CITY OF BREA PENSION ANALYSIS

Transcription

1 CITY OF BREA PENSION ANALYSIS Prepared by: Reason Foundation Pension Integrity Project May 2016 City of Brea Pension Analysis May Background 1

2 City of Brea Pension Analysis May What is a Defined Benefit? A plan designed to provide the employee with a specified amount of monthly retirement income typically based on the employee s salary, years of work, and age. They are designed to be pre-funded such that when an employee retires, the employer has reserved enough money to pay for all promised retirement benefits. City of Brea Pension Analysis May Who Pays for the Benefit? Normal Cost: The projected cost to pre-fund an employee retirement promises during the year they are working Shared by Employee and Employer Unfunded Liability: The portion of the accrued liability not covered by the plan assets Sole responsibility of Employer (taxpayer) 2

3 City of Brea Pension Analysis May What Do Retirees Receive? How much a worker receives in retirement benefits depends on how long they will have worked for the city and their final average compensation at retirement. Specifically, the annual retirement allowance is determined by the following formula: Annual Retirement Benefit = Benefit Multiplier x Years of Service x Final Average Salary City of Brea Pension Analysis May What Do Retirees Receive? Asst. City Manger IT Specialist Police Officer Firefighter Paramedic Final Avg. Salary $203,174 $89,937 $104,326 $94,008 Multiplier 2.0% 2.0% 2.7% 2.7% Years of Service Retirement Benefit $121,904 $53,962 $84,504 $76,146 Employer Annual Contribution (FY206) Employee Annual Contribution (FY206) 15.7% $31,809 7% $14, % $14,080 7% $6, % $43,325 9% $9, % $39,075 9% $8,507 Present Value of Pension Benefits (4.5% Discount Rate) $2,082,290 $921,747 $1,499,685 $1,664,285 Specific Employees Used: Assistant City Manager/Admi nist ra tive Services Director; IT Specialist II, A41; Police Office-Assign Post Advance, P39; Firefighter/Par a me dic, F02 3

4 City of Brea Pension Analysis May Why the City of Brea should be concerned about rising pension costs City of Brea Pension Analysis May Brea Challenges: A Summary On February 9, 2015, the City Council participated in a workshop to strengthen the Council/staff team and to discuss priorities for FY Using Mission Statements and Operational Goals as their guide, the Council and executive staff reviewed a list of possible priorities and added new items as part of their review. Following the brainstorming, the Council was tasked to identify their top and secondary priority items from the list. At the top of the list is: Continue on path toward pension reform Adopted Budget: a.c a. us/d ocumentcenter/vi ew/

5 City of Brea Pension Analysis May Brea Challenges: A Summary City Manager Tim O Donnell cautions in the Budget: Although we are anticipating a slight upward trend in revenues overall, staff will continue to be diligent in monitoring long-term economic uncertainties that could impact Brea s budget picture. At the top of the list is: Unknown CalPERS rate increases that may occur Adopted Budget: a.c a. us/d ocumentcenter/vi ew/ City of Brea Pension Analysis May Brea Challenges: A Summary Staff Not Recommending 100% Funding of Pensions: Assumes that the organization does not want to be 100% funded because The plans funding status will gradually improve as the organization hires new PEPRA employees CalPERS does not refund payments if the plans are over funded Target of 100% funded will always be moving based upon market conditions and annual actuarial Valuations American Academy of Actuaries: Pension plans should have a strategy in place to attain or maintain a funded status of 100% or greater over a reasonable period of time 2 1 City Council Study Session, April 7, 2015, CalPERS Unfunded Liability: Closing the Gap 2 ry. or g/fil es/ 80 _Pe rce nt _F un din g_ IB_ pd f 5

