Cotati City Council
Agenda Staff Report
Item type: REGULAR AGENDA (ACTION)
To: City Council/Successor Agency to the Former Cotati Community Redevelopment Agency
Subject: Presentation on the Pension Unfunded Accrued Liability Management Policy status and Discussion on Estimated Activity.
Date: October 25, 2022
Written by: Angela Courter, Director of Administrative Services Recommendation
It is recommended that the City Council receive a presentation and discuss potential measures to address impacts of 2022 CalPERS Unfunded Pension Liability. No action will be taken.
Background
The City provides a defined-benefit pension to its retirees through the California Public Employees Retirement System (CalPERS) in lieu of a social security pension. Funding of CalPERS pensions relies on three sources: employee contributions, employer contributions, and investment returns.
These three sources contribute to the City’s Market Value of Assets (MVA).
The MVA is then compared to the CalPERS actuarial determination of the Actuarial Accrued Liability (AAL) for all member agencies. The AAL is the actuarial projection of the total amount that CalPERS should currently have to cover promised benefits over time (accounting for anticipated investment earnings and future contributions of CalPERS members and member agencies). If the AAL exceeds the MVA, the member agency’s “account” is in a deficit position and a Unfunded Accrued Liability (UAL) exists.
For the Fiscal Year Ending (FYE) June 30, 2021, CalPERS recorded investment earnings of
21.3% and therefore a credit actuarial base was added to the City’s pension plans, lowering the UAL balance. Currently for FYE June 30, 2022, CalPERS is reporting an estimated investment loss of 6.1% which will create a new loss actuarial base and increase the UAL balance.
Historical Actions Taken to Address Increasing Costs
The City has taken several steps to address the CalPERS pension costs. These have included:
1) Lower Benefit Tiers for Employees - Two new lower benefit tiers have been established with CalPERS:
a. Tier 2 Employees hired in 2011-12 (depending on employee group) are required to pay the full employee contribution and have a lower retirement benefit.
b. Tier 3 was created in 2013 because of the California Public Employees' Pension Reform Act (PEPRA) established a reduced tier of benefits for new CalPERS employees.
2) Prepayments to CalPERS - Since FY2015/16 the City has prepaid the annual Unfunded Accrued Liability payment at the beginning of each fiscal year to save over 3% annually.
3) Unfunded Pension Liability Policy – creation of this policy guides City actions to address the outstanding UAL owed by the City. This policy included establishment of a Section 115 Trust.
4) UAL Refinancing - In January of 2022, the City Council approved a refinancing strategy to contribute approximately $6,000,000 (six million dollars) to pay down the UAL.
The contributions were made up of an additional borrowing of approximately $4.0 million in the form of taxable pension obligation loan at 3.2% interest rate; as well as make an additional $2.0 million cash contribution to CalPERS from reserves and on- going revenues.
Analysis/Discussion
City staff reviewed the CalPERS actuarial reports as of June 30, 2021. The reports are based on actual returns of 21.3% for fiscal year 2020/21 and a discount rate / projected return of 6.8% for FY 2021/22. With these reports the City’s plans are all slightly overfunded except for Tier 1 Miscellaneous and Safety plans which are on average 77% funded, making overall all plans 80% funded before adjusting for the City’s Additional Discretionary Payments to those plans in January 2022. Adding the $6 Million in plan assets and reducing the liability, the City’s funded level is increased to an average 94.6% for the Tier 1 Miscellaneous and Safety Plans and even higher on combined basis, thus currently meeting the City Policy target of 90%.
Actuarial Adjustments Post June 30, 2021 - CalPERS recently announced a preliminary 6.1% investment loss for the 12-month period ending on June 30, 2022. This is CalPERS’ first loss since the global financial crisis of 2009, which was also driven by tumultuous global markets.
The investment loss, combined with the CalPERS’ 6.8% discount rate hurdle, is expected to result in a roughly 10% drop in the pension plan’s overall funded level to an estimated 84.2%, before any other adjustments are considered. As a result, employer contributions are expected to increase in the coming years.
CalPERS remains focused on the long-term performance of the fund. The total fund annualized returns for the five-year period ending June 30 stood at 6.7%, the 10-year period at 7.7%, the 20- year period at 6.9%, and the 30-year period at 7.7%. This year’s returns are based on the investment portfolio that was in place before November’s new asset allocation.
Individual CalPERS members will not see an increase in rates, but CalPERS employers will.
Current estimates of the 2022 loss impact to the City are approximately $4.3 million. These losses are negatively amortized over the first two years and then are ramped up to minimize the impact to the City and hopefully be offset by future market recovery gains. However, given the CalPERS discount rate hurdle that the investment performance needs to clear every year, we do not expect that the future market returns will be able to cover the 2022 investment loss fully and quickly.
In addition to the increase in the UAL, the City can also expect the employer normal rates, which is based on a percent of employees’ salaries, to also increase from fiscal years 2022/23 to 2023/24. Miscellaneous plans for Classic and PEPRA will increase by about 1.5-2% and 0.2% respectively. Safety plan employer rates are scheduled to increase for Classic and PEPRA by 1.8-
3.2% and 0.75% respectively.
Financial Considerations
Councils’ actions over fiscal year 2021/22 have allowed to the City to meet the policy recommendation of meeting the Funded Level Objective of 90% with a calculated funded level of 94.6% after refunding.
Staff will explore the impact of eliminating negative amortization and convert from a ramp-up to a level UAL amortization for the additional 2022 bases. During strategic planning, staff will provide additional information on this strategy against other competing budget demands and provide a final recommendation to the City Council.
Environmental Issues
This action is exempt from the California Environmental Quality Act (CEQA) because it is not a project which has a potential for resulting in either a direct physical change in the environment, or a foreseeable indirect physical change in the environment, pursuant to CEQA Guideline Attachments:
Cotati - 2022 Pension Analysis (PDF)