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HomeMy WebLinkAboutPension Cost Increases - Study Session #2 Supplemental Commu • An Existential Threat Pension Cost Increases Huntington Beach City Council Study Session October 21, 2019 �3 CaIPERS Pension Cost Increases • The greatest challenge to Huntington Beach's long-term fiscal sustainability — and the fiscal sustainability of government agencies in California — relate to unfunded CalPERS pension cost obligations • CalPERS methodology changes that have been implemented during the past several years have created a pension cost structure that is requiring all California governmental agencies to rethink their operations or face insolvency Pension Cost Background Unfunded Accrued Liabilities Driving Cost Increases How Do Pension Costs Work? • On an annual basis, the City and employees make contributions toward CalPERS to pay for future retirement benefits • In total, the City's account at CalPERS has a balance of around sgi:t.g6 million in assets to pay for promised retirement benefits • Our annual payment to CaIPERS includes three components: 1. Employer Normal Cost 2. Employee Normal Cost 3. Unfunded Accrued Liability (UAL) Cost Three Different Pension Cost Areas • Employer Normal Cost (FY 2o18/ig actuals - $13.03 million) • Employer pension costs are determined by CalPERS and paid by the City(with a portion being paid by some employees) • Misc.employer costs are currently 9.211%of payroll Safety employer costs are currently 19.8i6%of payroll • Employee Normal Cost (FY 2018/1g actuals - $7.6o million) • Employees also contribute towards pension related costs • Misc.employees contribute 8%(Classic)or 6.25%(PEPRA)of payroll costs • Safety employees contribute 9%(Classic)or ii%(PEPRA)of payroll costs • UAL Cost (FY 2018/1g actuals - $24.93 million) • UAL costs are assessed to make up for valuation lost and costs incurred from prior years • Lower than projected investment returns • Changes in actuarial assumptions City of Huntington Beach Pension Cost Areas FY 2018/19 Actuals Data Employer Employee UAL TOTAL Category Cost Cost Cost Total Contribution $ 13,031,511 $ 7,603,098 $ 24,930,996 $ 45,565,605 Percentage of Total 29% 17% 55% 100% UAL Payments Driving Pension Cost Increases • CalPERS pension "Normal Cost" are fairly consistent • Public Safety Normal Cost are projected to hover at around zo%— 21% of payroll • Misc. Normal Costs are projected to hover at around Zo%-11% of payroll • Primary driver of increased pension costs are unfunded liabilities • HB currently has $gi3.g6 million in assets in our CalPERS account, however, the value of the retirement benefits that have been promised is currently estimated at $3.35 billion in liabilities • This means that the City currently has a projected UAL of $416.17 million • The entire CAPERS portfolio has an estimated UAL of$3-51.7 billion • CalPERS has instituted aggressive funding schedules in an attempt to reach i00% funded status within the next 20-30 years UAL Structure SimilarTo A Mortgage • Accelerated UAL payments mandated by CalPERS have been the cause of our current pension crisis • Of note, UAL payments will end when the overall accrued debt load has been paid off • In some ways, UAL payment is similar to a mortgage payment • For HB specifically, our UAL "mortgage" includes the following key terms: • We're being charged an interest rate of 7%to service our UAL debt load • We have 24 years left on the term of our current "mortgage" • Final payment scheduled for June 30, 2043 • ARMs stink... our annual payments will increase through FY 2o2g/3o UAL Cost Increase Impact On H13 • HB's annual UAL payment costs (i.e., our mortgage payments) have increased dramatically during the past decade, and will continue to increase until 2030 • FY 2oo8/o9 UAL Payment- $4.58 million • FY 2018/19 UAL Payment- $24.93 million • FY 2028/29 UAL Payment- $44.79 million • FY 2029130 UAL Payment - $46.02 million • In the past so years (from 2009 — 203.9), our annual UAL payment has increased a staggering 444%, from $4.58 million to $24.93 million • By FY 2029/30, our UAL payment is projected to increase by another 85%, from $24.93 million to $46.02 million • This equates to a $21.0g million annual cost increase!!! • Between 2009 — 2030, our UAL costs will have increased an astounding 904%, with annual costs having increased by $41.44 million City of Huntington Beach UAL Payment Amounts FY 2008109 $45,000,000 $35,D010,000 515,000,DDO $21 . 