CITY COUNCIL: Report on Implementation Plan for Recommendations of the CalPERS Committee

Meeting Date: January 10, 2012
Prepared by: Jason Stilwell

City Council
Agenda Item Summary

Name: Receive report on the implementation plan for recommendations of the CalPERS Committee.

Description: The CalPERS Pension Committee's final report was presented to the City Council at its November 1, 2011 meeting. The Council directed staff to return with a proposed implementation plan for the four recommendations submitted by the committee. The following report provides additional analysis and outlines the requirements associated with implementing the Committee's recommendations.

Overall Cost: N/ A

Staff Recommendation: Receive the report.

Important Considerations: The implementation of the CalPERS Pension Committee recommendations are progressing. Implementing certain recommendations will require coordination with CalPERS, which is in process. Others require additional policy direction from the City Council, and still others will require negotiations with the City's recognized employee bargaining groups. This agenda item will provide the opportunity for staff to describe the implementation effort and for the City Council to identify additional policy direction.

Decision Record: None

Reviewed by:

Jason Stilwell, City Administrator Date


CITY OF CARMEL-BY-THE-SEA
MEMORANDUM

TO: HONORABLE MAYOR McCLOUD AND COUNCIL MEMBERS
FROM: JASON STILWELL, CITY ADMINISTRATOR
DATE:JANUARY 10, 2012
SUBJECT: IMPLEMENTATION PLAN FOR RECOMMENDATIONS OF THE CALPERS PENSION COMMITTEE

BACKGROUND
In October 2010, ari ad hoc committee was formed to study the City's pension plan provided by the California Public Employees' Retirement System (CalPERS) and to make recommendations to the City concerning the plan and any alternatives.

The CalPERS Pension Committee's fmal report was presented to the City Council at its November 1, 2011 meeting. The Council directed staff to return with a proposed implementation plan for the four recommendations submitted by the committee. The following information provides additional analysis and outlines the requirements associated with implementing the Committee's recommendations.

IMPLEMENTATION PLAN
Recommendation 1: Pay the Side Fund Debt

The CalPERS Committee recommended "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 ~qui valent to
refinancing a mortgage at a lower interest rate. Importantly, no benefit payments to current or past employees would be affected." In 2003, CalPERS combined the retirement plans for all public agencies with "small" plans (less than 100 employees) to reduce the volatility of employer contribution rates.

CalPERS also created for each member agency a so-called Side Fund to amortize each agency's June 30, 2003 unfunded liability over a fixed term at a fixed interest rate. These Side Funds ate distinctly different from the City's CalPERS Plan. The largest difference is that Side Fund liabilities are retired over a fixed term with a fixed amortization schedule based on CalPERS' actuarial earnings assumption rate (currently 7.75%). The City's Side Fund debt is approximately $6 million dollars.

Staff agrees with implementing this recommendation. There are certain short-term and long-term steps to accomplish this recommendation.

Short-term Implementation. Short-term implementation options include an analysis of available reserve balances and prioritization of reserve appropriation by the City Council. The short-term implementation primarily relates to the part of the recommendation that the City use a portion of its current reserves to pay a portion of the side fund debt. The short-term implementation of Committee Recommendation 1 involves four steps.

1. Analyze liabilities. Implementation in the short-term involves an analysis of the City's reserves
and overall liabilities. The City has a number ofun- or under-funded liabilities. These include:
a. Road maintenance ($670,000 annually),
b. Facility maintenance ($325,000 annually),
c. Vehicle replacement ($205,000 annually),
d. Preventative tree maintenance ($412,000 annually)
e. Equipment and technology replacement ($93,000 annually),
f. Long-term debt obligations ($9.2 million),
g. Other Post Employment Benefits ($866,000 total, pay-as-you-go),
h. Retirement ($34.4 million total),
i. The Side Fund Debt ($6.2 million), and
j. Certain others
i. parks,
ii. Sunset Center subsidy,
iii. storm water,
iv. other capital replacement.

