EAST PALO ALTO
CITY COUNCIL
STAFF REPORT
DATE: March 15, 2022
TO: Honorable Mayor and Members of the City Council
VIA: Jaime M. Fontes, City Manager
BY: Valerie J. Armento, Interim City Attorney
SUBJECT: CalPERS Prefunding
Recommendation
It is recommended that the City Council adopt a Resolution to:
1. Commit $3 million General Fund Balance to prefund CalPERS future contributions: and
2. Submit the funds to CalPERS in the form of a direct payment as further described in the staff report.
Alignment with City Council Strategic Plan
This recommendation is primarily aligned with:
Priority No. 3: Increase Organizational Effectiveness and Efficiency Priority No. 5: Improve Communication and Enhance Community Engagement Background and Analysis
The City participates in the California Public Employees’ Retirement System (CalPERS), a defined benefit pension plan. A defined benefit pension provides retirement income based on a fixed or defined formula. What this means is the employer bears the risk of providing adequate resources to fund a defined amount of retirement income to employees.
The City has two basic CalPERS plan types: Miscellaneous for non-public safety personnel and Safety for all sworn or public safety-related personnel. Within in each type, there are also two sub-types, or tiers, of benefits: Classic and PEPRA. The PEPRA tier is required as a result of the California Public Employees’ Pension Reform Act of 2013, and generally restricts the provision of pension benefits for new employees joining a public retirement system on or after January 1, 2013. The City has the following fixed or “defined” benefit formulas:
Tiers Miscellaneous Safety
Tier 1 Classic 2.5% @ 55 yrs old 3% @ 55 yrs old
Tier 2 PEPRA
(Hired ≥ 1/1/13) 2.0% @ 62 yrs old 2.7% @ 57 yrs old
The following is a simple example illustrating the calculation of CalPERS monthly retirement allowance (not modified for other factors):
· Miscellaneous - Classic 2.5% @ 55
· Age 55
· 20 Years of Service
· $6,600 - 3-year final average compensation (monthly)
X = X = =
Service
Credits
Benefit
Factor
% of Final
Compensation
Final
Compensation
Unmodified
Allowance
20 x 2.5% = 50% x $6,600 = $3,300
City employees belonging to CalPERS do not earn social security benefit credits during the time they work for East Palo Alto. Unmodified allowance calculations may be further modified by chosen survivor benefit options, etc.
In recent years, a number of studies by the CalPERS Board highlighted the serious issues related to the long-term sustainability of the pension fund. In January 2018, the League of California Cities cited, “Several factors have contributed to un-sustainability of the CalPERS system-and as a result, the contributions paid by all public employers to CalPERS are dramatically increasing.” The fact that the CalPERS funding levels have remained low compared to previous economic expansions underscores the difficulty employers will face during the next recessionary cycle impacting investment returns.
Beginning in 2013, the CalPERS Board enacted a number of changes related to funding policies, demographic assumptions, risk mitigation strategies, discount rate reduction, and amortization policies aimed at improving system sustainability. The impact of those changes result in significantly increased annual pension contribution costs and costs are expected to ramp up over the next seven years. The table below reflects recent payroll and pension contribution history:
Fiscal Year Covered
Payroll
Contribtuion
Paid
Contribution as
a Percentage of
Covered Payroll
2020-21 $ 10,345 $ 2,261 21.9%
2019-20 $ 9,674 $ 1,976 20.4%
2018-19 $ 9,577 $ 1,812 18.9%
2017-18 $ 9,258 $ 1,642 17.7%
The pension contribution increases are a factor contributing to the City’s projected structural General Fund deficit gap, as rate of growth in pension contribution costs are expected to outpace the rate of growth in General Fund revenues.
As a consistent, long-term strategy to improve the City’s fiscal environment - including addressing the General Fund structural gap that intensified in the past few years - staff articulated three areas of emphasis:
1. Implementing, securing, and stabilizing local resources
2. Improving financial analytics, practices, and risk mitigation strategies
3. Improving information technology and information systems Council strategic priorities aimed at resiliency measures to address the City’s General Fund projected structural deficit include:
1 GOAL: Address Structural Deficit Through Fiscal Resiliency Measures
1.1 Perform Risk-based Study of General Fund Reserves
1.2 Adopt a General Fund Reserve Policy
1.3 Perform Actuarial Study of CalPERS Pension Obligations
1.4 Adopt a CalPERS Funding Plan
Performing an actuarial study and providing options to pre-fund the City’s net unfunded pension liabilities addressed Council Strategic Finance Goal 1.3 and accomplished the following:
1) Providing information about the range of future pension rates; 2) Providing comparison of options to fund additional contributions with the goal of reducing total future pension costs compared to only paying the minimum required contribution;
3) Allowing Council to move forward on Goal Items 1.2 and 1.4 decisions.
In the study session on 3/23/21, staff re-introduced basic information about the City’s CalPERS pension benefits and provided the available prefunding options with example payment plans.
As funding source, staff also identified a unique opportunity of available fund from cash conversion of Successor Agency sponsoring loan receivable. During the session, the Council started decision making process and expressed interest in considering the options, but did not choose one.
