Attachment 2
PREPARED BY: STEPHEN CONWAY
FINANCE DIRECTOR
Reviewed by: Town Manager, Assistant Town Manager, and Town Attorney
110 E. Main Street Los Gatos, CA 95030 ● 408-354-6832
www.losgatosca.gov
TOWN OF LOS GATOS
FINANCE COMMITTEE REPORT
MEETING DATE: 08/07/2017
ITEM NO: 4
ITEM NO: 11
DATE: JULY 18, 2017
TO: COUNCIL FINANCE COMMITTEE
FROM: LAUREL PREVETTI, TOWN MANAGER
SUBJECT: REVIEW, DISCUSS, AND RECOMMEND PUBLIC AGENCY RETIREMENT
SERVICES (PARS) FOR TOWN COUNCIL CONSIDERATION TO ESTABLISH AN
IRS SECTION 115 PENSION TRUST FOR THE TOWN OF LOS GATOS.
RECOMMENDATION:
Review, discuss, and recommend Public Agency Retirement Services (PARS) for Town Council
consideration to establish an IRS Section 115 pension trust for the Town of Los Gatos.
BACKGROUND:
The Town Council Finance Committee has been meeting in recent months to explore strategies
to address volatility associated with CalPERS investment returns and the growth in unfunded
pension and other post-employment benefit (“OPEB”) liabilities.
CalPERS actuaries determine an assumed rate of return on portfolio assets as part of calculating
the funded status of pension plans. If this rate of return is not met, an “unfunded” obligation
amount is calculated for the year in which returns did not achieve the expected rate.
Conversely, if returns exceed the expected rate, an actuarial credit is computed for that fiscal
year which reduces the unfunded liability
Until recently, CalPERS actuaries used an assumption of 7.5% annual returns on its investment
portfolio. However, CalPERS returns for the past three fiscal years have been quite variable,
with returns for two years significantly below its 7.5% expected rate as shown below:
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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BACKGROUND (cont’d):
FY 2014/15 2.40%
FY 2015/16 0.60%
FY 2016/17 (Preliminary Estimate)…………………11.20%
For the past twenty year period, the CalPERS portfolio has returned an average of 6.9%. As a
result of the recent disappointing returns and historical average on its investments, the CalPERS
Board made a policy move to reduce its assumed rate of return and risk exposure on its
investment portfolio. As such, CalPERS announced it will be lowering its expected rate of return
from 7.5% to 7.0% over a three year period as follows:
FY 2017/18 7.375%
FY 2018/19………………………………………………………….7.25%
FY 2019/20………………………………………………………….7.00%
This proposed change in expected rates of returns will result in an increase in actuarial liabilities
and the transition to investing in less risky assets in the future could mean lower expected
assumed rates of return going forward. The combined effect of these changes has the potential
to make it more challenging to fund the Town’s pension obligations over the long term. As of
the most recent actuarial valuation date, the Town’s Miscellaneous Plan is 74% funded and its
Safety Plan is 78% funded.
The Town recognizes the potential future impacts to service delivery if unfunded liabilities are
allowed to grow without effective strategies to address them. To date, the Town has taken the
following proactive steps to meet this challenge:
The Town prudently addressed a major new unfunded liability pertaining to a “side
fund” liability created by CalPERS when state law required the Town’s safety pension
plan be placed in a state pool. Upon doing this, the Town incurred a side fund liability
determined by CalPERS for the Town’s proportionate share of pooled unfunded
liabilities. On June 5, 2014, the Town authorized payment of the entire approximate
$4.5 million side fund liability, thereby decreasing the unfunded liabilities significantly
and this is the major reason funding levels are at 78% for the safety plan compared to
73% for the miscellaneous plan.
Recently, the Town introduced dependent cost sharing and a reimbursement cap to
Medicare eligible employees who retire on or after February 1, 20 16 with estimated
savings approaching $200,000 per year.
The Town closed the CalPERS retiree Tier 1 benefit for non-safety employees and
created a new Tier 2 for non-safety new employees who enter employment as Tier 1
Classic employees.
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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BACKGROUND (cont’d):
The Town supported the creation of a Tier 3 Public Employees Pension Reform Act
(PEPRA) for all new non-classic employees.
Currently, the Town participates in the CalPERS discounted prepayment option (current
year savings of approximately $40,000).
