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HomeMy WebLinkAboutADOPT RESOLUTION TO ESTABLISH FISCAL YEAR 2006/2007 TAX RATE 77 Council/Agency Meeting Held: 21 bG BUG -9 5, 24 Deferred/Continued to: �Ap oved J Conditionally Approved LJ Denied CA Clerk's S* r, jM OttCouncil Meeting Date: 8/21/2006 Department ID Number: FN 06-007 CITY OF HUNTINGT6N BEACH REQUEST FOR CITY COUNCIL ACTION SUBMITTED TO: HONORABLE MAYOR AND CITY COUNCIL MEMBERS SUBMITTED BY: PENELOPE CULBRETH-GRAFT, DPA, CITY ADMINISTRATOR PREPARED BY: DAN T. VILLELLA, CPA, FINANCE DIRECTOR SUBJECT: ADOPT RESOLUTION TO ESTABLISH FISCAL YEAR 2006/2007 TAX RATE Statement of Funding Source,Recommended Action,Alternative Action(s),Analysis,Environmental Status,Attachment(s) Statement of Issue: Should the City of Huntington Beach adopt a tax rate to fund the portion of retirement costs that can be legally collected in accordance with court cases, state law, and the City Charter? The Fiscal Year 2006/2007 General Fund proposed budget contains estimated retirement tax revenue of$1.615,831 to fund a portion of the cost of pre-1 978 employee retirement benefits. This estimated revenue results from a proposed tax rate on secured properties of $.00700 per $100 of assessed valuation (an increase of$.00004 per$100 of assessed valuation). Funding Source: Not applicable. Recommended Action: Motion to: Adopt Resolution Number 06-- "A Resolution of the City Council of the City of Huntington Beach Levying a Retirement Property Tax for Fiscal Year 200612007 to pay for Pre-1978 Employee Retirement Benefits"of$.00700 per $100 of assessed valuations. Alternative Action(s): 1. Do not adopt a tax rate that will cause a reduction of $1,615,831 in estimated General Fund revenues for FY 2006/2007. 2. Adopt a tax rate that will recover the allowable portion of the safety employer contribution rate. This will result in an additional $5.8 million of General Fund revenue for FY 2006/2007. 3. Adopt last year's tax rate of$.00696 per $100 of assessed valuation. 4. Adopt an alternative less than the maximum rate. REQUEST FOR CITY COUNCIL ACTION MEETING DATE: 08/21/2006 DEPARTMENT ID NUMBER: FN 06-007 Analysis: History of the Retirement Levy The City receives a pro-rata (approximately 16 percent) of the one-percent basic levy collected as property taxes on all real property within the City limits. In addition, the City can legally levy taxes to recover costs related to pre-1978 retirement benefits. The City has levied a retirement property tax since 1966, when a City Charter amendment allowed the City to recover retirement costs. Section 607(b)2 of the City Charter states, "There shall be levied and collected at the same time and in the same manner as other property taxes for municipal purposes are levied and collected...tax sufficient to meet all obligations of the City for the retirement system in which the City participates, due and unpaid or to become due during the ensuing fiscal year." In 1978, after the passage of Proposition 13, the City was still allowed to levy tax overrides above the one percent basic levy. This authority was limited by Revenue and Taxation Section 96.31(a)(4), which effectively set the City's maximum retirement tax rate at $.04930 per $100 of assessed valuation. In 1999, the Howard Jarvis Taxpayer's Association filed a lawsuit against the City concerning the levying of these taxes. The court determined that the City could only levy taxes for retirement costs that were in effect prior to 1978. Determining the exact amount of pre-1978 benefits in any given year requires an actuarial report. In 2004, the City commissioned a report from an actuary, John Bartel of Bartel Associates, which made assumptions and recommendations concerning how to determine these amounts. Subsequently, the California Attorney General issued an opinion supporting the assumptions made by the City. For FY 2006/2007 staff is recommending the City Council adopt a tax rate of $.00700 per $100 of assessed valuation ($.00004 higher than the tax rate in FY 2005/2006). This will yield approximately $1,615,831 in FY 2006/2007. This will result in a homeowner with a $500,000 assessed valuation (e.g., a property assessed at $500,000) paying an additional 20 cents ($.20) per year. Any increase in the portion of pension costs paid by the tax rate frees other revenues, which can be used for infrastructure, reduction in unfounded liabilities and enhanced services. Calculation of Possible Tax Rates The City may levy any tax rate between zero and the maximum allowable tax rate. To compute the maximum allowable tax rate, the pre-1978 retirement costs are divided by the City's total secured assessed valuation. For FY 2006/2007, the City's secured assessed valuation (not including Redevelopment Agency incremental assessed valuation) is $23,083,305,804. This represents an increase of approximately $1,888,341,174, or 8.9 percent over the prior years City-wide secured assessed valuation. Unsecured valuation is levied at the prior year secured rate so it is not used in determining the current year tax rate. On July 19, 2006, the City Council approved a prepayment of retirement costs resulting in savings to the City and taxpayer. Since the City can recover only actual costs of the retirement program, only the discounted amounts can be recovered and thus were used in the following calculations. -2- 8/9/2006 10:59 AM REQUEST FOR CITY COUNCIL ACTION MEETING DATE: 08/21/2006 DEPARTMENT ID NUMBER: FN 06-007 The table below summarized the calculation of the amount of estimated 2006/2007 safety retirement costs recoverable through a property tax levy: Total Full Amount of Estimated Employer Costs—Safety Employees $8,613,382 Discount Amount from PERS Prepayment 312,652 Discounted Safety Costs 8,926,034 Less Amount Related to 3%at 50 (Discounted Safety Costs x 15.33%) (1,437,868) Safety Retirement Costs Recoverable Through Property Tax $7,488,166 The amount of safety retirement costs related to the post-1978 benefits was computed as follows: Employer Safety Estimated Employer Retirement Rate Safety Retirement FY 2006/2007 Ratio of Costs Costs FY 2006/2007 Retirement Percentage Attributable to Pre-1978 Benefits 23.9560% 83.89% $ 7,488,166 Retirement Percentage Attributable to Post-1978 Benefits 4.6000% 16.11% $ 1,437,868 Total Safety Employer Rate 2006/2007 28.5560% 100.00% $ 8,926,034 Below is a table summarizing the results of levying the maximum allowable rate, the prior year tax rate, and a staff recommended rate: Maximum Allowable Staff Rate Prior Year Rate Recommendation Total Pre-1978 Retirement Costs Recoverable through Property Tax Levy $ 7,488,166 $7,488,166 $7,488,166 Amount of Pre-1978 Costs to be Recovered $ 7,488,166 $ 1,673,523 $ 1,683,141 Total City-wide Secured Assessed Valuation $23,083,305,804 $23,083,305,804 $23,083,305,804 Tax Rate for FY 2006/2007 (per$100 of assessed valuation) $ 0.03244 $ 0.00696 $ 0.00700 Estimated Cost for Parcel with Assessed Valuation of$500,000 $ 155.71 $ 34.80 $ 35.00 The maximum allowable rate is the lesser of the above calculation ($.03244 per $100 of assessed valuation) and the amount allowed under Revenue and Taxation Code 96.31(a)(4) ($.04930 per $100 of assessed valuation for Huntington Beach). Because of the county's timeline for approving the tax rate and the city's budget cycle, the rate must be set before the City Council takes action on its annual budget adoption. While -3- 8/10/2006 9:07 AM REQUEST FOR CITY COUNCIL ACTION MEETING DATE: 08/21/2006 DEPARTMENT ID NUMBER: FN 06-007 the tax rate may be increased above the recommended level, it is suggested that the lower rate be adopted and that staff work with the Finance Board in reviewing the rate during the preparation of the long-term financial plan to determine the need for future rate adjustments. The recommended action preserves the city's future option of adjusting the rate without creating an increased burden upon residents this year and allows the city's financial plan to be studied over the next year. This will give the City Council adequate time to consider its options and impacts prior to the adoption of the 2007/08 budget. Environmental Status: Not applicable. Attachment(s): NumberCity Clerk's Page . Description 1. Resolution Number 06- .-57 , "A Resolution of the City Council of the City of Huntington Beach Levying a Retirement Property Tax for Fiscal Year 200612007 to pay for Pre-1978 Employee Retirement Benefits" of $.00700 per $100 of assessed valuation to pay for pre- 1978 employee retirement benefits. 