2. Prioritize Liabilities. Current available resources do not enable the City to fully meet its liabilities on an annual basis. The City has underfunded certain liabilities (road maintenance, building maintenance, preventative tree maintenance, and equipment replacement), has adopted a pay-as-you-go rather than amortized repayment schedule of other liabilities (vehicle replacement, other post employment benefits), is contributing to interest and possibly principal (retirement), and has an amortized repayment schedule for others (primarily the major portion of
long-term debt obligations). On an annual basis through the budget process the City Council is able to determine funding priorities for these liabilities. The City Council has a Special City Council Workshop tentatively scheduled for March 20, 2012 to set its three-year work program and priorities.

3. Analyze Reserves. A reserve requirement analysis is a key component of the annual budget process. Prudent reserve levels are recommended by staff and remaining reserve balances are
available fo:r appropriation per City Council priority. Prudent reserves are set aside for use in
extraordinary circumstances such as natural disasters, unforeseen emergency expenditures, and
·unanticipated litigation or risk management costs. Maintaining adequate reserve balances is
important to be able to have funds available for appropriation in an unexpected fiscal
environment.
4. Appropriate Available Reserve Balances. The proposed budget will be developed based on the
City Council priorities. As Council prioritizes liabilities to be paid and staff analyzes reserves
available for appropriation, the budget will be prepared to reflect the priority. The City Council
will have the opportunity during budget deliberations and adoption to appropriate funding for
outstanding liabilities.
110
CalPERS Study Committee Implementation
10 January 2012
Page3
Long-term Implementation. The long-term implementation primarily relates to the new debt
obligation portion of the Committee's Recommendation I. If the City chooses to use this opportunity, it
would issue taxable pension obligation bonds ("POB") to prepay its CalPERS Side Fund obligation. In
order to accomplish the recommendation by issuing a pension obligation bond, these four steps must be
undertaken:
I. Complete an Analysis of Lolfg-term Options. Long-term options include financing, structured
re-payment plans, use of reserves, and earmarked revenue.
a. Financing would involve issuance of a Pension Obligation Bond; other financing
mechanisms are not available for pension liability obligations.
b. A structured re-payment plan would be based on the City's adoption of an internal, longterm
repayment plan to earmark appropriation specifically to the pre-payment of the Side
Fund liability. For example, the City Council by policy could develop a forecast that sets
aside a growing dollar amount for pre-payment of the Side Fund liability and future
budgets would be balanced utilizing the forecast amount.
c. Use of reserves, as a long-term solution would be to adopt a policy that available yearend
fund balance or future annual available reserve balances be used to pre-pay the Side
Fund liability on an annual basis. This action would be adopting a policy or practice that
future reserve analyses be undertaken to identify reserves available for the pre-payment
ofthe existing Side Fund liability.
d. Earmarked revenue would include utilizing existing revenue, revenue growth, or a new
revenue source to pre-pay the Side Fund liability. For example, City Council by policy
could determine that 20% of future annual Sales Tax growth be earmarked for prepayment
of the Side Fund liability.
2. Build Repayment of Side Fund Liability Into Long Range Financial Forecasts and Budgets.
Financial forecasts and future budgets of the City should include whatever option, or
combination of options, Council selects as a long-term repayment method.
3. Evaluate Side Fund Rate Risk. The Committee recommended that before issuing arty new
bonds, the City administration independently evaluate the risk that CalPERS might lower the
interest rate charged on the Side Fund. It is possible at some point over the next I 0 years (the
amortization period for the City's Side Funds) that the CalPERS board could lower its 7.75%
actuarial earnings assumption. Such a reduction would reduce the cash flow savings realized by
the City through the issuance of POB. If the CalPERs earnings assumption were lowered to a
level approximating the interest rate on the City's POB, cash flow savings would be eliminated.
4. Engage Financial Advisory and Underwriting to Prepare Refinancing. The following is a
tentative list of financing milestones:
a. Council approval to proceed with refinancing
b. Distribution of first draft of loan documents
c. Comments due on loan documents
d. Second draft of loan documents due
e. Comments due on loan documents
111
CaiPERS Study Committee Implementation
10 January 2012
Page4
£ Loan documents due for council meeting agenda deadline
