Revision to Agenda Item #18
• Revision #1 to the Staff Report: Updated the first sentence of the second paragraph in the Background section to reflect that “UAL” stand for Unfunded Accrued Liability and not Unfunded Actuarial Liability.
• Revision #2 to the Policy: Updated the word “Actuarial” to “Accrued” under the section “II. Pension Contributions and Amortization Bases”
o From: “The annual pension contribution is comprised of two component parts: 1) normal costs; and 2) unfunded actuarial liability.
o To: “The annual pension contribution is comprised of two component parts: 1) normal costs; and 2) unfunded accrued liability.
And
o From: “Unfunded Actuarial Liability (UAL)”
o To: “Unfunded Accrued Liability (UAL)”
Redline Version
Item Number: {{item.number}}
City Council / Board of Directors
Written Communications
Meeting of: July 16, 2024
Submitted By:
Sophie L. Smith, Deputy City Manager
Carmen Cun, Finance Director / City Treasurer
Subject:
Pension Liability Management Policy
Recommendation:
That the Honorable City Council:
(1) Review the Pension Liability M anagement Policy and provide feedback, as needed.
(2) Adopt the Pension Liability Managem ent Policy incorporating any agreed upon changes.
Fiscal Impact:
There is no fiscal impact associated with adoption of the Pensi on Liability Management Policy (“Policy”). If adopted, the Policy would serve as a guide for the City in managing its pension liability and is intended to be reviewed annually by staff and Council.
Strategic Plan Goal:
This item aligns with Goal A. Financial Sustainability, Strategy 1 to develop a multi-year plan and strategies to address pension obligat ions due to increasing pension costs and resulting pressures on the general fund.
Background:
The City offers three pension plans—Safety (Fire and Police), Miscellaneous (Classic non-represented employees), and PEPRA Safe ty Fire (Employees hired after 01/01/2013). The California P ublic Employees’ Retirem ent System (“CalPERS”) publishes an annual report in August known as Actuarial Reports; one report for each pension plan. This report is tw o fiscal years in arrears, the current report is as of June 30, 2022.
Based on the most recent actuarial reports, the PEPRA Safety Fire plan carries a very manageable funding shor tfall, or Unfunded AccruedActuarial Liability (“UAL”) of $521,390, and annual UAL payments peak at approximately $74,750. The payment peak is the highest payment shown on the Amortization Schedule provided in the report.
Therefore, the Pension Li ability Management Policy focuse s on the City’s Safety and Miscellaneous Plans which have a combined a ccrued liability of $298.2 million with a market value of assets of $205.7 million, resulting in a UAL of $92.5 million (i.e., a funding ratio of 69%). The City’s combined a nnual UAL payments for the Safety and Miscellaneous Plans are projected to increase from $7.4 million in FY 2023-24 to $10.0 million in FY 2029-30, representing an increase of 35.0% over the next six years.
The City’s Issuer Credit Rating (“ICR”) from S&P is currently a st rong “AA-”. S&P noted in its ICR rating report in Ap ril 2021 that, while they view the City’s pension and Other Post-Employment Benefits (“OPEB”) liabilities as manageable, the rising costs related to the City’s underfunded pension liabilities may exacerbate budgetary pressures over the longer term. In its continued surveillance of the City’s ICR, S&P will continue to evaluate the City’s pension liabilities as part of its “debt and contingent liabilities” metric and consider whether a pension liability management policy has been adopted as part of its “management policies and practices” metric. Adopting the Pension Liability Management Policy helps to support factors for maintaining the City’s “AA-” rating.
Discussion:
In order to address the City’s pension liabilities and take advantage of opportunities to lower the UAL through various strategies, st aff has worked with its Municipal Advisor (Urban Futures, Inc.) to develop a Pensio n Liability Management Policy for Council’s consideration and adoption.
The attached Policy incudes: 1) Policy objectives and goals; 2) A description of the City’s pension plans and liabilities; 3) Strategies fo r managing the City’s pension liabilities; 4) Potential funding sources for these strategies; 5) Reserve and funding target levels; and 5) Policy review and amendment.
The Policy provides a guideline for the City in implementing a long-term plan that utilizes multiple strategies over time. For example, if the Policy is ado pted, staff will monitor opportunities to manage the City’s UAL through the following strategies:
(1) Additional Discretionary Payments (“ADPs”) to CalPERS —Payments above and beyond the annually required contributions to CalPERS in order to prepay a portion of the UAL, resulting in savings over time.
(2) Section 115 Trust —Trust assets can only be used to pay employer pension obligations (including normal costs) and allows the City to build a pension reserve that has greater investment flexibility and risk diversification compared to the City’s investment portfolio.
(3) Pension Stabilization Reserve Fund —Rainy-day fund to meet pension obligations when revenues are impaired based on economic or other conditions.
Moneys in this reserve fund are subject to California Government Code investment restrictions and the City’s Investment Policy. The current Reserve Fund target is recommended at $2.6 million, which r epresents the increase in annual UAL payments for the Miscellaneous and Safety Plans from FY24 to FY30 (the current anticipated peak year).
(4) Accelerating Payment of New Amortization Bases—Accelerate the repayment of new Amortization Bases added to the UAL.
