CITY COUNCIL: Receive, File & Disseminate the Report of the Ad Hoc Carmel CalPERS Pension Committee & Direct Staff to Return with Recommended Implementation Actions

Meeting Date: November 1, 2011
Prepared by: Jason Stilwell, City Administrator

City Council
Agenda Item Summary

Name: Receive, file and disseminate the report of the ad hoc Carmel CalPERS Pension Committee and direct staff to return with recommended implementation actions.

Description: In October 2010, an ad hoc committee was formed to review the City’s pension retirement plans provided by the California public Employees’ Retirement System (CalPERS) and to make recommendations to the City concerning those and alternative plans.

Mayor McCloud charged the committee with understanding issues, developing options and recommendations, and advising the Council of its findings. All five Committee members have significant experience concerning pension and money management. Two are retired financial executive (Richard Borda and Joseph Mark), two are financial executives (Barbara Santry and Laura Zehm), and William Sharpe is a retired Professor of Finance at Stanford University. In the course of its almost year of work, the Committee studied available documents and data, supplemented by additional information provided by CalPERS and the City’s administrations.

On September 13, 2011, William Sharpe delivered the Committee’s interim report to Council. His oral presentation may be viewed on the archive of that meeting on the City’s web site.

The Committee’s final report covers many of the issues raised by the 2010 Monterey Civil Grand Jury, the findings and recommendations included in the Committee’s Interim Report, and additional background information.

This agenda item will enable the City to disseminate and share this report with other government agencies and parties interested in better understanding the California municipal government and public sector pension cost issues.

Based on this final report, staff will develop a specific action plan and timeline for implementing the Committee recommendations and will offer this plan for Council consideration and approval. Many of the Committee’s recommendations could require a long-term, concerted strategy or involve negotiations with the City’s labor groups; others could put into effect more quickly.

Fiscal Impact: None, with the recommended action. Specific fiscal impacts will be identified and included in the staff implementation plan that Council will consider.

Staff Recommendation: Receive, file and disseminate the Committee’s report and direct staff to return with recommended implementation actions.

Reviewed by:

__________________________ _________________
Jason Stilwell, City Administrator Date

REPORT
The Carmel CalPERS Pension Committee
September 27, 2011

The Committee and This Report

In October 2011, at the request of Mayor Sue McCloud an ad hoc committee was formed to review the City’s pension retirement plans provided by the California Public
Employees’ Retirement System (CalPERS) and to make recommendations to the City
concerning those and alternative plans.
Mayor McCloud charged the committee with understanding issues, developing options
and recommendations and advising the Council of its findings. While the committee was
initiated by Mayor McCloud, it has operated independently (at her request) since its
inception.
The members of the Committee are:
Richard Borda
Joseph Mark
Barbara Santry
William Sharpe
Laura Zehm
Committee members have significant experience concerning pension and money
management. Richard Borda and Joseph Mark are retired financial executives. Barbara
Santry and Laura Zehm currently serve as financial executives. William Sharpe is a
retired Professor of Finance. Short biographies are provided in Appendix A.
Shortly after its formation, the committee began its work, studying available documents
and data and requesting additional information from CalPERS and from the City’s
Administration. At different times, information was obtained from City Administrator
Richard Gillen, Assistant City Administrator Heidi Burch, and Interim City
Administrator John Goss. Since its inception the Committee has held numerous meetings
in person, by telephone and via email.
On several occasions the Committee communicated by phone or email with Barbara
Ware, the CalPERS actuary responsible for the City’s actuarial reports and estimates. She
was extremely cooperative, provided important information and greatly helped the
members of the Committee understand the nature of the CalPERS plans.
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The Grand Jury Report
In January 2011, the 2010 Monterey County Civil Grand Jury issued a Report on the
CalPERS retirement system for public employees of the County of Monterey and the
twelve cities within the county. At the request of the City, in March, 2011, this
Committee provided suggestions concerning the City’s required responses to the Grand
Jury Report. Those recommendations, which were adopted with minor changes by the
administration, are contained in Appendix B.
The Interim Report
On September 13th, 2011 in a public meeting this Committee presented an interim report
to the Carmel-by-the-Sea City Council. The report was presented orally by William
Sharpe, with the PowerPoint slides included as Appendix C to this report. A video of the
Council meeting, including the presentation can be viewed at the Council’s web site.
This Report
This is the committee’s final report. It covers some of the issues raised by the Grand Jury,
the findings and recommendations included in the Committee’s Interim Report, and
provides additional background information.
The Committee’s Investigative Procedures
The committee worked with City Administration. At different times its meetings were
attended by Richard Gillen, City Administrator, Heidi Burch, Assistant City
Administrator, and John Goss, Interim City Administrator. The committee asked for
information from, and shared findings with the City Administration. It also obtained and
reviewed extensive information from public sources.
On numerous occasions the committee asked questions of, and received data and
explanations from Barbara Ware, Senior Pension Actuary, Actuarial Services, CalPERS.
Ms. Ware was responsive and helpful. We are grateful for her time and attention. The
committee vetted its understandings with Ms. Ware.
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The City’s Pension Plans
CalPERS offers a series of defined pension benefit plans that are differentiated, in the
City’s case, between safety employees (e.g. police and firefighters) and miscellaneous
employees. In addition, CalPERS also offers “optional” benefits which amend the terms
of the defined benefit plans.
For each plan, the employee’s annual benefit is based on his or her years of service, a
salary base computed from recent pay before retirement and a specified percentage
factor. For example, a safety employee retiring at age 50 would receive annual payments
in retirement equal to the product of:
3 % times salary base times years of service
For convenience, this is generally termed a “3% at 50” plan. However, all such plans
include provision for retirement other ages, often with different percentage factors.
After the first year in retirement, benefits are adjusted either partially or fully for
inflation. The Cost-of-Living Adjustment increases the amount paid each year by the
smaller of (a) 2% per year compounded annually or (b) the cumulative change in the
Consumer Price Index. In addition there is a Purchasing Power Protection Allowance
which provides the additional guarantee that the payment in any year will not fall below
80% of the initial amount adjusted for inflation since retirement.
The City’s pension plans for current employees hired before August, 2011 are as follows.
• For safety employees, the City had selected a “3% at 50” standard plan. It pays
the employer contribution to this plan, with the safety employees paying the
employee contribution.
• For miscellaneous employees, the City had selected a “2% at 55” standard plan. It
pays the employer contribution to this plan, with the miscellaneous employees
paying the employee contribution.
• The City had selected an “optional” benefit which allows the pension obligation
for retiring employees to be based on the highest 12 months of full time
equivalent monthly pay (which may include some unused sick leave and vacation
leave). If this benefit had not been selected, the pension obligation would be
based on the highest three years of equivalent monthly pay (which may include
some unused sick leave and vacation leave). To pay for this optional benefit, the
City makes the entire additional contribution.
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There are three key aspects of the City’s current pension plans.
• The Pension Obligation. When the City chooses a defined benefit plan for an
employee, it incurs an obligation to pay that employee’s pension, providing
additional money if and when prior contributions are insufficient to cover the
promised payments. This liability remains with the City, typically extends far into
the future, and is not insured by any third party. No other entity participates in the
obligation to make current and future pension payments to current and past
employees of the City based on their service to the City. (However, when
employees leave the City then work elsewhere in the CalPERS system, or when
employees come to the City after working elsewhere, CalPERS allocates the
pension obligation among the affected municipalities or agencies.)
• The Contribution Rate. CalPERS calculates a contribution rate for the City
annually. This contribution rate is generally expressed as a percentage of payroll.
Carmel is “pooled” with a large number of other small municipalities for purposes
of CalPERS’ administration. The pooled entities are reviewed together and
contribution rates are set accordingly. However, the liability to pay its’ pensions
remains with each individual municipality in the pool. CalPERS does not currently
