CITY OF LAGUNA NIGUEL
CITY COUNCIL AGENDA ITEM
To: Honorable Mayor and Council Members
FROM: Eric Hendrickson, Finance Director
DATE: October 17, 2022
SUBJECT: Study Session - Unfunded Pension Liability Options
RECOMMENDATION
Staff recommends that the City Council provide direction regarding the City's unfunded pension liability.
BACKGROUND
At the June 7t, 2022 City Council meeting, staff presented a balanced budget for Fiscal Year 2022/2023. The City Council adopted a General Fund budget with estimated revenues of $49.0 million and expenditures of $47.9 million. This resulted in revenues exceeding expenditures by $1.1 million. Furthermore, at that meeting, discussion ensued regarding the best use of these excess funds and what options are available to address the City's unfunded pension obligations. The City Council directed staff to present options at a future study session.
Following that meeting, the City retained an actuarial consultant, Foster & Foster, to assist staff with formulating options regarding the City's unfunded pension obligations. Foster & Foster is an independent national actuarial consulting firm that specializes in providing retirement consulting services to sponsors of public, private, and multi-employer benefit plans. Foster & Foster has analyzed the City's pension valuation reports and has provided the attached report (Attachment A).
ANALYSIS
Since incorporation, the City has contracted with the California Public Employees' Retirement System (CalPERS) to provide retirement benefits to employees. These benefits are in lieu of employees participating in Social Security. CaPERS offers a defined benefit plan, otherwise known as pension benefits, that provide monthly payments to retirees.
Due to the nature of defined benefit plans, an actuarial analysis must be conducted to determine the various components involved with pensions. This includes the value of pooled assets, accrued liabilities, funded status, investment returns, future contribution rates, etc. The following chart shows the City's funded status, as of the valuation date of June 30, 2021.
Description Amount
Pooled assets $37.2 million
Actuarial accrued liability $44.1 million
Unfunded liability $6.9 million
Funded ratio 84.5%
The City has been proactive in reducing its pension liability. These actions include adding two additional pension tiers, which offer lower benefit levels to new employees and opening a Section 115 trust to set aside funds each year to pay pension costs in a fund where the City controls the investment and retains the funds as an asset.
As shown in the attached report, options are available to the City to further address pension liabilities. These options include additional direct payments to CaPERS and/or designating more funds into the Section 115 trust.
The consultant from Foster & Foster will be at the Study Session to present their report.
In addition, CaPERS Senior Pension Actuary Kerry Worgan will also be attending the Study Session to answer questions.
FISCAL REVIEW
Based upon the City Council's direction at the budget meeting, the FY 2022/2023 $1.1 million surplus is being held in the General Fund reserves and is available to put towards the unfunded pension liability.
LEGAL REVIEW
No legal review of this study session material is necessary.
CONCLUSION
Staff recommends that the City Council provide direction regarding the City's unfunded pension liability.
Jamara SHetonseau Ere Kendricken
Tamara S. Letourneau Eric Hendrickson
City Manager Finance Director
Attachments:
A. Foster & Foster Actuarial Report
ATTACHMENT A
Foster & Foster Actuarial Report
FOSTER & FOSTER
ACTUARIES AND CONSULTANTS
EXECUTIVE SUMMARY OF CALPERS ACTUARIAL STUDY
FOR THE CITY OF LAGUNA NIGUEL
The City of Laguna Niguel retained Bartel Associates, now Foster & Foster Consulting Actuaries, to provide CalPERS-related actuarial consulting services and review the City' options to reduce the City's pension liability. We reviewed the pension plans' current position, estimated future contribution rates, and analyzed the City's options to reduce the unfunded liability.
Background
Across California, several issues have combined to slow improvement in CaPERS pension funding and to produce expected increases in future pension costs:
• Investment losses, especially in 2008-2009;
• Enhanced benefits granted for past service in the early 2000's; • CaPERS past policy prioritized smooth contribution rates over funding progress; and, • Larger share of plan liabilities for retirees increases contribution rate volatility.