Potential funding sources for the above strategies include:
(1) Reserves in Excess of Policy Targets—To the extent that the City has reserves in its General Fund or other funds in excess of reserve targets, the City may consider allocating all or a portion of the excess toward the UAL.
(2) Operating Surplus—On a case-by-case basis, st aff may recommend that 50% of remaining operating surpluses (after c onsiderations of deficits, reserve deficiencies and other fiscal matters), up to $1 million, be used to address the UAL.
(3) Debt Service Savings from Refinancings —When issuing refunding bonds for savings, the City can set aside all or a por tion of debt service savings to address the UAL.
(4) Savings from Annual Prepayment Option to CalPERS -- Each year, CalPERS gives its member agencies an option to make a lower (approximately 3% savings) lump sum payment for the entire year’s required contribution by July 31st. The City can continue to make the prepayment ever y July to CalPERS and set aside the savings to address the UAL.
(5) Financing Strategies—Tax-Exempt Exchange and Pension Obligation Bonds
Although the Policy discusses Pension Ob ligation Bonds (“POBs”) and provides guidelines for the potential iss uance of POBs, current mark et dynamics eliminate POBs as an economical option. Therefore, staff is not recommending that the Council consider this as a viable strategy at this point; however, staff recommends including the guidelines in the Policy should a market opportunity return, and the Council is interested in exploring POBs.
While the ultimate goal is to have pension li abilities fully or mostly funded, the City’s intermediate goal is to have its pension liab ilities to be 80% funded. The funded status goal may be achieved over a several year ti me frame. The funding level is expected to fluctuate; however, it should not fall below 70%, unless it is due to factors out of the City’s control (i.e., unanticipated investment earnings far below CalPERS’ investment target in a given year). The City should anticipate that its UAL will change over time and CalPERS investment results will vary. Therefore, it should expect to “actively manage” this liability
and make adjustments to the Policy as the landscape changes. Staff recommends reviewing this Policy annually as part of its Mid-Year Budget Review process.
Staff remains available for any questions the Council may have.
Attachments:
A. Pension Liability Management Policy
CITY OF VICTORVILLE
COUNCIL POLICY
SUBJECT:
PENSION LIABILITY MANAGEMENT
POLICY
POLICY NO.: CP-24-02
DATE:
June 16, 2024
BACKGROUND
The City recognizes that its unfunded pension liability can cause financial stress on the organization and direct resources away from programs and services necessary for the City’s operations and service to the public. This Pension Liability Management Policy (“Policy”) is intended to support the decision -making process of the City Council as it applies to the City’s unfunded pension liability and should be consistent with the City’s financial goals and policy objectives. Adherence to this Policy signals to the public, City employees, rating agencies, and capital markets that the City is well-managed and is able to meet its pension obligations in a timely manner.
This Policy is intended to work in conj unction with the City’s other adopted financial policies, including the Reserve Policy, Debt Management Policy, and Budget. This Policy does not cover other post-employment benef its, known as OPEB, which principally involves retiree health care benefits and associated liabilities. Nothing in this Policy shall constitute an obligation upon the City, nor an implied c ontract. The City Council may revoke or amend this Policy by resolution at any time.
PURPOSE
The City’s main objective shall be to reduc e its unfunded pension liabilities in the most cost-efficient, fiscally prudent, and sustainable manner possi ble. As with any fiscally prudent policy, the City recognizes that this Policy should:
Maintain the City’s sound financial position;
Ensure the City has the flexibility to res pond to changes in future service priorities, revenue levels, and operating expenditures;
Provide guidance in making annual budget decisions;
Protect the City’s creditworthiness;
Ensure that all pension funding decisions are structured to protect both current and future taxpayers, ratepayers, employees, and residents of the City; and Ensure that the structure of Pension Ob ligation Bonds, if authorized and issued, is consistent with the City’s strategic planning goals, objectives, capital improvement program, budget, and Debt Management Policy.
POLICY
I. RETIREMENT PLANS AND RETIREMENT BENEFITS
CalPERS is an agent multiple-employer pub lic employee defined benefit pension plan that provides retirement and disability benef its, annual cost of liv ing adjustments, and death benefits to plan members and beneficia ries. CalPERS acts as a common investment and administrative agent for participating public entities within the State, including the City. CalPERS plan benefit pr ovisions and all other requirements are established by State statute and the City Council. The City contributes to CalPERS on behalf of active City employees who participat e in the City’s Miscellaneous Plan or the City’s Safety Plan. Benefits are based on years of credited service, equal to one year of full-time employment. City employees are s ubject to different benefit levels based on their hire date.
Miscellaneous Plan – The Miscellaneous Plan has a two- tier benefit plan structure.
Employees hired before January 1, 2013 receive a benefit formula equal to 2.5% @ 55.
Employees hired after January 1, 2013 receive a benefit formula equal to 2.0% @ 62.
Safety Plan – The Safety Plan also has a two-tier benefit plan stru cture. Employees hired before January 1, 2013 receive a benefit formula equal to 2.5% @ 55. Employees hired after January 1, 2013 receive a benefit formula equal to 2.0% @ 62.
Pension costs associated with each Plan are allocated across the City’s various funds and entities based on payroll.