provide the values of the individual obligations of each municipality on a regular
basis.
• Portfolio Performance. CalPERS manages the City’s funds, as well as those of
hundreds of other municipalities and agencies, in a single large, diversified,
professionally managed portfolio. The performance of this portfolio can vary
greatly from year to year. The City has, in effect, hired an investment adviser to
manage its accumulated pension contributions within a larger fund. This provides
administrative cost savings and diversification opportunities. However, the City has
no influence over the portfolio’s management.
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Fiscal Year 2011/2012 contribution rates paid by the City and its employees are
summarized below:
Miscellaneous
2% at 55
Safety
3% at 50
Employer Contributions (% of payroll)
Normal Cost 7.684 % 17.164 %
Amortization Payments 1.855 % 5.927 %
Optional benefits 0.520 % 1.021 %
Side Fund Payments 9.435 % 10.756 %
Total Employer Contributions 19.494 % 34.868 %
Employee Contributions (% of salary) 7.000 % 9.000 %
Importantly, when the performance of the portfolio, plus the current contribution rate,
does not keep pace with the accumulating pension obligation, additional future
contributions are required to make the promised pension payments.
The Side Fund Debt
In 2003, when Carmel’s pension plans were pooled with other small cities and agencies,
CalPERS reviewed the contributed assets and estimated liabilities of Carmel’s pension
plans. It determined that at the time the liability values for the two plans exceeded the
asset values by roughly $6 million.
At the time, other small cities also had assets that were not equal to their liabilities.
CalPERS dealt with this by creating what it calls Side Funds, representing the differences
between assets and liabilities. At inception in 2003, Carmel’s Side Fund balances were
equal to approximately -$ 6 million. Thus Carmel had “Side Fund Debts” (this
Committee’s term) of approximately $ 6 million.
The Side Fund Debts were treated as loans from CalPERS to Carmel for unfunded
liabilities at the inception in 2003. These loans bear an interest rate of 7.75% (the return
that CalPERS expects to earn in the long run on its portfolio). CalPERS established a
payment schedule for the Side Fund Debts such that payments in the past several years
have not exceeded the accruing interest. As of June 30, 2011 Side Fund Debts for the two
funds totaled $6.2 million.
While Side Fund Debt contributions are charged to the City as percentages of estimated
payroll, these constitute payments toward the interest and possibly principal on loans
made at an above-market interest rate.
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The Side Funds are analogous to revolving debt on a consumer credit card. In the last
eight years, the required payments have primarily covered only interest charges and the
balances have grown. Thus, while the City has made all required payments, the Side
Fund Debts are approximately the same as they were in 2003.
Carmel is permitted to pay the Side Fund Debts in whole or in part at any time. We
understand that the City of Pacific Grove has used this ability to pay its entire Side Fund
Debt.
The City’s cash reserves currently equal $ 8.9 million and earn interest at a rate averaging
approximately 0.50 % (one-half of one percent), well below the Side Fund interest rate.
Some of these reserves are required by law, but it is possible that some of these funds
could be used to pay off a part of the Side Fund Debts. Additional funds could be raised
by issuing bonds.
The City’s Interim Administrator has obtained estimates from investment bankers that the
City could raise funds for this purpose by participating in a pool of Pension Obligation
Bonds carrying an average interest rate of approximately 6.0% -- less than the current
cost of 7.75% for the Side Fund Debts.
Recommendation 1: Pay the Side Fund Debt
The Committee recommends that the City actively explore the possibility of using a
portion of its current reserves plus new debt obligations to pay the Side Fund Debts. This
would be equivalent to refinancing a mortgage at a lower interest rate. Importantly, no
benefit payments to current or past employees would be affected.
A question has been raised concerning the possibility that CalPERS could lower the
interest rate charged for Side Fund Debts, either prospectively or retrospectively. The
Committee has learned that in a recent email to Joe Nation of Stanford University, David
Lamoureux, CalPERS Deputy Chief Actuary, stated that this would not happen since side
fund terms were fixed at the time when employers were assigned to risk pools. This said,
the Committee recommends that before issuing any new bonds, the City administration
independently evaluate the risk that CalPERS might lower the interest rate charged on
these debts at some time in the future.
Terminating CalPERS Pension Plans
All participating cities are able to terminate their participation in CalPERS. However, this
has been rare.
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Fortunately, participating cities can elect to exit the CalPERS pension system and, with
the appropriate Council resolution, be permitted to remain in the CalPERS health
insurance system.
To terminate the CalPERS pension system, a city or agency must pay an amount
determined sufficient by CalPERS to cover any difference between the value of the
subsequent benefit payments and the accumulated assets. This may be paid in a lump
sum on the date of termination or in a series of payments thereafter. In the latter event,
CalPERS will charge interest on the unpaid balances until the termination cost is paid in
full.
• From the termination date forward, CalPERS will make the same payments to
retired employees that they would have received if the plans had not been
terminated.
• Payments to all employees who worked for the City and have left but have not yet
retired will be made in exactly the same manner as if the plans had not been
terminated.
• To cover extra obligations that can arise when an employee leaves Carmel-by-the-
Sea, then works for another city or agency that uses CalPERS pension plans, the
City can elect a “non-frozen” option, at a somewhat higher termination cost.
• After termination, CalPERS will make all benefit payments for which current
employees would be eligible if they were to terminate their service with Carmel-bythe-
Sea on the date of termination of the CalPERS plans. However, CalPERS is not
liable for any additional benefits that would have been accrued had the City
remained in the CalPERS system after the date of termination.
The process required for termination takes a considerable amount of time. To begin,
Carmel-by-the-Sea must pass a resolution to terminate the CalPERS pension plans. For
each plan, CalPERS will then prepare two termination unfunded liability estimates – one
for the “frozen” option, the other for the “non-frozen” alternative. These provide
estimates of the payments that the City would be required to pay to terminate the plans.
However, the exact amounts would only be determined at a later date if the City chose to
actually terminate the plans.
The preparation of the initial termination unfunded liability estimates by CalPERS
typically requires six or more months. After it receives the estimates, the Council may
