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TOWN COUNCIL AGENDA REPORT
DATE: FEBRUARY 14, 2014
MEETING DATE: 2/18/2014
ITEM NO: 3
ADDENDUM
TO: MAYOR AND TOWN COUNCIL
FROM: GREG LARSON, TOWN MANAGER
SUBJECT: ACCEPT FY 2012/13 COMPREHENSIVE ANNUAL FINANCIAL REPORT
(CAFR)
The Finance Committee requested that staff provide the Town Council with a simple explanation
of pension and other post - employment benefit (OPEB) related liabilities, funding and reporting.
The attached document, albeit long, attempts to do that using home mortgages as a comparison.
In summary, the Town is subject to changing Government Accounting Standards Board (GASB)
requirements to disclose pension and retiree health care information, as follows:
1. Safety PERS — Our police officer pensions are currently consolidated with numerous
other jurisdictions and only reported jointly. This is changing effective 2015 and PERS
will be providing each jurisdiction, including Los Gatos, with its own reportable figures.
2. Miscellaneous PERS — The pension obligations for non - police employees and retirees are
already reported by jurisdiction. However, beginning next fiscal year, to be reported after
the fact by early 2016, the Town will need to expand its reporting to including the
difference between local pension plan assets and liabilities.
3. OPEB (principally retiree health care) — The Town is fully reporting its liabilities,
payments and obligations for OPEB.
By 2016, the Town will be reporting the following information for all Town retiree benefits,
including pensions and health care:
A. Total liabilities and assets
B. Unfunded liability (difference between liability and assets)
C. Annually Required Contribution (amount we should be paying each year)
D. Amount actually funded (including direct costs and trust payments)
The Town currently complies with all requirements and recommended best practices.
Attachment:
4. Pension and OPEB Liabilities, funding and Reporting
PREPARED BY: Stephe , - istrative Services and Finance Director
N:\MGR \AdminWorkFile0014 Council Reporis\2 -18 -14 CAFR.Addendum.doc
Reviewed by: ssistant Town Manager Town Attorney V Finance
Pension and OPEB Liabilities, Funding and Reporting
As part of the review of the Town's FY 12/13 CAFR, the Council's Finance Committee requested the
funding status of both the Town's pension plan administered by CALPERS and its other post- retirement
health care benefits. The primary concern was whether costs for both these plans have been fully
accrued, whether there existed unfunded liabilities for either plan, and how these liabilities will be
addressed and what impact can be anticipated.
As background, as early as the 1970s, it was not uncommon for state and local governments to fund their
pensions and other post retirement benefits on a "pay -as- you -go basis." Following the passage of ERISA,
which set private sector funding requirements, state and local officials took steps to fully advance -fund
their pensions. They were further encouraged to meet their actuarial funding obligations by new
accounting and reporting standards issued by the Governmental Accounting Standards Board (GASB) in
1986.
The trend to improve pension funding continued over the next decade. To comply with GASB, employers
were required to disclose unfunded liabilities in the footnotes of the financial statements and also had to
disclose their actuarially - determined contribution (ARC) and the percentage of the ARC the employer
actually paid. GASB defined the ARC to include the normal cost of pensions for today's employees plus
a contribution to pay for any unfunded liabilities, typically amortized over a maximum 30 -year period.
Paying the full ARC has been an important measure of whether or not a pension plan is on track to fund
its pension promises. The Town has fully paid its ARC for pensions and has phased in a ten -year strategy
of 100% of the ARC for other post - employment benefits. For FY 13/14, the current ARC percentage
paid is 68% of the ARC for other post- retirement benefits.
What are the unfunded liabilities?
