RESOLUTION ADOPTING A CITY COUNCIL POLICY FOR FUNDING OTHER POST RETIREMENT BENEFITS (OPEB) RELATED TO RETIREE HEALTHCARE

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1 TO: FROM: Honorable Mayor and City Council Laura C. Kuhn, City Manager Agenda Item No. 9B November 10, 2015 SUBJECT: RESOLUTION ADOPTING A CITY COUNCIL POLICY FOR FUNDING OTHER POST RETIREMENT BENEFITS (OPEB) RELATED TO RETIREE HEALTHCARE DISCUSSION: At the March 10, 2015 City Council meeting, the Council reviewed unfunded liabilities and directed staff to prepare a funding policy to address funding OPEB liabilities related to retiree health care. The policy approach directed by Council focused on applying as many of the four options as presented in the report (see Attachment 1, March 10, 2015 staff report). The proposed policy includes application of three of the four tiers as detailed below. Tier 1 - The City will begin budgeting a portion of the Annual Required Contribution (ARC) for retiree health care as part of a plan to reach full ARC funding over a 5-year period. Upon approval of the OPEB policy, the costs will be budgeted and included in the City s financial forecast. Tier 2 - The City will begin allocating a portion of any annual budget surpluses or one-time funds towards catching up the current unfunded liabilities. This would be done each year at the close of the final audit for the prior fiscal year, starting in Tier 3 - The City worked with the labor groups to increase the employees health care contribution from 8% to 15% of the Kaiser Bay Area Medical Rate. Thus far, the City has achieved agreements with all but one labor group. Tier 4 - The City reviewed the idea of creating a new tier of retirement health care for new hires, to try and reduce the growth rate of the unfunded liability. However, this tier was later determined to be infeasible due to the limitations of the City s current health care contract through CalPERS. Exiting the CalPERS healthcare system was also determined to be infeasible at this time. It is recommended that the City Council approve the attached resolution which includes the OPEB policy to ensure the City achieves funding for the ARC within five years. FISCAL IMPACT: Fiscal impact will vary and grow as policy is implemented. The cost is estimated as follows: Tier 1: $2.2 million to begin funding the ARC; Tier 2: Unknown; Tier 3: Savings from the 15% health care contribution from employees is estimated to be $1.65 million per year; and Tier 4: N/A. The precise fiscal impact is dependent upon the annual review of Tier 2 at the close of each fiscal year. RECOMMENDATION: By simple motion, adopt the subject resolution. ATTACHMENTS: Resolution Action Item Attachment 1: March 10, 2015 Staff Report

2 RESOLUTION NO RESOLUTION ADOPTING A CITY COUNCIL POLICY FOR FUNDING OTHER POST RETIREMENT BENEFITS (OPEB) RELATED TO RETIREE HEALTHCARE WHEREAS, the City offers OPEB benefits in the form of retiree healthcare; and WHEREAS, the City Council desires to develop a policy for making its OPEB obligations fiscally sustainable; and WHEREAS, the City has established a CalPERS Employee Retiree Benefit Trust to reserve funds to finance future retiree healthcare obligations; and WHEREAS, the City has contracted for and received an actuarial valuation to determine an annual required contribution to move the City towards funding its retiree healthcare obligations; and WHEREAS, the City Council wishes to adopt a formal policy to achieve funding of the annual required contribution in each fiscal year. NOW, THEREFORE, BE IT RESOLVED that the City Council of the City of Vacaville does hereby adopt the Other Post Retirement Benefits Funding Policy as outlined in Exhibit A attached hereto. I HEREBY CERTIFY that the foregoing resolution was introduced and passed at a regular meeting of the City Council of the City of Vacaville, held on the 10th day of November, 2015, by the following vote: AYES: NOES: ABSENT: ATTEST: Michelle A. Thornbrugh, City Clerk

3 EXHIBIT A Other Post Retirement Benefits Funding Policy PURPOSE The City offers Other Post Retirement Benefits (OPEB) to its employees in the form of retiree health care. In the past, the City has chosen to pay the cost of the benefit each year as the premiums were due. In 2009, the City created a CalPERS Employee Retiree Benefit Trust (CERBT) to begin setting funds aside to fund future retiree health care costs. In order to ensure financial stability and recognize the benefit cost when it is earned by the employee, the City is changing its funding policy to reflect a goal of funding actuarially determined annual required contributions (ARC) to begin moving the CERBT towards being more fully funded. FUNDING GOALS Beginning with the fiscal year, the City will establish a goal of funding a percentage of the ARC in each successive year until full ARC funding is reached. The funding goals will be as follows: HARDSHIP EXEMPTION FISCAL YEAR PERCENTAGE % % % % % If at any time the General Fund Reserve is projected to reach a level below 10%, the ARC funding goal will be suspended and an appropriate contribution amount will be reviewed and recommended by the City Council. Once General Fund Reserve levels meet or exceed the Council's Fund Reserve Policy, the funding percentage will begin again towards reaching the 100% goal. ONE TIME CERBT CONTRIBUTIONS Recognizing a goal to get the funded status of the CERBT trust to a level in excess of 70% (as of 7/1/14 it was 11.2%), when a fiscal year is closed out and budgeted revenues have exceeded budget expenditures, the City Council will direct 25% of that excess towards a one-time payment to the CERBT. Such one-time payments will cease at any time the funding level exceeds 70%.