g. City Council meeting to approve loan documents and authorize refinancing
5. Validation Procedure. The issuance of a pension obligation bond requires what is called a
"validation procedure" in the local Superior Courts. For a validation, the City Council provides
initial authorization to issue the bonds and then files a court action, publicly noticing the City's
intent to issue bonds to refund its existing CalPERS obligation. If there is no challenge, the
validation is ratified by the Superior Court typically within 90 days of its filing. Because the
bonds are payable from all legally available funds of the City (which is also true for the existing
CalPERS obligation), validation is necessary to affirm bond counsel's position that the POB are
exempt from the Constitutional Debt Limit since they are issued to refund a pre-existing
obligation imposed by law (vested pension benefits). Before the validation process may begin, it
is necessary for the City Council to adopt a resolution authorizing the issuance of pension
obligation bonds to refinance the City's outstanding side fund obligations. Once the validation
procedure has been completed, the POB issue will be brought back before the City Council one
more time for fmal authorization.
Recommendation 2: Pass a Non-binding Resolution to Terminate the CalPERS Pension Plans
The CalPERS Committee recommended the City 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. Further, the
Committee suggested 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.
Staff partially agrees with implementing this recommendation as proposed. Clearly, obtaining estimates
of the City's Unfunded Accrued Actuarial Liability are a key to any decision to terminate the plan;
however, in 2011 CalPERS enacted certain policy changes that make terminating the plan onerous and
costly to the City. Specific CalPERS policy changes affecting potential termination of the plan are
outline in this section.
Termination of CaiPERS. California Government Code sections 20570-20593 have contract
termination guidelines for public agencies. They include the following requirements:
• The terminating agency is responsible for sufficient funding to continue paying the retirement
and death benefits,
• Based on the actuarial valuation, sufficient funding for future benefits payable to members or
beneficiaries of members electing to have their funds remain on deposit with the retirement
system, is also the responsibility of the agency, and
• To maintain eligibility, if the City desires, in PERS health benefit programs, the City file a new
resolution adopted by the City Council.
'- 1
112
CaiPERS Study Committee Implementation
10 January 2012
Page 5
CalPERS Policy Changes. In August 2011, the CalPERS Board adopted a more conservative
investment strategy for the assets of the terminated agency pool to protect the retirement benefits of
workers who belong to a CalPERS pension plan that has been terminated by a public agency employer.
When a public agency terminates its pension plan the terminated agency's plan assets and liabilities are
transferred to the CalPERS Terminated Agency Pool if the employer wants to continue with CalPERS as
the plan administrator. Funds from the pool are used to pay benefits when workers retire pursuant to the
aforementioned Government Codes.
There was concern by CalPERS that the funded status of the pool would deteriorate dramatically in the
future if a large under-funded agency terminated its plan and left its assets and benefit obligations with
CalPERS. The primary stated reason by CalPERS was that employers do not make contributions to the
pool after their pension plan is terminated. The only source of future pool income is from investment
earnings. While this is true in a sense, if a jurisdiction terminates the plan it will be required to make
contributions to the plan to cover those employees and dependents who will still be eligible for a
pens10n.
The August 2011 action included three main elements:
• Terminated agency pool assets will remain a part of the Public Employees' Retirement Fund
(PERF) but will be invested more conservatively than in the much larger PERF, more closely
reflecting the characteristics of future expected benefit payments from the pool. The new asset
allocation policy for the pool will be determined by the CalPERS investment and actuarial staff,
subject to approval by the CalPERS Board.
• CalPERS will develop a new regulation to ensure investment earnings of the pool are allocated
appropriately.
• The discount rate of the pool is expected to be significantly lower than the rate for the regular
CalPERS pension fund because of lower projected investment returns from the more
conservative asset allocation. The discount rate for the regular CalPERS pension fund will not
change; it will remain at 7.75 percent.
The discount rate for the terminated pool is now 3.8 percent, because the investment strategy is shorter
term, more conservative and designed to protect the principal. In the future, if an employer terminates