II. PENSION CONTRIBUTIONS AND AMORTIZATION BASES
The City is statutorily required to make pension contributions on an annual basis to each plan. The City shall make a commitment to fund the full amount of the annual contribution each year. The annual pension contribution is comprised of two component parts: 1) normal costs; and 2) unfunded actuarial accrued liability.
Normal Costs - represent the current year’s pension obligation or the cost of retirement benefits earned by current employees during the year. Normal Costs are calculated based on a percentage of payroll.
Unfunded Actuarial Accrued Liability (UAL) – is the difference between the total pension liability less the current market value of assets in the pension fund, which represents the funding shortfall for benef its previously earned by current employees and City retirees. This amount effectively represents a “past due” amount.
CalPERS recalculates the UAL balance and payment schedule every year, and a number of factors impact the accrued liability. Additionally, the market value of assets can change dramatically from year to year depending on investment performance. To address these differences, at the end of each year, CalPERS adds new amortization bases to adjust the UAL for changes to the system. Amortization bases are the component parts of the UAL.
They function like “individual loans” that have distinct payment schedules and terms. The payment schedule for each amortization base is calculated using the current Discount Rate (currently 6.80%). Each base is amortized over specific periods, in accordance with
CalPERS amortization policies. The UAL is a dynamic liability, and the City should anticipate that its UAL paym ent schedule will fluctuate as a result of everchanging variables, making the management of pensi on liabilities an ongoing evaluation and management process.
GENERAL PROVISIONS
The financial objective of a defined benefit pensi on plan is to fund the long-term cost of benefits provided to the plan mem bers. In order to assure that the plan is financially sustainable, the plan should accumulate adequate resources in a systematic and disciplined manner over the active service life of benefitting employees.
I. MANAGING PENSION LIABILITIES
A. Additional Discretionary P ayments (ADPs) to CalPERS
The City can make Additional Discr etionary Payments (ADPs)—payments above and beyond the annually required cont ributions (ARC) calculated by CalPERS. These payments can be used to prepay small amounts of “principal” on the UAL, thereby saving the associated “interest” (calculated at the Discount Rate) that is charged to the City. “Slo w and steady” ADPs chip away at the City’s pension obligations; and over time, this strategy improves the Plans’ funding status and can result in signifi cant savings. Additionally, making smaller ADPs to CalPERS on a regular basis (i.e., dollar cost averaging) mitigates the market timing risk of a large lump sum deposit with CalPERS that is invested in the market all at once.
B. Section 115 Trust
The timing of when funds are availa ble may not line up with the timing and amounts of ADPs that the City desires to make to CalPERS. This should not prevent the City from accumulating funds it desires to allocate towards paying down its pension obligations. A Section 1 15 Trust allows the City to build its pension reserve while maintaining over sight of investment management and control over the risk toler ance and investment return targets of the portfolio.
Money placed into the trust is irrevocable, meaning it cannot be withdrawn and used for another type of expenditure of the City. The benefits of a Section 115 Trust include:
1. Assets in the trust will offset liabilities on the City’s balance sheet.
2. Assets held in trust will allow for greater investment flexibility and risk diversification compared to the City’s investment portfolio.
3. The City will control t he risk tolerance (i.e., c onservative, moderate, or aggressive) of the portfolio. The City s hould hire an investment advisor to manage the Section 115 Trust.
4. The City will have the flex ibility to access trust assets any time, as long
as they are used to pay employer pension obligations (including normal costs).
5. Assets can be used to make “slow and steady” ADPs to achieve UAL savings over time.
C. Pension Stabilization Reserve Fund
Because the City’s current UAL payment schedule is projected to increase through Fiscal Year 2030 by $2.6 million, it is important for the City to maintain a reserve to supplement pension costs, including normal costs, offset future unexpected contribution rate increases, and use as a rainy-day fund when revenues are impaired based on economic or other conditions.
It shall be the City’s policy to consider applying available resources to its Pension Stabilization Reserve Fund with a target balance of $2.6 million. Each year, staff will assess whether the ta rget balance of $2. 6 million remains suitable. Staff shall seek Council approval for making wit hdrawals from the Pension Stabilization Reserve Fund or for changing the target balance.
It is recognized that monies in this reserve fund are subject to California Government Code investment restrictions and the City’s Investment Policy and therefore has a lower investment return risk than a Section 115 Trust.
D. Accelerate Payment of New Amortization Bases
The City may seek to accelerate the repayment of any new Amortization Bases added to the UAL, thereby reducing overall “interest” costs.
II. FUNDING SOURCES FOR MA NAGING PENSION LIABILITIES
A. Reserves, One-Time Monies, and Savings
To the extent that the City has excess reserves, unspent budget monies at year-end, unspent proceeds from capital projects, and/or one-time revenues or any additional resources, the City sha ll consider applying a portion of such monies toward its unfunded pension liabilities. The allocation of additional resources shall be made on a case-by-case basis by the City Council, with input from the City Manager after all discretionary fund reserve balances, cash flows, and one-time monies have been reviewed by City staff. There shall be an annual assessment of allocation of reserves and/or one-time monies consistent with the City’s Reserve Policy.