choose to proceed with the termination process or not. If the City chooses to proceed,
CalPERS then prepares a final calculation and arrangements are made for the actual
payments and termination, requiring additional months of elapsed time.
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Recommendation 2: Pass a Non-binding Resolution to
Terminate the CalPERS Pension Plans
The Committee recommends that the Council pass a non-binding resolution to terminate
the CalPERS pension plans in order to obtain estimates of the termination unfunded
liabilities and to make it possible to subsequently terminate the plans if this appears to be
desirable at that time.
A key reason to pass such a resolution at this time is to obtain formal estimates of the
extent to which the City’s pension assets are insufficient to cover the costs of the benefits
already earned by current and past employees. While CalPERS has recently announced
that such estimates may be included in future actuarial reports, this is not guaranteed.
Moreover, at the earliest, estimates would be provided in October, 2012 based on the
values of assets and liabilities at the end of June, 2011.
Termination Unfunded Liabilities
Defined benefit pension plans such as those employed by the City and administered by
CalPERS guarantee employees benefits based on their service and salaries. The current
plans also provide for increases in payments to compensate for future inflation. To cover
these costs, a pool of assets is created. Ideally, the value of the assets would be sufficient
to cover the accumulated benefit obligations.
In the CalPERS plans, contributions are invested in a pool of assets that includes
marketable and non-marketable securities. At any given time, the market values of most
of these assets can be determined and the values of the remainder estimated with
reasonable accuracy. At present the CalPERS actuarial reports are not fully transparent
with regard to such termination asset values.
It is not a simple matter to determine the amount of money that would be required to
cover a plan’s accumulated benefit obligations with certainty or near-certainty. Until very
recently, CalPERS used an actuarial method that estimated benefit liabilities by
discounting expected future cash flows with an interest rate based on the expected return
on the funds’ assets (currently 7.75%). However, beginning on August 18th, 2011
CalPERS adopted a very different procedure, using a discount rate based on U.S.
Treasury bond yields (currently 3.8%). Henceforth, as shown in Appendix D, assets of
terminated plans plus cash from any payments required to be made by cities and agencies
to terminate such plans will be placed in a pool invested in a combination of U.S.
Treasury Bonds and U.S. Treasury Inflation-protected Securities. Accordingly, CalPERS
will value the liabilities of a terminated plan based on the estimated cost of placing an
amount of money in such a pool of Treasury securities that should be sufficient to cover
the required benefit payments with a high degree of confidence, since it is a larger and
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lower-risk pool. At present, CalPERS actuarial reports are not transparent with regard to
such termination liability values.
If the termination asset value of a plan is smaller than its termination liability value, the
plan is underfunded; the difference is the termination unfunded liability (sometimes
called the termination net liability). At present, CalPERS actuarial reports are not
transparent with regard to such values.
If a city or agency wishes to terminate an underfunded plan, CalPERS will require a
payment equal to the termination unfunded liability plus a load charge of 7% of that
amount, designed to cover possible increases in participants’ life spans.
While many alternative measures are used by the actuarial profession to measure aspects
of the funding of a pension plan, the Committee believes that the most relevant for the
City is the termination unfunded liability plus the associated load charge. This is the
amount of money that would be required to terminate a CalPERS plan and insure that all
benefits earned to date would be paid by CalPERS.
In April 2011, the Committee requested an estimate of the termination costs for its two
pension plans from Barbara Ware, the CalPERS actuary who prepares the City’s annual
actuarial reports. Using the method in place at that time, she provided a “very rough”
estimate that the total cost for the two plans at the end of June, 2009 would have been
approximately $14.4 million (over and above the costs of paying the Side Fund Debts).
Subsequently, based on the change in termination procedures made by CalPERS on
August 18, 2011, she informed the Committee that “.. the estimates that I provided
previously are much less than the results will be with the new methodology, even taking
into account the good investment returns over the past 2 years.” This information was
provided by the Committee to the City Council on September 13, 2011 in the interim
report shown in Appendix C.
In response to the August 2011 change in the actuarial procedures for determining
termination unfunded liabilities; the Committee prepared a set of estimates of the possible
values for the City’s two funds. After taking into account additional information from
Barbara Ware, the Committee prepared the estimates of termination unfunded liabilities
shown in Appendix E. These are at best very rough approximations and were reviewed
by Barbara Ware who commented that they were likely usable as talking points.
With these caveats, based on the estimate of $34.4 million in Appendix E, and adding in
the Side Fund Debts of $ 6.2 million, the Committee’s best estimate is that the total
liabilities associated with underfunded pension obligations could be between $35 million
and $45 million.
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These are at the very best, crude estimates. Only if the City passes a resolution to
terminate the CalPERS plans can better values be obtained in the relatively near future.
When and if such official estimates are available, the Committee believes they should be
included in the City’s reports.
Recommendation 3: Include Side Fund Debts and Estimated
Termination Unfunded Liabilities in the City’s Financial Reports
The Side Fund Debts and the Termination Unfunded Liabilities represent costs that will
have to be paid either sooner (via termination and/or payment of the Side Fund Debt) or
later, with pension contributions that would be greater than if those liabilities did not
exist. In order that the City’s taxpayers and employees are fully informed about these
obligations, the Committee recommends that the latest estimates of their magnitudes be
included on the City’s Financial Reports, either in footnotes or comments.
Estimates of the Side Fund Debts can be found in the CalPERS annual actuarial reports.
Estimates of the Termination Unfunded Liabilities will be obtained if the Council passes
a resolution to terminate the CalPERS plans. In future years such estimates may also be
provided in the annual actuarial reports provided to the City by CalPERS, although at the
earliest, this practice will start in October 2012 with values based on assets and liabilities
at the end of June 2011.
The Financial Risks of the CalPERS Pension Plans
