Staff Report
PREPARED BY: STEVE CONWAY
Finance & Administrative Services Director/Town Treasurer
Reviewed by: Assistant Town Manager Town Attorney Finance
S:\COUNCIL REPORTS\2016\5-17-16\Pension Liability\Staff Report - Unfunded Liability FINAL.doc
MEETING DATE: 05/17/16
ITEM NO: 4
COUNCIL AGENDA REPORT
DATE: MAY 12, 2016
TO: MAYOR AND TOWN COUNCIL
FROM: LAUREL PREVETTI, TOWN MANAGER
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM THE TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES,
INCLUDING:
A. ESTABLISH A GENERAL FUND CALIFORNIA PUBLIC EMPLOYEES
RETIREMENT SYSTEM (CALPERS) RESERVE ACCOUNT.
B. APPROVE A BUDGET ADJUSTMENT TO THE PROPOSED FY 2016/17
ANNUAL OPERATING BUDGET IN AN AMOUNT NOT TO EXCEED $2.5
MILLION PAYABLE TO THE NEW CALPERS RESERVE ACCOUNT
C. REVISE THE TOWN COUNCIL RESERVE POLICY TO PROVIDE FOR A
MAXIMUM OF $300,000 IN GENERAL FUND YEAR END SAVINGS TO BE
DEPOSITED IN THE CALPERS RESERVE ACCOUNT OR USED FOR LUMP
SUM PAY DOWN AS AUTHORIZED BY TOWN COUNCIL.
D. DIRECT STAFF TO RETURN TO THE TOWN COUNCIL IN EARLY 2017 FOR
CONSIDERATION OF A CALPERS 20-YEAR “FRESH START”
ALTERNATIVE AMORTIZATION PERIOD FOR THE MISCELLANEOUS AND
SAFETY PLANS BASED UPON AN UPCOMING CALPERS 2016 VALUATION
REPORT.
RECOMMENDATION:
Accept and approve recommendations from the Town Council Finance Committee to reduce unfunded
pension liabilities, including:
1. Establish a General Fund California Public Employees Retirement System (CalPERS)
Reserve Account.
2. Approve a budget adjustment to the Proposed FY 2016/17 Annual Operating Budget in an
amount not to exceed of $2.5 million payable to the new CalPERS Reserve Account.
3. Revise the Town Council Reserve Policy to provide for a maximum of $300,000 in General
Fund Year End Savings upon fiscal year close to be deposited in the CalPERS Reserve
Account or used for lump sum pay down as authorized by Town Council.
4. Direct staff to return to the Town Council in early 2017 for consideration of a CalPERS 20-
year “Fresh Start” alternative amortization period for the miscellaneous and safety plans
based upon an upcoming CalPERS 2016 valuation report.
PAGE 2
MAYOR AND TOWN COUNCIL
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES
MAY 17, 2016
BACKGROUND:
In recent months, the Finance Committee has met with Town staff to consider various strategies to
address the approximate $35.2 million in current unfunded pension liabilities that were actuarially
calculated by CalPERS as part of the Town’s participation in the CalPERS miscellaneous (i.e., the
majority of the Town employees) and public safety (pooled) pension plans. At its April 28, 2016
meeting, the Finance Committee refined its recommendations for addressing this liability. The
recommendations to the Council from this Finance Committee meeting are the subject of this report.
DISCUSSION:
Town Pension Funding Practice
The Town of Los Gatos “pre-funds” its pension obligations, as opposed to a pay-as-go pension
retirement systems like the federal Social Security program. Town employees and the Town as
employer make contributions into CalPERS over the course of the employees’ career with the
Town. These funds are kept in trust at CalPERS and are invested in a variety of investment
instruments. The earnings are added to the pension plan trust and re-invested or paid out in benefit
payments to retirees. The objective for the pension plan is that by the time the employee retires and
starts to receive benefits, there are sufficient assets in the trust to pay the benefits. To ensure there
are funds available, the annual contribution rates are determined actuarially by CalPERS staff,
setting pension expense rates for employees for each fiscal year. The rate is set by CalPERS as a
fixed percentage of base salary paid to the employee in each respective fiscal year. The Town has
fully paid these rates on an annual basis, always contributing 100% of the actuarially required
contributions set by CalPERS. As recently as FY 2000/2001, the plan’s trust was “super-funded,”
meaning there were more assets in the plan than retirement benefits expected to be paid out.