1. Reserves
The City seeks to maintain adequate levels of reserves in accordance to its stated reserve goals and adopted Reserve Policy. To the extent that the
City has reserves in its General Fund or other funds in excess of reserve targets, the City may consider a llocating the excess toward unfunded pension liabilities.
2. General Fund Surplus
Due to a variety of factors, the City may end a fiscal year with a surplus of revenues over expenditures, encumbrances, and commitments. On an annual basis, the City Manager will recommend allocations to the City Council on the use of budget surplu s funds. After deficits, reserve deficiencies and other matters of fiscal concern, the City Manager or his/her designee may recommend that 50 per cent (50%) of remaining budget surplus funds, up to $1 million, be used to address long-term pension liabilities. The 50% target level is a stated Poli cy goal; however, individual funding decisions, shall be made on a case-by-case basis.
3. Debt Service Refunding Savings
When issuing refunding bonds for savings , the City shall consider setting aside all or a portion of debt servic e savings to address long-term pension liabilities.
4. Annual Prepayment Option
Each year, CalPERS gives its member agencies two options for making its UAL payment: 1) make monthly payments to CalPERS; or 2) make a lower (approximately 3% savings) lump sum pay ment for the entire year by July 31 st to CalPERS. The City has been im plementing the second option to take advantage of the savings offered by CalPERS. The City shall continue to make the prepayment every July to CalPERS and set aside the savings to address long-term pension liabilities.
B. Financing Strategies
Because the financing strategies below involve borrowing funds and repaying them at an interest rate, savings achieved with these strategies should be used to make ADPs to CalPERS to further leverage the savings.
1. Tax-Exempt Exchange
To the extent the City has pay-go tax-exempt capital projects, the City may consider financing such projects with tax-exempt bonds and using the budgeted pay-go funds to make ADPs towa rds the UAL. In this case, the City would then use the budgeted UAL payments to pay debt service on the tax-exempt bonds and realize savings from the differential between the tax- exempt bond borrowing rate and the Discount Rate.
2. Pension Obligation Bonds (POBs)
Pension obligation bonds (POBs) are taxable bonds that state and local governments have issued as part of an overall strategy to fund the unfunded portion of their pension liabilities. The economic benefit of POBs is premised on the assumption that the bond pr oceeds, when invested with pension assets in higher-yielding asset classe s, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds.
The City may opt to pursue the use of taxable bonds to “refinance” a portion of its unfunded pension liability. There is risk of failing to achieve the targeted rate of return that can bur den the City with both the debt service requirements of the taxable bonds and the unfunded pension liabilities that remain unmet. To mitigate this risk, the City shall undertake the following measures prior to and during the iss uance of pension obligation bonds as part of a comprehensive strategy to address the City’s unfunded liabilities.
a. Financial Analysis Required Pr ior to the Issuance of POBs
The following analysis should be completed prior to the issuance of POBs:
i. Estimate Savings Achieved wit h the Issuance of POBs by Comparing Pension Payments with and without the POB
Issuance
The City shall compare the then current UAL payment schedule against a new estimated remaining UAL payment schedule
(adjusted for a credit derived fr om POB proceeds) + POB debt service. This analysis will indica te if the aggregate pension cost savings, assuming then current market conditions, meet a minimum budgetary savings threshold.
ii. Assessment of Risk
The strategy of issuing POBs to pay off all or a portion of outstanding UAL carries market ti ming risk (i.e., if investment returns are lower than interest cost s of the POBs). The City shall identify the level of risk that can be tolerated with this strategy.
b. General Guidelines for the Issuance of POBs
The City shall adhere to the following general guidelines for issuance of POBs:
i. Retirement Plan funding ratios should not exceed 100% after the application of bond proceeds.
ii. The bonds shall only be structured with fixed rate current interest bonds.
iii. The bonds shall not be structured to extend the final maturity date of the UAL or defer payments.
iv. Bonds shall be structured with th e most flexible prepayment option that can be achieved in the market without interest rate penalty at the time of issuance.
v. Bonds shall not finance non-current normal costs; they shall only be used to refinance unfunded pens ion liabilities (and current normal costs).
vi. After the issuance of POBs, the City shall determine an annual dollar amount, based on the expected savings achieved, for making ADPs to CalPERS.
FUNDING GOAL & FUNDING TARGET
While the ultimate goal is to have pension li abilities fully or mostly funded, the City’s intermediate goal is to have it s pension liabilities to be 80% funded. The funded status goal may be achieved over a several year ti me frame. The funding level is expected to fluctuate; however, it should not fall below 70%, unless it is due to factors out of the City’s control (i.e., unanticipated investment earnings far below CalPERS’ investment target in a given year). Calculations for funding le vel should take into consideration any outstanding pension-related debt, such as pension obligation bonds.
SUPERFUNDING
In the event that either City plans achiev e “superfunded” status, where asset values exceed the accrued liability (i.e., funding level exceeds 100%), excess amounts shall not be used for contribution holidays or to enhance benefits. Excess funding amounts should be viewed as reserves to be maintained to protect from future downturns and negative events.