4 Agenda Item No. 9C March 10, 2015 TO: FROM: SUBJECT: Honorable Mayor and City Council Members Attention: Laura C. Kuhn, City Manager Laura Kuhn, City Manager DISCUSSION OF UNFUNDED LIABILITIES AND REQUEST FOR DIRECTION FROM COUNCIL DISCUSSION: As part of the long range financial forecast, the City has been discussing the impact of unfunded liabilities on future financial sustainability. In order to assist the discussion, a whitepaper on the issues and possible solutions for the issues is provided in Attachment 1. The City has unfunded liabilities related to its 3 pension plans and its retiree health care program. Total unfunded liabilities from all of these plans total $266 million in Fiscal Year In order to fully fund these unfunded liabilities, the City needs to make its annual required contribution for each plan as determined by an actuarial report. While the City has met the annual required contribution for all of its pension funds, it has not done so for retiree health care, falling short $4.5 million in 2013/14 and $12.5 million overall. Lack of having Council adopted programs to address these liabilities can affect the City s credit rating and ability to borrow funds, especially since the liabilities must be disclosed in its financial statements. In order to ensure fiscal sustainability of the City and to maintain the ability of the City to provide negotiated benefits to its employees, the City needs to develop a policy for achieving a level of funding for these programs. In order to facilitate Council discussion, the whitepaper provides 3 possible programs to move toward more complete funding. Program One would move toward funding the annual required contribution for retiree healthcare over a 5-year budget period and would add one-time contributions toward catching up based upon 50% of any year end budget surplus. Program Two would continue the current pay-as-you-go method of budgeting, but dedicate part of budget surpluses while creating a new tier of retiree health benefit to future employees. Program Three would begin budgeting a portion of the annual required contribution, begin allocating a percentage of budget surpluses, create a new tier for new hires and work with employee groups to change the current contribution method toward retiree health costs. These program options are meant for discussion purposes only and any combination should be considered. FISCAL IMPACT: The City currently has a large unfunded liability total which will impact future budgets. If no additional financial resources are allocated, each annual budget will need to provide a larger appropriation to fund these benefits, limiting the Council s ability to provide essential services. RECOMMENDATION: It is recommended that the City Council direct staff to draft a policy for City Council adoption at a future meeting date that implements Program Three as a policy to address unfunded liabilities. ATTACHMENTS: Attachment 1: Unfunded Liabilities: Challenges and Opportunities.

5 CITY OF VACAVILLE UNFUNDED LIABILITIES CHALLENGES AND OPPORTUNITIES

6 DEFINING THE ISSUE OF UNFUNDED LIABILITIES What is an unfunded liability? As part of our annual (or biannual) actuarial reports on retirement plans and retiree health care, the actuary performs a funding status review. In performing the review, the actuary takes the present value of current assets in the plan plus future contributions and earnings and subtracts that from the present value of all retirement or health care obligations. The present value of an obligation represents taking a stream of payments out to provide a benefit and discounting it back to present day dollars if you were to pay the amount today. If assets equal or exceed the liability, the plan is fully funded; if not, the plan has an "unfunded liability". A current example is provided below from one of the City s retirement plans: Total Pension Liability $226,007,308 Market Value of Plan Assets $144,155,092 Unfunded Liability $ 81,852,216 Funded Ratio (Plan Assets / Total Pension Liability) 63.8% So, an unfunded liability is a bad thing? Not necessarily, while it would be ideal to have 100% funding, liability funding is a moving target and it is highly unlikely to be at 100% at any given time. This is because the factors affecting the actuarial analysis can change regularly; such as salary, investment return, life expectancy and benefit level. Instead, unfunded liabilities are amortized over a period of time and included in future retirement contribution requirements. While it is important to make sure the unfunded figure does not become unmanageable, a reasonable approach to fund the liability over a period of time. Many factors can affect the amount of the unfunded liability: new benefits given retroactively, good or bad investment performance, a change in actuarial assumptions and changes in employee salaries or health care costs can all have positive or negative impacts on the unfunded liability. In addition, like a home mortgage, the amortized cost of unfunded liabilities creates an additional expense for the City in the form of interest for each year the liabilities are outstanding. Since the plan isn t 100% funded, the amounts not in the account are not earning investment earnings, so the amortized costs includes the cost of lost investment earnings also (7.5% for our plans). Just like a mortgage, any unfunded amounts you pay down earlier will not only reduce the amount by that total, but also by the amount of interest you would not have to pay for those remaining years. Many factors can affect the amount of the unfunded liability: 2 P age Unfunded Liabilities