In response, CaPERS is phasing in funding policy changes and has lowered the discount rate to reflect the current portfolio's expected lower future investment returns. However, the current investment portfolio is more volatile than previously creating more expected variability in contribution rates and funded status.
City of Laguna Niguel CalPERS Funded Status
The City has three tiers in regards to CaPERS retirement. An employee is placed into one of those tiers based on certain eligibility criteria.
• Tier 1 - 2% @ 55 formula - eligible employees hired on or before March 23, 2012 • Tier 2 - 2% @ 60 formula - eligible employees hired by the City after March 23, 2012 • Tier 3 - 2% @ 62 formula - new employees hired into government service after January 1, 2013
funded status for active employees, retirees, and inactive employees across all three tiers.
June 30, 2020 June 30, 2021
Actuarial Accrued Liability
Active Employees $12,800,000 $14,000,000
Retirees 20,500,000 21,300,000
Inactives 8,100,000 8,800,000
Total Liability $41,400,000 $44,100,000
Assets* 30,900,000 37,200,000
Unfunded Liability $10,500,000 $6,900,000
Funded Ratio 74.6% 84.5%
*Excludes the City's Section 115 Trust balance
October 6, 2022 Page 1
SUMMARY OF CALPERS ACTUARIAL STUDY (CONTINUED)
Overall, the City's funded ratio as of June 30, 2020 was 74.6% and it increased to 84.5% as of June 30, 2021. However, due to poor CaPERS investment returns in FY 21/22, the funded status is projected to be 75% in 2022.
Options to Pay Down the Unfunded Liability
In general, setting aside and investing more funds earlier than required by CaPERS will result in savings for the City. The amount of savings will depend on the actual investment performance of CaPERS and of the City's funds, as well as the amount of time the funds are invested for before being used to pay required contributions. Use of the funds to pay contributions may be voluntary, at the City's discretion, if a Supplemental Trust is used, while if extra payments are made directly to CaPERS, use of the funds will be scheduled when the funds are deposited.
Cities have two options to pay down un funded pension liability at a faster rate. One is direct payments to CaPERS and the other is establishing a Supplemental (Section 115) Trust. • Direct Payments to CalPERS: This is a common tool used by CaPERS agencies called an Additional Discretionary Payment (ADP). It will immediately reduce the City's unfunded liability and trigger lower required contributions in a manner that is irrevocably selected by the City when the ADP is made. No subsequent decisions are required. We believe that funds invested with CalPERS are likely to perform better than a Section 115 trust over the long term. However, the City's unfunded liability cannot be permanently eliminated. Future unfavorable experience, especially poor investment results, will create additional unfunded liability. Thus, even if the City had paid CalPERS the entire unfunded liability amount of $6.9 million at 6/30/2021, there would likely be unfunded liabilities in the future.
• Section 115 Trust: A Section 115 trust is also irrevocable. Funds may be paid out only to CaPERS or to reimburse the City for CaPERS payments. The City must choose how to invest the funds and whether or not to make contributions or withdrawals to the trust in any year. This option provides the most flexibility allowing the City to use the Trust to stabilize fluctuating required contributions if needed or accumulate funds to eventually pay down the CaPERS unfunded liability.
In January 2020, the City established a Section 115 trust. As of August 2022, the balance in the trust was $926,740. The creation of the trust and any future contributions to the trust creates a restricted asset on the balance sheet. It provides the City with the option to determine the level of investment risk. The direct payment option to CaPERS does not provide this benefit.
Conclusion
Accelerating payments to CaPERS or continuing to set funds aside in the Section 115 trust is important to reduce the City's unfunded liability. The City has clearly taken steps to address this by creating and funding the trust.
Attached is our full analysis, which we will present in detail at the City Council Study Session on October 17, 2022.