2. February 11, 2005 memo entitled: "Attorney General Opinion Regarding Retirement Property Tax". from Jennifer McGrath, City Attorney, -4- 8/10/2006 9:07 AM ATTACHMENT # 1 RESOLUTION NO. 2 0 0 6-51 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF HUNTINGTON BEACH LEVYING A RETIREMENT PROPERTY TAX FOR FISCAL YEAR 2006/2007 TO PAY FOR PRE-1978 EMPLOYEE RETIREMENT BENEFITS WHEREAS, since 1948, the City has provided for employee pensions through a contract with the California Public Employees Retirement System (CaIPERS). Pursuant to the 1966 and 1978 Charter, the voters of the City authorized the City Council to pay for the cost of employee pensions through a separate retirement property tax. Section 607(b)(2) of the 1978 Charter provides that the City may impose a retirement tax "sufficient to meet all obligations of the City for the retirement system in which the City participates"; and Proposition 13 was added to the California Constitution in 1978. It limits the local property tax to I% of assessed value, except that the City may levy an override tax in excess of I%to pay"any indebtedness approved by the voters prior to July 1, 1978"; and In the case entitled Carman v. Alvord, 31 Cal. 3d 318 (1982), the California Supreme Court determined that under Proposition 13, an override property tax in excess of 1% of assessed value may be levied to pay for employee pension benefits the voters approved prior to 1978. Consequently, after Proposition 13, the City Council continued to levy an override tax to pay for employee pensions. Since 1983-84, Revenue and Taxation Code Section 96.31(a)(4) has limited the City to levying a maximum override tax of$0.04930 per $100 of assessed value to pay for its retirement system; and In 2001, Proposition 13, as applied to the City Charter, was interpreted in Howard Jarvis Taxpayers Association, et al., v. County of Orange, and City of Huntington Beach as Real Party in Interest, Orange County Superior Court Case No. 81-87-80. The Court held that the override tax may only be levied to pay for retirement benefits the City contracted for before July 1, 1978, and may not encompass the benefits the City added after the passage of Proposition 13. This interpretation was upheld in Howard Jarvis Taxpayers Assn v. County of Orange (2003) 110 Cal.AppAth 1375, 2 Cal.Rptr.3d 514, Court of Appeal Case No. G029292; and Prior to July 1, 1978, the City entered into collective bargaining agreements with employee associations representing its safety employees providing that, effective July 1, 1978, they would be entitled to a CalPERS retirement benefit known as "2% @ 50." Subsequently, on June 30, 1999, pursuant to collective bargaining agreements the City had entered into with its safety employees, the City provided its safety employees with the CalPERS retirement benefit known as 3% @ 50. Consequently, it is necessary to allocate the employer contribution to CalPERS for safety retirement between 2% @ 50 and 3% @ 50, because only the employer contribution for 2% @ 50 may be paid through the override property tax; and The City has received a report from John Bartel of Bartel Associates, a professional actuary experienced in pension calculations, entitled, "City of Huntington Beach CalPERS Actuarial Issues - "Cost" of 3% @ 50," dated August 10, 2004. The Report identified the additional cost of 3%@ 50 as what CalPERS refers to as the "normal cost" of the benefit, which represents the present value of future benefits employees earned during the current year. Under 06442/3776 1 Reso. No. 2006-51 this approach, the incremental cost of 3% @ 50 is 4.6% of safety payroll, and the remainder of the employer contribution represents the cost of 2% @ 50; and In April 2004, Assemblyman Harman formally asked the Attorney General regarding the correct method of allocating the employer contribution to CalPERS between its pre-1978 and post-1978 components. In his February 7, 2005, Opinion (Opinion No. 04-413) the Attorney General opined that "any reasonable accounting method may be used for purposes of determining which costs are not subject to the 1% property tax limitation of the Constitution"; and The City Council has determined that the allocation approach presented in the Bartel Report is a reasonable accounting method for determining which costs are not subject to the 1% property tax limitation of the Constitution; and In 2003/2004, CalPERS required the City to contribute 9% of safety employee payroll as the City's employer's contribution. In order to set the tax override, the City subtracted the 4.6% normal cost of 3% @ 50 from the 9% to set the override tax at the equivalent of 4.4% of safety employee payroll. The cost to the City of 4.4% of safety employee payroll for 2003/2004 was $1,279,113, and consequently, the City set the override tax for 2003/2004 at $0.00696 per $100 of assessed value, which amount was designed to yield $1,279,000; and For 2006/2007, CalPERS is requiring the City to contribute 28.5560%of safety employee payroll as the City's employer's contribution. In order to set the tax override, the City may subtracted the 4.6% normal cost of 3% @ 50 from the 28.5560% to set the override tax at the equivalent of 23.9560% of safety employee payroll. The cost to the City of 23.9560% of safety employee payroll for 2006/2007 will be $ 7,488,166, and consequently, the City may set the override tax for 2006/2007 at $0.03244 per$100 of assessed value; and Notwithstanding this authority, the City Council chooses to set the override tax rate for 2006/2007 at $0.00700 per $100 of assessed value, the same rate imposed for 2003/2004, which will yield approximately $1,683,141 in revenues. This amounts to an override tax of approximately$7.00 per $100,000 of assessed value. NOW, THEREFORE, BE IT RESOLVED by the City Council of the City of Huntington Beach that a retirement property tax levy of Zero and 0.00700/100`h Dollars ($0.00700) per $100 of assessed value shall be levied for employee retirement costs for Fiscal Year 2006/07; BE IT FURTHER RESOLVED that the remainder of the Zero and 0.03244/100th Dollars ($0.0467) per $100 of assessed value levy authorized under Revenue & Taxation Code Section 96.31(a)(4) is suspended for Fiscal Year 2006/2007; BE IT FURTHER RESOLVED that the City Council declares that although it is suspending a portion of the retirement property tax for Fiscal Year 2006/2007, it retains the authority to levy the tax in future years up to the rate of$0.0493%per $100 of assessed value. 06442/3776 2 i Reso. No.i 2006-51 PASSED AND ADOPTED by the City Council of the City of Huntington Beach at a regular meeting thereof held on the 21 .,t day of_ AiigiiSt , 2006. Mayor REV ED AND APPROVED: APPROVED AS TO FORM: T � City Administ for $) y Attorney N�cl - to 1 INItTIATED AND APPROVED: irector of Finance 0644213776 3 Res. No. 2006-51 STATE OF CALIFORNIA COUNTY OF ORANGE ) ss: CITY OF HUNTINGTON BEACH ) I, JOAN L. FLYNN the duly elected, qualified City Clerk of the City of Huntington Beach, and ex-officio Clerk of the City Council of said City, do hereby certify that the whole number of members of the City Council of the City of Huntington Beach is seven; that the foregoing resolution was passed and adopted by the affirmative vote of at least a majority of all the members of said City Council at an regular meeting thereof held on the 21st day of August, 2006 by the following vote: AYES: Bohr, Green, Coerper, Sullivan, Hardy, Hansen, Cook NOES: None ABSENT: None ABSTAIN: None Cit Jerk and ex-officio #rk of the City Council of the City of Huntington Beach, California ATTACHMENT #2 ' r Rev a.cc vu j i� q 04 S0 J. CITY OF HUNTINGTON BEACH TO: HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL PENELOPE CULBRETH-GRAFT, City Administrator CHUCK THOMAS, Acting Director of Administrative Services DANIEL VILLELLA,Finance Officer FROM: JENNIFER McGRATH,City Attorney DATE: February 11, 2005 SUBJECT: Attorney General Opinion Regarding Retirement Property Tax In August 2003,the City Council directed this Office to request through Assembl ty_nan Harman an Attorney General opinion regarding the proper methodology to determine the tofretiremetrtPrarCy tax e i may evy a er a eeision m owar arvis Taxpayers Association a County o,f Orange (2003) 110 Ca1.App.4th 1375_ The Attorney General issued the Opinion on February 7, 2005- The Opinion validates the methodology the Council adopted in August 2003 to Background. Since 1948,the City has provided retirement benefits through a contract-with the Public Employees Retirement System(PERS). Under its PERS contract,the City must make an annual employer contribution to PERS. This contribution—a percentage of payroll—fluctuates from year to year. In 1976,the City Council agreed through MOUs with the police and lifeguard employee associations to amend the PERS contract to increase police and marine safety benefits to 2% @ 50 by July 1, 1978. (The City was already offering the 2% @ 50 benefit to fire employees.) However, the effective date of the PERS contract amendment was September -_ 1979. This increase in benefits effected the employer contribution to PERS. Since 1978, the City instituted several additional retirement benefits, including amending the PERS contract to offer 3%@ 50 for safety personnel. Since at least 1966, the City has levied a retirement property tax to pay for at least a portion of the cost of the retirement program_ In June 1978, the voters of the City of Huntington_ --- - -Beach adopted a new City Charter. The Charter continued to authorize the City Council to levy a retirement property tax_ G_IEIELDQ005 MemoMG Opinion re Retirement Tax.doc HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL PENELOPE CULBRETH-GRAFT, City Administrator CHUCK THOMAS, Acting Director of Administrative Services DANIEL VILLELLA, Finance Officer February 11, 2005 Page 2 of 4 Also in June 1978, California voters approved Proposition 13, which limited the property tax to one percent of property value. One exception to Proposition 13's 1%limit is "indebtedness approved by the voters prior to July 1, 1978_" In 1982, the California Supreme Court held in the case of Carmen v. Alvord that pension plans were such indebtedness up to the level of benefits approved by the voters before July I, 1978. One difficulty in applying the Carmen decision was determining which retirement obligations were approved prior to 1978. For example,the Huntington Beach Charter,as approved by voters in 1978, merely states that the City shall "participate in a retirement system,"but the voters never approved a specific retirement system. For many years after Proposition 13,determining what retirement system could be supported by the retirement tax was never an issue because the employer contribution to PERS substantially exceeded the maximum retirement tax rate of.049%.I However,when the employer contributions to - _ --�ER�deelned-hetw^e�eri�Y`fi997198- ou --FY-2U00/OT,-a(-po Ion o e retiirement^� _.