The CalPERS pension plans currently used by Carmel-by-the-Sea create large financial
risks for the City. Several aspects of the plans contribute to such risks:
• Pension benefits are pre-determined and are adjusted in whole or in part for
inflation
• Carmel’s assets are invested in a single multi-asset portfolio with substantial risk
and year-to-year volatility. This volatility makes it difficult for the City to assess
its obligations.
• Pre-retirement, employees pay up to a fixed percentage of salary. Post-retirement,
employees bear no risk. CalPERS’ actuarial procedures may lead to situations in
which employees nearing retirement are not assessed the increasing costs of their
pensions. In such cases the obligations remain with the City.
• The City’s share of the current contribution is substantially larger than the
employees’ share.
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• Increased contributions will likely be required by CalPERS when the City is least
equipped to pay them since the contribution rate is affected by capital market
conditions in a lagged manner. Hence, CalPERS can be expected to increase
contribution rates after periods of poor capital market conditions, which typically
coincide with decreases in revenue from all the City’s sources of income.
Additional risks borne by City include:
• Inflation risk
• The risk that CalPERS will earn a lower-than-expected return on its investments
• The risk of greater-than-predicted life expectancies
• The risk that the contributions required by CalPERS will fail to fully fund the
actual accumulating pension obligations
• The risk that the City’s lack of current visibility on its increasing obligations will
lead to decisions that would not have been made if such there had been full
disclosure.
These risks can be mitigated or eliminated by either:
• Terminating the CalPERS plans and adopting lower-risk retirement benefits, such
as a combination of social security, a defined contribution plan similar to a
corporate 401(k) plan, and possibly higher salaries, or by
• remaining in the CalPERS system, but decreasing the levels of CalPERS benefits
to the extent possible.
Consideration of possible replacements for the CalPERS pension plans is beyond the
scope of this Committee’s work. The next section thus focuses on possible actions that
the Council could take to reduce the risks associated with benefits obtained within the
CalPERS system.
Adoption of Alternative CalPERS Benefit Tiers
CalPERS makes a number of alternative pension plans available for adoption by
participating cities and agencies. For each category of employees there are typically two
or more possible “tiers”. For example, as indicated earlier, Carmel-by-the-Sea has
adopted the “3% at 50” tier for its safety employees and the “2% at 55” tier for its
miscellaneous employees. Within each tier there are additional options, some of which
require higher employer contributions. In each plan, Carmel-by-the-Sea has chosen to
base an employee’s retirement income on his or her highest one-year salary – an option
that requires higher employer contributions than the standard approach which bases such
income on an employee’s highest average salary over three years.
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With regard to both the tiers utilized and the salary bases elected, the City has chosen to
provide very generous pension benefits to its employees. This increases the risk to the
City associated with the provision of each employee’s total compensation – his or her
lifetime salary plus benefits received after retirement. In effect, an employee’s total
compensation is “back-end loaded” and the back-end retirement benefits create
significant financial risks for the City. These risks could be reduced, although not
eliminated, if less generous retirement benefits were provided. CalPERS rules and current
agreements with the City’s unions may restrict changes that can be made for current
employees. However, such benefits could be offered to new employees.
The Committee offers no opinion on the appropriate level of overall compensation for
City employees but believes that the City should reduce the risks inherent in the current
retirement system. If less generous CalPERS tiers are offered to new employees, it may
be necessary and appropriate to provide additional retirement benefits and/or higher
salaries in order to attract qualified applicants. One alternative would be to offer a less
generous defined benefit retirement plan (such as one of the alternative tiers) with lower
but still substantial financial risk to the city, supplemented with City contributions to a
defined contribution plan (similar to a corporate 401(k)) for which the employee bears all
the future financial risk. CalPERS offers such a defined contribution plan and allows
employers and employees to make contributions on a before-tax basis up to Federal
limits. The Committee has learned that the organization representing the City’s
miscellaneous employees has agreed to the use of a lower CalPERS tier for newly-hired
employees.
When considering alternative CalPERS tiers, it is important to understand that the simple
descriptions indicate only the percentage factor to be used if an employee chooses to
retire at a specified age. Plan provisions also specify factors that will apply if an
employee retires at other ages.
Figure 1 shows the percentage factors that apply for two alternative tiers available to be
used for miscellaneous employees. The higher (blue) curve shows the terms for the City’s
current plan. As indicated, an employee who retires at age 55 will receive an income at
retirement equal to 2% of his or her highest annual salary times the number of years of
service. However, an employee can retire at an earlier age, but the retirement benefit will
be calculated using a smaller percentage of salary – for example, less than 1.50% if the
employee retires at age 50. On the other hand, if an employee retires at an age greater
than 55, the percentage will be larger, up to age 63 after which it remains the same.
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Figure 1
The lower (red) curve in Figure 1 shows the terms of an alternative tier, typically
described as “2% at 60”. It provides a lower percentage of salary than the “2% at 55” tier
for any employee retiring before age 63, but the same amount for those who retire at
older ages.
The Grand Jury report shown in Appendix B recommended that the cities in Monterey
County adopt the 2% at 60 tier for new miscellaneous employees. The Committee agreed
that a less generous tier should be utilized but recognized that at some point it might be
possible to utilize one with even lower percentages of salary. The Committee also agreed
with the Grand Jury that, to the extent permitted by CalPERS regulations and labor
agreements, the City should either require employees to pay the additional costs of the
optional benefit of basing benefits on the highest annual salary or utilize the standard
three-year average salary in its plans.
Figure 2 shows the percentages of salary for the City’s current “3% at 50” plan for Safety
employees and the “2% at 55” plan recommended by the Grand Jury. The current plan
does not provide for lower percentages for those who retire before age 50 nor for higher
percentages for those who retire at ages greater than 50. The lower tier provides lower
percentages for every retirement age, with those retiring between ages 50 and 55
