Pension Funding Stabilization State Association of County Auditors 2016 Annual Conference. April 20, 2016

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1 Pension Funding Stabilization State Association of County Auditors 2016 Annual Conference April 20, 2016

2 PANEL PARTICIPANTS Rob Larkins, Managing Director and Western Region Manager, Public Finance, Raymond James Dennis Yu, Senior Vice President, PARS Ellen Clark, Senior Managing Consultant, PFM Asset Management LLC Mary Beth Redding, Vice President and Senior Actuary, Bartel Associates

3 SETTING THE CONTEXT: WHY PENSIONS ARE A HOT TOPIC GASB worked! - Despite some confusion caused by introducing a new set of metrics and nomenclature, GASB materially improved the transparency of pension funding The transition of pension funding disclosure from the footnotes to the balance sheet, has resulted in greater focus on the scope of public agencies UAALs The primacy granted to pension plans and pensioneers in recent municipal bankruptcies compared to the shellacking experienced by unsecured bondholders has resulted in vastly greater emphasis on pension plans funded ratios, actuarial funding methodologies and plan sponsors funding policies In California, given the practical conclusion that PERS is a super-senior creditor, none of the bond insurers will insure conventional unsecured POBs (though they remain open to considering taxable lease revenue bonds whose proceeds are applied to pension funding) Bond investors remain reluctant to purchase unsecured POBs except from the most highly rated issuers

4 ADDRESSING PENSION FUNDING VOLATILITY Since the first dot.com bust in 2001, PERS has implemented at least 11 funding policy changes with an attendant impact on plan sponsors contribution rates As a result, plan sponsors have experienced significant contribution rate changes, which make long-range budget planning very challenging Like rate stabilization funds commonly incorporated in Enterprise Fund Revenue Bond indentures, Pension Stabilization Funds provide a tool for banking money during the good times to mitigate contribution rate shocks in the future CalPERS Changes since Demographic assumption changes a study i. First included in 6/30/03 valuation impacting 05/06 rates b study i. First included in 6/30/09 valuation impacting 11/12 rates ii. First study to reflect actual experience for enhanced benefit formulas c study i. First included in 6/30/14 valuation impacting 2016/17 rates. ii. Includes anticipation of future mortality improvement 2. Economic assumption changes a. Decreased discount rate from 8.25% to 7.75% i. Real rate of return remained at 4.75% ii. Inflation reduced from 3.5% to 3.0% iii. First included in 6/30/04 valuation impacting 2006/07 rates b. Decreased discount rate from 7.75% to 7.5% i. Real rate of return remains at 4.75% ii. Inflation reduced from 3.0% to 2.75% iii. First included in 6/30/11 valuation impacting 2013/14 rates 3. Risk Pools a. Adopted in 6/30/03 valuation impacting 2005/06 rates b. Modified in 6/30/13 valuation impacting 2015/16 rates i. Very significant rate increases for some agencies with little impact for others 4. Contribution policy changes a. Prior to 2004 valuation: i. 3 year rolling asset smoothing ii. 90%/110% corridor around market valuation b. Beginning with 6/30/2004 valuation: i. 15 year rolling asset smoothing ii. 80%/120% corridor around market valuation iii. Gains/losses amortized on rolling 30 year basis c. Direct rate smoothing i. Eliminated asset smoothing, using Market Value of Assets ii. Eliminated rolling amortization periods 5. Risk Mitigation Strategy a. Gradual shift to less risky

5 NEW TOOLS FOR PREFUNDING PENSIONS AND MITIGATING CONTRIBUTION RATE VOLATILITY Most California pension plans are under-funded (typically between 65-85% funded), resulting in increasing contribution rates New GASB 68 requirements to disclose Net Pension Liability on financial statements Previously, only way to reduce unfunded liability was to send excess contributions in excess of annual required contribution to pension system directly (if available) In response to the lack of options, new tools have been created to enable public agencies to pre-fund retirement obligations through a locally controlled trust separate and apart from the retirement system using a Section 115 Trust

6 SECTION 115 TRUST Section 115 Trust can be used by local governments to fund essential governmental functions Any income derived from a Section 115 Trust is tax exempt Trust can be setup as an irrevocable trust designed to pre-fund retirement plan obligations Once contributions are placed into trust, assets from the trust can only be used for retirement plan purposes Private Letter Ruling has been obtained by a Special District back in 2014 determined that pre-funding retirement obligations into an irrevocable trust is an essential governmental function