09 Million / Year • Moving forward, the challenge we face on the pension front is that by 2030, our annual UAL payment will increase by $21.04 million year over current costs CaIPERS Overvi How the heck did we get here? Has CalPERS Always Been Underfunded? • No! In fact, 20 years ago, CalPERS was 128% funded • Also, during the i-99o's, and again during the mid-2000'S, the CaIPERS portfolio . • funded at above i • 1 - Throughout that period, on multiple occasions, CalPERS was superfunded, meaning that it . • more than • • 1 of needed to cover . liabilities Funded ratio M 128% 71% 96% 119% 101% %5008 1201, 87% 61% 76% S400B ID0% 80%— --S300B Actuarial liabilities M 60% 40% Assets $zooB 20%i F100B 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005;Or! 09 2010 2011 2012 701 nv. 2015 2016 2017 2018 1993-2000 2007-2009 Increased life Additional $trongeconomy SB400 AB616 Great Recession expectancies $6billion from State t PEPRA law Steps to strengthen Discount Discount the Fund rate lowered rate lowered Discount rate Dotcomcrash &25%+7.75% 7.75%-75% lowered to7% So What Happened ? • Our current pension crisis in California began in September of Zggg, when then Governor Gray Davis signed SB 400 into law • SB 400 instituted significantly enhanced retirement benefits for CalPERS members • Public safety personnel were provided with the "3Qa 50" retirement benefit • Non-public safety personnel were offered enhanced pension plans as well • These enhanced retirement plans are now near universally provided as standard benefits for public sector employees in California • SB 400 significantly increased pension benefits for public sector employees • Prior to SB 400, a California Highway Patrol officer who retired with 30 years on the job collected a CaIPERS pension averaging s62,218/year • After SB 400, California Highway Patrol officers with 3o years on the job began collecting a pension averaging s96,270/year CaIPERS Investment Returns Tanked • When SB 400 was instituted, CalPERS projected that the enhanced benefits could be provided at no additional cost • The CaIPERS board assumed ongoing annual investment returns of 8.25% • According to actuaries, if investment returns of 8.25%were achieved, then the enhanced retirement benefits would not have added any additional costs • Unfortunately, we have had two major stock market collapses since 1ggg • In 2000, the dot.com bubble burst • The Dow Jones Industrial Average dropped 6%in z000,7%in zooi,and 1-7%in 2002 • In 2008, the Great Recession hit • CaIPERS investments lost 3%in 2oo8,and then, lost an unbelievable 24%in 2009 • Today, the overall CalPERS portfolio is estimated to be funded at around 70% CalPERS Cost Increases Enacted • In response to deteriorating financial conditions, CalPERS has enacted a series of pension cost increases • March 16, 2012—Change in Discount Rate From 7.75% - 7.50% • Designed to more accurately reflect investment return earnings • Impacted employer rates beginning in FY 2013/14 • April 17, 2013 —Change in Amortization & Rate Smoothing Policy • Designed to pay down unfunded liabilities faster • Impacted employer rates beginning in FY zo15/16 • February A, 2014—Change in Actuarial Assumptions & Asset Allocations • Designed to account for demographic and mortality adjustments • Impacted employer rates beginning in FY 2oi6/17 Additional Increases Enacted In zoi6 • On December 21, 201.6, the CaIPERS Board voted to enact two substantial new changes 1. Lower the discount rate from 7.5%to 7.0% 2. Enact an accelerated payback schedule for all unfunded accrued liabilities(UAL) • The net effect of the two changes includes the following: • Discount Rate Reduction • Designed to more accurately reflect investment return earnings • Impacted employer rates beginning in FY 2018/19 • UAL Payment Acceleration • Designed to accelerate payments to fully fund existing unfunded liabilities over a 20-30 year period • Son 0 What Do WeDo Now? Refinancing our UAL debt, coupled with stronger pension funding policies, are two recommended areas of analysis. HB's UAL Cost Increase Scale • 2009 vs. 2019 vs. 2029130 • FY 20o8/og UAL Payment - $4.58 million • FY 2018/sg UAL Payment - $24.93 million • FY 2029/30 UAL Payment - $46.02 million • From 2009 — 203.9, we saw an annualized 444% cost increase • From $4.58 million to $24.93 million • From 203.9 — 2030, we will see an annualized 85% cost increase • From $24.93 million to $46.02 million • That's a cost increase of $21.09 million / year in 2030 11'vs.20191 1 UAL Payment Amounts 546,019,351 8 UAL Payment Amounts Scale of Pending Budget Problem • If we do nothing, by 2030, we will need to find an additional $21.09 million / year to address escalating UAL cost payments • Eliminating our Library, Community Services, and IT Departments would result in $20.81 million in savings, which isn't enough to cover the UAL cost increase • Eliminating 25% of our entire Police Department operation (-91 