Town Pension and OPEB Plans Information (updated 8-9-18)

Introduction

 The following informational items provide an overview of pension and OPEB unfunded liability issues, including additional links for further exploration.  The Town of Los Gatos is committed to providing information access and transparency on these and other issues.  The community is encouraged to sign up for “Notify Me” to subscribe to the items of interest (such as upcoming Town Council, Council Finance Committee, and other Commission meetings):  www.losgatosca.gov/list.aspx.

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 You can find information on the following pension and OPEB related areas below:

  • Town of Los Gatos Retirement Plans
  • Calculating the Town’s Pension and OPEB Obligation
  • What is the Discount Rate?
  • How does the Town Fund the Pension and OPEB Plan?      
  • What is the Unfunded Accrued Liability?
  • What Caused this Unfunded Obligation?
  • What has the Town Done to Address the Unfunded Obligation?

Town of Los Gatos Retirement Plans

The Town of Los Gatos provides a defined benefit pension plan for all full-time employees and some part-time benefitted employees as part of their total compensation package.  Defined benefit plans provide a fixed, pre-established benefit payment for employees in retirement based on a formula which takes into account an employee’s years of service and highest average annual salary.  The defined benefit pension has been a standard part of compensation in governmental organizations and in Los Gatos is in lieu of participating in Social Security, except for the required Medicare rate of 1.45% of all wages.

The Town’s pension plans are administered by the Board of Administration of the California Public Employees’ Retirement System (CalPERS).  The Board of Administration is responsible for the management and control of CalPERS.  In addition, the Board has exclusive control of the administration and investment of funds.  Sworn employees are covered under the Safety Plan which is a pooled plan, while all other employees are covered in the Miscellaneous Plan, which is a separate plan.  The Miscellaneous Plan is administered by CalPERS in the Public Employees’ Retirement Fund (PERF).  In addition, the Town Council has established an Internal Revenue Code Section 115 Trust as a supplement to the PERF fund.  The Town’s Pension 115 Trust is administered by the Town Pension and OPEB Trusts Oversight Committee.  The Pension 115 Trust assets are maintained by Public Agency Retirement Services (“PARS”) and invested with Highmark Capital Managements Capital Appreciation Index PLUS.

The Town also provides a healthcare benefit for all eligible employees.  The healthcare plan pays all, or a portion of, health insurance premiums for qualified retirees and their survivors and dependents.  Healthcare benefits are also referred to as Other Post-Employment Benefits or OPEB.  The Town’s healthcare plan is an Internal Revenue Code Section 115 Trust which is administered by the Town Pension and OPEB Trusts Oversight Committee. The Oversight Committee is responsible for the management and control of the healthcare assets.  The healthcare assets are maintained at CalPERS and invested in the CalPERS managed California Employers’ Retiree Benefit Trust (CERBT) Strategy 1.

For more information on CalPERS and PERF, please refer to: https://www.calpers.ca.gov/page/home

www.calpers.ca.gov/docs/forms-publications/facts-pension-retirement.pdf

For more information on CalPERS CERBT Strategy 1, please refer to:

www.calpers.ca.gov/page/employers/benefit-programs/cerbt

For more information on Highmark Capital Management, please refer to:

www.unionbank.com/commercial-bank/investment-management/highmark-capital-management/index.jsp

For more information about the pension and other benefits offered to Town employees, see:

https://ca-losgatos2.civicplus.com/DocumentCenter/View/18949

Calculating the Town’s Pension and OPEB Obligation

In order for the Town to understand the value of future pension and healthcare benefit payments, an actuarial valuation is performed each year for the pension plan and every other year for the healthcare plan.  The CalPERS actuary estimates the payments that will be made for all potential retirees from the plan in each future year.  The actuary calculates the present value of future benefits the plan will be required to pay to its current participants: those still working who will retire in the future, retirees, and those who have terminated employment but have not yet begun drawing benefits. For the healthcare plan, the Town Pension and OPEB Trusts Oversight Committee retain the services of Bartel and Associates to analyze the respective assets and liabilities of the Healthcare Plan.

Although an estimate, considering these payments as a certain stream of future cash flows is helpful to understand the pension and healthcare obligations.  Expressing the value of these future series of payments as single amounts on a specific date annually is useful for several purposes, including financial statement preparation, annual funding decisions, and regulatory compliance.  This single amount is referred to as the Actuarial Accrued Liability (AAL) and is an estimate of the present value of the benefit obligation.  To calculate the present value of the obligation, the actuary uses a discount rate which is the interest rate used to bring future cash flows to the present to account for the time value of money.

