in the latest valuation, the City will pay down the UAL over 30
years at a net present value cost of $440 million (including interest). Under this plan, the City will reach an
80% funded status in 2021 (Miscellaneous Plan) and 2027 (Public Safety Plan).
Under the 19 -year payment plan, the City will pay down the UAL at a net present value cost of $375 million
(including interest) and realize present value savings of $47 million from the 30 -year plan. Under this plan,
the City will reach an 80% funded status in 2020 (Miscellaneous Plan) and 2024 (Public Safety Plan). On
average this option will require additional funding of $5 million for the first 4 years and an average of an
additional $3 million for the remaining years when compared to the current payment plan. From a cash
flow perspective, staff recommends this as a financially sustainable option when compared to the
scenarios that follow. It achieves significant return on investment with relatively low incremental cost.
Scenario 2: 15 -Year UAL Payment Plan — More Savings But Twice the Cash Flow
Under the 15 -year payment plan, the City will pay down the UAL at a net present value cost of $364 million
(including interest) and realize present value savings of $76 million from the 30 -year plan. Under this plan,
the City will reach an 80% funded status in 2020 (Miscellaneous Plan) and 2023 (Public Safety Plan). On
average this option will require additional funding of $9 million annually for the first 4 years and an average
of an additional $8 million for the remaining years when compared to the current payment plan.
Scenario 3: 10 -Year UAL Payment Plan- Extremely ggressive
Under the 10 -year payment plan, the City will pay down the UAL at a net present value cost of $330 million
(including interest) and realize present value savings of $109 million from the 30 -year plan. Under this
plan, the City will reach an 80% funded status in 2019 (Miscellaneous Plan) and 2021 (Public Safety
Plan). On average this option will require additional funding of $18 million annually when compared to the
current payment plan.
Summary
CalPERS acts as an investment and administrative agent for the City's pension assets and recognizes that
a long time investment horizon is a responsibility and an advantage. While accelerating UAL payments
increases the City's exposure to market risk, doing so in an orderly "dollar cost average" basis as
proposed in the accelerated payment scenarios above is an accepted method of mitigating market risk and
lowering the City's pension costs.
There are two options for an accelerated UAL pay down. The first - as described in detail above - is
known as a "Fresh Start" which pays down the UAL sooner and saves significant interest costs. The City
employed a Fresh Start in 2013 and in doing so changed the amortization methodology from a rolling 30
year basis to a fixed declining basis. This methodology decreases interest costs by paying down principal
sooner rather than deferring payments down the road. However, like any fixed mortgage rate, there is no
flexibility in contributing lower payment amounts. This is akin to refinancing a home mortgage over 15-
years versus 30.
The second alternative is known as "Additional Discretionary Payments (ADP)" which allows agencies to
contribute any desired amount above the minimum payment, thereby providing more flexibility should the
City find itself cash constrained in any down year. Finance Committee discussed both options and
recommended the Fresh Start option as a further commitment of fiscal discipline and to ensure
contributions are made on a "dollar- cost - average" basis. This is akin to making an additional contribution
to principal on an existing mortgage, but that too is an oversimplification.
The City could commit to a Fresh Start option any day but the payments under the new Fresh Start would
not become obligatory until July 1, 2015. The Council may elect to start payments during the current
27 -4
fiscal year at any time prior to the start of the fiscal year on a discretionary basis. If it is Council's desire to
start additional contributions during the current fiscal year, Council should amend the recommendation to
adopt a budget amendment, increasing appropriation in the amount of the desired additional contribution.
Funds for the additional contribution would derive from the available surplus in the General Fund. The
first -year cost of the fresh start is approximately $6.6 million but Council may elect to make additional
contributions, if any, in any amount and any frequency as desired.
Using cash now to pay off the UAL also has an opportunity cost. That cost can be services, programs,
facilities, or beautification that the community might desire or expect now which could not be accomplished
if the cash is committed towards the UAL. To reach the right balance between a Fresh Start's benefits and
this opportunity cost, the Finance Committee (as well as City staff) recommend scenario 1, the 19 year
payment amortization. This plan produces significant long -term savings at a relatively low incremental
cost. Staff proposes that the incremental cost of the first year could come from the FY 2013 -14 operating
surplus and future contributions could come from future anticipated revenue growth, prudent use of
reserves (if needed) and future operating surpluses until the incremental cost can be fully absorbed into
the operating budget. This initiative does not appear to have a significant impact on the Facilities Financial
Plan as currently contemplated.
Staff requests that City Council approve the recommendation, as stated, consistent with Finance
Committee direction. Council is welcome to discuss further changes, too.
ENVIRONMENTAL REVIEW:
Staff recommends the City Council find this action is not subject to the California Environmental Quality
Act ( "CEQA ") pursuant to Sections 15060(c)(2) (the activity will not result in a direct or reasonably
foreseeable indirect physical change in the environment) and 15060(c)(3) (the activity is not a project as
defined in Section 15378) of the CEQA Guidelines, California Code of Regulations, Title 14, Chapter 3,
because it has no potential for resulting in physical change to the environment, directly or indirectly.
NOTICING:
The agenda item has been noticed according to the Brown Act (72 hours in advance of the meeting at
which the City Council considers the item).
ATTACHMENTS:
Description
Attachment A - Charts. Figures. and Tables
Attachment B - Analysis of Unfunded Pension Liability Funding Options
27 -5
ATTACHMENT A
FIGURE 1
Funding a Pension Plan
Im
Employer
Contributions
Employee '� Investment
Contributions t 11t Income
enetits ana
Expenses
CHART 1
t
Asset Value History
Ad uarial Value (AVA)
Market Value (MVA)
ONt m T m T a O a a
rl 'i rl 'i rl N N N N N N N N N N N N N
27 -6
CalPERS Pension Plan Update and Alternative Payment Recommendation — Attachment A
Page 2
i@s
CHART 2
Total Cost Projection
2015 2016 2017 2018 2019 2020 2021
• UAL Payment
• N arm al C ost
* Based on zero vacancies and assumed payroll growth of 3%
27 -7
TABLE 1
Miscellaneous
Public Safety
Total
Accrued Liability
$316,856,655
$437,688,131
$754,544,786
Less Market Value of Assets (MVA)
$222,107,686
$274,484,679
$496,592,365
Unfunded Liability
$94,748,969
$163,203,452
$257,952,421
Funded Ratio (MVA/Accrued Liability)
70.1%
62.7%
65.8%
i@s
CHART 2
Total Cost Projection
2015 2016 2017 2018 2019 2020 2021
• UAL Payment
• N arm al C ost
* Based on zero vacancies and assumed payroll growth of 3%
27 -7
CalPERS Pension Plan Update and Alternative Payment Recommendation — Attachment A
Page 3
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CHART 3
Normal Cost Projection
2015 2016 2017 2018 2019 2020 2021
• Based on zero vacancies and assumed payroll growth of 3%
TABLE 2
Projected Unfunded Liability - 6/30/L
Total Payment Requirement
Gross Payment Saving!
NPV Savings @ 3%
0 Employer
M Employee
Unfunded ..
Payment Schedule
Current
19 Yr
15 Yr
10 yr
273
273
273
273
664
535
465
390
N/A
129
198
274
N/A
47
76
109
27 -8
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