receiving less than 2% of salary and all those retiring after age 55 receiving 2% of salary.
Miscellaneous 2@55 and 2@60
0.00
0.50
1.00
1.50
2.00
2.50
3.00
50 52 54 56 58 60 62 64
Retirement Age
% of Salary
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Figure 2
The Grand Jury also recommended utilizing the “2% at 55” tier for new safety
employees. Here, too, the Committee agreed that a less generous tier should be utilized
but recognized that at some point it might be possible to utilize one with even lower
percentages of salary. In this case the Committee also agreed with the Grand Jury that, to
the extent permitted by CalPERS regulations and labor agreements, the City should either
require employees to pay the additional costs of the optional benefits of basing benefits
on the highest annual salary or utilize the standard three-year average salary in its plans.
Safety Plan 3@50 and 2@55
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
50 52 54 56 58 60 62 64
Retirement Age
% of Salary
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Recommendation 4: Provide Substantially Lower Defined
Benefits for New Employees
The Committee recommends while the City chooses to remain within the CalPERS
pension system it negotiate with its unions and prospective employees to provide
substantially lower defined benefits. This should be accomplished by adopting tiers with
less generous terms and basing benefits on highest three-year average salaries.
Governmental retirement systems in California are in a state of flux at this time. It is not
impossible that CalPERS will offer even lower tiers than the two analyzed here (“2% at
60” for miscellaneous employees and “2% at 55” for safety employees). In fact, there is
in principle an option for a City to adopt a “1.5% at 65” option for miscellaneous
employees. However, this would require the use of Social Security and a number of other
requirements; apparently no City has yet chosen this option and no pool exists for small
cities such as Carmel-by-the-Sea. That said, in the future it may be possible for the City
to remain within the CalPERS system and significantly reduce its financial risk by
selecting benefit choices not currently offered by CalPERS. We expect that such choices
would include moving toward a hybrid system with a combination of a considerably less
generous defined-benefit plan (with other characteristics similar to those of the current
CalPERS tiers) and a defined contribution plan (such as the current CalPERS optional
plan). This would allow the City to greatly reduce its financial risk and allow employees
to bear amounts of such risk that they deem appropriate.
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Appendix A
Committee Member Biographies
William Sharpe:
• Professor of Finance Emeritus at Stanford University Graduate School of Business
• Author of seven books
• Nobel Prize winner in Economic Sciences
• Co-founder and current board member of Financial Engines, a firm that provides
investment management and advice for individuals in employer-sponsored retirement
plans.
Joseph Mark:
• Principal of Mark Investment Company
• Founding Partner, RCM Capital (retired)
• Formerly with Wells Fargo and Greenshields Ltd. (Canada)
• Past member of Board of Security Analysts Society of San Francisco, Community
Foundation for Monterey County, Monterey Institute of International Studies, and Flagg
Memorial Youth Fund
Richard Borda:
• Former Vice Chairman and Chief Financial Officer of National Life Insurance Company
• Former Executive Vice President of Wells Fargo Bank
• Former member of the Grace Commission
• Former Assistant Secretary of the Air Force
• Past chair of the Monterey Institute of International Studies Board
Barbara Santry:
• Former venture capitalist
• Health care reimbursement consultant
• Past Chair of Health Plan Board
• Director, Santa Lucia Community Services District
Laura Zehm:
• MBA
• Vice President/Chief Financial Officer, Community Hospital of the Monterey Peninsula
since 1996
• Fellow and former board member/chair of the Healthcare Financial Management
Association (HFMA) Board of Directors
• Board Member, California Hospital Association (Northern California HFMA designee)
and former Board member of Natividad Hospital (as part of the grant agreement between
CHOMP and the County of Monterey)
• Board member of the Monterey County AIDS Project, Monterey Federal Credit Union
and Monterey Institute for Research on Astronomy
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Appendix B
Carmel CalPERS Pension Committee
Response to Grand Jury Findings and Recommendations
March 18, 2011
Introduction
The Carmel CalPERS Pension Committee was appointed by the Mayor in October, 2010
to investigate conditions concerning the city’s retirement systems and its participation in
the CalPERS retirement system.
On January 10, 2011 the Monterey County Civil Grand Jury released a report that
included findings and recommendations concerning retirement systems and participation
in CalPERS for the cities in the county. Each of the cities is required to provide a written
response by April 11, 2011.
This Committee has not yet completed its work and is not ready to issue a full report on
its findings and recommendations. However, in order to provide assistance to the city
administration and council, we have studied the Grand Jury findings and
recommendations. This document provides our suggestions concerning the city’s
response. For convenience we have grouped each of the Grand Jury’s findings (F1.1
through F1.12) with its associated recommendation (R1.1 through R1.12). We follow
each finding and recommendation with our comments and/or suggested response (in
italics).
Comments and Suggested Responses
F1.1. The CalPERS retirement system is worth retaining.
R1.1. Continue to participate in the CalPERS retirement system.
By virtue of its participation in the CalPERS retirement system, Carmel by the Sea
(hence, Carmel) is exposed to the uncertainty associated with a series of risks, including
reliance on a risky asset portfolio to support payments that are specified and not subject
to asset risks.
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The Committee believes that more information is needed to assess whether Carmel
should continue to participate in the CalPERS retirement system. CalPERS regulations
make it possible for the Council to request that CalPERS estimate the cost of exiting the
retirement system. Our understanding is that the request for this estimate is non-binding
and does not commit Carmel to any further action.
The Committee recommends that Carmel request this “exit estimate” as a necessary first
step in considering the costs and benefits of a possible withdrawal from the system and
adoption of an alternative retirement plan better suited to the needs of the City and its
employees.
F1.2. Those local agencies that have binding arbitration have ceded their collective
bargaining authority and responsibility to an individual arbitrator.
R1.2. Abolish binding arbitration in labor matters.
The Committee agrees with the finding. Carmel’s current labor contracts do not provide
for binding arbitration and we recommend that this practice continue.
F1.3. A vote of the electorate before granting increased retirement benefits has not been
implemented as a check on overspending.
R1.3. Require a vote of the electorate as a prerequisite to increase retirement benefits