  • The Town of Los Gatos 2017 Annual Valuation for the Miscellaneous Pension Plan calculated an AAL of $99.9 million.
  • The Town of Los Gatos 2017 Annual Valuation for the Safety Pension Plan calculated an AAL of $84.6 million.
  • The Town of Los Gatos 2017 Actuarial Valuation for the Retiree Healthcare Plan calculated an AAL of $24.7 million.

For more information on the Town’s actuarial valuations and pension and healthcare obligations, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

What is the Discount Rate?

As previously noted, the discount rate is the long-term interest rate used in determining funding for future pension and healthcare benefits.  The discount rate is also known as the assumed rate of return because it is the expected return on investments during the fiscal year.  State and local government plans, multiemployer plans, and some private sector plans not subject to the Pension Protection Act funding rules commonly use expected return-based methods.  Using an expected return-based method, a discount rate is selected by looking at the asset allocation of the pension plan investment portfolio and estimating the average return the portfolio is expected to produce during the time period in which benefits are paid.

CalPERS is currently in the process of lowering the discount rate for PERF from 7.25% to 7.00% over the course of the next two years. For the 2017 healthcare valuation, Bartel and Associates recommended lowering the discount rate from 7.25% to 6.75%.                                                                                     

For more information regarding CalPERS discount rate history, see: 

www.calpers.ca.gov/docs/forms-publications/facts-investment-pension-funding.pdf

For more information on the expected-return based method, see: 

www.actuary.org/content/measuring-pension-obligations-0

How does the Town Fund the Pension and OPEB Plans?       

 Once the Town knows the current value of the benefit obligations, the Town can budget accordingly to accumulate the appropriate amount of assets to meet that obligation.  The obligations are prefunded to account for the benefits that accrue over the lifetime of an employee.  Assets for the defined pension plan are accumulated in three ways: employee contributions, employer contributions, and investment gains.  Assets for the OPEB plan are accumulated from employer contributions and investment earnings only.

Basic Retirement Funding Equation:

C + I = B + E

(Left Side = Right Side)

                                         • C = Contributions (employer and employee)

                                         • I  = Investment Income

                                         • B = Benefits Paid

                                         • E = Expenses (administrative)

Town employees contribute a percentage of their salary towards their pension in what’s referred to as the normal cost.  The normal cost is the annual cost of service accrual for active employees and can be viewed as the cost of benefits earned by employees in the current year.  The second source of normal cost funding is provided by employer normal cost contributions.  The employer normal cost rates for all cities/towns in CalPERS are established annually by CalPERS.  These rates are the minimum contractual obligations the Town must pay, and are also applied as a percentage of salaries.

It should be noted, that the normal cost calculation assumes all actuarial assumptions will be met going forward. In the event the plans experience unfavorable economic or demographic assumptions an unfunded liability may occur. The cost associated with an unfunded liability is borne solely by the employer.  The unfunded liability is discussed in greater detail in the next section.

The balance of the funding is earnings from the investment of plan assets. Both plans currently invest in a range of assets including stocks, bonds, real estate, and other investment vehicles.  According to CalPERS, 61% of every dollar paid out of the PERF fund has historically been from investment returns.  

  • The Town of Los Gatos 2017 Annual Valuation for the Miscellaneous Pension Plan calculated a Market Value of Assets (MVA) of $69.5 million.
  • The Town of Los Gatos 2017 Annual Valuation for the Safety Pension Plan calculated a Market Value of Assets (MVA) pool share of $62.5 million.
  • The Town of Los Gatos 2017 Actuarial Valuation for the Retiree Healthcare Plan calculated a Market Value of Assets (MVA) of $13.6 million.

For more information about the Town and employee contribution rates see:

https://ca-losgatos2.civicplus.com/DocumentCenter/View/18949

For more information regarding CalPERS investments, assets, and earnings, see:

https://www.calpers.ca.gov/docs/forms-publications/facts-investment-pension-funding.pdf

For more information on the Town’s actuarial valuations and pension assets, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports


What is the Unfunded Accrued Liability?

