Retirement Board Presentation to the City Council. Proposal for Use of Water Sale Proceeds April 7, 2014

Transcription

1 Retirement Board Presentation to the City Council Proposal for Use of Water Sale Proceeds April 7, 2014 This presentation is based upon an analysis prepared by Cheiron, the pension plans actuaries, including a 15 year stochastic ( Monte Carlo ) simulation. Cheiron will be present at the Council meeting to address any questions the Council has about their analysis. 1

2 Recap Proposal for use of Water Sale proceeds: Create $11 million endowment account within the pension trust Earnings from endowment account will effectively be used to fund the City s capital improvement or other projects Expected (mean) annual amount generated by the endowment fund = $800,000 - $900,000* Translates to Expected (mean) annual funding for Capital Improvement = $800,000 - $900,000* Why $11 million? This is the ESTIMATED unfunded liabilityof the pension plans as of July 1, 2014** Key rationale: Maximizes the flexibility of the investment options (stocks, bonds, etc.) for an endowment fund This is the only mechanism in which the City can invest the proceeds of the Water Sale in stocks and investment vehicles expected to generate higher investment returns (with accompanying higher investment risks) Purpose of this document: Provide additional details about how the endowment will work Provide information about the risk / reward of this proposal Address some of the questions and concerns raised by Council on February 18 *The mean is $795,000 in year 1, increasing each year in the analysis 15 year time period to a mean of $905,000 in year 15. Assumes 5 year annual smoothing of the returns, no cap on annual payouts and an investment mix identical to the current pension plan assets. With a $1 million annual cap, mean is $750,000 in year 1, increasing to $775,000 in year 15. ** Reflects a change to a 7.0% interest rate for measuringthe Plans liabilities. 2

3 Overview of the Proposal Illustrated using Estimated 2014 Results Current State Assets = $93 m Proposal Add l Assets = $11 m Net Result Assets = $104 m Liabilities = $104 m Liabilities = $104 m City s Cash Contribution = $3.6 m Endowment Payout = $0.8 m City s Revised Cash Contribution = $2.8 m Note: $11 million Water Sale money could be maintained in a separate subaccount within the pension plan for ease of tracking Savings invested in Capital Improvement = $0.8 m 3

4 Key Endowment Provisions 1. Should the $11 million be used to reduce the volatility of the City s pension contribution? In other words, should some of the $11 million be spent to smooth out the normal increases and decreases of the annual pension contributions City Council Guidanceon February 18: No, only use theearnings 2. How should the annual payout of earnings be determined? Recommendation: Smoothed returns over 5 years with $1.0 million annual cap Rationale: smoothed returns reduces the volatility. $1.0 million annual cap helps protect the $11 million fund for the inevitable down years Note: With $1 million annual cap, expected annual payment is $750,000 $775,000 rather than $800,000 - $900,000, with the difference expected to increase the $11million fund balance 3. Should the $11 million be invested the same as the other pension assets? Recommendation: YES: Current mix is approximately 75% stocks (Mix of US / Non-US; large/medium/small cap; value/growth). See Appendix for details Rationale: Current mix is set based upon a long term time horizon. An endowment is similarly a long term time horizon investment A more conservative investment mix will provide better downside protection in any one year, but cumulatively over time is projected to provide relatively small downside protection while giving up significant upside opportunity For comparison purposes, an alternative investment mix of 50% stocks is compared to the current investment mix on slides 6 and 7 below. See Appendix for portfolio assumed. Other alternatives are possible 4. When will the first payout be made? Answer: FY16 Rationale: 12 months of investment returns must be known and calculated before the first payout can be determined. Likely assets will be invested over this summer, resulting in the first payout in fall 2015 (i.e. FY2016) 4

5 Role of the Retirement Board Retirement Board has agreed to take on the responsibility of managing the additional money We have assumed that the $11 million will be invested in same asset funds currently used by the pension plans, although possibly in a different mix of stocks/bonds/other Assistance with oversight from our outside professional investment consultant, who is also a fiduciary of the Plans Investment consultant to provide guidance on investment timing strategy (e.g. whether to invest the $11 million at once, or over time) Assets invested in professionally managed asset funds e.g. T Rowe Price, Templeton The Retirement Board has a strong investment track record. The following results were provided by our investment consultant, as of December 31, 2013: Time Horizon Comparison to plans with a similar investment mix Plans Compound Annual Return 10 years Top 10 percentile 8.0% 5 years Top 20 percentile 14.0% 3 years Top 10 percentile 11.6% 1 year Top 15 percentile 20.7% Past performance does not guarantee future performance 5