its plan but continues with CalPERS as the plan administrator, the employer is likely to be required to
deposit more assets into the pool to fund the terminated liabilities. Termination does stop future benefits
from being accrued from the point of termination forward. The new investment strategy for the
terminated pool will result in terminated liabilities that will fluctuate with interest rates.
The result is that plan termination is much more expensive based on the August 2011 action by
CalPERS. With termination the City does not in all likelihood leave CalPERS but rather is required to
continue to make contributions to CalPERS to cover the cost of promised retirement benefits for current
retirees, dependents, and those who would be owed a CalPERS retirement who are currently working at
the City.
113
CaiPERS Study Committee Implementation
10 January 2012
Page6
Actuarial Estimate. The CalPERS Committee report states "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 tennination 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" finding "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 jncluded in the City's
reports."
The process of calculating the amount of the total pension liability (referred to as an actuarial valuation)
essentially involves three steps:
1. Projecting benefit payments
2. Discounting the projected benefit payments to their actuarial present value (their estimated value
in today's dollars)
3. Attributing the present value of projected benefit payments to past and future years during which
employees have worked or are expected to work.
The portion of the present value related to work provided by employees in prior years is a government's
total pension liability.
The actuarial valuation process is complex. For example, projections are made using assumptions
regarding the factors that affect the amount of benefits that will be paid to employees and their
beneficiaries in the future. The assumptions are based on historical experience and expectations about
the future. These factors may include, but are not limited to:
• How many employees of a government are expected to receive benefits
• How long employees are expected to work for the government
• What employee salaries will be and at what pace they will grow
• How long employees are expected to live after retiring (and, hence, how many years they will receive
benefits).
The CalPERS Committee found that such estimates may be included in future actuarial reports but are
not guaranteed to be so. 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.
Staff is working with CalPERS on its requirements and process for obtaining a termination valuation
and the City has been given an estimated timeframe for doing a valuation of six months. It may,
however, be possible to obtain an actuarial estimate from an independent actuary more quickly. Should
it be determined that the City can obtain an independent valuation, staff will evaluate the cost and
timeframe.
Recommendation 3: Include Side Fund Debts and Estimated Termination Unfunded Liabilities
in the City's Financial Reports
The CalPERS Committee found the Side Fund Debts and the Tennination Unfunded Liabilities
represent costs that will have to be paid either sooner or later, with pension contributions that would be
114
CalPERS Study Committee Implementation
10 January 2012
Page7
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.
Staff agrees with implementation of this recommendation.
The primary goal of the Governmental Accounting Standards Board (GASB) is to develop high-quality
standards of accounting and financial reporting for state and local governments. High-quality standards
lead to information in financial reports that improves transparency, assists in assessing accountability,
and is useful for making important decisions. The City complies with GASB standards in its financial
reporting. GASB periodically reviews its existing standards to determine whether they continue to
achieve these objectives effectively and proposes significant improvements to its standards for
accounting for and reporting on the pensions that governments provide to their employees. In
accordance with this CalPERS Committee recommendation, the GASB proposals relate solely to
accounting and fmancial reporting and do not apply to how governments approach the funding of their
pension plans.
Pensions are a form of compensation, like salaries, which governments provide to their employees in
return for work. Consequently, like salaries, the costs and obligations associated with pensions should be
recorded as they are earned by the employees, rather than when contributions are made by the
government to a pension plan or when benefit payments are made to retirees. The fact that pensions
earned today are not received by the employees until some point in the future when they retire means
that a government has an obligation now to provide those benefits at that future time. The GASB's
proposals for new standards are constructed on this basic understanding of the pension transaction. A