The Unfunded Accrued Liability (UAL) obligation represents the market value of the assets minus the discounted value of the future liabilities.  When a plan or pool’s Market Value of Assets is less than the Actuarial Accrued Liability, the difference is the plan or pool’s UAL.  An unfunded liability results in the Town paying contributions in excess of the normal cost or the employer Unfunded Accrued Liability (UAL) annual contribution amount.  The pension UAL is amortized over a period of time based on CalPERS amortization policies.  The Town’s annual UAL contribution payment calculated by CalPERS is designed to pay down the UAL principal and interest over that amortization period (currently 30 years). The Town Pension and OPEB Trusts Oversight Committee in consultation with their actuary determines the amortization period for the healthcare UAL (currently 20 years for the 2017 valuation).

  • The Town of Los Gatos 2017 Annual Valuation for the Miscellaneous Pension Plan calculated a UAL of $30.4 million ($99.9 M of AAL minus $69.5 M of Market Value).
  • The Town of Los Gatos 2017 Annual Valuation for the Safety Pension Plan calculated a UAL of $22.1 million.
  • The Town of Los Gatos 2017 Actuarial Valuation for the Retiree Healthcare Plan calculated a UAL of $11.1 million.

For more information on the Town’s UAL and amortization, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

What Caused these Unfunded Obligations?

The UAL is an annual actuarial estimate based on a series of complex economic and demographic assumptions associated with the pension plan’s membership.  Demographic assumptions include mortality rates, retirement rates, and employment termination rates among others.  Economic assumptions include future investment earnings, inflation, and salary growth rates.  The development of a UAL typically results from unfavorable investment returns, changes in actuarial assumptions, unfavorable demographic shifts, and other experiences that differ from those anticipated by the annual actuarial assumptions.  

The Town’s pension plans over the past several decades, like all other CalPERS participants, have experienced unfavorable investment returns, changes in actuarial assumptions, and unfavorable demographic shifts which have outweighed any positive plan experiences.  The table below provides the preliminary PERF investment returns for the 12 month period that ended June 30, 2018, five years, ten years, twenty years, and since inception.


CalPERS  Investment Return*

2018

5 Years

10 Years

20 Years

PERF  Since Inception (1988)

*preliminary

8.6%

8.1%

5.6%

6.1%

8.4%






As the CalPERS chart below illustrates, over the last several decades pension plans have shifted their asset allocations toward greater equity and other asset class exposures as risk free rates of return (10 Year Treasury) steadily declined.  However, the greater volatility associated with equities was evident during the 2001 and 2007 recessions as market declines impacted pension plan funding. The subsequent pension plan investment losses from those two recessions are still a contributing factor to the Towns current pension UAL.

2

In addition, the CalPERS chart below illustrates how the significant asset class gains since the last recession are reducing future expectations for asset class returns.  In 2014, CalPERS estimated from its capital market assumptions that the PERF asset allocation would yield 7.1% over the course of the next decade.  Two years later (2016), that same exercise resulted in CalPERS only forecasting that the PERF asset allocation would yield 6.2% over the course of the next decade.  Those reduced estimates of future investment returns and other factors have led CalPERS to lower the assumed rate of return for the PERF asset allocation.

3

The following data from the Town’s 2017 pension actuarial valuations help illustrate the sensitivity of changes in the discount rate to the UAL.

Discount Rate

Miscellaneous Pension UAL

Safety Pension UAL

7.25% (current discount rate)$30,375,955$22,076,192

6.0%

$46,451,950

$36,576,635

7.0%

$33,072,614

$24,533,001

8.0%

$22,042,272

$14,684,466








In June 2004, GASB issued Statement No. 45, Accounting and Financial Reporting by Employers for Post-Employment Benefits Other Than Pensions (“GASB 45”), which addresses how state and local governments should account for and report their costs and obligations related to OPEB.  GASB 45 generally requires that employers account for and report the annual cost of OPEB and the outstanding obligations and commitments related to OPEB in essentially the same manner as they currently do for pensions.  With the implementation of GASB 45, the Town started calculating and recording the OPEB obligation which resulted in the initial healthcare plan UAL.  The provisions of GASB 45 allowed implementation to be applied prospectively and did not require governments to fund their OPEB plans.

In 2009, the Town proactively opted to transition from a “pay-as-you-go” funding policy for OPEB benefits and adopted a ten year phase-in approach to prefunding the OPEB obligations. Since implementation of the ten year phase in to prefunding the healthcare plan has gone from zero percent funded to the current 54.9% funding ratio.

For more information on the Town’s pension and OPEB UAL, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

For more information on CalPERS decision to lower discount rates, view:

https://www.youtube.com/watch?v=oeokuypi7Ko

What has the Town Done to Address the Unfunded Obligation?

