Attachment 1
PREPARED BY: STEVE 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: 2/12/2018
ITEM NO: 3
ITEM NO: 11
DATE: FEBRUARY 8, 2018
TO: COUNCIL FINANCE COMMITTEE
FROM: LAUREL PREVETTI, TOWN MANAGER
SUBJECT: RECOMMEND TO THE TOWN COUNCIL A REDUCED AMMORTIZATION
STRATEGY TO OBTAIN INTEREST SAVINGS AND LOWER THE TOWN’S
UNFUNDED LIAILITIES
RECOMMENDATION:
Recommend to the Town Council a reduced amortization strategy to obtain interest savings and
lower the Town’s unfunded liabilities.
BACKGROUND:
On January 22, 2016, the Finance Committee discussed the Town’s unfunded liabilities with
respect to retirement benefits. During this discussion , the Finance Committee asked Town staff
to return to the Committee with various pay off options for the pension -related unfunded
actuarial liability (UAL). On February 18, 2016, staff presented various pay off options to the
Finance Committee which included reduced amortization strategies or a “fresh start .” The
Town currently has a 30-year amortization. A fresh start is a CalPERS term for re-amortizing the
current unfunded liability over a shorter period of time. There are multiple fresh start choices
provided by CalPERS, but for purposes of this analysis, the Town utilized data for a 20-year fresh
start and a 15-year fresh start provided in the actuarial valuations. The Committee requested
that these options be provided to Council for its consideration during the 2016/17 budget
discussion. It was determined that the increased pension costs associated with a shorter
amortization period were not tenable for the Town’s finances at the time.
PAGE 2 OF 6
SUBJECT: RECOMMEND TO THE TOWN PENSION AND OPEB TRUSTS OVERSIGHT
COMMITTEE REDUCED AMMORTIZATION STRATEGIES TO OBTAIN INTEREST
SAVINGS AND LOWER THE TOWN’S UNFUNDED LIAILITIES
DATE: FEBRUARY 8, 2018
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BACKGROUND (Continued):
Since that time, the Town Council has made a concerted effort to accumulate additional
funding to increase options for addressing the Town’s unfunded liability. On December 19,
2017, the Town Council approved an expenditure budget adjustment in the amount of
$3,388,913 for deposit into the newly established 115 Pension Trust. This includes the
previously allocated excess pension reserves total of $1.5 million and the previously
unallocated pension funds total of $1.8 million held in a deposit account. In addition to the
aforementioned monies, the Town Council approved another $1.0 million to address pension
related liabilities as part of the FY2017-2018 adopted budget.
There are a multitude of variables when selecting an amortization method ; however, there is
peer consensus around best practices for the length of amortization period for investment
gains/losses. In selecting an amortization period , plan sponsors attempt to balance the twin
goals of demographic matching and contribution volatility management. Demographic
matching refers to the goal of intergenerational equity or rather, equitable allocation of cost
among generations. Contribution volatility management refers to longer amortization periods
having less volatile impacts on contribution rates and shorter amortization periods having more
volatility. In addition, longer amortization periods tend to incur negative amortization.
Negative amortization is when amortization payments are not sufficient to cover the interest
accruing on the UAL. The Society of Actuaries and Conference of Consulting Actuaries
recommend that amortization of gains/losses should be completed over a period of no more
than 15 to 20 years. In addition the Government Finance Officers Association (GFOA)
recommends that amortization should never exceed 25 years and ideally fall within a 15 to 20
year range.
With the advent of the aforementioned budget actions, staff has reanalyzed the ability of the
Town to consider reduced amortization strategies and the potential for associated interest
savings.
DISCUSSION:
Staff performed analysis on two options for achieving interest savings either through the direct
fresh start approach provided by CalPERS or through a Council Policy which would closely
approximate a fresh start. Following are the results of both analyses.