October 6, 2022 Page 2
SUMMARY OF CALPERS ACTUARIAL STUDY (CONTINUED)
Actuarial Certification
The calculations and projections in this report are based on information contained in the City's June 30, 2021 and earlier CaPERS actuarial valuation reports. We reviewed this information for reasonableness, but do not make any representation on the accuracy of the CaPERS reports. Future investment returns and volatility are based on Foster & Foster Capital Market model which results in long term returns in our full report.
Future results may differ from our projections due to differences in actual experience as well as changes in plan provisions, CaPERS actuarial assumptions or methodology. Other than variations in investment return, this study does not analyze these.
As members of the American Academy of Actuaries meeting the Academy Qualification Standards, we certify the actuarial results and opinions herein.
Respectfully submitted,
Bianca
Mary Elizabeth Repling SA, EA, FCA, MA Bianca Lin, FSA, EA, FCA, MAAA Foster & Foster, Ine. Foster & Foster, Inc.
October 6, 2022 Page 3
BACKGROUND
CalPERS Background
F
October 6, 2022 1
BACKGROUND
• CalPERS
Established in 1932
Basis is in California Government Code
• 2.1 million members
649,000 public agency members (not State or school employees) 1,562 public agencies
• $423 billion assets (9/27/2022)
• Largest US pension fund
October 6, 2022 2
BACKGROUND
• CalPERS
• Administers CaPERS pension plans in accordance with State law and Board policies
List of pension benefits offered is in State law
CaPERS calculates benefits, pays retirees, and tracks all data CaPERS collects contributions from employees and employers • CalPERS actuaries determine required contributions, in accordance with Board policies
• CaPERS invests the funds in accordance with Board policies • CalPERS Board
• 13 Board members elected by members or appointed
October 6, 2022 3
BACKGROUND
• CalPERS Defined Benefit Promise:
• At retirement, employees receive a monthly annuity for life • Final average pay (monthly) x years of service x factor • Cost of living increase up to 2% per year
• Member Contributions specified in law. For Laguna Niguel:
• Classics hired before 2013 = 7% of PERSable pay
PEPRA hired 2013 and later = ½ cost of benefits earned each year City employees have no Social Security
• City Contributions - Total required amount minus Member contributions October 6, 2022 4
BACKGROUND
Present Value of Benefits
• PVB - Present Value of all Projected
June 30, 2021
Benefits:
Future Normal • The value now of all future expected
Costs
benefit payments based on various
Current Normal
Cost assumptions
• Normal Cost (NC):
• Portion of PVB allocated to (or
"earned" during) current year
Actuarial
• Actuarial Liability (AAL):
• Discounted value (at valuation date) of benefits earned through valuation date Target- Have money in the bank to cover Actuarial Liability (past service) Unfunded Liability (UAAL or UAL) - Money short of target at valuation date • If all actuarial assumptions were always exactly met, then the plan assets would always equal AAL
: Any difference is the unfunded (or overfunded) AAL
Every year, the actuary calculates the difference between the expected UAAL and Actual UAAL. This is a new layer or amortization base
• Each UAAL layer is amortized (paid off) over a period of time as part of the contribution
October 6, 2022
How CALPERS GOT HERE - INVESTMENT RETURN
Annual Return on Market Value of Assets
28.00%
21.00%
14.00%
7.00%
0.00%
-7.00%
-14.00% 20-Year and 30-Year
average return rates on
-21.00% 6/30/22 are 6.9% and
7.7%, respectively
-28.00%
97 99 100 04|
•Rate of Rarurn -19-61% 3.7% 16.6%1
Discount Rati 835 8 35 8. 25 8.25448 29938 251 1059627521 - Year Rolling Average
Returns (after 2001) shown are gross returns, unreduced for administrative expenses, from CaPERS valuation reports, when available. The discount rate is based on expected returns net of administrative expenses.