government would report in its financial statements a net pension liability equal to the difference
between the total pension liability and the value of assets set aside in a pension plan to pay benefits to
current employees, retirees, and their beneficiaries.
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. Currently, estimates ofthe Side Fund Debts can be found in
the CalPERS annual actuarial reports and estimates of the Unfunded Liabilities will be obtained from
implementation of Recommendation 2.
The amount a government reports as pension expense in the fmancial statements is the product of a
variety of inputs:
1. Employees work and earn more benefits
2. Interest on the outstanding liability
3. Changes in the amount of the total pension liability due to:
a. Actual economic and demographic changes differing from what was assumed
b. Changing the assumptions about economic and demographic factors
c. Changing the terms of the pension benefits
4. Changes in the amount of plan assets due to:
a. Projected investment earnings
115
CalPERS Study Committee Implementation
10 January 2012
Page 8
b. Effects other than investment eanungs, such as receiving contributions and paying
benefits
c. The difference between actual investment earnings and what was projected.
At present, 1, 2, and 4b generally are incorporated into the calculation of pension expense immediately.
All other inputs are introduced into expense over a period of up to 30 years. GASB is proposing that, in
addition, governments immediately incorporate into expense 3c and 4a for all persons covered by the
plan and the portion of 3a and 3b related to employees no longer working for the government (inactive
employees). Governments would not incorporate the portion of 3a and 3b related to active employees
into expense immediately. Rather, governments would report the active-employee portion of 3a and 3b
as a deferred outflow of resources or deferred inflow of resources and then introduce part ofthat amount
into expense in each year of the weighted average of the remaining employment of active employees.
The implications of these proposals would be that most governments would recognize pension expenses
sooner than they do at present. For instance, the full impact of changes in pension benefits would be
recognized as expense immediately, rather than recognized over as many as 30 years. The effects of 4c
would be deferred and incorporated into expense over a five-year period. This proposed change would
improve consistency in financial reporting because governments may now select their own period. This
change also would result in differences between projected and actual investment earnings affecting
expenses sooner than they do now for many governments.
Again, it should be noted that these proposals would be required only for accounting and financial
reporting purposes. Governments would not have to change their annual pension contributions to adopt
the change in expense reporting.
As this recommendation is a change in reporting, it can be implemented easily by including this
information as a note to the financial statements in accordance with GASB standards.
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 threeyear
average salaries."
The City has already made great strides in implementing this recommendation.
Second Tier. Second tiers have been approved by the City Council and labor organizations and a
request to amend the City's contract with CalPERS has been made. These second tiers include lower
defined benefits based on three-year final average salary.
CalPERS is in the process of preparing the documents necessary to amend the contract. Valuation
reports are in process and CalPERS has started the amendment but will be unable to complete it until the
valuations reports are completed. City Council will then need to adopt a Resolution of Intention as well
116
CalPERS Study Committee Implementation
10 January 2012
Page 9
as an Amendment Cost Analysis ordinance. The estimated timeframe to complete the CalPERS
requirements to amend the contract is approximately 90 days including the actions required by the City.
Other Efforts. The CalPERS Committee expects that such future defined benefit choices would
include moving toward a hybrid system with a combination of a considerably less generous definedbenefit
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.
Reaching this structure will require evolution in CalPERS, State law, and negotiation with the City's
recognized bargaining units. It should be noted that the City could create its own Defined Contribution
plan as a side-by-side plan to the CalPERS Defined Benefit plan. Establishing such a plan would require
an analysis of funding and plan administration options.
Summary
The implementation of the CalPERS Pension Committee recommendations are under way or being
evaluated for feasibility. Staff will keep the City Council apprised of its progress and develop further
options designed to provide the City with more flexibility and cost-containment in providing retirement
benefits for consideration prior to labor negotiations.