6 Investment Strategy Comparison Assuming 5 year averaging for payout determination and a $1.0m annual cap Metric Current Mix Alternative Future Expected Return Median Standard Deviation Sample Range of Annual Payouts Year 5 5 th percentile 25 th percentile 50 th percentile 75 th percentile 95 th percentile Range of payouts in other years are similar. 8.1% 12.7% $320,000 $600,000 $810,000 $1,000,000 $1,000, % 8.9% $420,000 $620,000 $760,000 $920,000 $1,000,000 In any one year, the alternative asset mix provides better downside protection, but the current investment mix provides a higher median and best case payouts. As the next slide shows, however, over the long term, the alternative asset mix provides relatively small downside protection while giving up significant upside potential. 6

7 Investment Strategy Comparison (cont d) Assuming 5 year averaging for payout determination and a $1.0m annual cap Metric Current Mix Alternative Total 15 Year Payouts: 5 th percentile 25 th percentile 50 th percentile 75 th percentile 95 th percentile* Market Value at the end of Year 15: 5 th percentile 25 th percentile 50 th percentile 75 th percentile 95 th percentile $7,300,000 $9,900,000 $11,800,000 $13,400,000 $14,600,000* $5,900,000 $9,300,000 $12,300,000 $17,900,000 $31,100,000 $7,900,000 $9,800,000 $11,200,000 $12,700,000 $14,200,000* $6,600,000 $8,900,000 $10,700,000 $13,300,000 $19,100,000 Over the long term, the alternative asset mix provides a relatively small downside protection while giving up significant upside potential. * Note that the 95 th percentile results are similar due to the $1.0 million annual cap. 7

8 Other Important Notes Other benefits of this proposal: In FY15, new accounting rules will require any unfunded pension liability to be recorded on the City s balance sheet. This additional funding is estimated to eliminate that expected $11 million dollar liability. Better funded pension plans should lower the cost of any other City borrowing Better funded pension plans should make the City a moreattractive place to work Other jurisdictions have underfunded plans and may be inclined to reduce pension benefits even for those already retired If a more conservative investment mix is desired for the $11 million: Then an overall reviewof the other $93million pension investment strategy should be considered Any detailed discussion about changes to the investment strategy should be undertaken with our professional investment consultant Using a subaccount structure within the pension plan for the endowment funds will incur additional vendor fees no additional vendor fees would be incurred if assets are comingled and the endowment is tracked as a purely notional account. Important implementation details are still to be determined In addition, it will be important to document the purpose of the endowment fund and that employee pension benefits, including employee contributions, are not intended to change due to this additional funding 8

9 Appendix Investment Mix Current Alternative S&P % 16% Small cap growth 9% 6% Mid cap Core 6% 4% Large Cap Value 16% 11% International Developed 8% 5% International Large Growth 8% 5% International Emerging Markets 4% 3% Barkleys Aggregate Index 14% 40% Infrastructure 6% 6% REIT 4% 4% Total 100% 100% Equities 76% 50% Fixed Income 14% 40% Other (Infrastructure, REIT) 10% 10% Total 100% 100% 9

10 Appendix Historical Returns Metric Current Mix Alternative Historical Returns (1). Number of years to return to starting value after significant negative market results, starting in: yrs 6 yrs 2 yrs 4 yrs 3 yrs 6 yrs 2 yrs 4 yrs (1) For historical modeling, the current investments were modeled as 75% S&P500 index and 25% long term aggregate bond index The illustrative Alternative was valued as 50% S&P500 and 50% long term aggregate bond 10

11 Appendix - Investment Strategy Add l Comparisons Assuming 5 year averaging for payout determination and a $1.0m annual cap Metric Current Mix Alternative Total 15 Year Value: 15 years of payouts PLUS the change in the market value of the account (1) 5 th percentile 25 th percentile 50 th percentile 75 th percentile 95 th percentile $2,300,000 $8,100,000 $13,000,000 $20,200,000 $34,200,000 $3,500,000 $7,700,000 $10,800,000 $15,000,000 $22,400,000 (1) The three metrics shown on this slide and slide 7 were analyzed separately, meaning, for example, that the 50 th percentile Total 15 Year Value is not equal to the 50 th percentile Total 15 Year Payouts plus the 50 th percentile change in market value 11

12 Appendix - Payout Determination - Comparison Comments below reflect current investment mix. Similar comments apply to the alternate investment mix. Payout Determination Key Advantages Disadvantages 1. Fixed Amount per year based upon assumed long term return (7% used) 2. Actual balance above $11 million Predictable annual payment Significant Risk to $11 million fund: projected market value in 15 years ranges from $0.5m to $36.6m (5 th to 95 th percentile results of stochastic forecast) Highest likelihood (95% with an $1 million annual cap) that fund will remain at current value ($11 million) or more 15 years from now With $1 million annual cap, generally 50% likelihood each year that payment will be $1 million 3. Smoothed returns Lower payout volatility than method #2. Generally 95% likelihood each Recommended year that payout would be at least $320,000 and 75% likelihood that payout would be at least $590,000 Payout volatility: even with $1 million annual cap, at least 30% likelihood each year that the payment would be $0 Approximately 25% likelihood that in 15 years the account balance will be $9 million or less (although only 25% chance that the total 15 years of payment would be $10 million or less) 12