October 6, 2022
HOW CALPERS GOT HERE
• CaPERS Old Contribution Policy
Effective with 2003 valuations:
• Slow (15 year) recognition of investment losses into funded status • Designed to first smooth rates and second pay off UAL • Demographics
• Around the State
• Large retiree liability compared to actives
• Declining active population and increasing number of retirees Higher percentage of retiree liability increases contribution volatility City of Laguna Niguel percentage of liability belonging to retirees is 48% vs about 55% State average
October 6, 2022
HoW CAPERS GOT HERE
Enhanced Benefits implemented in early 2000's for all (future & prior) service City of Laguna Niguel does not have an Enhanced Benefit Tier 1 Tier 2 PEPRA
• Benefit 2%@55 FAEI 2%@60 FAE3 2%@62 FAE3
• 6/30/2021 Count 21 11 44
• 6/30/2021 Payroll $2,087,000 1,251,400 2,584,200
The City voluntarily adopted a lower Tier 2 lower benefit for employees hired after March 23, 2012
• PEPRA tier required for new employees hired after 1/1/13 • Employee pays half of total normal cost
• 2022 Compensation limit (Non-Social Security participants): $161,969 * FAE1 is highest one year (typically final) average earnings * FAE3 is highest three years (typically final three) average earnings October 6, 2022 8
CALPERS CHANGES
• CalPERS goal is to create a more stable and sustainable fund:
• Contribution policy changes:
• Eliminated excessive smoothing
Pay-off new unfunded layers faster, beginning after 2019 In 018, is count at reddin to telet inver anticipated improvement • Reduce from 7.5% to 7.0% in 3 steps (phase-in through 24/25) • "Risk mitigation policy" to reduce contribution volatility • Gradually shift to more conservative investments over 20 years First triggered 6/30/2021
• Discount rate dropped to 6.8%
• New asset allocation is more volatile than previously • All expected to increase the City's future CaPERS costs and rates.
October 6, 2022
City of Laguna Niguel's CalPERS Plan
City of Laguna Niguel's CalPERS Plan
F
October 6, 2022 10
City of Laguna Niguel's CalPERS Plan
Number of Participants Each Year
100
90 80
70 60
50 40
30 20
10 '13 '14 '15 '16 '17 '18 '19 '20 '21
Valuation Year
• Receiving Payments • Classic Actives • PEPRA Actives
October 6, 2022 11
FUNDED RATIO
City CalPERS Assets and Actuarial Liability (SMillions) $50 2020 2021 Estimated 2022
$45
$7 M $13 M
$40 } Infunded Infunded
$35 Unfunded
$30
$25
$20
$15
S10
55 SO
AAL Assets AAL Assets AAL Assets
• Retired • Inactive • Active
October 6, 2022 12
FUNDED STATUS ($ MILLIONS)
$50
$45
$40
$35
$30
$25
$20
$15
$10
$5
SO
11 '12 '13 '14 15 16 '17 118 '19 '20 '21 22
• Actuarial Liability 20 22 24 27 29 32 34 37 39 41 44 48 • Market Asset Value 17 17 20 23 24 24 27 28 31 37 35
6/30/22 funded status estimated
October 6, 2022 13
CONTRIBUTION PROJECTIONS
Market Value Investment Return:
• June 30, 2022 (6.1%)
Future returns based on stochastic analysis using 1,000 trials Single Year Returns at 25th Percentile 50t Percentile 75h Percentile Current investment mix - first 10 years, -1.8%
6.0% 14.7%
without risk mitigation
Current investment mix - after 10 years, -0.7% 7.5% 16.4% without risk mitigation
• Assumes investment returns will generally be lower over the next 10 years and higher beyond that.
Discount Rate decreases due to Risk Mitigation policy - Ultimate rate 6.0% No Other: Gains/Losses, Method/Assumption Changes, Benefit Improvements Different from CaPERS projection
Impact of Risk Mitigation Policy:
• Net impact of investment gain and discount rate change amortized over 20 years with 5 year ramp up
• Same amortization method for all future years
New hire assumptions:
• All new hires assumed PEPRA members and none are Classic members Gross return based on July 2022 CaPERS press release.
