Loading...
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 N:\MGR\AdminWorkFiles\Council Committee - FINANCE\2018\2-12-2018\Item 3 Shortened Amortization Schedule.docx 4/11/2018 8:43 AM 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.