positions) would achieve $1g.64 million in savings, which wouldn't be enough to cover the UAL cost increase • Eliminating 40% of our entire Fire Department operation (--79 positions) would net $1g.62 million in savings, which wouldn't be enough to cover the UAL cost increase Scale of Pending Budget Problem • The magnitude of $21.09 million / year also dwarfs the impact that the Great Recession had on HB • The effects of the Great Recession were first felt in Huntington Beach in FY 20o8/og, as combined Property Tax & Sales Tax revenues dropped by 1.7% COMBINED PROPERTY TAX& SALES TAX DURING THE GREAT RECESSION Total Combined Annual Dollar Annual Percent Fiscal Year Property/Sales Tax Increase/(Decrease) Increase/(Decrease) Revenues 2007/08 $89.04 million - - 2008/09 $87.53 million 2009/10 $87.68 million $15k 0.2% 2010/11 $90.46 million $2.78 3.2% What Are Our Options? • Our pension problem is really a UAL cost problem • To solve the problem, we can either... 1. Find the funds needed (either through cuts and / or revenue increases) to pay for the increasing UAL costs 2. Refinance our current UAL costs via a pension obligation bond (POB) Refinancing Seems Like A Good Idea • Current CalPERS UAL Balance — $436 million • If we do nothing, our UAL payments to CaIPERS during the next 24-year period will cost the City the following amounts: • Annual cost: Fluctuates (avg. $34.79M /year, high of$46.o2M/year) • Total payments: $834.90 million • Total interest costs: $391.78 million • Refinancing with a POB could result in the following cost structure during the next 24-year period (assuming a conservative interest rate of 3.16%): • Annual cost: Fixed at --$26.26 million/year • Total payments: $630.28 million • Total interest costs: $192.12 million CaIPERS UAL vs . POB Refinance CalPERS UAL Payment Costs vs. POB Refinancing Costs CalPERS POB Refinancing UAL Payment Refinancing Savings Annual Payment(average) $ 34,787,631 $ 26,261,554 $ 8,526,077 Total Payments $ 834,903,132 $ 630,277,291 $ 204,625,841 Totallnterest $ 391,784,473 $ 192,122,289 $ 199,662,184 CaIPERS Costs vs.Refinance Costs Annual Payment Total Payments Total Interest M CaIPERS UAL Payment Costs 0 POO Refinancing Costs Why Is RefinancingCheaper? • One of the primary cost savings driver when assessing the POB option is the current municipal bond market • We currently live in a low-interest rate world, with certain governmental entities (Germany, Japan, and the EU) offering negative savings rates • These global market conditions have created a scenario where municipal borrowing rates are currently near the lowest levels ever recorded • For the proposed POB, preliminary research indicates that we could refinance our UAL debt at somewhere around --3% interest • By comparison, CaIPERS is currently assessing an interest rate of 7% on our UAL debt Why Shouldn't We Refinance? • In order to more fully vet the POB option, staff has been asking ourselves one key question... • What are the reasons why we SHOULD NOT issue a POB? Reasons Why Refinancing Could Be Bad Idea • Issuing a POB now does nothing to address future possible unfunded actuarial liabilities growth • Returning our UAL to zero now does nothing to keep it at zero in the future • CaIPERS could underperform from an investment perspective, and our POB funds could lose value • If CaIPERS does not earn at least a -3% return (i.e., the cost of refinancing our UAL debt), then our POB funds will cost more than the benefit we are receiving Reasons Why Refinancing Could Be A Bad Idea • CalPERS could over-perform from an investment perspective, and we wouldn't have had to issue such a large POB • If CalPERS over-performs and beats 7% investment returns (6.7% return earned in FY 2o18/lg), then our UAL amount will decrease • Unknown possible State legislative /judicial changes in the future • The State and / or the Courts could make pension rule changes to reduce our UAL amounts Reasons Why Refinancing Makes Sense • Despite the reasons identified as to why we shouldn't consider refinancing our UAL debt, there continue to be compelling reasons why we should consider the strategy • Refinancing removes an unknown cost variable and replaces UAL cost increases with a stable fixed payment amount • Similar to transitioning from a variable rate ARM loan into a fixed-rate loan • Interest rates are at historic lows, and given HB's current fiscal situation, we will likely be able to refinance our UAL debt load at an interest rate of -3% Reasons Why Refinancing Makes Sense • More than likely, CAPERS will be able to earn an investment return of at least (and likely greater than) 3%, which makes refinancing an attractive option • CalPERS actual investment return performance (for