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Addendum�pW N OF t 8 s��os 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.