HomeMy WebLinkAbout2023-06-06; City Council; ; Report on Options Related to a Section 115 Pension TrustCA Review JRT
Meeting Date: June 6, 2023
To: Mayor and City Council
From: Scott Chadwick, City Manager
Staff Contact: Zach Korach, Finance Director
Zach.Korach@carlsbadca.gov or 442-339-2127
Subject: Report on Options Related to a Section 115 Pension Trust
Districts: All
Recommended Action
Receive an informational report on options related to a Section 115 Pension Trust and provide
direction to staff as necessary.
Executive Summary
As a result of the significant increase in retirement costs based on CalPERS’ recent actuarial
forecasts, the city may elect to establish and fund a secondary pension trust, specifically a
Section 115 Trust, to assist in stabilizing the potential impact of pension cost increases on the
city’s operating budget. The trust would enhance the city’s control over assets, serve as a
pension rate stabilizer, have a potential for higher investment return than the General Fund
and would increase diversification from the assets held by CalPERS.
Explanation & Analysis
The California Public Employees' Retirement System
The city provides a defined benefit pension to its employees through the California Public
Employees' Retirement System (CalPERS). Retiree pensions are calculated using a formula
based on an employee’s age, earnings and years of service, and are funded by a combination of
employer contributions, employee contributions and investment earnings. Each year, the
employer’s contributions are determined by CalPERS based on actual investment returns and
actuarial assumptions including expected investment returns, inflation rates, salaries,
retirement ages and life expectancies.
CALPERS’ actuarial valuation assessed both the city’s miscellaneous and safety pension plans’
abilities to meet their pension obligations. As of June 30, 2021, the city has a total actuarial
liability of $828.8 million, an unfunded liability of $116.0 and a funded ratio of 86%. The
unfunded liability is the difference between pension liabilities and assets while the funded ratio
is the comparison of pension assets to liabilities.
Poor investment returns during the Great Recession and actuarial assumption changes have
increased the gap between pension assets and liabilities, resulting in the CalPERS funded ratio
June 6, 2023 Item #13 Page 1 of 6
falling below desired levels. As a result, on Dec. 21, 2016, the CalPERS Board of Administration
voted to lower CalPERS’ assumption of its expected investment returns, referred to as its
discount rate, from 7.5% to 7.0% over three years. The discount rate used by CalPERS is not the
same as the target rate of return, but is very closely related. Although this improved the
likelihood of CalPERS investments earning the assumed rate of return, it significantly increased
the city’s pension costs.
In November 2021, CalPERS completed its quadrennial asset liability management process,
which reviewed investment strategies and actuarial assumptions. At those meetings, the
CalPERS Board approved a discount rate reduction from 7.0% to 6.8% because the fiscal year
2020-21 investment gain of 21.3% triggered CalPERS’ Funding Risk Mitigation Policy. When
CalPERS achieves certain levels of return in excess of its target rate, its policy directs portions of
the return be used to fund the additional costs associated with reductions in its target rate in
future periods. While lowering the discount rate increases the likelihood of CalPERS achieving
its target rate of return, it also increases the city’s costs.
CalPERS’ latest actuarial reports, which were current as of June 30, 2021, reflect a funded status
of 86%. This represents a significant increase in funded status compared to the previous year
and is driven by a 21.3% investment return during FY 2020-21. However, as of July 20, 2022,
CalPERS has released preliminary return rates of -6.1% for FY 2021-22, which effectively
neutralizes the positive investment return experienced in FY 2020-21. Impacts from the -6.1%
investment performance in FY 2021-22 will impact the city’s required contributions in FY 2024-
25.
CalPERS historical investment returns
Note: FY22 performance is preliminary and unaudited.