POLICY REVIEW AND AMENDMENT
Addressing retirement costs is a dynamic process. Adjustments are made annually to a City’s normal costs and UAL. Ther efore, this Policy is in tended to serve as a living document that should be reviewed annually. After the release of the most current annual actuarial reports, staff sha ll present to City Council a summary of each plan’s funding status during its annual Mid-Ye ar Budget Review process and w ill review this Policy to determine if changes are needed to ensure adequate resources are being accumulated.
This Policy will incorporate matters by which the responsibility of decision is vested in the City Council. Any amendments to this Policy shall be prepared by the City Manager in writing and approved by action of the City Council.
Clean Version
Item Number: {{item.number}}
City Council / Board of Directors
Written Communications
Meeting of: July 16, 2024
Submitted By:
Sophie L. Smith, Deputy City Manager
Carmen Cun, Finance Director / City Treasurer
Subject:
Pension Liability Management Policy
Recommendation:
That the Honorable City Council:
(1) Review the Pension Liability Management Policy and provide feedback, as needed.
(2) Adopt the Pension Liability Management Policy incorporating any agreed upon changes.
Fiscal Impact:
There is no fiscal impact associated with adoption of the Pension Liability Management Policy (“Policy”). If adopted, the Policy would serve as a guide for the City in managing its pension liability and is intended to be reviewed annually by staff and Council.
Strategic Plan Goal:
This item aligns with Goal A. Financial Sustainability, Strategy 1 to develop a multi -year plan and strategies to address pension obligations due to increasing pension costs and resulting pressures on the general fund.
Background:
The City offers three pension plans —Safety (Fire and Police) , Miscellaneous (Classic non-represented employees) , and PEPRA Safety Fire (Employees hired after 01/01/2013). The California Public Employees’ Retirement System (“CalPERS”) publishes an annual report in August known as Actuarial Reports; one report for each pension plan. This report is two fiscal years in arrears, the current report is as of June 30, 2022.
Based on the most recent actuarial reports, the PEPRA Safety Fire plan carries a very manageable funding shortfall, or Unfunded Accrued Liability (“UAL”) of $521,390, and annual UAL payments peak at approximately $74,750. The payment peak is the highest payment shown on the Amortization Schedule provided in the report.
Therefore, the Pension Liability Management Policy focuses on the City’s Safety and Miscellaneous Plans which have a combined accrued liability of $298.2 million with a market value of assets of $205.7 million, resulting in a UAL of $92.5 million (i.e., a funding ratio of 69%). The City’s combined annual UAL payments for the Safety and Miscellaneous Plans are projected to increase from $7.4 million in FY 2023- 24 to $10.0 million in FY 2029-30, representing an increase of 35.0% over the next six years.
The City’s Issuer Credit Rating (“ICR”) from S&P is currently a strong “AA -”. S&P noted in its ICR rating report in April 2021 that, while they view the City’s pension and Other Post-Employment Benefits (“OPEB”) liabilities as manageable, the rising costs related to the City’s underfunded pension liabilities may exacerbate budgetary pressures over the longer term. In its continued surveillance of the City’s ICR, S&P will continue to evaluate the City’s pension liabilities as part of its “debt and contingent liabilities” metric and consider whether a pension liability management policy has been adopted as part of its “management policies and practices” metric. Adopting the Pension Liability Management Policy helps to support factors for maintaining the City’s “AA-” rating.
Discussion:
In order to address the City’s pension liabilities and take advantage of opportunities to lower the UAL through various strategies, staff has worked with its Municipal Advisor (Urban Futures, Inc.) to develop a Pension Liability Management Policy for Council’s consideration and adoption.
The attached Policy incudes: 1) Policy objectives and goals; 2) A description of the City’s pension plans and liabilities; 3) Strategies for managing the City’s pension liabilities; 4) Potential funding sources for these strategies; 5) Reserve and funding target levels; and 5) Policy review and amendment.
The Policy provides a guideline for the City in implementing a long-term plan that utilizes multiple strategies over time. For example, if the Policy is adopted, staff will monitor opportunities to manage the City’s UAL through the following strategies:
(1) Additional Discretionary Payments (“ADPs”) to CalPERS —Payments above and beyond the annually required contributions to CalPERS in order to prepay a portion of the UAL, resulting in savings over time.
(2) Section 115 Trust —Trust assets can only be used to pay employer pension obligations (including normal costs) and allows the City to build a pension reserve that has greater investment flexibility and risk diversification compared to the City’s investment portfolio.
(3) Pension Stabilization Reserve Fund —Rainy-day fund to meet pension obligations when revenues are impaired based on economic or other conditions.
Moneys in this reserve fund are subject to California Government Code investment restrictions and the City’s Investment Policy. The current Reserve Fund target is recommended at $2.6 million, which represents the increase in annual UAL payments for the Miscellaneous and Safety Plans from FY24 to FY30 (the current anticipated peak year).
(4) Accelerating Payment of New Amortization Bases—Accelerate the repayment of new Amortization Bases added to the UAL.
Potential funding sources for the above strategies include:
(1) Reserves in Excess of Policy Targets—To the extent that the City has reserves in its General Fund or other funds in excess of reserve targets, the City may consider allocating all or a portion of the excess toward the UAL.