-._ --prom tam-was-us6ti--t8-paTivar-rP�f'.ii:�a 4 io�.40� 1z�..a��.�.I:�I=s"C'VrIGiGTI ., a ..a...... .. , In December 1999,the Howard Jarvis Taxpayers Association(HJTA)filed suit challenging whether the retirement tax could be-used to pay for benefits approved-after-l978_ In April __ 20Ho—war - - 0!t th e-Su ri o�otirt-lief m�ardTarvis Tax rs Association v. Co o.�Orange PaYe g that the use of the retirement tax was limited to those retirement benefits in place prior to July 1, 1978. The Court of Appeal affirmed this ruling in July 2003_ During FYs 2001/02 and 2002/03, the period following the Superior Court decision until the Court of Appeal decision, the City suspended the tax levy because its employer contribution to PERS for those years was 0%_ Then for FY 2003/04, PERS set the safety employer contribution at 9%of payroll. Given that the Court ruling permitted the City to levy the retirement tax to pay for employer contributions associated with pre-1978 retirement programs, it was necessary for the City to allocate the 9%employer contribution rate - -- between pre-1978 benefit oft%o @ 50 and-the post-I978-beneTit-of 3%at-50_ Based upon - the recommendation of John Bartel, a professional actuary, the City allocated the first 4.6% of the employer contribution to the incremental cost of 3%® at 50, and the remaining 4.4% contribution to 2% @ 50. The tax levy was then set at a rate sufficient to pay 4.4%of safety '^�` payroll_ This recommendation was based principally on a 1999 PERS actuarial study c t- identifying the "normal cost"attributable to the benefit increase to 3%at 50 as 4.6%t,of �� payroll 10 I After Proposition 13 was adopted,the Legislature adopted a statute limiting a retirement tax to no more than the highest rate charged in 1981 or earlier. For Huntington Beach,this rate was .049%of assessed value. GAFIELD12005 Memos\AG Opinion re Retirement Tax doc HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL PENELOPE CULBRETH-GRAFT,City Administrator CHUCK THOMAS,Acting Director of Administrative Services DANIEL VILLELLA, Finance Officer February 11,2005 Page 3 of 4 The Attorney General Opinion. The Jarvis opinion presented three immediate questions regarding how to set the retirement tax in the future. First, after suspending the tax for two years,did the levy of the retirement property tax for 2003/2004 require new voter approval under Proposition 218? Our office opined that this was not a new tax under Proposition 218. Second, did the 2%@ 50 retirement program for police and marine safety officers approved prior to July 1, 1978,but implemented afterwards constitute a pre-1978 indebtedness? In August 2003, the City Attorney opined that this was a pre-1978 retirement obligation and the Council set the 2003/04 retirement tax in reliance on that Opinion. Third, how should the City Council allocate the employer contribution between the pre-1978 component of 2%@ 50 for safety officers, and the 2001 amendment of 3%@ 50? Our office recommended using a"reasonable"actuarial approach,such as recommended by Mr. In April 2004,Assemblyman Harman formally asked the Attorney General to answer these three questions. -- - --- --- Jnthe-attaehecJ Opiniorr the Attorney Generad answers all Three questions consistent with the City Attorney's earlier advice. First,suspending and then re-levying a tax does not amount to a new tax that must be voter-approved under Proposition 218. Notably, the HJTA advised the Attorney General that it agreed with this conclusion,so the Attorney General's Opinion is of little surprise. Second, the Attorney General agreed that where the 2%@ 50 retirement program for police and marine safety officers was approved prior to July 1, 1978,but offering the benefit was delayed until after July 1, 1978,it still constituted a pre-1978 indebtedness. Again,HJTA had agreed with our Opinion. Most importantly, the Attorney General agreed with our conclusion that any reasonable accounting method could be used to allocate the employer contribution to PERS between the 2% @ 50 and the 3% @ 50 safety program. The Attorney General states that:"any reasonable accounting method may be used for purposes of determining which costs are not subject to the 1%property tax limitation of the Constitution." While the Attorney General has not specifically approved the allocation Mr. Bartel recommended, we do conclude his approach is areasonable accounting method,and consequently, we recommend continuing to use his allocation in the future. GAFiELD\2005 Memos\AG Opinion re Retirement Tax-doc HONORABLE MAYOR AND MEMBERS OF THE CITY COUNCIL PENELOPE CULBRETH-GRAFT, City Administrator CHUCK THOMAS, Acting Director of Administrative Services DANIEL VILLELLA, Finance Officer February 11, 2005 Page 4 of 4 For the Council's further information, prior to the Attorney General issuing his Opinion, we had forwarded to his Office the most current revised versions of Mr. Bartel's analysis. A copy of that analysis is attached along with the Attorney General Opinion. JENNIFER McGRATH City Attorney Attachments: Attorney General Opinion Bartel Associates Report G_\FI£LM2005 MemosWG Opinion re Retirement Tax-doc TO BE PUBLISHED IN THE OFFICIAL REPORTS OFFICE OF THE ATTORNEY GENERAL State of California BILL LOCKYER Attorney General OPINION No. 04-413 of : February 7, 2005 BILL LOCKYER Attorney General SUSAN DUNCAN LEE : Deputy Attorney General THE HONORABLE TOM HARMAN, MEMBER OF THE STATE ASSEMBLY, has requested an opinion on the following questions: I_ Where voters of a charter city have approved a city employee pension plan prior to July 1, 1978, but collection of a property tax to pay for the retirement benefits is ----_delay-ed_until_af#er_July-_L,__L9_Z8, is the collection of the tax subiect to the one percent tax limitation of the Constitution? 2. Where voters of a charter city have approved a retirement benefit prior to July 1, 1978,to be offered to employees after July 1, 1978,is the collection of a property tax to pay for the retirement benefit subject to the one percent property tax limitation of the Constitution? 3 Where voters of a charter city have approved different levels of retirement benefits before and after July 1, 1978, what accounting method may be used for purposes 1 04-413 3 s of determining which costs are not subject to the one percent property tax limitation of the Constitution? CONCLUSIONS 1. Where voters of a charter city have approved a city employee pension plan prior to July 1, 1978, but collection of a property tax to pay for the retirement benefits is delayed until after July 1, 1978, the collection of the tax is not subject to the one percent property tax limitation of the Constitution. 2. Where voters of a charter city have approved a retirement benefit prior to July 1, 1978, to be offered to employees after July 1, 1978, the collection of a property tax to pay for the retirement benefit is not subject to the one percent property tax limitation of the Constitution. 3. Where voters of a charter city have approved different levels of retirement benefits before and after July 1, 1978,any reasonable accounting method may be used for purposes of determining which costs are not subject to the one percent property tax limitation of the Constitution. ANALYSIS In June 1978,California voters approved Proposition 13,which added article XIII A to the Constitution. Article XIII A generally limits ad valorem("according to value") taxes on real property to one percent of the value of the property,except that the one-percent cap may be exceeded in order to repay certain indebtedness, including indebtedness approved by voters prior to July 1, 1978- Section 1 of Article XIII A states in part: a)_The maximum amount of any ad valoremitax on real property _ shall not exceed One percent (1%) of the full cash value of such property. The one percent (1%) tax to be collected by the counties and apportioned according to law to the districts within the counties. "(b) The limitation provided for in subdivision(a) shall not apply to ad valorem taxes or special assessments to pay the interest and redemption charges on any of the following: 2 04-413 "(1) Indebtedness approved by the voters prior to July 1, 1978. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A tax in excess of the one-percent cap, imposed to pay voter-improved indebtedness, is frequently referred to as a "tax override" or "excess tax." (See, e.g., Howard Jarvis Taxpayers Assn.v. Countyof0range(2003) 110Cal.AppAth 1375, 1379-1383, 1386-1388; Valentine v. City of Oakland(1983) 148 Cal.App.3d 139, 142, 145.) We are informed that prior to July 1, 1978, the voters of a charter city approved a retirement system for the benefit of city officers and employees. The three questions presented for resolution concern article XIII A's requirement that"Indebtedness" be "approved by the voters prior to July 1, 1978" in order to qualify for the levy of a tax override. 