Since FY 2001-02, CalPERS’ investment performance has experienced significant volatility. While
it is important to notice the overall level of return, it is equally important to compare the
annual level of return compared to the discount rate, the assumed rate of return. Since 2000,
CalPERS has reduced its assumed rate of return from 8.25% to 6.8%, a difference of 145 basis
June 6, 2023 Item #13 Page 2 of 6
25%
2""
15%
'"" ~ C: a 5%
~ <: "" " E t: " -5% > .!:
-;;; :, -10% C: C: -,:
-15%
-20%
-25%
-30%
-- -----I -■ -I _ I
I ■ I
FY02 FY03 FY04 FYOS FY06 FY07 FY08 FY09 FYlO FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22
-Annual Investment Return --Discount Rate
points. For reference, every 25 basis points1 currently represents approximately $50 million in
future contributions the city would have to pay.
Over the last six years, the city has taken proactive steps to address pension contribution
volatility and manage the unfunded liability. Since FY 2016-17, the city has contributed $56.4
million in additional discretionary payments to CalPERS, which has significantly helped increase
the funded status of the plan. While contributing additional funds to CalPERS saves the city
future interest costs, there is also a higher risk of pension rate volatility during periods of poor
investment performance by CalPERS. To mitigate this risk, as well as the potential impacts of
CalPERS further reducing its discount rate, many agencies in California have turned to what are
known as Section 115 trusts as a solution.
Pension Rate Stabilization Program
A Section 115 trust is a tax-exempt investment tool that allows local governments to pre-fund
pension and retiree health costs. Under the Internal Revenue Code, once contributions are
placed into the trust, assets from the trust can only be used for retirement plan purposes.
Withdrawals may be made to either reimburse the city for retirement system contributions or
to directly pay CalPERS.
The benefits of a Section 115 trust include the following:
• Local control over assets: The city controls the contributions, withdrawals, investment
strategy, and risk level of assets in the trust.
• Pension rate stabilization: Assets can be transferred to CalPERS at the city’s discretion to
pay for its normal cost or its unfunded actuarial liability contributions and can be used
to reduce or eliminate large fluctuations in the city’s pension costs.
• Potential for higher investment return than General Fund: Investment limitations that
apply to the city’s General Fund assets under Government Code 53601 do not apply to
trust assets.
• Diversification: Trust assets will be diversified from CalPERS’ investments.
The Section 115 trust will be available to help offset future increases in pension costs while
minimizing the impact on the city’s operating budget. It will provide the city with an alternative
to sending funds directly to CalPERS while allowing the flexibility for the city to make additional
payments to CalPERS to reduce its unfunded actuarial liability at its discretion.
Pension contribution volatility is a significant concern for many cities in California. More than
133 cities and towns, 64 special districts, 49 education districts, and 25 counties have
established a Section 115 Trust for pensions. In San Diego County, the cities of Chula Vista,
Coronado, Escondido, El Cajon, La Mesa, Lemon Grove and Solana Beach have adopted Section
115 trusts.
Funding Strategy
If directed by the City Council, staff would recommend a funding strategy that uses a phased
approach, with an initial contribution of approximately $15 million from the General Fund. In
the long term, the trust is projected to grow through investment returns and additional
contributions each fiscal year.
1 A basis point is one hundredth of 1% and used to express differences in interest rates.
June 6, 2023 Item #13 Page 3 of 6
Subsequent annual contributions would be determined by calculating the difference between
CalPERS’ current discount rate and a more conservative rate determined by the city. The city
has modeled alternative discount rate scenarios of 6.0%, 6.25% and 6.5%. The lower the
discount rate, the more the city pays to CalPERS. The investment community has forecasted
long-term expected rates of return between 6.0% and 6.5% and CalPERS’ investment
consultant, Wilshire Associates, has forecasted a long-term expected rate of return of 6.2%.
Staff recommend using a more conservative discount rate of 6.25%.