(2) Operating Surplus—On a case-by-case basis, staff may recommend that 50% of remaining operating surpluses (after considerations of deficits, reserve deficiencies and other fiscal matters), up to $1 million, be used to address the UAL.
(3) Debt Service Savings from Refinancings—When issuing refunding bonds for savings, the City can set aside all or a portion of debt service savings to address the UAL.
(4) Savings from Annual Prepayment Option to CalPERS -- Each year, CalPERS gives its member agencies an option to make a lower (approximately 3% savings) lump sum payment for the entire year’s required contribution by July 31st. The City can continue to make the prepayment every July to CalPERS and set aside the savings to address the UAL.
(5) Financing Strategies—Tax-Exempt Exchange and Pension Obligation Bonds
Although the Policy disc usses Pension Obligation Bonds (“POBs”) and provides guidelines for the potential issuance of POBs, current market dynamics eliminate POBs as an economical option. Therefore, staff is not recommending that the Council consider this as a viable strategy at this point; however, staff recommends including the guidelines in the Policy should a market opportunity return, and the Council is interested in exploring POBs.
While the ultimate goal is to have pension liabilities fully or mostly funded, the City’s intermediate goal is to have its pension liabilities to be 80% funded. The funded status goal may be achieved over a several year time frame. The funding level is expected to fluctuate; however, it should not fall below 70%, unless it is due to factors out of the City’s control (i.e., unanticipated investment earnings far below CalPERS’ investment target in a given year). The City should anticipate that its UAL will change over time and CalPERS investment results will vary. Therefore, it should expect to “act ively manage” this liability
and make adjustments to the Policy as the landscape changes. Staff recommends reviewing this Policy annually as part of its Mid-Year Budget Review process.
Staff remains available for any questions the Council may have.
Attachments: A. Pension Liability Management Policy
CITY OF VICTORVILLE
COUNCIL POLICY
SUBJECT:
PENSION LIABILITY MANAGEMENT
POLICY
POLICY NO.: CP-24-02
DATE:
June 16, 2024
BACKGROUND
The City recognizes that its unfunded pension liability can cause financial stress on the organization and direct resources away from programs and services necessary for the City’s operations and service to the public. This Pension Liability Management Policy (“Policy”) is intended to support the decision- making process of the City Council as it applies to the City’s unfunded pension liability and should be consistent with the City’s financial goals and policy objectives. Adherence to this Policy signals to the public, City employees, rating agencies, and capital markets that the City is well-managed and is able to meet its pension obligations in a timely manner.
This P olicy is intended to work in conjunction with the City’s other adopted financial policies, including the Reserve Policy, Debt Management Policy, and Budget. This Policy does not cover other post -employment benefits, known as OPEB, which principally involves retiree health care benefits and associated liabilities. Nothing in this Policy shall constitute an obligation upon the City, nor an implied contract. The City Council may revoke or amend this Policy by resolution at any time.
PURPOSE
The City’s main objective shall be to reduce its unfunded pension liabilities in the most cost-efficient, fiscally prudent, and sustainable manner possible. As with any fiscally prudent policy, the City recognizes that this Policy should:
• Maintain the City’s sound financial position;
• Ensure the City has the flexibility to respond to changes in future service priorities, revenue levels, and operating expenditures;
• Provide guidance in making annual budget decisions;
• P rotect the City’s creditworthiness;
• Ensure that all pension funding decisions are structured to protect both current and future taxpayers, ratepayers, employees, and residents of the City; and • Ensure that the structure of Pension Obligation Bonds, if authorized and issued, is consistent with the City’s strategic planning goals, objectives, capital improvement program, budget, and Debt Management Policy.
POLICY
I. RETIREMENT PLANS AND RETIREMENT BENEFITS
CalPERS is an agent multiple- employer public employee defined benefit pension plan that provides retirement and disability benefits, annual cost of living adjustments, and death benefits to plan members and beneficiaries. CalPERS acts as a common investment and administrative agent for participating public entities within the State, including the City. CalPERS plan benefit provisions and all other requirements are established by State statute and the City Council. The City contributes to CalPERS on behalf of active City employees who participate in the City’s Miscellaneous Plan or the City’s Safety Plan. Benefits are based on years of credited service, equal to one year of full-time employment. City employees are subject to different benefit levels based on their hire date.
Miscellaneous Plan – The Miscellaneous Plan has a two -tier benefit plan structure.
Employees hired before January 1, 2013 receive a benefit formula equal to 2. 5% @ 55.
Employees hired after January 1, 2013 receive a benefit formula equal to 2.0% @ 62.
Safety Plan – The Safety Plan also has a two-tier benefit plan structure. E mployees hired before January 1, 2013 receive a benefit formula equal to 2.5% @ 55. Employees hired after January 1, 2013 receive a benefit formula equal to 2.0% @ 62.
Pension costs associated with each Plan are allocated across the City’s various funds and entities based on payroll.
II. PENSION CONTRIBUTIONS AND AMORTIZATION BASES
The City is statutorily required to make pension contributions on an annual basis to each plan. The City shall make a commitment to fund the full amount of the annual contribution each year. The annual pension contribution is comprised of two component parts: 1 ) normal costs; and 2) unfunded accrued liability.