1. Delay in Collecting the Tax The first question deals with the city's initial collection of a property tax after July 1, 1978,to pay for retirement benefits that were approved by city voters prior to July 1, 1978. May a tax override be levied in such circumstances? We conclude that it may. Preliminarily,--we-nute-that the-phrase7`to-paY me-interest-and Yedempti-ow- — charges on . . . [i]ndebtedness approved by the voters prior to July 1, 1978" (Cal. Const., art. XIII A, § 1, subd. (b)) has been interpreted to include voter approved public pension plans. The phrase is not limited to"traditional,fixed, long-term debt for borrowed funds." (Carman v.Alvord(1982)31 Cal.3d 318,325.) Rather,it includes obligations arising under a city's pension plan for current and future city employees up to the level of benefits approved by the voters before July 1, 1978. (Id. at p. 325-333; Howard Jarvis Taxpayers Assn. v. County of Orange, supra, 110 Cal.AppAth at pp. 1381-1387; Valentine v. City of Oakland, supra, 148 Cal.App.3d at pp. 145-149.) Significantly, it is not necessary that the voters approve the levy of the tax override itself for purposes of Proposition 13.' All that needs to be approved prior to July 1, 1978, is the underlying"indebtedness" for which that tax override will be imposed. In Valentine v. City of Oakland; supra 148 Cal.App.3d 139, the court observed: While Proposition 13 does have a voter approval requirement for"special taxes" (Cal. Const., art_XM A,§4),this provision is inapplicable to ad valorem taxes on real property. (See Carman v.Alvord, supra, 31 Cal.3d at pp. 333-334.) 3 04-413 ". . _ Once the indebtedness is found to have had the voters' prior approval, ad valorem taxes etc. to pay the obligations arising thereunder are exempt,and there is no express requirement that such taxes need also be voter approved_" (Id. at p. 149.) Although Proposition 13 does not require voter approval of a tax override,we note that in November 1996, California voters approved Proposition 218, which added article XIII C and article XIII D to the Constitution. Section 2 of article XIII C provides: "Local Government Tax Limitation. Notwithstanding any other provision of this Constitution: "(a)All taxes imposed by any local government shall be deemed to be either general taxes or special taxes. . . . "(b)No local government may impose,extend,or increase any general tax unless and until that tax is submitted to the electorate and approved by a majority vote. A general tax shall not be deemed to have been increased if it is imposed at a rate not higher than the maximum rate so approved. .t "(c) Any general tax-imposed,extended, or increased, without voter -- --- appiovall-by any IoeaT government on or after January 1, 1995, and prior to the effective date of this article,shall continue to be imposed only if approved by a majority vote of the voters voting in an election on the issue of the imposition,which election shall be held within two years of the effective date of this article and in compliance with subdivision(b). "(d)No local government may impose,extend,of increase any special tax unless and until that tax is submitted to the electorate and approved by a two-thirds vote. A special tax shall not be deemed to have been increased if .__-------------itis-imposed-at--a--rate-net-#ighe-r-than4hemaximuni-mt"' o_approv_ed"___------ ---- — In 1997, the Legislature enacted the Proposition 218 Omnibus Implementation Act, which interpreted various provisions of article XIII C and article XIII D_ As part of the act, Government Code section 53750 was enacted to provide-in part: "For purposes of Article XIII C and Article XIII D of the_California Constitution and this article: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 04-413 "(e) `Extended,' when applied to an existing tax or fee or charge, means a decision by an agency to extend the stated effective period for the tax or fee or charge, including, but not limited to, amendment or removal of a sunset provision or expiration date. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . "(h) (1) `Increased,' when applied to a tax, assessment, or property- related fee or charge, means a decision by an agency that does either of the following: "(A)Increases any applicable rate used to calculate the tax,assessment, fee or charge. "(13) Revises the methodology by which the tax, assessment, fee or charge is calculated, if that revision results in an increased amount being levied on any person or parcel. "(2)A tax,fee,or charge is not deemed to be `increased' by an Ipgency action that does either or both of the following: -- --"-(AIAdjusts-th"mouW-e#'a tax--or--fee-or--charge-in-accordance--with---- --- - ___ __-- a schedule of adjustments, including a clearly defined formula for inflation adjustment that was adopted by the agency prior to November 6, 1996. "(13)Implements or collects a previously approved tax,or fee or charge, so long as the rate is not increased beyond the level previously approved by the agency, and the methodology previously approved1by the agency is not revised so as to result in an increase in the amount being levied on any person or parcel. 1 "(3) A tax, assessment, fee or charge is not deemed to be `increased' in the case in which the actual payments from a person or property are higher than would have resulted when the agency approved the tax, assessment, or fee or charge,if those higher payments.are attributable_ to events other than an increased rate or revised methodology, such as a change in the density, intensity, or nature of the use of land. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 04-413 We are informed that when the voters of the charter city in question approved the city employee pension plan prior to July 1, 1978,they authorized the city council to levy a tax override sufficient to meet all obligations of the city for the retirement system in which the city participated. Under the Legislature's implementing definitions,the fact that the tax override was not levied until after July 1, 1978, did not"extend"or"increase" the tax levy previously approved. The "level previously approved"by the voters(Gov. Code, § 53750, subd. (h)(2)(B)) was the rate in excess of one percent needed "to continue providing all retired, current, and future city employees with the retirement benefits to which city employees were entitled"at the time of the voter approval. (See Howard Jarvis Taxpayers Assn. v. County of Orange, supra, 110 Cal.AppAth at p. 1380.) Accordingly, the voter approval requirement of article XIII C of the Constitution was satisfied when the voters of the charter city authorized the tax override prior to July 1, 1978. We conclude that where voters of a charter city have approved a city employee pension plan prior to July 1, 1978,but collection of a property tax to pay for the retirement benefits is delayed until after July 1, 1978,the collection of the tax is not subject to the one percent property tax limitation of the Constitution. 2. Delay in Offering Retirement Benefits The second question is similar to the first, but it deals with a specific__ _ retirement benefit that was not actually offered to employees until after July 1 I978;- although approved by city voters prior to July 1, 1978. As with question one,we conclude that a tax override may fund such a retirement benefit in the described circumstances-. We reject the suggestion that if a retirement benefit is not offered until after July 1, 1978, it cannot constitute an"indebtedness"approved by the voters prior to July 1, 1978. A retirement benefit that is first offered after July 1, 1978, may be funded by a tax override as long as the granting of the benefit is in fact approved by the voters prior to July 1, 1978. All that is required, as indicated in response to the first question, is for the "�n�P�,tedness—(i_e_ ligation"which in this case is the retirement benefit) to be approved by the voters prior to July 1, 1978, regardless of when the indebtedness actually accrues. (Howard Jarvis Taxpayers Assn. v. County of Orange, supra, 110 Cal.App_4th at pp. 1382-1383; Valentine v. City of Oakland, supra, 148 Cal.App.3d at p. 149.) As the Supreme Court stated in-Carman v.-Alvord,-supra; 31 CaL3d-31.8: "Plaintiff and taxpayers imply that subdivision (b) exempts only indebtedness which was fixed and certain when approved. But the subdivision imposes no such restriction. It speaks only of the time of 6 04-413 approval, not the time an indebtedness is incurred or accrues." (Id. at p. 326, fn. 6.) We conclude that where voters of a charter city have approved a retirement benefit prior to July 1, 1978, to be offered to employees after July 1, 1978,the collection of a property tax to pay for the retirement benefit is not subject to the one percent property tax limitation of the Constitution. 3. Different Levels of Benefits The final question concerns the approval of different levels of retirement benefits by the voters of a charter city before and after July.1, 1978. What accounting method may be used in setting the amount of the tax override to cover only the benefits approved prior to July 1, 1978? We conclude that any reasonable accounting method may be used to separate the two levels of retirement benefits for purposes of calculating the amount of the tax override. If voters do not approve the granting of retirement benefits before July 1, 1978, the costs of such benefits may not be funded by a tax override. (See Carman v. Alvord, supra, 31 Cal.3d at p. 331;Howard Jarvis Taxpayers Assn. v. County of Orange, --supra, 11-0 Cal.AppAth_at pp._1381-1387.)___How_are the costs of such benefits_to be__ - excluded-whCh calculafi-rig the amount-of the.-tax override? A somewhat related question was presented in County of Orange v. Orange County Assessment Appeals Bd_ (1993) 13 Cal.App.4th 524, where the court examined whether a county assessment board had used the proper method of appraising property for purposes of assessing property taxes owed by a cable company. The court noted that more than one method of valuation could be"valid": " The County's attack is directed at the Board's method of valuation, ------ �o-we-and-thetrial-eourtJook-to-see--whether,-as-a-matter_of_iaw,-the-metiLod --- — was arbitrary, in excess of discretion, or in violation of the standards prescribed by law. [Citation_] In this regard we look not to whether another approach might also have been valid or yielded a more precise reflection of the property's value, but whether the method chosen was contrary to law. -- [Citations.] `The law requires only that an assessor adopt and use a reasonable method--neither a trial court, nor this court, can reject a method found by the board to be reasonable merely because, in [its] nonexpert opinion,another method might have been better.' [Citation.]" (Id. at pp. 529- 530, fn. omitted.) 