As early as the end of FY 2003, the Town's pension plan was 100 percent funded (no unfunded liability)
for miscellaneous employees and nearly 99.6% funded for its safety employees. Unfortunately, the last
decade of economic upheaval and the wide swings in the stock market have reduced pension assets in
both public and private plans. The most recent actuarial valuation (2011) indicates a funded ratio
(pension assets as a percentage of pension liabilities) of 83.4% for the Town's safety employees and an
81.7% funded ratio for its miscellaneous employees. Because the Town's safety plan is in a statewide
pool, the actual unfunded pension liability for the Town's safety plan is undetermined at this point, but
will be available mid calendar year 2015. The unfunded pension liability for the miscellaneous
employees is approximately $13.8 million. The unfunded liability for other post - retirement benefits is
approximately $21.6 million.
The New Pension Standards
Under prior GASB statements, there was a close link between accounting and funding measures because a
financial statement liability only occurred if the annual ARC payment was not paid in full (just as a
homeowner would report a liability only for mortgage payments in arrears). Thus, many government
employers today do not report a liability for pensions on the face of their financial statements. However,
if the plan they sponsor does have an unfunded pension liability, it is reported in the notes to the financial
statements, which are considered an integral part of financial reporting. That link has now been broken.
The new GASB standards focus entirely on accounting measurements of pension liabilities and no longer
ATTACHMENT
on how employers fund the cost of benefits or calculate their ARC. This is a significant change for
government employers because the ARC historically served as a guide for policy makers, employees,
bond rating agencies and the public to determine whether pension obligations were being appropriately
funded. The ARC also was often used to inform budget decisions.
Beginning in fiscal year ending 2015, the new GASB standards will require the Town to report its
unfunded pension liability on the face of its financial statements, even if the Town fully funds each year's
ARC Oust as a homeowner would report a mortgage liability even if all monthly mortgage payments are
paid on time, in full). Thus, in the future, all employers will report any unfunded pension liability on the
face of their financial statements, and that amount may be substantial for many.
How Are the Liabilities Going to be Addressed?
The public employers task force in 2013 concludes that generally speaking, employers with well - funded
pension plans take a long -term approach to estimating investment returns, adjust their demographic and
other assumptions as needed, and consistently pay their annual required contribution in full. A clear
pension funding policy is important because it:
Lays out a plan to fund pensions;
Provides guidance in making annual budget decisions;
Demonstrates prudent financial management practices;
Reassures bond rating agencies; and
Shows employees and the public how pensions will be funded.
In examining the task force's recommendations, the Town's plan for both its pension and other post -
employment benefits appear to be in concordance as evidenced by:
• Unfunded liabilities are paid down (amortized) for both the pension plan and other post -
retirement benefits as part of the annual ARC calculation which the Town is fully funding for its
pension plan and is expected to fully fund at 100% by FY 17/18 for its other post- retirement
benefits.
Annual budget decisions and plans are developed with the Town's Five Year Financial Plan as a
tool to provide guidance and parameters for informed decision making. The Plan includes up -to-
date estimates for anticipated increases in the annual ARC for both plans. For instance,
CALPERS recently advised cities that employer pension rates could increase up to 34% in the
next ten years due to changes in assumptions about investment returns, mortality rates, and the
new pension standards requiring shorter amortization periods.
• The Town's bond ratings have remained very strong, with only a slight Moody's downgrade due
to the dissolution of redevelopment agencies statewide.
To recap, the Town has unfunded liabilities for its pension plans and other post- retirement benefits. The
unfunded liability is "amortized" or reduced over time by its inclusion in the annual ARC. The ARC in
turn is factored into the Town's employer rates on pensions and its annual contribution for out of pocket
and trust payments made for its other post- retirement benefits. Annual pension costs for both safety and
miscellaneous employees are expected to be approximately $4.2 million in FY 14/15 rising to $6.5
million in five years based on current estimates, subject to change. Annual ARC funding costs for other
post- retirement benefits are estimated to be $2.1 million for FY 14/15 and rising to $2.3 million in five
years. The expected cost increase impacts are included in the latest Five Year Plan and do affect the
availability of funding available for future Town service delivery.