Normal Costs - represent the current year’s pension obligation or the cost of retirement benefits earned by current employees during the year. Normal Costs are calculated based on a percentage of payroll.
Unfunded Accrued Liability (UAL) – is the difference between the total pension liability less the current market value of assets in the pension fund, which represents the funding shortfall for benefits previously earned by current employees and City retirees. This amount effectively represents a “past due” amount.
CalPERS recalculates the UAL balance and payment schedule every year, and a number of factors impact the accrued liability. Additionally, the market value of assets can change dramatically from year to year depending on investment performance. To address these differences, at the end of each year, CalPERS adds new amortization bases to adjust the UAL for changes to the system. Amortization bases are the component parts of the UAL.
They function like “individual loans” that have distinct payment schedules and terms. The payment schedule for each amortization base is calculated us ing the current Discount Rate (currently 6.80%). Each base is amortized over specific periods, in accordance with
CalPERS amortization polic ies. The UAL is a dynamic liability, and the City should anticipate that its UAL payment schedule will fluctuate as a result of everchanging variables, making the management of pension liabilities an ongoing evaluation and management process.
GENERAL PROVISIONS
The financial objective of a defined benefit pension plan is to fund the long- term cost of benefits provided to the plan members. In order to assure that the plan is financially sustainable, the plan should accumulate adequate resources in a systematic and disciplined manner over the active service life of benefitting employees.
I. MANAGING PENSION LIABILITIES
A. Additional Discretionary Payments (ADPs) to CalPERS
The City can make Additional Discretionary Payments (ADPs) —payments above and beyond the annually required contributions (ARC) calculated by CalPERS. These payments can be used to prepay small amounts of “principal” on the UAL, thereby saving the associated “interest” (calculated at the Discount Rate) that is charged to the City. “Slow and steady” ADPs chip away at the City’s pension obligations; and over time, this strategy improves the Plans’ funding status and can result in significant savings. Additio nally, making smaller ADPs to CalPERS on a regular basis (i.e., dollar cost averaging) mitigates the market timing risk of a large lump sum deposit with CalPERS that is invested in the market all at once.
B. Section 115 Trust
The timing of when funds are available may not line up with the timing and amounts of ADPs that the City desires to make to CalPERS. This should not prevent the City from accumulating funds it desires to allocate towards paying down its pension obligations. A Section 115 Trust allows the City to build its pension reserve while maintaining oversight of investment management and control over the risk tolerance and investment return targets of the portfolio.
Money placed into the trust is irrevocable, meaning it cannot be withdrawn and used for another type of expenditure of the City. The benefits of a Section 115 Trust include:
1. Assets in the trust will offset liabilities on the City’s balance sheet.
2. Assets held in trust will allow for greater investment flexibility and risk diversification compared to the City’s investment portfolio.
3. The City will control the risk tolerance (i.e., conservative, moderate, or aggressive) of the portfolio. The City should hire an investment advisor to manage the Section 115 Trust.
4. The City will have the flexibility to access trust assets any time, as long
as they are used to pay employer pension obligations (including normal costs).
5. Assets can be used to make “slow and steady” ADPs to achieve UAL savings over time.
C. Pension Stabilization Reserve Fund
Because the City’s current UAL payment schedule is projected to increase through Fiscal Year 2030 by $2.6 million, it is important for the City to maintain a reserve to supplement pension costs, including normal costs, offset future unexpected contribution rate increases, and use as a rainy -day fund when revenues are impaired based on economic or other conditions.
It shall be the City’s policy to consider applying available resources to its Pension Stabilization Reserve Fund with a target balance of $2.6 million. Each year, staff will assess whether the target balance of $2.6 million remains suitable. Staff shall seek Council approval for making withdrawals from the Pension Stabilization Reserve Fund or for changing the target balance.
It is recognized that monies in this reserve fund are subject to California Government Code investment restrictions and the City’s Investment Policy and therefore has a lower investment return risk than a Section 115 Trust.
D. Accelerate Payment of New Amortization Bases
The City may seek to accelerate the repayment of any new Amortization Bases added to the UAL, thereby reducing overall “interest” costs.
II. FUNDING SOURCES FOR MANAGING PENSION LIABILITIES
A. Reserves, One-Time Monies, and Savings
To the extent that the City has excess reserves, unspent budget monies at year-end, unspent proceeds from capital projects, and/or one-time revenues or any additional resources , the City shall consider applying a portion of such monies toward its unfunded pension liabilities. The allocation of additional resources shall be made on a case-by-case basis by the City Council, with input from the City Manager after all discretionary fund reserve balances, cash flows, and one- time monies have been reviewed by City staff. There shall be an annual assessment of allocation of reserves and/or one-time monies consistent with the City’s Reserve Policy.
1. Reserves
The City seeks to maintain adequate levels of reserves in accordance to its stated reserve goals and adopted Reserve Policy. To the extent that the
City has reserves in its General Fund or other funds in excess of reserve targets, the City may consider allocating the excess toward unfunded pension liabilities.