7 04-413 Similarly,in Concrete Pipe&Products of Cal., Inc. v.Construction Laborers Pension Trust for Southern Cal. (1993) 508 U.S. 602, the United States Supreme Court considered the propriety of an actuary's method of calculating an employer's share of certain unfunded pension plan liability. The court looked to "the scope of professional acceptability": ". . . Since the methodology is a subject of technical judgment within a recognized professional discipline, it would make sense to judge the reasonableness of a method by reference to what the actuarial profession considers to be within the scope of professional acceptability in making an unfunded liability calculation. Accordingly, an employer's burden to overcome the presumption in question (by proof by a preponderance that the actuarial assumptions and methods were in aggregate unreasonable)is simply a burden to show that the combination of methods and assumptions employed in the calculation would not have been acceptable to a reasonable actuary. In practical terms it is a burden to show something about standard actuarial practice, not about the accuracy of a predictive calculation, even though consonance with professional standards in making the calculation might justify confidence that its results are sound." (Id. at p. 635.) Hence, as long as an actuarial method is "reasonable" and not'"arbitrary" or - "irrational,"it may be applied even though other approaches maybe equally correct or even more precise" or "better." (See Concret�ipe Products ofCal.Rnc v.- onsrucfion Laborers Pension Trust for Southern Cal., supra, 508 U.S. at p. 635, fn. 20; Claypool V. Wilson (1992) 4 Cal.AppAth 646, 680-681; Texaco,Inc. v. County of Los Angeles(1982) 136 Cal.App.3d 60, 63.) We conclude that where voters of a charter city have approved different levels of retirement benefits before and after July 1, 1978,any reasonable accounting method may be used for purposes of determining which costs are not subject to the one percent property tax limitation of the Constitution. RECEIVE FEB 1 1 2005 city of Hun QtyAttor,,9 n 8eocr 8 04-413 ONTRACT AMENDMENT COT LYSIS-VALUATION BASIS: JUNE 30, _Y99 kFETY PLAN FOR CITY OF HUNTINGTON BEACH MPLOYER NUMBER 97 enefit Description: 21362.2,3%Q 50 Full Formula he table below shows the change in the total present value of benefits for the proposed plan amendment. he present value of benefits represents the total dollars needed today to fund all future benefits for urrent members of the plan, i.e.without regard to future employees. The difference between this amount nd current plan assets must be paid by future employee and employer contributions_ As such, the change t the present value of benefits due to the plan amendment represents the"cost"of the plan amendment. lowever, for plans with excess assets some or all of this "cost" may already be covered by current excess ssets. he CAPERS Board adopted a resolution providing a one-time increase in the actuarial value of assets to 5"/0 of market value for the calculation of the employer rate when a rate plan adopts a contract mendment that increases the present value of benefits_ This resolution applies only to plans that(1)file resolution of intention to amend their plan with CalPERS before June 30,2001 and that(2)amend their ontract with an effective date on or before June 30,2002.If a plan amends more than once during the ,,indow period,only the first qualifying amendment will result in the asset increase to 95%of market alue, Therefore, if your plan previously adopted an amendment which increased the actuarial value of ssets to 95% of market value,no increase in assets will be shown in the tables below. If your plan's ctuarial value of assets was not previously increased to 95%of market value, the tables below show the ec on ids asseTs due co this one=lime c ange m actuan—al m"e�iod-ii e�e-9 a m cet value o-Fassets . J Change Due to Post-Amendment Pre-Amendment Plan Amendment Post Method - _-&__1�ethod_- - -- - ------ Changes- ----Cfia - -_---- - Total Present Value of Benefits S 263,664,509 S 22,909,322 S 286,573,931 Actuarial Value of Plan Assets 257,337,475 11,743,423 269,080,898 Present Value of Future Employer - and Employee Contributions S 6,327,034 S 11,165,899 I. S 17,492.933 t is not required, nor necessarily desirable,to have accumulated assets sufficient to cover the total present •alue of benefits until every member has left employment. Instead,the actuarial funding process alculates a regular contribution schedule of employee contributions and employer contributions(called formal costs)which are designed to accumulate with interest to equal the total present value of benefits ,y the time every member has left employment. As of each June 30, the actuary calculates the desirable" level of plan assets as of that point in time by subtracting the present value of scheduled future mployee contributions and future employer normal costs from the total present value of benefits. The esulting"desirable" level of assets is called the accrued liability_ �plan with assets exactly equal to the plan's accrued liability is simply"on schedule" in funding that plan, and only future employee contributions and future employer normal costs are needed. A plan with ssets below the accrued liability is"behind schedule",or is said to have an unfunded liability,and must =porarily increase contributions to get back on schedule. A plan with assets in excess of the plan's ccrued liability is "ahead of schedule", or is said to have excess assets, and can temporarily reduce future ontributions. A plan with assets in excess of the total present value of benefits is called super-funded, nd neither future employer nor employee contributions are required. Of course,events such as plan mendments and investment or demographic gains or losses can change a plan's condition from year to >eccmber 12,2000 Page 1 of 3 2 26 PM ,ONTRACT AMENDMENT COST ANALYSIS-VALUATION BASIS:JUNE 30, 1999 ;AFETY PLAN FOR CITY OF HUNTINGTON BEACH ,MPLOYER NUMBER 97 lenefit Description: 21362.2,3%@ 50 Full Formula rear. For example,a plan amendment could cause a plan to move all the way from being super-funded to Being in an unfunded position. Che changes in your plan's accrued liability,unfunded accrued liability,and the funded ratio as of June 10, 1999 due to the plan amendment are shown in the table below. Change Due to Post-Amendment Pre-Amendment Plan Amendment Post Method Change &Method Change Accrued Liability S 217,156,760 S 20,150,034 S 237,306,794 Assets 257,337.475 11,743,423 269,080,898 Unfunded Liability S (40,180,715) S 8,406,611 S (31,774,104) Funded Ratio 118-5% White the tables above give the changes in the"cost" and funded status of the plan due to the amendment____- here remains the question of what will happen to the employer contribution rate because of the change in rlan-provisio1121. -- - — �aIPERS policy is to implement rate changes due to plan amendments immediately on the effective date )f the change in plan benefits. In general,the polio als provides_that the change- - - -- - - iue to the plan amen3menf wilt be separately amortized over a period of 20 years from the effective date )f the amendment and all other components of the plan's unfunded liability/excess assets will continue to )e amortized separately. 3owever,special rules have to be applied to plans with a current employer contribution rate of zero. The )re-amendment excess assets in these plans were sufficient to cover the employer's normal cost for one or nore years into the future- A plan amendment will use up some or all of the pre-amendment excess tssets. If there is still excess assets(i.e. if the plan is still ahead of schedule)after the plan amendment, he remaining excess assets were spread over the greater of 5 years or the number of years for which the :xcess assets would keep the employer rate equal to zero. If the amendment uses up all excess assets and :reates an unfunded liability(i.e_ from being ahead of schedule to behind schedule),the post-amendment mfunded liability was amortized over 20 years. Che table below shows the immediate short-term change in your plan's employer contribution rate due to he plan amendment- Rate Change Due to Post-Amendment Component Pre-Amendment Plan Amendment Post Method Change & Method Change Normal Cost 12.451% 4.589% 17.040% Unfunded/Excess Asset Cost (12.451)"/a (4.589)% (17.040)% 1959 Survivor 0.000% 0.000% 0.000% Total Employer Rate 0.000% 0.000% 0.0000/0 Amortization Period 20 Years 8 Years )ecember 12,2000 Page 2 of 3 2.26 PM CONTRACT AMENDMENT COST ANALYSIS-VALUATION BASIS: JUNE 30, 1999 SAFETY PLAN FOR CITY OF HUNTINGTON BEACH EMPLOYER NUMBER 97 Benefit Description: 21362.2,3`/0 @ 50 Full Formula Note that the change in normal cost in the table above may be much more indicative of the long term change in the employer contribution rate due to the plan amendment. The plan's unfunded liabilitylexcess asset cost shown in the table above is a temporary adjustment to the employer contribution to"get the plan back on schedule". This temporary adjustment to the employer rate varies in duration from plan to plan. For example,a plan with initial excess assets being amortized over a short period of time will typically experience a large rate increase when excess assets are fully amortized. While a plan amendment for such a plan may produce little or no increase in the employer contribution rate now,the change in normal cost due to the plan amendment will become fully reflected in the employer contribution rate as soon as initial excess assets are fully amortized. If your agency is requesting cost information for two or more benefit changes,the cost of adopting more _ than one of these changes may not be obtained by adding the individual costs. Instead,a separate valuation should be done to provide a cost analysis for the combination of benefit changes. If the proposed plan amendment applies to only some of the employees_in the plan,the rate change due to the plan amendment still applies to the entire plan, and is still based on the total plan payroll. Please note that the cost analysis provided in this document may not be relied upon once the CalPERS -artuarialstafl-have ual-valuation�4hat-i-, atiort-as-of-June3$;VW.