7 WHAT TYPE OF AGENCIES ARE ADOPTING THE SECTION 115 TRUST PROGRAM? Agencies that are very concerned about reducing their unfunded pension liability Agencies that are concerned about CalPERS/37 Act having too much assets without any input on risk tolerance level Agencies that are concerned about CalPERS/37 Act contribution volatility 7

8 ADVANTAGES OF PRE-FUNDING THROUGH COUNTY-CONTROLLED TRUST Complete Local Control over Assets - Account can be accessed at anytime as long as it is used to pay the employer s pension obligation Offset Net Pension Liability - Assets in the trust could lower County s Net Pension Liability under GASB 68 Pension rate stabilization - Assets can be transferred to CalPERS/37 Act plan at the County s direction, which will eliminate large fluctuations in Employer contributions and better prepare for future increases Rainy Day Fund - Emergency source of funds when Employer revenues are impaired based on economic or other conditions Lower Costs 115 Trust can have lower overall administrative and investment management costs compared to the CalPERS/37 Act pension program

9 POTENTIAL DISADVANTAGES County retains fiduciary responsibility over assets Add administrative complexity (i.e., burden of new program to administer) Market Volatility Could add additional pension costs to the County if CalPERS/37 Act System earns a greater net return compared to the locally controlled trust over the long term Assets are not completely accessible for any purpose, must be used only for retirement plan purposes Retirement System would not factor in contributions held in the locally controlled trust

10 SECTION 115 TRUST INVESTMENT FLEXIBILITY Access to a broader universe of investments than allowed by California Government Code Sec 53601, including stocks, longer-term bonds Agency has oversight responsibility for investment of the assets Agency customizes investment policy based upon risk tolerance and return objectives

11 INVESTMENT POLICY BEST PRACTICES Background & Purpose: Identifies the fiduciaries and purpose of the trust. Roles and Responsibilities: Defines roles of investment committee, investment advisor, custodian, and trustee, if applicable. Statement of Objectives and Investment Guidelines: Documents and establishes investment time horizon, expected long-term rate of return, asset allocation targets and ranges, risk tolerances, and performance benchmarks. Selection of Investment Managers: Describes the criteria for selecting investment managers. Guidelines for Portfolio Holdings: Clear definition of permitted and prohibited investments. Establishes the criteria for portfolio holdings in equities, fixed income, cash, and other asset classes. Control Procedures: Documents the procedure for reviewing investment objectives, investment performance, the voting of proxies, and the execution of security trades.

12 EFFICIENT FRONTIER BASED ON PFMAM S LONG-TERM CAPITAL MARKET ASSUMPTIONS Emerging Markets Equity 9 International Developed Equity Domestic Equity Arithmetic Mean Emerging Markets Debt PFMAM 50/50 Model Core Fixed Income Bank Loans PFMAM 30/70 Model Investment Grade Corporate High Yield PFMAM 70/30 Model Risk: Standard Deviation

13 PFMAM S 2016 CAPITAL MARKET ASSUMPTIONS Forward-Looking Based on Economic Fundamentals Intermediate: Next 5 Years Long Term Projections Expected Return Expected Risk Expected Return Expected Risk US Equity 7.1% 17% 7.7% 16% International Developed Equity Emerging Markets Equity 7.3% 18% 7.7% 17% 6.5% 24% 8.1% 20% Core Bonds 1.5% 4% 5.5% 5% Intermediate Investment Grade Emerging Markets Debt 2.6% 6% 6.3% 7% 4.4% 10% 7.3% 10% High Yield 5.7% 10% 6.8% 10% Bank Loans 4.5% 6% 5.2% 6% REITs 5.5% 12% 6.4% 12% Private Equity Real Estate 6.8% 15% 7.7% 15% Commodities 3.0% 16% 5.3% 16% Hedge Funds 6.5% 15% 7.4% 15% Private Equity 9.5% 25% 9.8% 25% Cash 1.0% 1% 3.3% 1% For the intermediate term (up to 5 years), our capital market assumptions are derived from our assessment of current economic conditions, including corporate profits, balance sheets, etc., and current valuations for various asset classes. Our long-term assumptions are derived using an economic building block approach that projects economic and corporate profit growth and takes into consideration the fundamental factors driving long-term real economic growth, our expectation for inflation, productivity and labor force growth. Please refer to PFMAM s 2016 Capital Market Assumptions for a complete description of the methodology used to develop these assumptions and important disclosures.