and thereby limit spending.
The Committee believes that the Council should retain a full range of choices concerning
its employees’ salaries, benefits and other contract terms. Thus we do not concur with
this recommendation. However, the Committee recommends that public notice be made
of any intention to enter into negotiations to significantly change retirement benefits in
order to allow sufficient time for comments by interested parties.
F1.4 Some agencies may allow retired employees to come back to work part time at the
same agency and receive retirement and a salary, provided they don’t work more than
960 hours per year, the maximum allowed by CalPERS.
R1.4. Do not allow those who have retired from the agency to be re-employed by the
same agency on a part-time basis.
Findings and Recommendations 4 through 9 relate to particular practices allowed within
the CalPERS retirement system. The Grand Jury recommended that each of these be
restricted. Carmel has avoided broad use of these practices and avoided use of some
them entirely.
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The Committee believes that the City Council and administration should continue to have
the full range of available choices in managing its employees, and recommends against
imposing the restrictions in recommendations 4 through 9 categorically. However, the
Committee does believe it prudent to avoid frequent use of these practices.
With regard to recommendation 1.4 the Committee recommends continuation of the
restriction that retired employees can only be hired on a part-time temporary basis with
no benefits
F1.5. Some agencies may have practices that allow employees to increase or “spike”
their base year salaries by converting unused sick leave or vacation leave to salary
during their last year of employment.
R1.5. Prevent “spiking” the base salary.
The committee thoroughly concurs that practices related to unused sick leave or vacation
leave in the last year of employment have the potential to unduly increase pension costs.
There are currently caps on accumulated sick and vacation leave in the City’s Municipal
Code and we recommend that they be continued. We also recommend that the City
analyze the costs and benefits associated with changing such caps.
F1.6. The practice of offering an employee up to two years unearned credit for
retirement in exchange for taking an early retirement (“a Golden Handshake”), as
authorized by Section 20903 of the Government Code, may be subject to abuse.
R1.6. Do not offer a “Golden Handshake.”
The Committee believes that the Council and administration should continue to have the
full range of choices in managing its employees and thus recommends against restricting
the Council’s ability to make such an offer. However, we recognize that any use of early
retirement should be carefully considered, supported by a sound financial analysis
indicating that the benefits of such an offer will outweigh the costs, and endorsed by the
City Council.
F1.7. Some employees do not pay an appropriate CalPERS retirement share.
R1.7. Require employees to pay the CalPERS employee contribution rate.
At present, Carmel employees pay the full share for the standard plans specified by
CalPERS and the Committee recommends that this practice be continued.
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F1.8. Some employees may pay for all optional CalPERS benefits. Some employees
may pay for some or a portion of some of these benefits and some may pay nothing for
optional benefits received.
R1.8. Require employees to pay for all optional CalPERS benefits.
At present, Carmel uses plans that include an optional provision that bases retirement
benefits on a single year’s compensation rather than the average of amounts over three
years. The additional required contribution is currently paid by the City.
The Committee concurs with the Grand Jury and recommends that Carmel require
employees to pay for optional CalPERS benefits, to the extent permitted by CalPERS
regulations and labor agreements.
F1.9. Some agencies have no caps on the maximum amount of time one can
accumulate in sick leave or vacation leave.
R1.9. Place a cap on the maximum amount of sick leave and vacation leave an
employee can accumulate.
The Committee recommends continuation of caps such as those currently specified in the
City’s Municipal Code. We also recommend that the City analyze the costs and benefits
associated with changing such caps.
F1.10. The California Legislature could enact changes that would limit new employees to
2% @ 55 for Safety with a 90% of salary retirement cap and 2% @ 60 for Miscellaneous
in the CalPERS system with a 36-month salary base for each.
R1.10. Urge passage of legislation that new hires are limited to 2% @ 60 for
Miscellaneous employees, 2% @ 55 for Safety employees with a 90% of salary
retirement cap, and a 36-month salary base for each.
The Committee believes that it is important for CalPERS to offer employers multiple
tiers, including the two included in this recommendation. This can allow employers
maximum flexibility in providing overall compensation plans, balancing salary payments,
health and retirement benefits. We understand that the two specific plans specified in the
recommendation are now available for use by employers when hiring new employees.
The Committee recommends that CalPERS continue to make these plans available in the
future, preferably with additional alternatives. However, we do not recommend that City
urge the California Legislature to mandate that all CalPERS member agencies be
required to utilize these particular plans for all new employees.
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F1.11. CalPERS could be made more affordable to the agencies if new employees were
provided, in lieu of benefits accorded to existing employees, a second-tier of benefits of
2% @ 55 for Safety employees with a 90% of salary retirement cap and 2% @ 60 for
Miscellaneous employees, each with a 36-month salary base
R1.11. Contract for a CalPERS retirement benefit for newly hired employees of 2% @ 55
for Safety employees with a 90% of salary cap and 2% @ 60 for Miscellaneous
employees with a 36-month salary base for each.
As indicated in the previous response, the Committee understands that these
tiers are currently available for use by Carmel for new employees. We
recommend that the Council undertake negotiations with the employee
organizations to allow the adoption of some set of benefits for new employees
that will decrease the risk to the City associated with retirement payments. The
tiers proposed by the Grand Jury meet this criterion but the Committee
recommends that the City also consider any other plans allowed by CalPERS
that could accomplish this goal.
F1.12 Some MOUs may not allow the reopening of negotiations to make prospective
changes to salary and benefits in the event of unforeseen dire economic circumstances.
R1.12. In all future MOUs, reserve the right to reopen negotiations in the event of
unforeseen dire economic circumstances to make changes to salary and benefits with
no reduction to salary and/or benefits already earned.
The Committee understands that Carmel’s current agreements with labor organizations
(MOUs) do not preclude the reopening of negotiations to make prospective changes to
salary and benefits. In general, we recommend that no future MOUs restrict in any way