Projected 20-year CalPERS costs at lower discount rates
Note: Cost increases are with respect to cost estimates assuming a 6.8% discount rate The funding goal would be for the city to have sufficient assets in the trust to be prepared for
further discount rate reductions by CalPERS. Staff are recommending the initial funding of $15
million and additional contributions of $6 million per year for the next four fiscal years to
maximize the benefits of the trust and, over a 20-year period, accumulate approximately $116
million in assets to help fund the increased costs associated with a possible reduction in the
discount rate by CalPERS (from 6.8% to 6.25%). The following graph illustrates the projected
value of assets for the trust, assuming varying rates of return.
Projected value of assets assuming 1.38% and 6.25% investment returns
$-
$20
$40
$60
$80
$100
$120
$140
FY
2
3
FY
2
4
FY
2
5
FY
2
6
FY
2
7
FY
2
8
FY
2
9
FY
3
0
FY
3
1
FY
3
2
FY
3
3
FY
3
4
FY
3
5
FY
3
6
FY
3
7
FY
3
8
FY
3
9
FY
4
0
FY
4
1
FY
4
2
Pr
o
j
e
c
t
e
d
v
a
l
u
e
o
f
a
s
s
e
t
s
(
i
n
mi
l
l
i
o
n
s
)
1.38% investment return 6.25% investment return
June 6, 2023 Item #13 Page 4 of 6
900
+$166M
800 +$116M
700 +$64M
600
~ C ~ 500
~ 400 .,,.
300
200
100
0
6.80% 6.50% 6.25% 6%
--
After the initial funding, the trust will serve as a stabilization tool to minimize potential impacts
to the city’s operating budget. When required contributions to CalPERS are lower than
projected, additional savings may be transferred to the trust. When required contributions to
CalPERS are higher than projected, the difference may be funded by the trust. The city will
continue to proactively address the unfunded liability and increased pension costs through
annual deposits to the trust. Any deposits or withdrawals from the trust will require the
approval of the City Council.
Trust administrator & investment strategy
With the establishment of a Section 115 Trust, the city would need to hire an outside trust
administrator. Trust administrators are responsible for administering the trust as well as
deploying the investment portfolio for the assets contributed to the trust. The investment
strategy itself would be at the sole discretion of the City Council, governed by a City Council-
approved investment policy, and managed by the City Treasurer. If directed, city staff would
issue a request for proposal and return to the City Council with the recommendation for
selecting the trust administrator and proposing a pension investment policy that would govern
the trust’s investment strategy, asset allocation and risk tolerance.
Options
Staff provide the following options for the City Council’s consideration:
1. Provide direction to staff to pursue the establishment of a Public Agencies Post-
Employment Benefits Section 115 Trust.
Pros
• If CalPERS reduces its discount rate, the city will have funds available to mitigate
fiscal impacts to the city’s operating budget.
• Local control over assets - The city controls the contributions, withdrawals,
investment strategy, and risk level of assets in the trust.
• Pension rate stabilization - Assets can be transferred to CalPERS at the city’s
discretion to pay for its normal cost or its unfunded actuarial liability
contributions and can be used to reduce or eliminate large fluctuations in the
city’s pension costs.
• Potential for higher investment return than General Fund - Investment
limitations that apply to the city’s General Fund assets under California
Government Code 53601 do not apply to trust assets.
• Trust assets will be diversified from CalPERS’ investments.
Cons
• Funds contributed to the trust are restricted to pension-related items and
cannot be used for other purposes.
2. Do not provide direction to pursue the establishment of a Public Agencies Post-
Employment Benefits Section 115 Trust.
Pros
• Funds that would have otherwise been contributed to the trust could be used for
other purposes.
June 6, 2023 Item #13 Page 5 of 6
Cons
• If CalPERS reduces its discount rate, the city may be less prepared to mitigate
fiscal impacts to the city’s operating budget.
• Continuing to discretionarily contribute to CalPERS reduces the city’s local
control over assets.
• Investment returns in the General Fund may be lower than returns in the trust.