Nih percentile means N percentage of our trials result in returns lower than the indicated rates.
October 6, 2022 14
CONTRIBUtIon PROJECTIONS
Impact of 21/22 Investment Return
Contribution Projection - Percent of Pay
35%
115%
30%
27.9% 19.2% 30.5%
25%
130%% 21.3%
1191%
20%
19.5% 211%
15%
No. "
10%
48%%
5%
0%
50th Percentile - actual -6.1% return for 21/22 50th percentile - assuming 6.8% investment return for 21/22 October 6, 2022 15
CONTRIBUTION PROJECTIONS
Contribution Projection - Percent of Pay
50%
38.6% 39.5% 40.2%
32.7% 349% 36.6%
213%219% 230%231% 248% 258%219% 286% 29% 299% 30,5% 312% 24.8% 26.8% 29.0% 221% 229"0
10%
0%
- 75th Percentile 50th Percentile 25th Percentile
October 6, 2022 16
CONTRIBUTIon PROJECTIONS
Contribution Projection - Percent of Pay
50%
105 406°° 40.2%
40% 1000*
30% 219% 19.2% 30.5% 115%
20% 213% 230% 248%
18.2°
13.0%
10% 9,7%% 45%0
100- 45°0
75th Percentile 50th Percentile 25th Percentile
October 6, 2022 17
CoNTRIBUTIon PROJECTIONS
Contribution Projection - S000s
(50 Percentile)
$3.000
2,649
$2.500 2,518
2,403
2,276
2,174
$2.000 2,062
1,851 4795
1,733
1,615
$1.500 1,520 4328 1418 149645991.689
1,429 1,406
$1.000 87095610541439
824 764 780 804 829
712 734 757
642 650 659 679
$500 605
So
22/23 23/24 24/25 25/26 26/27 27/28 28/29 29/30 30/31 31/32 32/33 33/34 Total Normal Cost UAL Payment
October 6, 2022 18
DIRECT PAYMENTS TO CALPERS
Paying Down the Unfunded Liability
October 6, 2022
DIRECT PAYMENTS TO CALPERS
Make payments directly to CaPERS:
: Likely bestlong-term investment return
Must be considered an irrevocable decision
Extra payments cannot be used as future "credit"
• PEPRA prevents contributions from dropping below normal cost • Option #1: Request shorter amortization period (Fresh Start):
Higher short term payments
Less interest and lower long term payments
Likely cannot revert to old amortization schedule
October 6, 2022 20
DIRECT PAYMENTS TO CALPERS
• Make payments directly to CaPERS (continued):
• Option #2: Target specific amortization bases with an "Additional Discretionary Payment" "ADP":
Unfunded Liability can never be paid off. Future investment gains and losses will create new unfunded (or overfunded) liabilities Extra contribution's impact is muted by reduced future contributions • CaPERS can't track the "would have been" contribution No guaranteed savings
• Larger asset pool means larger loss (or gain) opportunity • Payoff Options:
• Paying off longer amortization bases: smaller contribution savings over longer period but more interest savings vs paying off shorter amortization bases
• Maintaining the current payment schedule - not letting payments reduce due to extra payment - gives the greatest long-term savings
October 6, 2022 21
SECTION 115 TRUST
Can only be used to:
• Reimburse City for CaPERS contributions
• Make payments directly to CaPERS
Investments significantly less restricted than City investment funds • Fiduciary rules govern Trust investments
• Assets don't count for GASB accounting
• Are considered Employer assets
• The City established a Section 115 Trust several years ago October 6, 2022 22
SECTION 115 TRUST
• More flexibility than paying CaPERS directly
• City decides if and when and how much money to put into Trust • City decides if and when and how much to withdraw to pay CaPERS or reimburse Agency
