CITY OF SALINAS
PENSION UNFUNDED ACCRUED LIABILITY (UAL)
COST MANAGEMENT STRATEGIES DISCUSSION
APRIL 4, 2023
2 Introduction to NHA Advisors
NHA was hired as the City’s Municipal Advisor in December 2021 NHA has 8 Practice Groups to optimally serve public agencies NHA’s Pension & Fiscal Sustainability Practice Group was established in 2014 and has since served 85+ California public agencies Education – NHA Summary Reports, White Papers, Newsletters, Workshops Financial Planning – CalPERS Sensitivity Analysis & Projection Modeling Cost Management Strategies – Section 115 Trusts, Additional Discretionary Payments (ADPs), POBs/UAL Restructurings
Stress Testing and Risk Assessment
Pension Funding Policy Development
Public Agencies Served by NHA Advisors*
*Engagements since 2012
3 Executive Summary
City of Salinas has a $165M CalPERS Unfunded Accrued Liability (“UAL”), as of the latest CalPERS valuation (6/30/2021)
23% decrease compared to previous valuation due to CalPERS strong investment returns of 21.3% in FY 2021 However, CalPERS reported investment returns of -7.5% for FY 2022, which is projected to offset the benefits of the strong investment returns in FY 2021
City’s UAL balance is projected to grow to $238M
This increase will be recorded in this summer’s CalPERS reports City’s UAL payments will be impacted in FY 2025
Additionally, CalPERS is currently underperforming for FY 2023, with investment returns estimated at
0.0% to date
City’s UAL Balance may increase to approximately $272M if CalPERS finished the year at 0.0% Continuing to plan for and evaluate options to manage variable costs is important for budget predictability and fiscal health
Cost management strategies:Section 115 Trust, Additional Discretionary Payments (“ADPs”), UAL Restructuring In April 2022, the City approved a Section 115 Trust with PFM Asset Management This Trust can be used to enhance budget predictability, limit the impacts of pension costs on the General Fund, and more 4 Table of Contents
I. Background on CalPERS Costs
II. Historical and Projected CalPERS Costs
III. Potential Cost Management Strategies
IV. Comparison of Section 115 Trust and ADP
V. Fiscal Health
VI. Conclusion
Appendix – Additional Pension Information
I. BACKGROUND ON CALPERS COSTS
6 $483 Million
$754 Million
$272 Million
$-
$50
$100
$150
$200
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$550
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$800Millions
CalPERS Pension Funded Status
Background on How CalPERS Works
Two Payments Made to CalPERS Annually
(1) Normal Cost (“NC”) = Annual cost for current employees (2) Unfunded Accrued Liability (“UAL”): Annual payment to amortize the “debt” to CalPERS
CalPERS actuaries calculate how much the City is required to have in its account with them to pay out benefits to City’s retirees over the next 30-40 years (Actuarial Liability) CalPERS annually calculates the Market Value of City’s assets held on account with them; Most public agencies have less assets than required to meet Actuarial Liability
This shortfall (i.e., the “UAL”) is not repaid all at once but amortized over time with the City paying down a portion each year (principal and interest)
CalPERS uses a “discount (i.e., interest) rate” of 6.80% CalPERS annually adjusts this repayment schedule by adding a new “base” (i.e., layer) which adds to (in bad investment years) or lowers (good investment years) the overall repayment schedule
Over the past 20 years, the addition of these “layers,” along with other CalPERS assumption changes, has created a very irregular repayment shape for most CalPERS public agencies
Actual Market
Value of Assets
Actuarial
Liability
Shortfall (UAL)
The numbers reported in this chart assume -7.5% investment returns for FY 2022, 0.0% investment returns for FY 2023, and
6.80% investment returns every year thereafter.
7 Now …
Sluggish returns outlook (<7%)
Assumptions have changed/changing
Discount Rate: 8.25% → 7.00% → 6.80%
Inflation rate (prices going up)
Mortality rates (people living longer)
Shorter (20 year) amortization
UAL payments have grown rapidly from
past changes, remain exposed to the
effects from future poor investment
returns and assumption changes
Why CalPERS Costs have Trended Higher
Then (late 1990s)…
Robust investment returns (10%+)
Retirement plans were “Super-
Funded” through the late 1990s
Earnings on funds were more than
adequate to cover retirement costs
Super-funded status induced
widespread retirement benefits
enhancements….