FY ending 6/30/19): • Last year(FY zoi8/ig)—6.7% • Last 3 years—6.7% • Last 5 years—8.1% • Last ao years—5.6% • Last zo years—6.1% • Last 3o years—8.4% • Even if the State/courts make pension program changes, HB could still take advantage of those options if we refinance • Refinancing our UAL debt does not preclude the City from taking part in future State/ court decisions related to pension program changes Reasons Why Refinancing Makes Sense • It is unlikely that the State / courts will agree to a pension program fix within the next few years • Without refinancing our UAL debt, within the next few years, Huntington Beach will need to institute more draconian measures or run the risk of running out of cash • If our pension fund becomes over-funded (at +t00%), those funds stay in the City's CalPERS account and can be used to cover future UAL shortfalls • By refinancing, the City's CaIPERS pension fund will have a larger pool of assets to invest with, and given compounding interest, that larger asset pool gives HB a better chance to earn more significant returns 7%return on $913.96 million(current CaIPERS balance) = $63.98 million • 7% return on s1.35 billion (CalPERS balance if fully funded) = $94.S1 million Additional Refinance Consideration • Staff has spent significant time researching why some state pension funds are currently better funded than CalPERS, and why certain local jurisdictions in California have lower UALs than others • NewYork vs. California • In zoig, NY=96%funded //California =70%funded • State of California—Brown + Newsom = $g billion "POB"to pay down State UAL • California city examples • Newport Beach—$8M - $gM extra per year to pay down UAL • Santa Monica—Paid down UAL by $77.5M through 2oi8 with cash savings • Ontario/Simi Valley—Considering refinancing w/POB option to pay down UAL Savings From Refinancing UAL Debt Should Be Conservatively Managed • If we do move forward with refinancing our existing UAL debt, staff would recommend that we conservatively manage any realized savings • Fiscal threats are on the horizon • CalPERS will almost certainly look to lower their assumed rate of return from 7% down to 6% within the next few years • We are currently in our��4th consecutive month of economic expansion, making this current period the longest growth cycle in the history of our nation • Growth cycles in the US have historically averaged 56 months in length • We are overdue for a recession, which is looming over the world Section 115 Trust Benefits Limitations • Assets can theoretically be accessed to pay • Assets not recognized when CaIPERS sets CaIPERS at anytime contribution rates • Provides access to a broader base of • Investment returns (net of expenses) likely investment options than allowed by City to be lower than if invested directly with investment policy CaIPERS • Can serve as a rainy-day-fund to help offset • Given scale of City's CaIPERS portfolio ($914M),Trust is not likely to have a pension costs material impact on pension asset • More control over investments when diversification compared with paying CalPERS directly • Assets can't simply be transferred to • Provides diversification of investment CaIPERS, they have to be sold at market assets and strategies value • In a downturn,when reserve funds are likely to be needed most, market value of the portfolio will likely be negatively impacted Development Of A CalPERS UAL Policy • In addition to using our Section 115 Trust, if we do move forward with refinancing our UAL debit, staff also would recommend that a new City UAL policy be adopted • Such a policy could require that as part of our budget process, we annually identify any new UAL debt that has accrued, and that the City develop a pay-off plan for the new debt within a set time period • For example, a policy framework could be as follows: • UAL of$o - $5 million - paid off within 0-5 years • UAL of$5 - sio million - paid off within 5-10 years • UAL of$lo - $15 million - paid off within 10-15 years • UAL of$15 - $20 million - paid off within 15-20 years Proposed Next Steps 1. Direct staff to conduct further analysis and outreach regarding refinancing our UAL debt load • Present the concept to relevant City commissions /committees 2. Provide direction that staff initiate the judicial validation process needed to allow HB the opportunity to refinance our UAL debt in November 2019 • Instrument through which the refinancing would be achieved is a pension obligation bond (POB) • In California, POBs require a judicial validation action, which requires around 3 months to coordinate • To proceed, this will require that the City adopt a non-binding resolution authorizing the pension obligation bond process Questions?