— If you have not taken action to amend your contract,and we have already mailed the June 30 2000 annual valuation report, you must contact our office for an updated cost analysis,based on the new annual valuation- This actuarial valuation for this proposed plan_ameer d_irient.is..based-on-the-partieipant -bermfrts—and-asset — data used in the June 30, 1999 annual valuation,with the benefits modified if necessary to reflect what is currently provided under your contract with CAPERS,and further modified to reflect the proposed plan amendment Descriptions of the actuarial methodologies,actuarial assumptions,and plan benefit provisions may be found in the appendices of the June 30, 1999 annual report. Please note that the results shown here are subject to change if any of the data or plan provisions changes from what was used in this study. It is our opinion that the valuation has been performed in accordance with generally accepted actuarial principles, in accordance with standards of practice prescribed by the Actuarial Standards Board, and that the assumptions and methods are internally consistent and reasonable for this plan,as prescribed by the CaIPERS Board of Administration according to provisions set forth in the California Public Employees' Retirement Law. t Kung-pei Hwang,A.SA.,M.A.A.A. Senior Pension Actuary,Ca1PERS Fin Process Ids: Annual-49731 Base-53633 Proposal-53634 December 12,2000 Page 3 of 3 12:26 PM Mot City of Huntington Beach fEjEj t t CaIPE ctuarial- ssues - "Cost" of 3°7o—*-50 September 27,2004 o_clientskity of huntington bcachkcport 04-08-10_doc City of Huntington Beach Ca1PERS Actuarial Issues—"Cost" of 3% @ 50 BACKGROUND We understand the City of Huntington Beach' retirement property tax can be used to pay for only those benefits either contracted for or effective before July 1, 1978. Furthermore we understand the only benefit improvement effective after July 1, 1978 that affects the City's Ca1PERS contribution rates has been 3%@ 50. Accordingly the City has hired Bartel Associates to review the "Cost" of 3%@ 50 so that the retirement property tax can be limited to 2%@ 50_ This report's goal is to identify the most reasonable methodology to determine this cost_ Before discussing the "Cost"of 3%@ 50, it's important to understand some basic terms_ The following Basic Definitions have been taken from the January 2001 issue of Western City magazine. BASIC DERNMONS Understanding these terms makes it easier to understand how well funded the City's CatPERS plan is and understand the"Cost"of a benefit improvement_ the first ather nartidrinant data includin active employees, former employees not in payment status, participants and beneficiaries in payment status) at the valuation date -- example June 30,2002). Using this data and some actuarial assumptions,they project future benefit payments. (The assumptions predict, among other things, when people will retire, terminate,die or become disabled, as well as what salary increases,inflation and investment return might be_) Those future benefit payments are discounted, using expected fixture investment return, back to the valuation date. This discounted present value is the plan's present value of benefits. It represents the amount the plan needs as of the valuation date to pay all future benefits—if all assumptions are met and no future contributions(employee or employer)are made. Actuarial Liability: This represents the portion of the present value of benefits that participants have earned (on an actuarial, not actual, basis) through the valuation date. Actuarial Liability is also referred to as Prior Cost. Current Employer Normal Cost:The total normal cost represents the portion of the present value of benefits expected to be earned(on an actuarial,not actual,basis)in the coming year. The current employer normal cost represents the employer's portion of the total normal cost —that is,the total normal cost offset by employee contributions. City of Huntington Beach Ca1PERS Actuarial Issues-"Cost" of 3%@ 50 Page 2 Present value of Benefits _ Employe `• "- Norms'cost Aatomial r.iobwdy Once these amounts (present value of benefits, actuarial liability and normal cost) are calculated,the actuary compares actuarial assets to the actuarial liability_ When assets equal liabilities,a plan is considered on track for funding. When assets are greater than liabilities, the plan has excess assets; when assets are less than liabilities, the plan has an unfunded liability. - oa _. liability)immediately nor do they allow an immediate credit for any excess assets Instead, _ the difference is amortized over time. An agency's contribution rate is nothing more complicated than the current employer normal cost, plus the amortized unfunded liability or less the amortized excess assets_ Simply put, this contribution is the value of employer _-__ _----------A)cnetits--earned---during_the--year-phis -the-.plan-towardA)eing-on.track for-- ------ ------_- fimding. There is a two-year delay from the valuation date to the contribution effective date_ / For example, the June 30, 2002 valuation generates an agency's 2004/05 fiscal year contribution- Fresh Start: When CaiPERS prepares a valuation and determines an agency's contribution rate, it's usually in layers,such as gains/losses or plan changes,with each layer(base)adding up to the contribution rate. But there are several situations where CAPERS will combine the layers (or bases) into a single base_ For example, if the calculation results in a zero contribution rate, CalPERS combines the layers into one base and tells the agency it will have a zero contribution for a fixed period'. That combination is called a"fresh start." An agency with a fresh start will know it-, the actuarial report (usually on page 10) will show several bases or a single base(labeled fresh start)- Super-Funded: When actuarial assets are greater than the present value of benefits,a plan is super-funded. When this happens, the excess of actuarial assets over present value of benefits may perhaps be used to pay employee contributions. However, any super-surplus It is important to know that,in this case,the contribution will only remain zero for the fated period if all future actuarial assumptions are met. Statistically,it is virtually impossible for this to happen,there will always be some variance around expected assumptions. 2 � City of Huntington Beach CalPERS Actuarial Issues—"Cost" of 3%@ 50 Page 3 use must occur in the fiscal year for which the valuation report's contribution rate was calculated_ For example, a plan super-funded in the June 30, 2002 valuation can use this difference to pay 2003/04 fiscal year employee contributions. 3 I City of Huntington Beach CAPERS Actuarial Issues—"Cost"of 3% Q 50 FUNDED STATUS The City's CAPERS Safety plan has moved from being over-funded in 2001 to under-funded in 2002- The following shows the plan's funded status over the last several years2: 300_0 250_0 200_0 150-0 100_0 50.0 1993 1994 1995 19% 19" 199E 19" 2000 200i 2002 f{ — OAcm�alliability 126.9 140.1 158.5 1769 1839 203.2 2172 258.E 283.4 299.1 ®Acolarial Asset Value 127.4 140.8 1523 170.E 194.E 229.5 2573 290.7 2953 272.4 The following chart shows more detailed information at the two most recent valuation dates (June 30,2001 and June 30,2002)_ r...e1 V. ..ra—.w P--VW . ]r..m. J.r 74.ZM1 J—31k 2902 vam.m rve - orr...rve .Fxi'�'a-,-•. IIes ire �„c.: s.rr 1fra, .. v+a1 June 30,2001 June 30,2002 $ 50,200,000 Unfunded PVB $ 88,800,000 11,900,000 Excess Assets/ (Unfunded Liability) (26,700,000) 283,400,000 Actuarial Liability 299,100,000 345,500,000 P VB 361,200,000 2 Information prior to June 30, 1993 is not available_ E i. City of Huntington Beach CAPERS Actuarial Issues—"Cost" of 3%@ 50 Page 5 The plan went from having $11.9 million in excess assets at June 30,2001 to having an unfunded liability of $26.7 million at June 30,2002. This change in funded status was caused by the following events: ■ $37.7 million asset loss - CAPERS' investment return (on an actuarial basis) was significantly lower than expected (-4.7% compared to an 8.25% expected rate). By comparison there was a$10.7 million asset loss in the prior year(June 30,2001). ■ $3 2 million actuarial gain — An actuarial gain for the plan indicates that the City's experience was better than expected. This gain was likely caused by a combination of factors, including smaller than expected pay increases and fewer active participants than expected. At June 30,2002 actuarial assets fell short of the actuarial liability by approximately 9'/•_ Additionally, on a market value basis, assets