Origins of Unfunded Pension Liability
The Town’s pension plans are separated into two trusts, one stand-alone trust for miscellaneous
employees and a “pooled” trust for public safety employees. Pension reporting standards have
evolved since 1994 with the introduction of Statement No. 27 – Accounting for Pensions by State
and Local Governmental Employers. The pension accounting standards moved from a “pay-as-you-
go” approach to one that funds and reports the pension trusts on an actuarially calculated basis. The
actuarial-based approach calculates levels of “pre-funding” needed to be made to the trust sufficient
to provide the benefits expected to be paid out to retirees in the future. CalPERS actuaries value the
pension trust assets every two years and match the asset value against the actuarially determined
liabilities (expected benefit pay-outs). The result is a match (rare), an unfunded liability, or excess
assets over liabilities (surplus). The Town's most recent valuation indicated an unfunded liability in
the amount of approximately $35.2 million total for the miscellaneous and safety plans.
PAGE 3
MAYOR AND TOWN COUNCIL
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES
MAY 17, 2016
DISCUSSION (Cont’d):
The unfunded liability is an amount actuarially determined by CalPERS based on certain
assumptions and as the assumptions change, the amount of the Town’s unfunded liability continues
to change over time. Unlike other types of debt like a loan, there is no set amount of obligation to
pay, no specific due date, and the unfunded pension liability amount fluctuates from year to year no
matter what funding policy the Town or CalPERs were to adopt.
The table below summarizes Looking below at the origin of the Town’s $35.2 million dollar
unfunded liability as of June 30, 2016. The balance consists of changes to a number of factors
shown as column headings. Explanations of each column heading factor are listed below the table.
Miscellaneous Plan
Unfunded
FY AC MC BC Special G/L Payment Liability
FY 2002/03 2,017,551$ 2,017,551$
FY 2003/04 (184,080)$ 1,833,471
FY 2006/07 1,765,980$ 3,599,451
FY 2008/09 2,664,557 2,073,175$ 8,337,183
FY 2009/10 1,727,985 10,065,168
FY 2010/11 1,749,089 794,578 12,608,835
FY 2011/12 1,754,755$ 195,748$ 14,559,338
FY 2012/13 9,370,435 23,929,773
FY 2013/14 4,255,044 (6,989,924) 21,194,893
FY 2014/15 (Adjustment only)416959 21,611,852
10,686,241$ (184,080)$ 1,765,980$ 4,595,738$ 4,135,266$ 612,707$ 21,611,852$
Safety Plan
Pool Share Unfunded
FY AC (Beg.)NA G/L G/L Payment Liability
FY 2012/13 7,387,275$ (94,365)$ 7,694,124$ 14,987,034$
FY 2013/14 4,017,392$ 73,435 (5,985,668) 467,941 13,560,134
Total All Plans 14,703,633$ (184,080)$ 1,765,980$ 4,669,173$ (1,850,402)$ 1,080,648$ 35,171,986$
AC (Assumption Change): Since FY 2002/03, actuaries from CalPERS have changed their
assumptions four times regarding factors such as retiree life expectancy, CalPERS
investment return assumptions (referred to as the “discount rate”), average retirement age,
and other criteria. Small changes to these actuarial assumptions can lead to large growth of
liabilities from year to year.
MC (Method Change): A change in actuarial method results in an impact to the unfunded
liability. This relates usually to a mathematical change in how the liabilities are amortized
over a certain time period.