Historical PERS
Returns
5-Year: 6.7%
10-Year: 7.7%
20-Year: 6.9%
30-Year: 7.7%
II. HISTORICAL AND PROJECTED CALPERS COSTS
9 Historical and Projected UAL Payment Schedule
The City’s UAL Balance as of FYE 2021 is
23% lower than FYE 2020, but is
expected to increase 44% in the next
CalPERS valuation
The City’s UAL balance could increase
another 14% if CalPERS earns 0.0% in FY
2023
City’s $10M payment in 2018 has
increased to $16M in FY 2023.
Projected payments peak at nearly
$30M in FY 2031.
Rapidly increasing impact to City’s budget
Annual Pension Cost (UAL + Normal
Cost) is currently 17% of General Fund
Budget (includes General, Measure E, &
Measure G Funds) and projected to
increase to 27% in FY 2031
Note that the UAL will fluctuate
annually moving forward based on
future CalPERS investment returns &
assumption changes
2023:
$272M
2022:
$238M
2021:
$165M
2020:
$216M
UAL
Balance
(FYE):
Returns: 4.7% 21.3% -7.5% 0.0% (est.)
$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
$30.0
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
Millions
UAL Payments (6/30/2021
Actuarial Valuation)
New UAL Payments from
-7.5% FY 2022 Returns
New UAL Payments from
Hypothetical 0.0% FY
2023 Returns
Historical UAL
Payments
Source: CalPERS Pension Outlook Tool. Assumes FY 2022 returns of -7.5%, FY 2023 returns of 0.0%, and 6.80% returns from FY 2024 onward.
III. POTENTIAL COST MANAGEMENT STRATEGIES
11 Cost-Containment Strategies – Not Mutually Exclusive (1) Prepay UAL early in Fiscal Year (≈ 3.3% discount)
(2) Negotiate Cost Sharing With Employees
• Require employees to pay their share; new employees already governed by lower cost/benefit PEPRA plans • Negotiated cost sharing of the City’s share
(3) Fresh Start Amortization offered by CalPERS
• Pros: Smooths payment, shortens repayment period; reduces overall interest paid from shorter amortization period • Cons: New structure “locked-in” + increased annual payments in near term; still amortized at discount rate (4) Use Cash Reserves to Pay Extra (two options)
• Section 115 Trust – Separate trust solely dedicated to pension/OPEB → City has adopted a Section 115 Pension Trust • ADP – Reduce UAL through direct lump sum payment to CalPERS → City made an ADP in 2018 and 2020 • Choose optimal amortization bases to pay off
(5) Restructure All or Portion of Remaining UAL
• Restructure portion of UAL at lower bond interest rate and “smooth out” payments for enhanced budget predictability, near and mid-term potential savings, and preservation of cash for other critical activities Currently not
recommended;
Continue to
Monitor
Currently not
recommended
12 Use Cash Reserves: Section 115 Trust
What is it? Dedicated (restricted to pension/OPEB) account managed by 3rd party The City approved a Section 115 Pension Trust in April 2022; The Trust balance is $6.2M as of 12/31/2022 The target asset allocation for the Trust is 50% equity, 50% fixed income Pros:
Potential for increased investment returns vs. current General Fund reserves General Fund investments restricted by Government Code (limits types of instruments and maturities) Flexibility – more investment options than CalPERS and the City can decide when and how to use Longer-Term: Trust funds can grow over time and pay off full UAL in the future Shorter-Term: Apply during challenging budget years or to “smooth” payment spikes in UAL and/or Normal Cost
Diversify asset management away from CalPERS
Potential shock absorber for volatility from CalPERS investment performance & assumption changes Cons:
Market risk (dependent on type of investment portfolio) Note: The Trust will show up as an asset on the City’s financial statements, but will not technically offset UAL until funds are transferred to CalPERS
13 What is it? City makes Additional Discretionary Payment (“ADP”) directly to CalPERS and designates which amortization base(s) / layer(s) shall be paid off CalPERS will eliminate payments associated with the portion of the UAL paid off, essentially giving the City credit at the discount/interest rate (currently 6.8%) The City made an ADP to CalPERS in FY 2018 ($11.3M) and FY 2020 ($4.3M) Pros:
Reduced future payments
Reduced UAL / higher CalPERS funding ratio
Broader, less restrictive CalPERS investment portfolio has potential for higher returns Cons:
Re-investment and market timing risk with ADP funds
No options for other investment portfolios like there is with Section 115 Use Cash Reserves: ADP
14 Section 115 vs. CalPERS ADP Comparison
OPTION Section 115 Trust CalPERS ADP
Reduced UAL & UAL Payments with
CalPERS No Yes
Reduced Pension Liability in ACFR No (but the Trust will show up as an asset on the City’s financial statements) Yes
Control of Investment Strategy Yes No
Funds Managed By Trust Administrator (e.g., PFM Asset
Management for the City’s Trust) CalPERS
Flexibility in Uses Yes (annual pension or OPEB expense, ADP , OPEB, etc.) No
Savings Varies; Depends on when City utilizes
funds to pay liabilities
Immediate; Length of time varies based
on which amortization component is
paid off (City's amortization bases
currently range from 2 - 27 years)
Enhanced Budgetary Flexibility Yes No
How Many Agencies in CA Have Used? Over 300 (Estimated) CA agencies maintain Section 115 Trusts (>150 cities)
Historically, hundreds of ADPs made by
CA agencies annually
IV. COMPARISON OF
SECTION 115 TRUST AND ADP
16 Comparison of Section 115 Trust and ADP
$6 Million & $20 Million Deposit Amounts
$6 Million (City’s Current Trust Balance) $20 Million
*Assumes 6.80% Discount Rate, -7.5% FY 2022 Investment Returns, 0.0% FY 2023 Investment Returns, 6.80% Investment Returns from FY 2024 onward $0.0
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
$16.0
$18.0
$20.0
$22.0
$24.0
$26.0
$28.0
$30.0
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
Millions
Projected UAL Payments (CalPERS Pension Outlook Tool)*
ADP Net Payments
Section 115 Trust Net Payments
$0.0
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
$16.0
$18.0
$20.0
$22.0
$24.0
$26.0
$28.0
$30.0
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
Millions
Projected UAL Payments (CalPERS Pension Outlook Tool)*
ADP Net Payments
Section 115 Trust Net Payments
Trust savings more
optimally concentrated in
peak years
ADP savings distributed
across the next 13 years
17 Comparison of Section 115 Trust and ADP
Assumptions & Savings Summary
2 Different Deposit Amounts: $6M and $20M
Cost Management Strategy Section 115 Trust ADP
Deposit Assumptions
$6M by FYE 2023. For the $20M
scenario, the remaining balance
($14M) is deposited in 2024
$6M by FYE 2023. For the $20M
scenario, the remaining balance
($14M) is deposited in 2024
Assumed Interest Rate Benefit 5.00% 6.80%
Gross Savings $8.7M - $29.7M $8.6M - $28.0M
Gross Savings during Peak Payment
Years (2029 – 2036) $8.7M - $29.5M $5.0M - $17.3M
Additional Budget Flexibility from
Liquidity
$6M - $20M (equal to total amount
deposited)
$0 (funds deposited cannot be
retrieved from CalPERS
Average Annual Payment from
2023 - 2036 (Excludes Deposits) $22.5M - $24.0M $22.7M - $24.0M IV. FISCAL HEALTH
19 Economy
30%
Finances
40%
Institutional
Framework
10%
Management
20%
S&P Credit Scorecard
City’s “AA-” Issuer Credit Rating
Criteria and Summary
Economy:
Weak economy
Per capita buying income of 60.6% of national level
Weak county unemployment rate
Diverse taxpayer base
Finances:
Strong budgetary performance
Very strong budgetary flexibility
Very strong liquidity
Very weak debt and contingent liability profile
City’s plan to mitigate rising pension/OPEB costs may not sufficiently address the increasing obligation right away and may result in budgetary pressure
Management:
Very strong management
Strong financial policies and practices
Not Controllable
Controllable
“AA-” Issuer Credit Rating Summary
Policies and practices
Metrics include budgetary
performance, budgetary
flexibility, liquidity, debt and
contingent liabilities
Metrics include median
household income, per
capita effective buying
income, assessed values,
diversity of tax base, etc.