are short of liabilities by approximately 17%_ Furthermore, while CAPERS does not measure a plan's funded status on a market value basic if hem did, then recognizing all asset losses through June 30,2004 would mean the plan's funded status would drop significantly. In fact, unless future gains offset osses, a pans con u o ec-4hese------- -- losses_ The above- actuarial obligations are calculated using the following key actuarial - ----- __ --assuiriPt-ions -------- ----- --- _ _--------- -- ---- --- -- _ ------- _ t- ■ Economic Assumptions: • Investment return - CaIPERS long-term investment return assumption is 8.25%, including 3.5%inflation_ Investment returns greater than 8-25%result in investment gains and returns less than 8.25% result in investment losses. It's important to note Ca1PERS assets are invested in a diversified portfolio designed to have the following mix: ♦ Fixed Income 29% ♦ Equities 65% ♦ Real Estate 6% Their current asset allocation is very similar to the above mix_ The following chart illustrates Ca1PERS market value and actuarial value investment returns over the past several years: 3 CAPERS has announced they will change several actuarial assumptions with their June 30,2003 valuation, including: investment return(7.75%)-,Inflation(3.0%),future salary increases and various demographic ^assumptions. /.. ..1 1\` 11 5 City of Huntington Beach Ca1PERS Actuarial Issues—"Cost" of 3%@ 50 Page 6 24.75^.6 I I 16.50% ' r 1 9-25% I e I I 0.00% I 1 { i i -8-25% I 1994 I1995 1996 1997 19" 1999 2000 2001 2002 2003 2004 ♦ AVARate 10.3% 9.9% 13.6% 15.9% 19.6% 13.9% 1L0% 4.5% 4.7% 33% 7_4% i—MVA Rak 20% 163% 15396 20.1% 19.5% 125% 10.5% -7.2% 0% 3.79G 16 5% The above chart shows two lines, MVA (or Market Value) Rate and AVA (or Ac during the respective fiscal year end, while the AVA Rate is a smoothed rate reflecting asset gains and losses over a period of time,rather than immediately. The -.-_ __.--..--AVA-Rate directly affects the City's contribution rates_ - • Salary increases: ♦ Aggregate payroll growth 3.75%annually. ♦ Individual annual salary increases(including inflation,promotion,step rate,etc.): Service Increase4 0-2 1 I.6% 3-6 7.4 7+ 5.2 Salary increases greater than above generate actuarial losses and lower salary increases generate actuarial gains. ■ Demographic Assumptions: CAPERS demographic assumptions are based on their 1990-95 experience study_ The rates used are based on CAPERS experience for agencies with similar plans (for example Safety 3%@ 50 formulas). Generally we have found this study to generate results consistent with actual experience. One assumption, retirement age,does vary somewhat from one agency to the next_ CAPERS assumptions generally assume Safety employees with 3%@ 50 retire at approximately age 54. For those hired under age 40_ t< i. ` ' 6 - City of Huntington Beach Ca1PERS Actuarial Issues-"Cost" of 3%@ 50 Page 7 Historical Contribution Rates The following chart shows the City's historical contribution rates over the past several years: I 25% j j I zox i 15% � i 1096 -5X S I 1993 1994 1995 1996 1997 1999 1999 200o tool 2002 Normal Coat 129% 132% 133% 135%11.0% 125%125% 17.6% 172X 17.3% _ Amod Da+w -01% -0-2% 23% 28% -5-9'A l25 125 17. -&2% 7.8% Total 128% 13.0Y. I5.655 lb3% 5,1% 0-0%1&0% 40_0%1 90% 25.1X It is important and interesting to remember that if assets equal liabilities, then the City's contribution rate would equal the Normal Costs. However, if assets are greater than liabilities the contribution rate is less than the Normal Cost and if assets are less than ________ liahilities_thc_contribution_rate_-u-more-than-the-hlor>naI-Cosh--'I�-abeve-chart-shows the- _ - - -_ _-- City's contribution rate declined rapidly in the late 1990s and has only recently begun to climb again. CAPERS Historical Investment Return The following chart shows CalPERS' actual(market value)investment returns back to 1986: C W ERS Hbtedvd M rW Value Raps of Rehire-Jam Jd Year Ed. ' Actaarhl Assumed Investment Retsa=&IS% z�79'a i 2a73Y. 16-3054 j it�9'H i 839% f 1 1 aJJ•h j i l I aatre. j I i 47J% i 19'86 79a1 7988 9989 I990 1"1 — I993 1999 1995 19% 7997 199t 1979 2aaa 20a7 7DD2 3 ISn&16 4. OY.76. 13 l 1 -] bt96 5 In reality,assets will almost never exactly equal to liabilities. City of Huntington Beach CAPERS Actuarial Issues—"Cost" of 3%@ 50 Page 8 CAPERS' actual investment return will significantly impact when future contributions might be required because future contribution rates are highly dependent on CaIPERS future investment returns_ In fact, CaIPERS investment return is the single biggest reason why the City's contribution rates will increase, having much more impact than the 3%@ 50 benefit improvement. "Cosy"of 3%@ 50 First of all it's very important to understand there is no perfect way to determine the "cost" of any benefit improvement. For example 3%@ 50 likely caused Safety employees to change behavior (principally retirement) from what they would have done under 2%@ 50. That behavior night manifest itself as a difference in retirement age or even in who the City night hire. For example, a Safety member hired at age 25 reaches the maximum eligible benefit(90°/a)at age 55 under 3%@ 50, while it would take them 3 years more to reach the maximum under 2%@ 50. On the other hand, agencies typically negotiated lower salary increases than would otherwise have been provided when implementing 3%@ 50. All of these various factors are virtually impossible to quantify,making it impossible to determine — stof�benefit-imp -- 1 Member's retirement benefits are calculated by multiplying final compensation (monthly _ averar"e_ofthe highest 12 months for the City's Safety members)times years of City service - times the 2%@ 50 or 3%@ 50 benefit factor at retirement,with benefits capped at 905/6 of final compensation. Final compensation is, generally, base pay and does not include overtime. Members retiring at age 50 get a substantially (501/6) higher benefit under 3%@ 50 than under 2%@ 50,while those retiring at age 55 receive a more modest(11%) increase_ The following chart shows the benefit factors for both r/a @ 50 and 3%@ 50: 0 2%050- -31/60501 3.50% 3.00% i 2.50% © o ` 2.00% i o � U � l6 � U_ 1.50% 1 1.00% I O.50% 0.00% 50 51 52 53 54 55 56 57 58 59 60 Retirement Age I City of Huntington Beach CAPERS Actuarial Issues-"Cost" of 3%@ 50 Page 9 CalPERS experience analysis has demonstrated that Safety members with the 3%@ 50 benefit, generally retire around age 54. The above chart does not reflect different salary increases or changes -in behavior. The following table illustrates how a different salary increase might affect retirement benefits: 3%@ 50 3%@ 50 Same Final 5%Lower 2%na,50 Comp. Final Comp. 1. Retirement Age 54 54 54 2. Benefit Factor 2.56% 3.00% 3.00% 3_ Final Compensation $50,000 $50,000 $47,500 4. Service 30 years 30 years 30 years 5. Annual Retirement Benefit $38,400 $45,000 $42,750 [(2)x(3)x(4)) 6_ 3%@ 50 Increase over 21/6 @ 50 17.2% 113% [I(5)for 3%@50)/I(5)for 2°ib@50) 11 Actuaries typically determine the"cost"of a benefit improvement by preparing an actuarial study using the two terahve a ormu as, comp contribution rate before and after the change. This is what CalPERS did when the City was considering implementing 3%@ 50. It would be theoretically possible to make this comparison after benefits have been improved However,-doing-so would require significant actuariarfeeand ies_fs wou-td nto consi er cltanges—ink-behavior;salary increases,-etc:- o� -- �- these reasons I recommend agencies look to CAPERS original Contract Amendment Cost Analysis to determine,the"cost"of 3%@ 50. When benefits are improved under CAPERS law the benefit improvement applies to prior and future service. The City should consider the "cost"of a benefit improvement as the combination of prior cost (for service before the effective date), bow that prior cost is paid for, and the normal cost (for service after the effective date)_ There are several ways to determine "cost"_ These include, but are not limited to: ■ Short Term Cash Flow-This method refers to the change in the contribution rate when implementing a benefit improvement. CalPERS' Contract�.mendment Cost Analysis, provided to the City when implementing 3%@ 50, shows there was no increase in the City's contribution rate, meaning that 3%@ 50 had no short term cost. This essentially freezes the"cost"at zero and allows excess assets($31.8 million after the amendment)to pay for both prior and future"cost". It is important to note this zero contribution rate is consistent with CaIPERS' Board contribution policy at the time, which was to minimize agency contributions increases,within certain parameters,due to benefit improvements_ ■ Normal Cost-Normal Cost represents the value of benefits being eared (or allocated) to a particular year and is the best representation of the long term impact of a benefit improvement. In fact CalPERS' Contract Amendment Cost Analysis said: "Note that the change in normal cost in the table above may be much more indicative of the long term change in the employer contribution rate due to the plan amendment." 