In FY 2016-17, the Town Council authorized a pre-funding payment of $1.6 million in its
adopted budget and an additional $1.0 million from prior year (FY 15/16) savings
thereby achieving a total of $2.6 million in pre-funding assets placed into trust with
expected immediate reductions in the Town June 30, 2017 OPEB unfunded liability
reported in the Town’s annual financial report.
The Town Council established a General Fund reserve for CalPERS/Other Post-
Employment Benefits (OPEB) providing a minimum of $300,000 annually to be
committed to use as a funding source for unfunded liabilities.
The Town Council authorized the creation of an irrevocable Internal Revenue Code (IRS)
Section 115 Trust for the Town’s pension obligations, and directed staff to issue a
Request for Qualifications and recommend a Trust provider. Funds in the trust would
be dedicated to be used only for pre-funding of pension obligations and offer the
following potential benefits:
o Local control over the assets. Although the funds are dedicated to pay pension
obligations, the Town can access the account at any time.
o An additional reserve fund to help the Town pay for increasing CalPERS annual
contribution requirements or make a future lump-sum payment to CalPERS.
o Diversification and control of varying risk choices in the allocation of investments
compared to the funds invested in the CalPERS pension trust.
Establishment of the trust would enable the Town to craft an alternative portfolio
investment allocation policy that would include safeguards against risk, yet likely
surpass the low returns the Town earns on its current operating portfolio which is
heavily restricted by State law (basically limited to fixed income instruments, such as
U.S. Treasury and U.S. Agency notes with no maturities exceeding five years).
DISCUSSION:
Pursuant to Council direction, the Town issued a Request for Proposal in April 2017 for IRS
Section 115 Pension Trust Services and received proposals from two firms. These proposals
were provided to the Town Council Finance Committee for its June 12, 2017 meeting. After
discussion with the Finance Committee, staff extended the RFP date to July 7, 2017 and
received an additional proposal.
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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DISCUSSION (cont’d):
Staff reviewed the submittals and created an overview of each firm’s proposal which is
intended to aid in the discussion of the merits of each submittal. The Town’s RFP indicated that
the vendor selected would be based on the following factors:
Firm’s experience with the planning and implementation of a pension trust.
Firm’s experience with fiduciary investment advisors
Qualifications of proposed key personnel
Communication skills
• Firm’s reputation for integrity and competence
• Proposed Fees and Charges for Services
• Ability to provide the required services in a timely manner
Comparative data for each of the proposers is presented below:
Public Agency
Retirement Services
(PARS)
Public Financial
Management (PFM)
Robinson Capital
Management
Founded 1984 1975 1982
Headquarters Newport Beach, CA Philadelphia, PA Mill Valley CA
Office Locations in
California
Newport Beach
San Francisco
Highmark
San Francisco
Los Angeles
Mill Valley
Core Business Pension/OPEB Plans
Pre-funding of
Pension/OPEB
Asset Management/
Investment Advisory
Asset Management/
Investment Advisory
Products/Programs Section 115
Trusts for OPEB &
Pension
Supplemental
Defined Benefit
Pension Plans
Customized
Defined
Contribution
Pension Plans
Section 115 Trusts
for OPEB & Pension
Asset Management
Investment
Advisory/Consultan
t Services
Section 115 OPEB
Trust (Matrix Trust)
Asset Management
Investment
Advisory/Consultan
t Services
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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DISCUSSION (cont’d):
Public Agency
Retirement Services
(PARS)
Public Financial
Management (PFM)
Robinson Capital
Management
Plans under
Administration
250 Section 115
Trusts, including 80+
CA Pension Pre-
funding Accounts
60 Section 115 Trusts,
including 5 CA
Pension Pre-funding
Accounts
(TASC-partner) $200
VEBA or Sec 115 Trust
No Pension Pre-
funding Trusts at this
time.-
Investment Assets
Managed
Approx. $1.3 billion
Section 115 Trusts
Approx. $3.4 billion
Section 115 Trusts
(TASC-Partner) $200
Billion Section 115 &
VEBA Trusts
Minimum Investment No minimum No Minimum
$20,000 minimum fee
No Minimum
Cancellation Advance
Notice
30 days 90 days None-Just written
notice to terminate
Private Letter Ruling
from IRS
Yes Yes No
Another important aspect in evaluating the proposals is to examine the historical return data
provided by each firm to the Town as part of their proposal. Historical returns are not
indicative of future performance, but do provide some relevant comparison data when using
the same periods for comparison. The following table portrays historical yield for one, three,
and five year periods ending March 31, 2017 with the 60/40 Allocation. The returns are less
underlying fund fees and management fees.