the City’s right to reopen negotiations to make prospective changes in salary and benefits.
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Conclusions
The Committee recognizes that decisions concerning retirement benefits are extremely
important to the employees and to the citizens of the City of Carmel. The City’s current
CalPERS retirement plans are highly complex and increasingly costly. The Grand Jury
has made a major contribution by indentifying a number of crucial issues and
recommending the adoption of specific policies by the cities in Monterey County. We ask
the Carmel city administration and Council to consider our suggestions and
recommendations when responding to the Grand Jury report. This Committee will
continue to analyze Carmel’s current pension plans, explore possible alternatives, and
issue a final report with findings and recommendations for possible action by the City at
a later date.
Respectfully Submitted:
Richard Borda
Joseph Mark
Barbara Santry
William Sharpe
Laura Zehm
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Appendix C
Interim Report1
1
Carmel CalPERS Committee
Interim Report
2
Charge
• Appointed by Mayor Sue McCloud in October, 2010
• Goal: to review the City’s pension retirement plans
provided by the California Public Employees’ Retirement
System (CalPERS) and to make recommendations to
the City concerning those and alternative plans.
• At the Mayor’s request, the committee has operated
independently since its inception.
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3
Members
• Richard Borda
• Joseph Mark
• Barbara Santry
• William Sharpe
• Laura Zehm
4
Investigation
• The committee worked with City Administration
• At different times its meetings were attended by:
– Richard Gillen, City Administrator
– Heidi Burch, Assistant City Administrator
– John Goss, Interim City Administrator
• Information was obtained from
– City Administration
– CalPERS actuary
– Public sources
• There were numerous meetings in person, by phone and
email
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5
The Grand Jury Report
• In January 2011, the 2010 Monterey County Civil Grand
Jury issued a Report on the CalPERS retirement system
for public employees of the County of Monterey and the
twelve cities within the county
• In March, 2011, at the request of the City, the Carmel
Committee provided suggestions to the City
administration concerning the City’s required responses
to the Grand Jury Report
• With minor changes those recommendations were
adopted by the administration for its response to the
Grand Jury
6
The City’s Pension Plans
• Formula for retitrement benefit
– % factor times years of service times salary base
– Post-retirement, payments adjusted each year for inflation
• Miscellaneous employees
– 2% at age 55
– Salary base: Highest year
• Safety employees
– 3% at age 50
– Salary base: Highest year
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7
Current Contributions
• Employee contributions
– Miscellaneous: 7% of salary
– Safety: 9% of salary
• Employer contributions
– Miscellaneous: 19.494 % of payroll
– Safety: 34.868 % of payroll
8
The “Side Fund” Debt
• Established by CalPERS in 2003
– Based on estimates of past underfinding at the time
– Loans to the City
– Interest charged at 7.75 % per year
– CalPERS designates a portion of the employer contributions to
be applied each year towards interest and principal
– The City has made all required payments
– May be paid in whole or in part at any time
• Amount owed, 6/30/2011
$ 6.2 million
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9
Interest Rates
• Side Fund: current interest rate
7.75 %
• Reserve Funds (many required by law)
$ 8.9 Million
• Current interest rate on reserves
0.51 %
• Estimated interest rate on a new bond issue
6.0 %
10
The Side Fund Debt:
Recommendation
• Pay the Side Fund Debt as soon as possible, using
– Proceeds from a new bond issue
– And possibly some reserves
• This is equivalent to refinancing a mortgage at a lower
interest rate
• This does not modify the benefits.
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11
Termination
• Terminating the CalPERS pension plans does not
require terminating the CalPERS health plans
• A Council resolution to terminate is not binding
– After approximately 6 months, CalPERS provides an estimate of
the amount required to be paid to CalPERS to terminate the
plans
– A resolution is the only way to obtain a CalPERS estimate of the
cost
• If the plans are terminated, all benefits earned to date
will be paid by CalPERS
12
The Termination Unfunded Liability
• Termination Unfunded liability
= termination assets – termination liabilities
• Current actuarial reports are not transparent
– They do not include any of these values
• Such values may be included in future actuarial reports
– At the earliest, values as of June, 2011 will be provided in the
actuarial reports in October, 2012
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13
Possible Termination Asset and
Liability Values
• In April, 2011, the City’s CalPERS actuary provided the
committee a “very rough” estimate of the termination
unfunded liability (in addition to the side fund debt) as of
6/30/2009: Total for Miscellaneous and Safety:
– $ 14.4 million
• On August 18, 2011, CalPERS changed the method
used to calculate termination unfunded liabilities
• On August 17, 2011 the City’s Actuary advised the
committee that
– “the estimates that I provided previously are much
less than what the results will be with the new
methodology, even taking into account the good
investment returns over the past 2 years.”
• At present the committee has no further CalPERS
estimate of these liabilities
14
Termination:
Recommendation
• The committee recommends that the Council pass a
resolution to terminate the CalPERS pension plans
– the only way to obtain an official estimate of the
termination assets, liabilities and unfunded liability
– makes it possible, but not necessary, to terminate the
plans at a later date if desired
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15
Financial Risk
• The CalPERS pension plans create large financial risks
for the City
– Risks that asset values will decrease substantially, most likely
when City revenues also decrease
– Risks of demographic changes
– Risks associated with changes in CalPERS actuarial procedures
• These risks can be reduced by
– Decreasing the levels of CalPERS benefits, or
– Replacing the CalPERS plans
• For example, with a combination of social security, a defined
contribution pension plan and possibly higher salaries
16
Current CalPERS Tiers
and Salary Bases
• Tiers
– Percentage Factors related to age at retirement
• Salary bases
– Highest single year
– Highest 3-year average
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Tiers and Salary Bases:
Recommendation
• For new employees
– Adopt substantially lower tiers
– Base benefits on highest 3-year average salary
18
Major Recommendations
• Pay the side fund debt as soon as possible
– to lower interest costs
• Pass a non-binding resolution to terminate the CalPERS
plans
– To obtain an estimate of the termination unfunded liabilities
– To make it possible to subsequently terminate the plans if
desired
• Include estimates of the termination unfunded liabilities
in footnotes or comments in the City’s budget reports
• Adopt substantially lower retirement benefit tiers for new
employees