BC (Benefit Change): Liabilities increase due to a change in benefits offered. In FY
2006/07, the Town changed its PERS safety and miscellaneous benefit formulas through the
collective bargaining process. This plan is in effect for classic members only, new
PAGE 4
MAYOR AND TOWN COUNCIL
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES
MAY 17, 2016
DISCUSSION (Cont’d):
employees hired after January 1, 2013, that are not former “classic” members will be
enrolled into the new Public Employees Pension Reform Act (PEPRA) pension plan.
Special and Gains/Losses (G/L): Special refers to years when trust asset losses were
significant enough to be termed “special.” The G/L is the gain or loss above the expected
rate of return for the year. Positive amounts are losses, negative amounts are gains.
Pool Share Beginning: This term is used only for the safety plan and represents the
beginning actuarially determined Town share of the public safety pool’s unfunded liability.
This is determined by the same factors as “assumption changes and gain/loss” as shown in
the miscellaneous plan at the time the Town’s safety member plan was merged by State law
into a “pooled” plan.
Payment: Payment reflects changes introduced by CalPERS to “smooth” pension payments
(i.e., make consistent in terms of cost impact from year to year).
As seen above, until FY 2002/03 the Town had no actuarially determined “unfunded liability.”
However, as can be seen in the Miscellaneous Plan, beginning in FY 2002/03 an unfunded liability
amount began to appear in the CalPERS calculations. The $2.017M amount shown for FY 2002/03
results from an actuarial calculation made by CalPERS termed an assumption change. Positive
amounts in each column represent unfunded liabilities for the Town and counterintuitively they are
“bad” from a liability perspective. Negative amounts in each column are good and are taken as
actuarial credits against the “bad” positive amounts.
Persistence of the Unfunded Liability
Upon review of the history of the calculated unfunded liability, the Finance Committee noted the
recurring nature of the unfunded liability. For example, if the Town were to use a substantial
amount of its cash balances to pay off the entire $35.2 million balance, it would only disappear for a
brief time and the Town would continue to be required to make future payments as new calculated
liabilities are determined by CalPERS. Based on current information received from CalPERS, a
new loss amount (i.e. “G/L”) for FY 2014/15 will be added (like the other G/L fiscal years columns
shown in the table above) to be amortized over a 20-year period. Even with a full payoff, this new
FY 14/15 Gain/Loss amount would be a new unfunded liability which must be paid off over time or
with another “lump sum” payoff.
Recommended Approach to Reduce the Liability
Because the liability is a “valuation” amount that will change positively or negatively each year
depending upon updated actuarial calculations, the Committee examined several options to reduce
the unfunded pension liability in a prudent and fiscally conservative manner. The Committee
considered four approaches: (1) status quo, (2) lump sum payments, (3) re-amortization (i.e., what
CalPERS terms a “Fresh Start”), and (4) a combination of lump sum and “Fresh Start.” Staff
PAGE 5
MAYOR AND TOWN COUNCIL
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES
MAY 17, 2016
DISCUSSION (Cont’d):
reports made to the Finance Committee are attached to this report as Attachments 1, 2, and 3 and
provide additional detailed discussion of each alternative.
Each option was evaluated against its ability to:
Preserve cash liquidity by allowing funds to be readily available for operations and capital
improvements while still paying down the liability;
Minimize risk of loss to principal for lump sums paid into the pension trust account due to
adverse investment market timing ;
Ensure that increased annual payments resulting from a shorter pay-back period (Fresh Start)
are expected to be affordable in future operating budgets;
Evaluate pay-downs to ensure no substantial impacts to future service delivery and/or
monies available for critical infrastructure improvements.
Upon discussion with staff, the Finance Committee selected the fourth option to be recommended for
Council consideration. This option is a blend of the lump sum pay-down ($2.0 million) and the “Fresh
Start” strategy which would shorten the pay-back years from approximately 30 years down to 20 years.