• Contributions will continue to be fully concentrated under CalPERS’
management.
Staff recommend Option 1.
Fiscal Analysis
Providing direction to further pursue the establishment of a Section 115 Trust has no
immediate fiscal impact. If a trust is eventually established, contributions to the trust will move
the funds from the “unassigned” fund balance to the “restricted” fund balance in the General
Fund. These funds will be available to mitigate budgetary pressures resulting from potential
volatility in CalPERS’ required contributions made by the city. The city will pay fees for trust
administration and investment management. The fees are calculated on a sliding scale between
0.25% down to 0.10% depending on the total value of assets in the trust. The fees will be
deducted from trust assets.
Next Steps
Staff will issue a request for proposals for trust administration services and return to the City
Council with a recommendation and the necessary documents to formally establish the trust.
Environmental Evaluation
In keeping with California Public Resources Code Section 21065, this action does not constitute
a project within the meaning of the California Environmental Quality Act in that it has no
potential to cause either a direct physical change in the environment, or a reasonably
foreseeable indirect physical change in the environment, and therefore does not require
environmental review.
Exhibits
None.
June 6, 2023 Item #13 Page 6 of 6
Tammy Cloud-McMinn
From:
Sent:
To:
Subject:
Mary Real <anewday4me2020@gmail.com>
Tuesday, June 6, 2023 12:13 PM
All Receive -Agenda Item # i:3
For the Information of the:
. pTY COUNCIL
Date&:/lp/i(!) CA v CC ✓
CM ✓ACM v ocMrn ✓
City Clerk; Council Internet Email; Scott Chadwick; Geoff Patnoe; Kyle Lancaster; Mick
Calarco; Mary Real
Item 13 Carlsbad City Council 6-6-2023. Meeting
Thank YOU City Council for protecting us from the African Violet Society and all other groups who were going to
bombard you with requests to fly their flags at the Carlsbad City Council meetings! It is nice to see the City Council
leadership in action on this matter. I just wish that the Council could evaluate the City Staff reports by Sheila Cobian on
how to protect the Council by legally setting and agreeing on a policy so that the City Council could actually make an
informed decision and Lead the City. We need results and real leadership from management.
Why are managers not contributing more money to their pension plans? ( Especially those managers who get over
120,000 dollars per year? Leadership by example?
Why does the City Manager allow the Library Director to start one hour early Mon. thru Thur. and close two hours
earlier? Why is the Library CLOSED on Sunday? Staff could now cover 7 days a week??? Does the City want to serve the
people or make life easy for the Staff and save money for the
City? Is it time for the City Council to
Lead and Serve the Community by advising the City Manager to review the staffing decisions for the Library and
definitely for Park and Rec. (Where does the money go, Director Lancaster?) Is it time to serve the Community with
some long range planning instead of putting 14 Million in Employee Pensions with no help from higher paid employees?
Thank you,
Mary Lucid
CAUTION: Do not open attachments or click on links unless you recognize the sender and know the content i
safe.
1
Report on Options Related to
a Section 115 Pension Trust
Zach Korach, Finance Director
1
{ City of
Carlsbad
TODAY’S PRESENTATION
•CalPERS background and history
•City pension plan status
•Challenges
•Section 115 Trust
2
{ City of
Carlsbad
CALPERS
•City provides defined benefit pension to its employees
through CalPERS
•Employee’s age, earnings and years of service
•Pension benefits are funded by employer and employee
contributions and CalPERS’ investment earnings
•CalPERS dictates annual required contributions based on
actual investment returns and actuarial assumptions
3
ITEM 13: Section 115 Trust
HOW IS THE PENSION LIABILITY CALCULATED?