2. General Fund Surplus
Due to a variety of factors, the City may end a fiscal year with a surplus of revenues over expenditures, encumbrances , and commitments. On an annual basis, the City Manager will recommend allocations to the City Council on the use of budget surplus funds. After deficits, reserve deficiencies and other matters of fiscal concern, the City Manager or his/her designee may recommend that 50 percent (50%) of remaining budget surplus funds, up to $1 million, be used to address long- term pe nsion liabilities. The 50% target level is a stated Policy goal; however, individual funding decisions, shall be made on a case-by-case basis.
3. Debt Service Refunding Savings
When issuing refunding bonds for savings, the City shall consider setting aside all or a portion of debt service savings to address long-term pension liabilities.
4. Annual Prepayment Option
Each year, CalPERS gives its member agencies two options for making its UAL payment: 1) make monthly payments to CalPERS; or 2) make a lower (approximately 3% savings) lump sum payment for the entire year by July 31 st to CalPERS. The City has been implementing the second option to take advantage of the savings offered by CalPERS. The City shall continue to make the prepayment every July to CalPERS and set aside the savings to address long-term pension liabilities.
B. Financing Strategies
Because the financing strategies below involve borrowing funds and repaying them at an interest rate, savings achieved with these strategies should be used to make ADPs to CalPERS to further leverage the savings.
1. Tax-Exempt Exchange
To the extent the City has pay-go tax-exempt capital projects, the City may consider financing suc h projects with tax -exempt bonds and using the budgeted pay-go funds to make ADPs towards the UAL. In this case, the City would then use the budgeted UAL payments to pay debt service on the tax-exempt bonds and realize savings from the differential between the tax- exempt bond borrowing rate and the Discount Rate.
2. Pension Obligation Bonds (POBs)
Pension obligation bonds (POBs) are taxable bonds that state and local governments have issued as part of an overall strategy to fund the unfunded portion of their pension liabilities. The economic benefit of POBs is premised on the assumption that the bond proceeds, when invested with pension assets in higher -yielding asset classes, will be able to achieve a rate of return that is greater than the interest rate owed over the term of the bonds.
The City may opt to pursue the use of taxable bonds to “refinance” a portion of its unfunded pension liability. There is risk of failing to achieve the targeted rate of return that can burden the City with both the debt ser vice requirements of the taxable bonds and the unfunded pension liabilities that remain unmet. To mitigate this risk, the City shall undertake the following measures prior to and during the issuance of pension obligation bonds as part of a comprehensive strategy to address the City’s unfunded liabilities.
a. Financial Analysis Required Prior to the Issuance of POBs
The following analysis should be completed prior to the issuance of POBs:
i. Estimate Savings Achieved with the Issuance of POBs by Comparing Pension Payments with and without the POB
Issuance
The City shall compare the then current UAL payment schedule against a new estimated remaining UAL payment schedule
(adjusted for a credit derived from POB proceeds) + POB debt service. This analysis will indicate if the aggregate pension cost savings, assuming then current market conditions, meet a minimum budgetary savings threshold.
ii. Assessment of Risk
The strategy of issuing POBs to pay off all or a portion of outstanding UAL carries market timing risk (i.e., if investment returns are lower than interest costs of the POBs). The City shall identify the level of risk that can be tolerated with this strategy.
b. General Guidelines for the Issuance of POBs
The City shall adhere to the following general guidelines for issuance of POBs:
i. Retirement Plan funding ratios should not exceed 100% after the application of bond proceeds.
ii. The bonds shall only be structured with fixed rate current interest bonds.
iii. The bonds shall not be structured to extend the final maturity date of the UAL or defer payments.
iv. Bonds shall be structured with the most flexible prepayment option that can be achieved in the market without interest rate penalty at the time of issuance.
v. Bonds shall not finance non- current normal costs; they shall only be used to refinance unfunded pension liabilities (and current normal costs).
vi. After the issuance of POBs, the City shall determine an annual dollar amount, based on the expected savings achieved, for making ADPs to CalPERS.
FUNDING GOAL & FUNDING TARGET
While the ultimate goal is to have pension liabilities fully or mostly funded, the City’s intermediate goal is to have its pension liabilities to be 80% funded. The funded status goal may be achieved over a several year time frame. The funding level is expected to fluctuate; however, it should not fall below 70%, unless it is due to factors out of the City’s control (i.e., unanticipated investment earnings far below CalPERS’ investment target in a given year). Calculations for funding level should take into consideration any outstanding pension-related debt, such as pension obligation bonds.
SUPERFUNDING
In the event that either City plans achieve “superfunded” status, where asset values exceed the accrued liability (i.e., funding level exceeds 100%), excess amounts shall not be used for contribution holidays or to enhance benefits. Excess funding amounts should be viewed as reserves to be maintained to protect from future downturns and negative events.
POLICY REVIEW AND AMENDMENT
Addressing retirement costs is a dynamic process. Adjustments are made annually to a City’s normal costs and UAL. Therefore, this Policy is intended to serve as a living document that should be reviewed annually. After the release of the most current annual actuarial reports, staff shall present to City Council a summary of each plan’s funding status during its annual Mid- Year Budget Review process and will review this P olicy to determine if changes are needed to ensure adequate resources are being accumulated.
This Policy will incorporate matters by which the responsibility of decision is vested in the City Council. An y amendments to this P olicy shall be prepared by the City Manager in writing and approved by action of the City Council.