Period Ending
3/31/17
CERBT
Strategy 2
PARS
Moderate
60/40
PFM
60/40
*Composite
Robinson
One Year 7.47% 8.20% 8.96% 9.44%
Three Year 3.89% 5.84% 4.56% 4.78%
Five Year 5.87% 4.53% 6.85% 7.88%
*Composite returns represent all the portfolios under PFM management within a particular
asset allocation.
Staff Evaluation of Proposals:
Staff has contacted references and done extensive review of each of the proposals submitted to
the Town. The following are highlights of staff’s pros and cons of each firm’s proposal.
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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DISCUSSION (cont’d):
Public Agency Retirement Services (PARS)
Pros:
Experience - One of two independent retirement plan administrators in California
authorized to offer Section 115 Trusts with Private Letter Ruling from the IRS, assuring
participants of the tax-exempt status of their trust investments.
Retirement plans and Section 115 trust plans are the core business for PARS.
Currently California’s most widely adopted Section 115 Trust Program with over 80 cities
establishing pension trust programs through PARS.
Flexible investment options with five investment strategies and the ability to diversify
and customize investments in accordance with Town’s risk tolerance and trust
investment policy.
PARS has partnered with U.S. Bank as a trustee for its program. U.S. Bank is the 5th
largest bank in the U.S. and one of the largest. The Town has a positive history with U.S.
Bank and its trustee services.
No minimum contribution requirements for the Trust.
The Trust has zero fee 30-day termination notice.
Excellent references from other California local governments.
Cons:
Because of its status as an established Section 115 Trust provider, its administrative fee
structure is higher than at least one of the other proposers.
PARS recent five year history lags the five year composite returns reported by CERBT
and the other two proposers.
PFM Asset Management
Pros:
Experience - One of two independent retirement plan administrators in California
authorized to offer Section 115 Trusts with Private Letter Ruling from the IRS, assuring
participants of the tax-exempt status of their trust investments.
Manages $2.2 billion nationally in Section 115 Trusts
No affiliation with any proprietary investment products, no soft dollar fees or other
remuneration from third party managers or broker/dealers.
Will partner with Town to establish a program that meets Town’s goals, risk tolerance
and diversification of investments and develop a customized investment policy/program
to meet Town’s specific needs.
Annual composite returns at or near the top on moderately conservative portfolios for
one and five year periods.
Excellent references from other California local governments.
Multiple employer trust is established with IRS approval.
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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DISCUSSION (cont’d):
Cons:
PFM’s Asset Management’s core business is investment advisory services; the pension
trust program is in its ramping up stage nationwide.
Wells Fargo trust deposits may be subject to CA state law.
Total administrative and trustee fees are the highest amongst the proposals.
90-day termination notice is required as part of PFM’s proposal.
No minimum investment level, but a minimum of $20,000 in annual fees is required .
Robinson Capital Management
Pros:
No initial minimum contribution requirements.
Robinson has the lowest fee structure of the three proposers.
Robinson is partnering with Matrix Trust Company ($300 billion in assets managed) for
its administration and trust services.
Trustee fees are essentially waived.
Excellent references from other California local governments for non-pension services.
Cons:
Experience - Robinson Capital Management has no Section 115 pension trust clients at
the time of the proposal submittal.
No private letter ruling available at this time.
No references available yet from clients who have established pension trusts with
Robinson Capital Management.
CONCLUSION AND STAFF RECOMMENDATION:
Based on the comparison above, Robinson Capital Management should not be considered as
the Town’s 115 Trust provider because it does not have a private letter ruling and no pension
clients at this time.
PFM Asset Management is a strong option because of its national reputation, excellent
references, and strong track record in providing investment advisory services for custom
portfolios.
Staff recommends PARS because of the following factors:
Supplemental retirement plans and Section 115 Trusts are the core business for PARS .
The PARS multiple employer pension trust is established with over 80 California clients.
A private letter ruling for the trust has been received from the IRS.