CalPERS Fresh Start
The actuarial valuations provided by CalPERS for both the Miscellaneous and Safety plans
include tables illustrating fresh start options. The tables provide the current 30-year
PAGE 3 OF 6
SUBJECT: RECOMMEND TO THE TOWN PENSION AND OPEB TRUSTS OVERSIGHT
COMMITTEE REDUCED AMMORTIZATION STRATEGIES TO OBTAIN INTEREST
SAVINGS AND LOWER THE TOWN’S UNFUNDED LIAILITIES
DATE: FEBRUARY 8, 2018
N:\MGR\AdminWorkFiles\Council Committee - FINANCE\2018\2-12-2018\Item 3 Shortened Amortization Schedule.docx 4/11/2018 8:43 AM
DISCUSSION (Continued):
amortization schedule and the associated annual UAL payments, and similar tables for both a
20-year amortization and a 15-year amortization. For purposes of this exercise, staff only
evaluated the 20-year option. The following table illustrates the potential interest savings of a
20-year fresh start for both the miscellaneous and safety plans.
Amortization
Scenarios
30 Year
Amortization
Miscellaneous
20 Year
Amortization
Miscellaneous
30 Year
Amortization
Safety
20 Year
Amortization
Safety
Total UAL
Payment
66,717,539 62,788,431 51,351,503 46,797,752
Total Interest
Paid
35,458,167 31,529,059 28,053,128 23,499,379
Estimated
Interest Savings
3,929,108 4,533,749
As the table above illustrates, the combined interest savings for the two plans with conversion
to a 20-year amortization is approximately $8.5 million.
In addition to the analysis of the interest savings, staff performed an additional analysis to
determine the budgetary impact associated with conversion to a 20-year amortization. The
reduction in years to amortize the unfunded liability is an implicit strategy to commit more
money to paying the unfunded liability on an annual budgetary basis. The additional annual
payments in turn yield interest cost savings and the outstanding liability being extinguished
sooner. The following table illustrates the annual budgetary change from the current 30 -year
amortization to a 20-year amortization.
As the table on the next page illustrates, the total additional contributions to address the UAL
that Council would need to commit for the conversion of both plans is approximately $13.0
million over the twenty year period.
It should be noted that the CalPERS tables only reflect the UAL payment. The change to a
shorter amortization period would also impact the normal cost payments which are
significantly less than the UAL payments. The normal cost payments and UAL payments are
subject to change on an annual basis as the CalPERS Board may take future actions to modify
the discount rate, actuarial assumptions, etc. The estimated annual additional cost to the Town
PAGE 4 OF 6
SUBJECT: RECOMMEND TO THE TOWN PENSION AND OPEB TRUSTS OVERSIGHT
COMMITTEE REDUCED AMMORTIZATION STRATEGIES TO OBTAIN INTEREST
SAVINGS AND LOWER THE TOWN’S UNFUNDED LIAILITIES
DATE: FEBRUARY 8, 2018
N:\MGR\AdminWorkFiles\Council Committee - FINANCE\2018\2-12-2018\Item 3 Shortened Amortization Schedule.docx 4/11/2018 8:43 AM
DISCUSSION (Continued):
ranges from $880,000 in 2018 to $3,700,000 in 2037. The combined budgetary impact to the
current five year forecast is approximately $830,000 highlighting that most of the budgetary
effect would occur in the later years.
Amortization
Years
Miscellaneous
Difference Safety Difference Total Difference
2018 -338,711 -543,959 -882,670
2019 -75,148 -307,913 -383,061
2020 53,964 -179,333 -125,369
2021 210,212 -35,550 174,662
2022 322,451 57,634 380,085
2023 332,125 59,363 391,488
2024 342,089 61,144 403,233
2025 16,359 62,979 79,338
2026 46,114 64,868 110,982
2027 47,495 66,813 114,308
2028 -212,915 68,818 -144,097
2029 -219,297 70,882 -148,415
2030 -225,877 73,008 -152,869
2031 -603,660 75,199 -528,461
2032 -750,395 -43,986 -794,381
2033 -1,143,640 -170,389 -1,314,029
2034 -1,364,534 -349,380 -1,713,914
2035 -1,597,655 -538,958 -2,136,613
2036 -1,843,531 -739,596 -2,583,127
2037 -1,953,613 -1,806,543 -3,760,156
Totals -8,958,167 -4,054,899 -13,013,066
PAGE 5 OF 6
SUBJECT: RECOMMEND TO THE TOWN PENSION AND OPEB TRUSTS OVERSIGHT
COMMITTEE REDUCED AMMORTIZATION STRATEGIES TO OBTAIN INTEREST
SAVINGS AND LOWER THE TOWN’S UNFUNDED LIAILITIES
DATE: FEBRUARY 8, 2018
N:\MGR\AdminWorkFiles\Council Committee - FINANCE\2018\2-12-2018\Item 3 Shortened Amortization Schedule.docx 4/11/2018 8:43 AM
DISCUSSION (Continued):
The initial conversion could be absorbed into the Town’s annual budget and/or through the use
of the IRS 115 Pension Trust funds. Increases in later years will be programmed into the budget
forecasts and budgeted for accordingly through the annual budget process. If the Town elects
to reduce its amortization period, the Town is committed to stay with this period and its
associated payment schedule. CalPERS does not allow expansions of the amortization period
once it is reduced.