• Funding strategies typically focus on
Using funds for rate stabilization/budget predictability Target increasing fund balance to pay off UAL sooner
October 6, 2022 23
COMPARISON OF OPTIONS
• All effective options involve setting aside more money, earlier than required by CaPERS funding policies
• Supplemental Trust • CalPERS
Flexible • Locked In
: •
Likely lower long-term return Likely higher long-term return Investment strategy choice • No investment choice
• Does not reduce net pension • Reduces net pension liability for liability for GASB reporting GASB reporting
• Source of required payments • PEPRA requires contributions if if overfunded overfunded
• More visible • More restricted
October 6, 2022 24
OPTION ANALYSIS
15 Trust Withdrawals Beginning 2028/29 - Current Balance Onl 34% Contribution Rate Projectio
32% 31.5°
30.5%
30% 29.3°
29.2%
28%
28.0% 28.0%
26%
24.8%
24%
23.8%
22% 21.3%
—Target Contribution Rate
2,500
Supplemental Trust Balance (S000s)
2,000
1,500
1,254
1. 046
95%
1,000
500
140 15 160
October 6, 2022
OPTION ANALYSIS
115 Trust Withdrawals Beginning 2028/29 - With Additional SIM Contribution Rate Projection
34%
32%
30.5%
30%
29.2%
28% 27.9%
26%
24.8% 26.0% 26.0% 26.0% 26.0%
24%
23.0%
32.3%
22% 21.3%
20.7%
-Target Contribution Rate 50th Percentile
20%
2,500
3.135 , 115
Supplemental Trust Balance (S000s)
1,95%
1,500
1,000
500
239 201
2am 1888188818281889118
OPTION ANALYSIS
Direct Payment (ADP) of S1M to CalPERS
Contribution Projection - Percent of Pay
40%
36.2°0
35%
30.5%%
30% 19.2°:
20207 30
:7.99%
2SH3910
521.190
248°
25% 36.200
13.0%%
113°%
33.0%
20% 51.29
15%
9.30. 9,190
10%
10.1°% 10.2%%
Current — Paydown Shortest Bases - - Paydown Longest Bases — No Payment Reduction F
October 6, 2022 27
OPTION ANALYSIS
Direct Payment (ADP) of S1M to CalPERS
Miscellaneous
UAAL Projection - (S000s) - Current Bases Only
$7.200
6.337
$6.200
5.656
$5.200 3.001
$4.200 → 1342
3,531
3.69฿
$3,200
1383
$2.200 2380,
1.605
$1.200
528
$200
6302035 6302036 6302037 630/2038 6302030 6302051
Current — Paydown Shortest Bases - - Paydown Longest Bases —No Payment Reduction October 6, 2022 28
OPTION ANALYSIS
Section 115 Trust Savings Illustration
• Savings depend on actual timing of fund deposits and withdrawals Current Additional SIM
Trust Balance at 6/30/22 $ 917,000 $ 917,000
Projected Balance at 6/30/23 963,000 1,963,000
Trust Earnings 4.5% 4.5%
Trust Target
- City's Target Contribution Rate 28.0% 26.0%
- Ist Year of Trust Withdrawals 2028/29 2028/29
- Last Year of Trust Withdrawals 2036/37 2036/37
$ Savings $ 580,000 $ 1,126,000
Present Value of Savings @ 3% discount rate 193,000 372,000 • The City's Section 115 Trust is invested with PARS Moderately Conservative fund. Our modeling currently projects a long-term average return of 4.5% for this fund, after expenses.
October 6, 2022 29
OPTION ANALYSIS
Direct Payment to CalPERS (ADP) Savings
Illustration of additional $1 million contribution (ADP) to CaPERS on June 30, 2023:
Estimated Savings
Pay Off Miscellaneous
Shortest Bases $1 Million
$ Savings $ 439,000
PV Savings @ 3% 215,000
Longest Bases $1 Million
$ Savings $ 882,000
PV Savings @ 3% 399,000
No Payment Reduction $1 Million
$ Savings $1,370,000
PV Savings @ 3% 620,000
October 6, 2022 30
OPTION ANALYSIS
Questions?
F
October 6, 2022 31