Cotati City Council
Agenda Staff Report
Item type: REGULAR AGENDA (ACTION)
To: City Council
Subject: PRESENTATION ON THE PENSION UNFUNDED ACCRUED
LIABILITY AND RELATED POLICY STATUS AND
RECOMMENDATION ON ADOPTING A RESOLUTION TO
APPROVE AN ADDITIONAL DISCRETIONARY PAYMENT
Date: March 12, 2024
Written by: Angela Courter, Director of Administrative Services Recommendation
It is recommended that the City Council receive a presentation, discuss options, and adopt a resolution to amend the adopted FY 2023-24 budget to authorize an additional discretionary payment to CalPERS.
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, expected future cost of living pay increases, future contributions of CalPERS members and member agencies, and various demographic assumptions such as life expectancy). If the AAL exceeds the MVA, the member agency’s “account” is in a deficit position and an Unfunded Accrued Liability (UAL) exists.
With each new CalPERS actuarial update, CalPERS creates a new UAL “layer“, which either adds UAL or credits the UAL owed, largely depending on the investment returns for that year.
For these long-term financial projections, CalPERS uses 6.8% as the assumed rate of return on investments, otherwise known as the ”discount rate”. If CalPERS over performs or underperforms this target, CalPERS will assign the loss or gain as additional UAL or a UAL credit in a layer for that year. If there is a loss, CalPERS will ramp up the full amortized payment for that loss over the first 5 years to soften the impact to the agency. During that time, the payments don‘t cover the full cost, so the agency is paying interest on the interest until the end of the 5-year ramp, adding significant additional cost over the term of the amortized payments.
To address this issue, the City adopted a policy to evaluate pre-paying the interest up front to avoid compounding interest as well as leveling the amortization schedule, which generally increases costs to the City in the first 5 years but lowers the payments over the remaining 15 years. The policy also set a minimum of 80% funding level for UAL, with a future target of 90% funded.
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. Subsequently for the FYE June 30, 2022, CalPERS reported an investment loss of 7% (net loss of 13.8% compared to the discount rate), adding back in new unfunded liability and increasing the UAL balance. Now for the FYE June 30, 2023, CalPERS has estimated investment earnings at 5.8%, which is less than the target discount rate of 6.8%, which creates a new loss actuarial base and increased UAL balance. However, this loss is much smaller than the 2022 loss.
Historical Actions Taken to Address Increasing Costs
The City has taken several steps to address the CalPERS pension costs. These have included:
• Lower Benefit Tiers for Employees - Two new lower benefit tiers have been established with CalPERS:
o 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. o Tier 3 was created in 2013 when the California Public Employees' Pension Reform Act (PEPRA) established a reduced tier of benefits for new CalPERS employees.
• Annual 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, rather than letting the interest accrue over the course of the fiscal year. • Unfunded Pension Liability Policy – Creation of this policy guides City actions to address the outstanding UAL owed by the City, as discussed briefly above. This policy also included the establishment of a Section 115 Trust.
• 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 and invest in street rehabilitation. The contributions included borrowing approximately $4.0 million in the form of tax-exempt pension loan at 3.2% interest rate; as well as 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, 2022. The reports are based on actual loss of 7% for fiscal year 2021/22 and a discount rate / projected return of 6.8% for FY (Fiscal Year) 2022/23. With these reports, the City’s UAL has a combined underfunded balance of $6.7M, which equates to 84.4% funded. This is above the 80% minimum required for the Unfunded Pension Liability Policy, but under the target of 90% funded.
Actuarial Adjustments Post June 30, 2022 - CalPERS recently announced a preliminary 5.8% investment return for the 12-month period ending on June 30, 2023.
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 6.1%, the 10-year period at 7.1%, the 20- year period at 7.0%, and the 30-year period at 7.5%. CalPERS's historical investment returns suggest that a quick elimination of the 2022 UAL is unlikely and the City may want to consider additional steps to reduce the long-term interest costs associated with the new UAL.
Staff are recommending two processes to address the new layers of unfunded liability from further degrading the City’s funded level. The first recommendation is the removal of the negative amortization for the 5-year ramp period by applying an additional discretionary payment (ADP) to CalPERS to be applied to the appropriate basis of each plan. This additional ADP would require a budget amendment for the current fiscal year approving the expenditure of $335,463.
The second step, which will be evaluated and discussed during budget discussions, would be to convert the new 2022 UAL bases from ramp-up to level amortization with CalPERS. City staff would coordinate this with CalPERS and Ridgeline directly to ensure this is applied only to the 2022 basis. Implementing this plan is projected to save the City approximately $790,000 over the 20-year repayment period. If a similar strategy is employed for the 2023 loss, the plan is projected to save the City an additional $68,000, for a total savings of approximately $860,000.
However, committing to leveling the amortization of the 2022 bases does have a real impact on current cash availability, so this must be balanced against operational and capital needs as we develop the FY 2024-25 budget.
Financial Considerations
Councils’ actions over have allowed the City to meet the policy minimum requirements with a funded balance of 84.4%. Applying the strategy proposed would continue to maintain the City’s funded status within the policy objectives.
This proposed ADP for the current fiscal year would require a budget amendment approving the expenditure of $335,463. The proposed funding source for the one-time payment would be the utilization of the one-time interest earnings on our investments. During the current fiscal year to date, the City has earned more than $500,000 in interest earnings on investments.
Future fiscal years actions for applying additional discretionary payments, as well as leveling the amortization of the UAL bases, will be explored by staff and presented to City Council during the budget development meetings. Delaying this decision allows for direct analysis of the cost benefit against other competing budget demands.
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 reasonably foreseeable indirect physical change in the environment, pursuant to CEQA Guideline section 15378.