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SUBJECT: CalPERS/OPEB UNFUNDED LIABILITIES
DATE: AUGUST 7, 2017
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CONCLUSION AND STAFF RECOMMENDATION (cont’d):
PARS offers full services to administer the 115 trust with a dedicated Senior Consultant
and an investment management team available to assist with developing a
recommended separate Investment Policy for the trust.
The selected trustee, U.S. Bank Trust is a leader in the industry and the Town has
positive past experience with U.S. Bank Trust.
PARS multiple employer trust offers five different investment options with the ability to
customize the options should the Town desire to choose that path.
PARS has no minimum contribution levels and a 30-day termination notice period.
The Council Finance Committee should discuss the proposals, consider the recommendation in
this report, and make a recommendation to the Town Council. After Council decision, the Town
will enter into an agreement with the selected trust provider. Once on board, the Town Council
Finance Committee will have an opportunity to discuss investment strategies with the provider.
Attachment:
1. PFM Asset Management Proposal
PREPARED BY: STEPHEN CONWAY
FINANCE DIRECTOR
Reviewed by: Town Manager and Assistant Town Manager
110 E. Main Street Los Gatos, CA 95030 ● 408-354-6832
www.losgatosca.gov
TOWN OF LOS GATOS
FINANCE COMMITTEE REPORT
MEETING DATE: 08/07/2017
ITEM NO: 4
ADDENDUM
ITEM NO: 11
DATE: AUGUST 4, 2017
TO: COUNCIL FINANCE COMMITTEE
FROM: LAUREL PREVETTI, TOWN MANAGER
SUBJECT: REVIEW, DISCUSS, AND RECOMMEND PUBLIC AGENCY RETIREMENT
SERVICES (PARS) FOR TOWN COUNCIL CONSIDERATION TO ESTABLISH AN
IRS SECTION 115 PENSION TRUST FOR THE TOWN OF LOS GATOS.
REMARKS:
Subsequent to posting the Agenda for the Council Finance Committee for Monday, August 8,
2017, staff received the following questions from Vice-Mayor Rennie regarding Item No. 4 (IRS
Section 115 Trust Recommendation):
Question: With the better than plan investment return from CalPERS, how much do we expect
our unfunded pension liabilities to drop (ball park)?
Answer: Staff consulted with the Town’s actuaries and an estimate of reductions to the
unfunded liabilities resulting from the FY 16/17 asset gains of 11.2 % would amount to $2.6
million reduction in unfunded liabilities reported in the FY 17/18 CAFR.
Question: Does it more than cover the increase because of the reduction in assumed return?
Answer: No, there are expected increases to the unfunded liabilities for the next three fiscal
years beginning in FY 18/19 due to CalPERS’ decision to systematically lower the discount rate.
The discount rate will be lowered during this timeframe from 7.5% to 7.375%, from 7.375% to
7.25%, and finally to the new targeted discount rate from 7.25% to 7.0%. The Town’s
preliminary estimate of the impact of these changes is an increase to unfunded liabilities
(assuming no other changes) of approximately $5.5 to $6.0 million over the next four fiscal
years.
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SUBJECT: IRS SECTION 115 TRUST
DATE: AUGUST 4, 2017
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Question: What is the 5 year return for CalPERS compared to PARS?
Answer: The 5 year return for PARS Moderate Portfolio is 5.84% and the simple average return
for CalPERS over the past five fiscal years is 9.02%. It should be noted that the CalPERS return
was based on a greater degree of risk taken than on the PARS Moderate Portfolio.
Question: Are the CERBT and Robinson Capital Returns also 60/40 risk type profiles?
Answer: Yes, staff attempted to get as close as possible to an “apples to apples” comparison of
returns net of administrative fees. The returns for Robinson Capital are for its RCM Vanguard
“Balanced” Portfolio which consists of 60% equities and 40% fixed income investments less
administrative fees.
For comparisons for CERBT, staff used the CERB Strategy 2 which CERBT describes as a
moderate allocation of equities, bonds, and other assets. Strategy 2 consist of 40% equities,
10% primarily Real Estate Investment Trusts (“REITS”), 10% in Treasury Inflation Protected
Securities (“TIPS”), and the balance of 40% in fixed income investments.
In reviewing the staff report, an error was made on the 3 and 5 year return data reported for
the PARS Moderate Portfolio which is restated below:
PARS Moderate 60/40 Originally Reported Corrected
Three Year 5.84% 4.12%
Five Year 4.53% 5.84%