Source: Salinas Facilities Financing Authority S&P Rating Report (August 5, 2020) IV. CONCLUSION
21 Takeaways
Rising pension costs are a challenge facing most public agencies Salinas has taken steps in addressing this challenge (e.g., Adopting Section 115 Trust, ADPs) City should incorporate latest estimates into budget and planning process; conduct sensitivity analysis and conservatively plan for CalPERS underperformance
City can consider various cost management strategies, including Section 115 Trust deposits and ADPs A Section 115 Trust may be the most helpful as a shock absorber for BOTH revenue volatility and CalPERS volatility, given recessionary pressures
The City should consider additional deposits to the Trust Even at a $20 million Trust balance, the smoothed UAL payments are still projected to increase 50% over the next several years ADPs can also be considered; perhaps after the Section 115 Trust is built up to sufficient levels ADPs can be executed at any time from a Section 115 Trust; the Trust does not preclude the City from executing other strategies
UAL Restructuring could be evaluated in future if interest rates come down again (would require significant evaluation/risk assessment)
City could consider incorporating its current Section 115 Trust reserve policy into a comprehensive pension funding policy to provide additional detail on how it will apply various one-time monies and/or surplus towards pension and OPEB liabilities
APPENDIX –
ADDITIONAL PENSION INFORMATION
23 Background - Retirement Plans
2 Main CalPERS plans
Miscellaneous: 759 covered members
Safety (Police & Fire): 870 covered
members
PEPRA helpful to manage long term
pension costs for new employees
PEPRA (effective 2013) enacted revised
benefit levels for new plan members
However, over 99% of UAL is
attributable from Classic plans and not
reduced by PEPRA
MISCELLANEOUS PLANS
Benefit Group # of Actives % of Actives Benefit Formula Miscellaneous 281 100.0% 2.0% @ 55
2.0% @ 62
Total Active Members 281 100.0% -
Total Covered Members 759 - -
SAFETY PLANS
Benefit Group # of Actives % of Actives Benefit Formula Safety Police 151 64.0%
3.0% @ 50
3.0% @ 55
2.7% @ 57
Safety Fire 39 16.5% 3.0% @ 50
PEPRA Safety Fire T2 28 11.9% 2.5% @ 57
Safety Fire T2 18 7.6% 3.0% @ 55
Total Active Members 236 100% -
Total Covered Members 870 - -
24 UAL Payments are like a “Layer Cake”
More Layers Each Year; Increasing or Decreasing Height and Shape of “Cake” Note: The numbers and charts in this presentation are a representation of another California public agency’s CalPERS UAL and are provided here for educational purposes.
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
2047
2048
2049
Net UAL Payments
25 $-
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
$16.0
$18.0
$20.0
$22.0
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
2044
2045
2046
2047
2048
2049
2050
Millions
10-Year Fresh Start Analysis
UAL Payments (6/30/2021 Valuation) 10-Year Fresh Start Payments CalPERS “Fresh Start”
What is it? City can request new,
smoother amortization schedule with
CalPERS
Must be shorter that current term
Amortized at discount rate (currently 6.8%)
Pros:
Overall reduction in interest paid on UAL
UAL paid off sooner
Cons:
Near term payments are higher
All payment reductions are in later years
Very low present value savings
City can’t go back to old schedule
Fresh Start is not commonly utilized –
City could achieve same result using
either the ADP or Section 115 strategy
while maintaining some flexibility
Source: CalPERS Actuarial Reports (6/30/2021 valuation) Years 1-10: $57.6M Net
Increase in Total Payments
Years 11-27: $108.5M in
Cashflow Savings
26 Restructuring UAL using Debt
What is it? Borrow money to pay off all or a portion of UAL with CalPERS (i.e., very large ADP) Pension Obligation Bond (“POB”) is typically utilized Unsecured debt (no collateral required)
“Court Validation” to confirm UAL is a “debt” that can be refinanced Typically a 3-to-4-month process
Validation provides option to issue POBs now or anytime in the future (does not lock an agency into issuing) Alternative option is Lease Revenue Bond
Pros:
Restructuring the annual payments into a smoother, predictable schedule is core objective POB interest rates typically lower than CalPERS interest rate (6.8%) Given recent market volatility driven by Fed rate hikes to combat inflation, taxable interest rates for pension bonds are currently estimated at 6.00% or higher
Cons:
Re-investment risk and market timing risk of bond proceeds sent to CalPERS Since Spring 2020, approximately 85 - 95 California public agencies have restructured their UAL through debt financing Last California UAL restructuring was in August 2022
POBs are not recommended in today’s market due to higher interest rates (estimated at 6.00% or higher) NHA and staff will continue to monitor the market; robust evaluation/risk assessment would be recommended if strategy was ever pursued in future
POB Debt Service
Unrefunded UAL Payments
UAL Payments Before POB