14 OTHER POLICY CONSIDERATIONS Funding Policy Determined by each entity Examples: 1) Contribute any excess contribution budgeted not paid to pension system, 2) Contribute X% of budget surplus Distribution Policy May access funds at any time to pay pension contribution to pension system

15 WHY CONSIDER A SECTION 115 TRUST? Desire to stabilize budgetary impact of pension contributions mitigate contribution rate shocks Assets allocated to trust access broader, more diverse universe of investments Addresses GASB 68 - assets in trust directly offset net pension liability Agency retains investment control of assets asset allocation is customized

16 DISCLAIMER The information contained herein is solely intended to facilitate discussion of potentially applicable financing applications and is not intended to be a specific buy/sell recommendation, nor is it an official confirmation of terms. Any terms discussed herein are preliminary until confirmed in a definitive written agreement. While we believe that the outlined financial structure or marketing strategy is the best approach under the current market conditions, the market conditions at the time any proposed transaction is structured or sold may be different, which may require a different approach. The analysis or information presented herein is based upon hypothetical projections and/or past performance that have certain limitations. No representation is made that it is accurate or complete or that any results indicated will be achieved. In no way is past performance indicative of future results. Changes to any prices, levels, or assumptions contained herein may have a material impact on results. Any estimates or assumptions contained herein represent our best judgment as of the date indicated and are subject to change without notice. Examples are merely representative and are not meant to be all-inclusive. Raymond James shall have no liability, contingent or otherwise, to the recipient hereof or to any third party, or any responsibility whatsoever, for the accuracy, correctness, timeliness, reliability or completeness of the data or formulae provided herein or for the performance of or any other aspect of the materials, structures and strategies presented herein. Raymond James is neither acting as your financial advisor nor Municipal Advisor (as defined in Section 15B of the Exchange Act of 1934, as amended), and expressly disclaims any fiduciary duty to you in connection with the subject matter of this Presentation. Municipal Securities Rulemaking Board ( MSRB ) Rule G-17 requires that we make the following disclosure to you at the earliest stages of our relationship, as underwriter, with respect to an issue of municipal securities: the underwriter s primary role is to purchase securities with a view to distribution in an arm s-length commercial transaction with the issuer and it has financial and other interests that differ from those of the issuer. Raymond James does not provide accounting, tax or legal advice; however, you should be aware that any proposed transaction could have accounting, tax, legal or other implications that should be discussed with your advisors and/or legal counsel. Raymond James and affiliates, and officers, directors and employees thereof, including individuals who may be involved in the preparation or presentation of this material, may from time to time have positions in, and buy or sell, the securities, derivatives (including options) or other financial products of entities mentioned herein. In addition, Raymond James or affiliates thereof may have served as an underwriter or placement agent with respect to a public or private offering of securities by one or more of the entities referenced herein. This Presentation is not a binding commitment, obligation, or undertaking of Raymond James. No obligation or liability with respect to any issuance or purchase of any Bonds or other securities described herein shall exist, nor shall any representations be deemed made, nor any reliance on any communications regarding the subject matter hereof be reasonable or justified unless and until (1) all necessary Raymond James, rating agency or other third party approvals, as applicable, shall have been obtained, including, without limitation, any required Raymond James senior management and credit committee approvals, (2) all of the terms and conditions of the documents pertaining to the subject transaction are agreed to by the parties thereto as evidenced by the execution and delivery of all such documents by all such parties, and (3) all conditions hereafter established by Raymond James for closing of the transaction have been satisfied in our sole discretion. Until execution and delivery of all such definitive agreements, all parties shall have the absolute right to amend this Presentation and/or terminate all negotiations for any reason without liability therefor. The information presented herein may include references to swaps or other derivative products and associated risks. This Presentation does not include a complete explanation of interest rate swaps or other derivative products or their associated risks. Before any decision with respect to the use of swaps or other derivative products can be made, you should receive a complete presentation that details such associated risks, which may be significant. You should not enter into any transaction involving swaps or other derivative products unless you fully understand all such risks and have independently determined that such transaction is appropriate for you.

9/15/2017 AASBO CONTINUING DISCLOSURE FOR DEBT ISSUANCE CONTINUING DISCLOSURE A QUIZ (TRUE/FALSE) WHAT IS THE MSRB?

9/15/2017 AASBO CONTINUING DISCLOSURE FOR DEBT ISSUANCE CONTINUING DISCLOSURE A QUIZ (TRUE/FALSE) WHAT IS THE MSRB? AASBO CONTINUING DISCLOSURE FOR DEBT ISSUANCE September 2017 MATT ADAMS 205-802-4275 (OFFICE) MATT.ADAMS@RAYMONDJAMES.COM CONTINUING DISCLOSURE A QUIZ (/FALSE) 1. A notice must be filed when a School Board