Council Policy to Make Additional Lump Sum Payments
Another option is a funding strategy that would incorporate a Council-approved unfunded
pension liability funding plan that will require the Town to annually appropriate additional
lump-sum payments to provide for a quicker pay down of the unfunded liability “bases .” Given
the current financial forecast, staff estimates that the Town could make additional payment of
$500,000 to $800,000 per year for 20 years to accelerate the reduction of the UAL. With this
approach, the Town would save additional interest over the fresh start option due to making
level annual payments versus escalating annual payments.
The majority of the Town’s current amortization bases are amortized over a 30-year repayment
period. By applying annual additional voluntary lump sum payments, the Town staff expects
that the Town could make lump sum payments to pay off the unfunded liability over the same
reduced twenty year period as the fresh start program. Staff expects that under this method,
the actual total payments including the additional lump-sum amounts will be higher in earlier
fiscal years of the twenty-year repayment period and less in the outer years compared to the
fresh start. This is because of the escalating payment levels used by CalPERS actuaries for the
fresh start amortization process.
The advantage of this strategy is that it is more flexible and would allow the Town to adjust its
additional lump sum payments should the Town incur a major unforeseen financial setback in a
future year. A Council Policy would establish the rules for the payment schedule, including
potential deferrals under a fiscal setback. After recovery, the Policy would require the Town to
not only get back on the payment schedule but also make up the deferred payment s. Under
the fresh start alternative, there is currently no provision for extending amortization years
without declaring a fiscal emergency under State law.
Staff believes the annual additional lump-sum payments could be achieved through a
combination of the annual budget process and utilizing accumulated funds in the 115 Trust.
The end result is that if the Town is disciplined in its approach through a new legally adopted
funding policy, the approximate same level of interest savings could be
PAGE 6 OF 6
SUBJECT: RECOMMEND TO THE TOWN PENSION AND OPEB TRUSTS OVERSIGHT
COMMITTEE REDUCED AMMORTIZATION STRATEGIES TO OBTAIN INTEREST
SAVINGS AND LOWER THE TOWN’S UNFUNDED LIAILITIES
DATE: FEBRUARY 8, 2018
N:\MGR\AdminWorkFiles\Council Committee - FINANCE\2018\2-12-2018\Item 3 Shortened Amortization Schedule.docx 4/11/2018 8:43 AM
DISCUSSION (Continued):
achieved over a twenty- year period as if the Town had formalized the process with CalPERS by
committing the Town to a 20 Year fresh start re-amortization strategy.
CONCLUSION:
With the advent of the aforementioned 115 trust budget actions, staff believes the Town
currently has the ability to consider reduced amortization strategies and the potential for
associated interest savings. A reduced amortization strategy will provide for interest rate
savings, intergenerational equity, and avoidance of negative amortization. The reduction in
years to amortize the unfunded liability is an implicit strategy to commit more money to paying
the unfunded liability. The additional annual payments in turn yield interest cost savings and
the outstanding liability being extinguished sooner.
COORDINATION:
This report was coordinated with the Town Manager’s Office, the Town Attorney’s Office, and
the Finance Department.
FISCAL IMPACT:
Depending upon the amortization option recommended, staff estimates potential total interest
savings in the amount of approximately $8.5 million over a twenty year period. Funding for
increased level of future payments required under either option will need to be incorporated
into the Town’s financial forecast and programmed through the annual budget process, utilizing
additional potential resources such as the Town’s newly approved IRS Section 115 Pension
Trust and anticipated annual budget savings to provide a level of assurance that adequate cash
flow is available to meet the higher level of payments needed as a result of the shorter
amortization period.