COMPENSATION
LEVELS
EMPLOYEE
CENSUS DATA
ASSUMED RATE
OF RETURN
RATE OF
INFLATION
LIFE
EXPECTANCY
4
••• 1fJ l·•·I
HOW IS THE PENSION PLAN FUNDED
INVESTMENT EARNINGS
CONTRIBUTIONS
RE
T
I
R
E
M
E
N
T
B
E
N
E
F
I
T
S
RE
T
I
R
E
M
E
N
T
B
E
N
E
F
I
T
S
GAP
5
INVESTMENTS PERFORM
AS EXPECTED INVESTMENTS
UNDERPERFORM
DISCOUNT RATE
The factor for which pension benefits are estimated
in the future.
6
ITE IM 13: Sect i on 115 Trust
DISCOUNT RATE
CONTRIBUTIONS
DISCOUNT RATE PROBABILITY OF MEETING
INVESTMENT RETURN
RISK
When the discount rate is reduced…
…contributions and probability of meeting investment return increase and risk decreases
7
=
8
CALPERS FUNDED STATUS (STATEWIDE)
uiil _ . ratio ( o}
1993-2000
Stron @«IIIIClll'l}I S8400 AB(H6
Dot.com er 5h
81
Disco n
rn lawe reo
8.25: -• 5%
61%
,2007-2009
Great · . Ci!SSiDn
16%
P PRAlaw
Increased f
I'
@~pedan
17
Discount·
When target rate of return is not achieved, city contributions increase and strain city resources
-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22
An
n
u
a
l
I
n
v
e
s
t
m
e
n
t
R
e
t
u
r
n
s
Annual Investment Return Discount Rate
CALPERS RETURNS HISTORY
9
I I I ■ -I
--
CITY OF CARLSBAD
•City Council Policy No. 86
•FY 11-12: Established 2nd Benefit Tier at 2% @ 60
•FY 16-17: $9 million
•FY 17-18: $11 million
•FY 18-19: $20 million
•FY 20-21: $10 million
•FY 21-22: $6.4 million
10
IIT EIM 13: S•e c t i o n 1 1 5 Trust
{ City of
Carlsbad
CITY PENSION PLAN STATUS –JUNE 30, 2021
$-
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
$30,000,000
FY 2023-24 FY 2024-25 FY 2025-26 FY 2026-27 FY 2027-28 FY 2028-29
Estimated Pension Payment Schedule
Normal Cost Unfunded Liability
June 30, 2020 June 30, 2021
Present Value of Projected Benefits 493,021,289$ 530,619,478$
Entry Age Normal Accrued Liability 430,502,885$ 456,814,169$
Market Value of Assets 330,903,112$ 404,515,911$
Unfunded Accrued Liability 99,599,773$ 52,298,258$
Funded Ratio 76.9%88.6%
June 30, 2020 June 30, 2021
Present Value of Projected Benefits 420,888,640$ 458,282,303$
Entry Age Normal Accrued Liability 343,243,950$ 372,017,358$
Market Value of Assets 251,416,320$ 308,342,667$
Unfunded Accrued Liability 91,827,630$ 63,674,691$
Funded Ratio 73.2%82.9%
June 30, 2020 June 30, 2021
Present Value of Projected Benefits 913,909,929$ 988,901,781$
Entry Age Normal Accrued Liability 773,746,835$ 828,831,527$
Market Value of Assets 582,319,432$ 712,858,578$
Unfunded Accrued Liability 191,427,403$ 115,972,949$
Funded Ratio 75.3%86.0%
CalPERS Miscellaneous Plan Status
CalPERS Safety Plan Status
11
• •
ESTIMATED PENSION PAYMENT SCHEDULE
AS OF JUNE 30, 2022
$-
$5,000,000
$10,000,000
$15,000,000
$20,000,000
$25,000,000
$30,000,000
$35,000,000
FY 2023-24 FY 2024-25 FY 2025-26 FY 2026-27 FY 2027-28 FY 2028-29
Normal Cost Unfunded Liability 12■ ■
CHALLENGES
STATE AND
CALPERS CONTROL
UNDERFUNDED
PENSION SYSTEM
VOLATILITY RISK
13