9 City of Huntington Beach CAPERS Actuarial Issues—"Cost" of 3%@ 50 Page 10 The Contract Amendment Cost Analysis indicates the Normal Cost increased 4.589% due to the benefit improvement from 2%@ 50 to 3%@ 50_ This method allows excess assets to pay for the prior cost,while attributing future costs to the increase in the Normal Cost_ ■ Use No(or Limited)Excess Assets—The City's Safety plan was very well funded when 3%@ 50 was implemented_ However,one measure of"cost"is to look at the theoretical cash flow impact of the benefit improvement. This theoretical increase is comprised of the Normal Cost plus an amortization of the increase in the Plan's Unfunded Actuarial Liability due to the amendment. Ca1PERS' Contract Amendment Cost Analysis shows the Plan's Unfunded Actuarial Liability increased $8.4 million due to the benefit improvement_ This increase was comprised of a $20.15 million Actuarial Liability increase offset by a$11.74 million Actuarial Asset increase. The following table shows the plan's funded status impact using and not using the additional Actuarial Asset Increase: After 3%@ 50 Including Excluding Actuarial Asset Actuarial Asset Before 3%fa,50 Increase Increase 00,000 Excess Assets 40,200,000 31,800,000 20,100,000 Actuarial Liability 217,200,000 237,300,000 237,300,000 --- ---- — -- -- - .----Pig----- 63,_-M, W_-------286,694,Q4Q ----. 2$6,600,QQO The following table shows the plan's contribution rate impact with and without the additional Actuarial Asset Increase, irrespective of how well fimded the plan was before the benefit improvement: Including Excluding Actuarial Actuarial Asset Increase Asset Increase • Normal Cost 4.6% 4.61/6 • Prior Cost Amortization(20-years) 3.7% 7.8% • Total 8.3%6 12.4%7 This method includes either a small portion of excess assets(as indicated above under the "Including Actuarial Asset Increase" column) or no excess assets (as indicated above under the "Excluding Actuarial Asset Increase" column)_ Furthermore it amortizes the prior cost over 20 years, consistent with CaiPERS general actuarial policy. Using a 20 year amortization means the City would use one rate for 20-years(for example 8.3"/6) and the Normal Cost (4.6%) beyond 20-years. However, as pointed out by CAPERS staff, the City could theoretically amortize the prior cost in perpetuity_ Under this 6 8.3%for first 20 years and 4.6%thereafter. 12.4%for first 20 years and 4.6%thereafter. i 10 1*01 City of Huntington Beach Ca1PERS Actuarial Issues—"Cost"of 3%@ 50 Page 11 method the City could use one rate on into the future. The following table shows the contribution rate impact using this method: Excluding Actuarial Asset Increase • Normal Cost 4.6% • Prior Cost Amortization(perpetuity) 4.7% • Total 9.1%8 We have only shown the perpetuity contribution impact excluding the actuarial asset increase_ Doing otherwise would perpetuate an asset gain and be inconsistent with generally accepted actuarial practice. ■ Use A Portion of Excess Assets—This method excludes the portion of excess assets that can be attributed to City contributions made after July 1, 1978 from paying for the benefit increase_ The above methods do not consider what portion of the plan's funded status (when 3%@ 50 was implemen was ern om sources a co - - - consequently contribution rate) can, theoretically, be segregated into three contribution sources: 1. Pre July 1, 1978 employee and-City-contributions-, employee-eontributi©ns;-and----- --- 3. Post June 30, 1978 City contributions. This method is a compromise between the Normal Cost method (which uses all plan assets to offset the benefit improvement) and the Use No (or Limited) Excess Assets method (which uses no assets to offset the benefit improvement). Essentially excess assets attributable to item 3 above would be excluded in determining the plan's funded status before the 3%@ 50 benefit cost is determined_ Bartel Associates discussed with CalPERS what historical information is available to do this allocation_ Complete historical records are not available_ Ca1PERS provided Bartel Associates with their readily available information_ Based on this information, and making several very significant assumptions for missing information, we've estimated excess plan assets (before 3%@ 50 cost is calculated) may be attributable to the following contribution sources: Allocation Source Allocation % 1_ Pre July 1, 1978 employee and City contributions 51% 2_ Post June 30, 1978 employee contributions 18% 3. _ Post June 30, 1978 City contributions 31% a 9_I%would be used for all years- 9 Assumptions made include:actual(City and employee)contribution amounts and Ca1PERS investment returns before 1983,among others. i, 1 I '" City of Huntington Beach CAPERS Actuarial Issues—"Cost" of 3%@ 50 Page 12 Applying the above percentages to the plan's funded status results in the following funded status change: Before 3%(a,50 Before Excess is Aker Excess is Allocated Allocated After 3%(a)50 $ 6,300,000 $ 20,400,000 Unfunded PVB $ 41,700,000 40,200,000 26,100,000 Excess Assets 7,600,000 217,200,000 217,200,000 Actuarial Liability 237,300,000 263,700,000 263,700,000 PVB 286,600,000 Using the two amortization methods discussed earlier (20-year amortization and perpetuity)results in the following 3%@ 50"Cost"impact: 20-Year Perpetuity Amortization Amortization • Normal Cost 4.6% 4.6% • Prior Cost ortization -years . a - o 0 o al !9%10 6 5°/u 1 The above indicated results should not be considered precise. Alternative assumptions will likely yield very different results with a high degree of variance. For administrative simplicity a single determined rate is preferable. However,there is an 1 argument that the above method should also be used to allocate gains and losses after June 30, 1999 (the valuation date from which the Contract Amendment Cost Analysis was prepared)_ However,doing so will yield results that will vary from one year to the next,become administratively difficult and likely yield unreliable results. There are advantages and disadvantages to each of the above methods. The Short Term Cash Flow method is not generally reasonable because it implies there is no"cost"to the benefit improvement. Furthermore, the Use No (or Limited)Excess Assets method virtually ignores how well funded the plan was when benefits were improved. Both the Normal Cost method and the Use a Portion of Excess Assets method consider the Plan's funded status. It's important to note that CAPERS' Contract Amendment Cost Analysis shows that, after 3%@ 50 was implemented, the plan still had very large excess assets. Consequently, if all excess assets, which generally were due to CAPERS investment returns greater than expected, are used to pay for the prior cost component of 3%@ 50, then it is reasonable to consider the "Cost" of 3%@ 50 as being equal to the increase in the Normal Cost. An additional advantage to Normal Cost is that it represents the "cost" of the benefit improvement attributable to a single year_ Another way to say this is that Normal Cost represents the value of benefits being earned during the year by members providing services to taxpayers_ Consequently, from a taxpayer's generational equity standpoint the increase in 10 7.915%for rust 20 years and 4.6%thereafter_ 6.5%would be used for all years_ ["ifin 12 City of Huntington Beach CaIPERS Actuarial Issues—"Cost' of 3%@ 50 Page 13 the Normal Cost,due to the new formula,represents the best and most reasonable estimate of the value of the benefit increase. If the City wants to allocate excess assets based on their contribution source, the Use a Portion of Excess Assets method is theoretically reasonable. However, the available information is far from complete and different assumptions might yield dramatically different results_ SUMMARY.AND CONCLUSION Determining the true "cost" of 3%@ 50 is virtually impossible_ If accurate historical information were available we would be inclined to recommend using the Use a Portion of Excess Assets method. However,the available information is modest and assumptions used to estimate missing information can significantly skew results_ Consequently, unless accurate historical information can be developed,we can not recommend this method. The best information available is CaIPERS Contract Amendment Cost Analysis. This information suggests the best and most reasonable, long term indicator of "cost" is the benefit im ovement_ As mentioned before Ca1PERS Contract Amendment Cost Analysis said: "Note that the change in normal cost in the table above maybe much more in& . -ve o — the long term change in the employer contribution rate due to the plan amendment_" An additional advantage to using Normal Cost is that this amount is constant and should not __-------vary-into,-the-fuwm.-consequently-we-rceemmend-ihe-City-useA.6%-as-the-po&m-of the----------- - Safety contribution rate that can not be paid from the retirement property tax. t 1 13 f�� RCA ROUTING SHEET INITIATING DEPARTMENT: FINANCE SUBJECT: ADOPT RESOLUTION TO ESTABLISH FISCAL YEAR 2006/2007 TAX RATE COUNCIL MEETING DATE: AUGUST 21, 2006 RCA ATTACHMENTS STATUS Ordinance (w/exhibits & legislative draft if applicable) Attached ❑ Not Applicable 19 Resolution (w/exhibits & legislative draft if applicable) Attached U Not Applicable Tract Map, Location Map and/or other Exhibits Attached ❑ Not Applicable 9 Contract/Agreement (w/exhibits if applicable) Attached ❑ (Signed in full by the City Attorney) Not Applicable N Subleases, Third Party Agreements, etc. Attached ❑ (Approved as to form by City Attorney) Not Applicable Q Certificates of Insurance (Approved by the City Attorney) Attached ❑ Not Applicable Fiscal Impact Statement (Unbudgeted, over $5,000) Attached ❑ Not Applicable Bonds (If applicable) Attached ❑ Not Applicable Eq Staff Report (If applicable) Attached ❑ Not Applicable Commission, Board or Committee Report (If applicable) Attached ❑ Not Applicable Rf Findings/Conditions for Approval and/or Denial Attached ❑ Not Applicable EXPLANATION FOR MISSING ATTACHMENTS REVIEWED RETURNED FORWARDED Administrative Staff ( ) Assistant City Administrator (Initial) ( ) City Administrator (Initial) ( ) ( ) City Clerk ( ) EXPLANATIONfOR LIETURN OF ITEM; Space Only) RCA Author: Robert Sedlak, Accounting Manager x5907