With the adoption of the General Fund Reserve Policy in September 2021, we now have clarity in available General Fund Reserve (after setting aside the target contingency reserve). The following tables show the General Fund Balance by classification (Table A) and the schedule of the cash conversion by the sponsoring loan receivable turnover (Table B), respectively.
Table A
Fund Balance Classification Per new GF
reserve policy Audited
Nonspendable 6,554,760 6,554,760
Restricted 23,784 23,784
Committed fund balance for:
Capital projects 980,355 980,355
Community benefits reserve 249,770 -
Information Technology Reserve 2,301,819 -
Vehicles and Equipment Reserve 1,147,742 -
Self Insurance Reserve 2,045,853 -
Total committed 6,725,539 980,355
Assigned 4,128,219 4,128,219
Unassigned fund balance for:
Minimum reserve fund balance 8,447,000* 4,250,000
Community benefits reserve - 249,770
Information Technology Reserve - 2,301,819
Vehicles and Equipment Reserve - 1,147,742
Self Insurance Reserve - 2,045,853
Other 16,924,057 21,121,056
Total unassigned 25,371,057 31,116,240
Total Fund Balances 42,803,358 42,803,358
* based on 30% targeted balance
General Fund Ending Fund Balance
June 30, 2021
Table B
FY20-21 FY21-22 FY22-23* FY23-24* FY23-24* Total
Available
SA Sponsoring Loan
Repayments
$2,300,000 $1,400,000 $2,200,000 $1,400,000 $950,000 $ 8,250,000 * Estimate based on the loan repayment schedules
Staff recommends the Council commits $3 million for future CalPERS prefunding in advance of deciding the option to pursue, because staff believes that the commitment of such funds is the first step to take and lies at the core of the decision-making process to address the unfunded liabilities regardless of the option selected - the options are just tools to fund the liabilities.
Additionally, the commitment will provide clarity in the available reserve for other future Council priorities and serve more for financial reporting purposes rather than appropriation of funds.
Since the commitment is not imposed by outside parties the Council will be able to remove or revise in the future if it wishes. In accordance with the Governmental Accounting Standards Board (GASB) 54 and the Reserve Management Policy, the City Council, as the highest level of decision-making authority, can impose and remove amounts used for specific purposes determined by a formal action which, in this case, would change the fund balance classification for the amount ($3 million) to “Committed Fund Balance” from “Unassigned Fund Balance”.
With respect to the dollar amount of the commitment, staff believes $3 million is adequate to leverage potential saving with consideration of the available funding source discussed above.
The following illustrate the Pros-and-Cons and the potential saving for each available option followed by the payment plan with the assumption of $3 million prefunding. 1) Make payments directly to CalPERS (ADP) by either:
· Target specific amortization bases (Option#1)
Pros: Likely higher Investment return, higher saving, easy to implement, reduce net pension liability for GASB reporting
Cons: Locked in, no investment choice
Saving: $3,132,000 (PV = $1,367,000)
Example cities: City of Belmont, Town of Colma, City of San Carlos · Request shorter amortization period (Fresh Start) (Option#2) Pros: Likely higher Investment return, highest saving, earlier UAAL paid-off, reduce net pension liability for GASB reporting
Cons: Locked in and cannot revert
Saving: $3,544,000 (PV = $1,471,000)
2) Establishing an irrevocable supplemental (§115) pension trust (Option#3) Pros: Flexible, more visible, investment choice
Cons: Likely lower long-term return, lower saving, more administrative tasks Saving: $1,708,000 (PV =$602,000)
Example cities: Town of Hillsborough, City of Burlingame, City of Berkley Option: FY21-22 FY22-23 FY23-24 FY24-25 Total commitment ADP CalPERS direct
payment $1,500,000 $500,000 $500,000 $500,000 $ 3,000,000 Section 115 Trust $1,500,000 $500,000 $500,000 $500,000 $ 3,000,000 In this staff report, staff would also like to express a preference among the available options.
Staff recommend Option#1 because it would bring higher investment return and saving and does not require additional administrative process/fees such as RFP, contractual requirement, and investment management. Although Option#2 would provide the highest investment return and saving and the fastest pay-off of unfunded liabilities, it would lock into a shorter amortization period with higher annual contributions and the decision is irreversible.
Fiscal Impact
A resolution to commit $3 million for CalPERS prefunding will reclassify the fund balance from unassigned to committed for that amount. The ADP payments to CalPERS will require appropriation of $1.5 million in the fiscal year 2021-2022 and $0.5 million going forward in the following three fiscal years. Staff identified the cash conversion (repayments) of SA sponsoring loan receivables for the funding source as described in the Table B above.
Environmental
The action being considered by the City Council is exempt from the California Environmental Quality Act (CEQA) because it is not a “project” pursuant to 15378(b)(4) because it is a fiscal activity which does not involve any commitment to any specific project which may result in a potentially significant impact on the environment.
Attachments
1. Resolution to commit CalPERS prefunding
2. BA EastPaloAltoCi 22-03-07 CalPERS Council Slides