6 City of Brea Pension Analysis May Brea Pension Contribution Rates Rising Both Plans Have Significantly Increased Rates City of Brea Pension Analysis May Brea Challenges: A Summary 1. Over past 15 years, the net fiscal position of Brea s pension liabilities has declined by $120 million*; the reported combined funding ratio has gone from overfunded to just 74.9% funded. 2. The CalPERS assumed rate of return (7.5%) has grown less realistic over time and has required adding an increasing amount of risk to the asset portfolio. 3. The plan s discount rate (7.5%) has not adjusted over time as risk-free rates of return have declined, suggesting the liabilities of the plan (i.e. the promised pension benefits) are being undervalued. 4. Conclusion: The plan s current defined benefit structure leaves taxpayers, employers, and employees vulnerable to volatile contribution rates and continuously increasing costs. *Does not include $6 million set-aside in PARS 6

7 City of Brea Pension Analysis May Brea Pension Funding Overview (Using CalPERS valuations) Safety Plan Misc. Plan Total Accrued Liabilities $219,922,597 $117,280,948 $337,203,545 Unfunded Liabilities (on an Actuarial Valued Basis) $61,304,863 $23,308,139 $84,613,002* Funded Ratio 72.12% 80.13% 74.91% Contribution Rates Employee Contribution 9.0% 7.0% Employer Contribution 41.5% 15.7% Total Contribution 50.5% 22.7% *Does not include $6 million set-aside in PARS City of Brea Pension Analysis May US Financial Markets: Two Recessions Markets Have Recovered Pensions Have Not Dow Jones Industrial Average 7

8 City of Brea Pension Analysis May Brea Pension Degrading Solvency Miscellaneous Employee Plan (Using CalPERS valuations) City of Brea Pension Analysis May Brea Pension Degrading Solvency Public Safety Plan (Using CalPERS valuations) 8

9 City of Brea Pension Analysis May Brea Pension Contribution Rates Rising Miscellaneous Employee Plan City of Brea Pension Analysis May Brea Pension Contribution Rates Rising Public Safety Plan 9

10 City of Brea Pension Analysis May CalPERS is Exposed to Significant Investment Return Risk City of Brea Pension Analysis May CalPERS Assumed Rate of Return is Unrealistic CalPERS is using an unrealistically high expected rate of return at 7.5%, based on the historic trend. Over the past 20 years the plan has averaged 7.68% return on a market basis, technically within the plan s strategy However, over the past 15 years the plan has averaged just a 5.19% return on a market basis ( to ) Actuarially valued returns have averaged just 5.69% since CalPERS returns for FY2015 were just 2.2% Institutional investment returns for 2016 nationally are well into negative territory, suggesting returns are going to get even worse Note: while past performance is not the best measure of future performance, it does help provide some context to the problem created by having an excessively high assumed rate of return. 10

11 City of Brea Pension Analysis May CalPERS Actual Investment Returns, Figure 8: Historic Investment Returns & Assumed Rate of Return Miscellaneous Plan of the City of Brea 30% Market Valued Investment Return (Actual) Actuarially Valued Investment Return (Smoothed by Plan) Assumed Long-Term Investment Return 20% 10% 0% % -20% -30% Source: Reason Foundation Analysis of Miscellaneous Plan Valuation Data City of Brea Pension Analysis May CalPERS Assumed Return Requires Excessive Taxpayer Risk Over the past 15 years the CalPERS portfolio has taken on considerably more risk. Low Risk Investments: Bonds/Fixed Income and Cash have fallen from 29% of the portfolio in 2001 to 27% in Medium Risk Investments: Equities have fallen as a percentage of the portfolio from 58% in 2001 to 52% in High Risk Investments: Real Estate/Alternatives have increased from 13% of the portfolio in 2001 to 21% in As markets have changed over the past few decades and the yields on bonds have fallen, pension investors have had to take on more risk in the portfolio to maintain a high assumed rate of return. The result is a lower normal cost, but more taxpayer risk. 11

12 City of Brea Pension Analysis May CalPERS Portfolio Distribution, FY % Figure 11: Plan Asset Allocation Has Become Riskier Over Time Miscellaneous Plan & Safety Plan of the City of Brea Cash & Short-term Fixed Income Equity Real Estate Alternatives Other 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: Reason Foundation Analysis of CalPERS Comprehensive Annual Financial Reports City of Brea Pension Analysis May The CalPERS Discount Rate Undervalues Liabilities 12