 The Town prudently recognized the potential impacts to future service delivery if unfunded pension and OPEB obligations were not addressed and additional funding strategies not identified.  To date, the Town has taken proactive steps totaling $30.5 million of additional discretionary spending strategies to address the current pension and OPEB unfunded obligations.


Council Action

Additional Discretionary Pension Funding/Savings

The Town authorized payment of the entire approximate $4.5 million side fund liability associated with the Safety Plan.          (June 2014).

$4,500,000.

The Town authorized the creation of an irrevocable Internal Revenue Code (IRS) Section 115 Trust for the Town’s pension obligations.  The Town Council to date has set aside $4.4 million towards additional Pension funding (115 Trust) including an additional $1.0 million adopted in the FY 17/18 budget.  (December 2017)

$4,400,000

(accumulated to date) 

 

The Town Council established a General Fund reserve policy for additional discretionary payments (ADPs) of $400,000 per year.    Under the updated policy 20-year amortization equivalence will be achieved through additional UAL payments of approximately $400,000 per year.  The total savings associated with the ADP methodology is approximately $13.8 million versus the existing amortization schedules for both plans.  (May  2018).

Additional minimum of $400,000 funding annually

$8,000,000

(estimated savings $13.8 million)

Additional discretionary Pension funding to date -  $16,900,000
















As reflected in the table above, the Town Council recently enacted another proactive additional discretionary spending policy with the adoption of an updated General Fund Reserve Policy.  On May 15, 2018, the Town Council revised the General Fund Reserve Policy as recommended by the Council Finance Committee.  The updated Policy lays out the procedures for the Town to set aside additional annual discretionary payments (ADPs) to reduce the effective amortization period of the Town’s pension unfunded actuarial liabilities from approximately 30 years to 20 years. 

The proposed UAL Funding Policy will ensure that the unfunded actuarial pension liability is reduced over a shorter time period and significant interest savings achieved. Under the updated policy 20-year amortization equivalence will be achieved through additional UAL payments of approximately $400,000 per year.  The total savings associated with the ADP methodology is approximately $13.8 million versus the existing amortization schedules for both plans. 

The first chart illustrates the strategy of $235K of ADPs made each year to accelerate the final payoff of the Miscellaneous Plan unfunded actuarial liability.   Total savings of approximately $8.2 million dollars are estimated if the Town maintains this annual ADP commitment.  

 001

The second chart illustrates the strategy of $155K of ADPs made each year to accelerate the final payoff of the Safety Plan unfunded actuarial liability.   Total savings of approximately $5.6 million dollars are estimated if the Town maintains this annual ADP commitment.   

002

Similar to the pension strategies, the table below illustrates additional discretionary payments to date for the prefunding of OPEB obligatoions.

Council Action

Additional OPEB Discretionary Funding

The Town Council proactively initiated prefunding OPEB obligations beginning in 2009 rather than remaining a pay as you go system.

$13,600,000

(accumulated to date)

The Town Council established a General Fund reserve for CalPERS/Other Post-Employment Benefits (OPEB) (May  2016).

Additional $300,000 funding annually when GF surpluses exist

Additional discretionary OPEB funding to date -  $13,600,000










In addition to the aforementioned strategies, the Town has also taken steps to change benefits or introduce new benefits which provide the Town with ongoing savings. To date these actions have resulted in $290,000 of ongoing annual savings.


Council Action

Additional Pension/OPEB Benefit and Savings Strategies

To help reduce costs related to OPEB benefits, the Town introduced dependent cost sharing and a reimbursement cap to Medicare eligible employees.  Employees retiring after February 1, 2016 are reimbursed to a maximum amount of benefit. It is estimated that this cap on reimbursement will achieve approximately $200,000 in savings per year in actuarially required contribution to the OPEB trust account. 

Estimated savings $200,000 per year.


The Town closed the CalPERS retiree Tier 1 benefit for non-safety employees and created a new Tier 2 for non-safety new employees (Effective Date: September 15, 2012).

TBD

The Town implemented the Public Employees’ Pension Reform Act (PEPRA) for all new non-classic employees (Effective Date: January 1, 2013).

TBD

The Town participates in the CalPERS discounted prepayment option (July 1, 2015 for Safety Plan and from July 1, 2017 for both Safety and Miscellaneous Plans).

Estimated savings $90,000 per year.



Additional discretionary Benefit and Savings Strategies -  $290,000/year

*does not include the savings associated with implementing different benefit tiers


Current and Archived Reports