{ City of
Carlsbad
SOLUTION: SECTION 115 TRUST
GIVES CITY LOCAL
CONTROL OF
PENSION ASSETS
PREFUNDS
FUTURE
PENSION COSTS
STABILIZES
VOLATILITY IN
PENSION COSTS
DIVERSIFIES
PENSION ASSETS
FROM CALPERS
14
SECTION 115 TRUST
•Tax -exempt investment tool used to pre-fund pension and retiree
health costs
•Irrevocable –must be used for retirement plan purposes
•The city controls the contributions, withdrawals, investment
strategy, and risk level of assets in the trust
•Assets can be transferred to CalPERS at the city’s discretion to pay
for normal cost or unfunded actuarial liability
•Potential for higher investment return than General Fund
•Trust assets will be diversified from CalPERS’ investments
15
ITE IM 13: Sect i on 115 Trust
16
175 cities, towns and counties
51 education districts
73 special districts
Cities in San Diego County
•Coronado
•Escondido
•Chula Vista
•Imperial Beach
•La Mesa
•El Cajon
•Lemon Grove
•Solana Beach
•National City
PENSION TRUSTS IN
CALIFORNIA
20-YEAR CALPERS COSTS AT LOWER DISCOUNT RATES
…If CalPERS reduces their
discount rate from 6.8% to
6.25%, the city will be
required to contribute an
additional $116 million over
a 20-year period…
17
900
4-$ 66M
800 i-$:116M
4-$64M 700
16(1)
'"' C ■le 500 --
C: 400
-1;1}-
300
200
100
0
6~8D% 6.50% 6.25%
POTENTIAL FUNDING SCHEDULE
18
$15 M
initial
investment
$6 M
in contributions
for 4 fiscal years
6.25%
target rate of
return
+x $116 M
In 20 years
=
GOAL: Achieve investment balance to fund a
reduction in discount rate from 6.8%to 6.25%over a
20-year time horizon
PROJECTED VALUE OF ASSETS ASSUMING VARYING
LEVELS OF INVESTMENT RETURN
$67 M
Funding gap
$-
$20
$40
$60
$80
$100
$120
$140
FY23 FY24 FY25 FY26 FY27 FY28 FY29 FY30 FY31 FY32 FY33 FY34 FY35 FY36 FY37 FY38 FY39 FY40 FY41 FY42
Pr
o
j
e
c
t
e
d
V
a
l
u
e
o
f
A
s
s
e
t
s
(
I
n
M
i
l
l
i
o
n
s
)
1.36% Investment Return 3.8% Investment Return 6.25% Investment Return
19
COMPARATIVE INVESTMENT RETURN PERFORMANCE
20
Equity (%)1 Year 3 Years 5 Years 10 Years
General Fund 0%1.28%1.38%1.58%1.36%
Cap.
Appreciation¹
75%-6.9%12.0%6.1%7.5%
Balanced¹60%-6.7%9.7%5.2%6.2%
Moderate¹50%-6.1%7.9%4.6%5.4%
Mod.
Conservative¹
30%-5.3%4.4%3.2%3.8%
Conservative¹15%-4.7%1.7%2.2%2.7%
¹ HighMark Capital investment returns as of March 31, 2023
NEXT STEPS
21
Request for Proposal
-trust administrator
-investment manager
July 2023
July-August 2023
Review committee
determination
City Council adoption
-trust administrator
-investment manager
-trust documents
-pension investment policy
September 2023
October -
December 2023
Initial trust
contribution
Reporting and
Monitoring
-Quarterly reports
provided to City
Treasurer and staff
-Included in quarterly
financial and economic
update for City Council
IITE IM 13 : S•ect i o n 1 15 Trust
0
0
0 0
0
RECOMMENDED ACTION
Provide input and direction for staff on options
related to a Section 115 Pension Trust
22
QUESTIONS?
23