13 City of Brea Pension Analysis May CalPERS Discount Rate is Inaccurate The discount rate should reflect the risk of a plan s liabilities The assumed rate of return is based on an assessment of the possible returns for the plan s assets, it should reflect the risk of the assets By contrast, the discount rate is used to determine the present value of all future pension benefits. The discount rate should reflect the risk of the pension plan (CalPERS) being able to pay the promised stream of pension payments. The CalPERS discount rate is currently based on the assumed rate of return, and undervalues liabilities There is virtually no risk that CalPERS would not honor pension commitments, thus it would be more appropriate to use a risk free rate of return, plus a risk premium reflecting California s debt risk At a minimum, the discount rate should be reduced as risk free rates of return i.e. Treasury bills or 30-year Treasury Bonds -- decline City of Brea Pension Analysis May CalPERS Discount Rate is Inaccurate In 2001, the yield on 30-year Treasury bonds was about 5.48%, and the CalPERS discount rate was 8.25%. This implies that CalPERS was pricing the risk that the state would not be able to fully pay promised pension benefits at about 2.77% (277 basis points) above a risk free rate of return. Over the past 15 years as the yield on Treasury bonds has decreased significantly, the discount rate has reduced only slightly. This has resulted in a systematic undervaluing of pension liabilities. If CalPERS pegged the discount rate to the yield on 30-year Treasury bonds, it would be about 2.6% today, implying that the current discount rate (7.5%) assumes a risk premium of 4.9% (490 basis points). 13

14 City of Brea Pension Analysis May 2016 Comparing Change in Discount Rate to Change in Risk Free Rate ( ) 27 City of Brea Pension Analysis May Misc. Plan Funded Ratio and Unfunded Liabilities 8% Discount Rate Undervalues Liabilities & Understates Costs Funded Ratio (FY2014) Unfunded Liabilities (FY2014) Normal Cost (FY2017) 7.5% Discount Rate (Current Rate) 80.0% $23 million 13.9% 6.5% Discount Rate 71.0% $39 million 17.6% 4.5% Discount Rate 55.0% $75 million 28.0% 14

15 City of Brea Pension Analysis May Safety Plan Funded Ratio and Unfunded Liabilities 8% Discount Rate Undervalues Liabilities & Understates Costs Funded Ratio (FY2014) Unfunded Liabilities (FY2014) Normal Cost (FY2017) 7.5% Discount Rate (Current Rate) 72.0% $61 million 26% 6.5% Discount Rate 63.0% $91 million 33% 4.5% Discount Rate 50.0% $159 million 53% City of Brea Pension Analysis May CalPERS is Implicitly Being Underfunded Due to the Rate of Return and Discount Rate, Creating Greater Long-term Costs for Brea 15

16 City of Brea Pension Analysis May The Risks of Inaction Plan continues to be systematically underfunded due to inability to achieve the assumed rate of return and a discount rate that is undervaluing liabilities Contribution rate volatility risks for taxpayers and employees will remain in the system Underperforming market scenarios will mean exponentially increasing costs over time as pension debt is added to the system, driving up unfunded liability amortization payments Growing employee contribution rates threaten recruitment and retention City of Brea Pension Analysis May Objectives of Good Reform 1. Provide Retirement Security for All Employees, Current and Future 2. Stabilize Contribution Rates for the Long-term 3. Reduce Taxpayer and Pension System Exposure to Financial Risk and Market Volatility 4. Reduce Costs for Employer/Taxpayers and Employees 5. Ensure Ability to Recruit 21 st Century Employees Improve Portability of Benefits Create More Retirement Planning Choices for Employees 6. Improve Governance Expert Driven Governance Improve Efficiency and Create Consistency for Employers 16

17 City of Brea Pension Analysis May Questions? Reason Foundation Pension Integrity Project Pete Constant, Director of Pension Reform Former San Jose City Councilman, Retired Police Officer, and Former Pension Board Trustee Anthony Randazzo, Director of Economic Research Truong Bui, Policy Analyst, Pension Reform Project 17