Concurrent with that strategy will be the implementation of a change to the existing General Fund
Reserve Policy (see Attachment 4) to include the establishment of a $500,000 CalPERS reserve and a
re-direction of up to $300,000 annually from fiscal year end savings (that would otherwise be placed
into the capital reserve each year) into the newly established reserve account. These reserve funds will
be available to pay lump sum pay downs of unfunded liability in the future or used as a funding source
for the last five years beginning in FY 2031/32 when payments under the 20-year “Fresh Start” increase
substantially.
General Fund Pension Liability (CalPERS) Reserve Account
Critical to the successful implementation of any “Fresh Start” alternative is the establishment of a
General Fund reserve. Staff recommends funding this new reserve with a beginning balance of
$500,000 and contributing annual amounts of up to $300,000 from annual future fiscal year savings.
Each year, the Town Council would decide the amount to place into the CalPERS Reserve and
determine if the money should be held there or used to pay down the liability in a lump sum pay
down. Reserve amounts not used for lump sum pay downs would accumulate and not be withdrawn
from the account until the later years of the “Fresh Start” new amortization payment period. This
action is necessary because in the last five years of the 20-year Fresh Start, the annual payments
required increase substantially and would cause a strain to the annual budget process were there not
reserve fund amounts there to step in and provide a supplemental funding source.
Source of Funds for CalPERS Reserve Account
The Town had FY 2014/15 savings in an amount of $5.8 million. To date, this savings has been
allocated to Almond Grove, the new Community Choice Energy Joint Powers Authority, and future
programmed annual transfers to the capital program leaving a remaining balance of approximately
PAGE 6
MAYOR AND TOWN COUNCIL
SUBJECT: ACCEPT AND APPROVE RECOMMENDATIONS FROM TOWN COUNCIL
FINANCE COMMITTEE TO REDUCE UNFUNDED PENSION LIABILITIES
MAY 17, 2016
DISCUSSION (Cont’d):
$2.5 million. If not redirected by Town Council under the current Reserve Policy the remaining
funds would reside in the General Fund Reserve for Capital Account. Should Council approve, staff
is recommending that up to $2.5 million of the estimated remaining balance be designated for the
CalPERS Reserve Account.
RECOMMENDATION:
For the reasons explained in this report, the Finance Committee recommends that the Town Council
take the following actions to reduce unfunded pension liabilities, including:
1. Establish a General Fund California Public Employees Retirement System (CalPERS)
Reserve Account.
2. Approve a budget adjustment to the Proposed FY 2016/17 Annual Operating Budget in the
amount not to exceed of $2.5 million payable to the new CalPERS Reserve Account.
3. Revise the Town Council Reserve Policy to provide for a maximum of $300,000 in General
Fund Year End Savings upon fiscal year close to be deposited in the CalPERS Reserve
Account or used for lump sum pay down as authorized by Town Council.
4. Direct staff to return to the Town Council in early 2017 for consideration of a CalPERS 20-
year “Fresh Start” alternative amortization period for the miscellaneous and safety plans
based upon an upcoming CalPERS 2016 valuation report.
ALTERNATIVES:
Staff provided three additional alternatives to the recommended blended approach (Status Quo, Lump
Sum Pay Down, and Fresh Start), all of which are discussed in the attached staff reports to the Finance
Committee with the advantages and disadvantages of each option discussed in more detail.
FISCAL IMPACT:
If Council implements the recommended blended option, CalPERS actuarial estimates indicate an
estimated $4.7 million in total interest savings and a net present value savings of $2.6 million resulting
from a $2.0 million lump sum drawdown and the implementation of the 20-year CalPERS “Fresh Start”
option.
Attachments:
1. Finance Committee Staff Report 1-22-2016
2. Finance Committee Staff Report 2-18-2016
3. Finance Committee Staff Report 4-27-2016
4. Proposed Modifications to the Town Council Reserve Policy