7 new benefits given retroactively, good or bad investment performance, a change in actuarial assumptions and changes in employee salaries can all have positive or negative impacts on the unfunded liability of the CALPERS plan. In addition, like a home mortgage, the amortized cost of unfunded liabilities cost the City interest for each year they are outstanding. Since the plan isn t 100% funded, the amounts not in the account are not earning investment earnings, so the amortized costs includes the cost of lost investment earnings also (7.5% for our plans). Just like a mortgage, any unfunded amounts you pay down earlier will not only reduce the amount by that total, but also by the amount of interest you would not have to pay for those remaining years. How many unfunded liabilities does the City have and how much are they? The City has three individual retirement plans and a retiree health care plan (referred to as OPEB). Each of those plans currently has an unfunded liability which taken together total $266.3 million. A brief discussion of each unfunded liability is provided below. 100,000,000 90,000,000 80,000,000 70,000,000 60,000,000 50,000,000 40,000,000 30,000,000 20,000,000 10,000,000-81,852,216 57,936,544 PERS - Safety PERS - Misc PARS OPEB 33,635,276 92,932,890 CALPERS The City currently has two plans with the California Public Employee Retirement System commonly referred to as CALPERS. One plan is for our public safety employees and the second plan is for all other employees and is referred to as the miscellaneous plan. Our annual required contribution (ARC) to CALPERS is expressed as a percentage (%) of payroll and the chart below shows the trend of that cost over time. 3 P age Unfunded Liabilities

8 60.000% % % % % % 0.000% FY 06/07 FY 07/08 FY 08/09 FY 09/10 FY 10/11 FY 11/12 FY 12/13 FY 13/14 FY 14/15 FY 15/16 FY 16/17 Safety Misc While useful for trending, percentage of payroll does not effectively communicate the budget impact of the pension cost. Below is a table showing the actual monetary amounts: ANNUAL PENSION COSTS Safety Miscellaneous Normal Unfunded Total Normal Unfunded Total GRAND Cost Cost Cost Cost Cost Cost TOTAL $ 3.8 $ 5.3 $ 9.1 $ 2.1 $ 3.4 $ 5.5 $ $ 2.1 $ 0.8 $ 2.9 $ 2.0 $ 1.2 $ 3.2 $ 6.1 source: CALPERS Actuarial Reports expressed in millions (x,000,000) Increase in contribution $ 8.5 While the normal costs have risen considerably in the Safety plan due to benefit enhancements, the unfunded cost is now the key driver in actual CALPERS costs. Those increases have resulted in an $8.5 million increase in annual costs to the City. The City has met its annual required contribution for the CALPERS plans and both are in good standing, so any additional amounts would be applied towards paying down the unfunded balances. However, it should be noted the total unfunded liabilities of the two plans total $139.8 million, so any contributions would change those amounts incrementally. PARS The City has an additional defined benefit program through the Public Agency Retirement System (PARS), which provides a supplemental plan to the Miscellaneous CALPERS plan. 4 P age Unfunded Liabilities

9 ANNUAL PARS COSTS Miscellaneous Normal Unfunded Total Cost Cost Cost $ 1.0 $ 2.8 $ $ 0.9 $ 1.3 $ 2.2 Increase in contribution $ 1.6 source: Actuarial Reports Milliman Group expressed in millions (x,000,000) While the normal costs for the PARS program have risen slowly in the period, unfunded costs have more than doubled in the plan. This reflects the unfunded costs of retroactive implementation of the PARS program and investment losses during the recession. A current unfunded cost for the PARS plan is $33.6 million. The City has always met its annual required contribution for the PARS plan and the plan is in good standing. Post-employment Health Benefits (OPEB) The City offers a retirement health insurance program for employees that retire from the City. Prior to 2009, a person who retired from the City past the age of 50 would be provided a retirement health insurance premium contribution equal to that of active employees. For those employees who were hired after January 1, 2009, there is a vesting period, whereby there is no earned benefit until the employee has worked five years with the City and a minimum of ten years at a public agency in CALPERS to receive 50% of the insurance premium. For many decades, the City has paid for retiree health care costs on a pay-as-you-go basis (PAYGO). As part of the annual budget, the City funded an amount required to pay for the cost of retiree health care. Health care cost increases combined with an increasing number of retirees, are showing that the PAYGO approach will exacerbate challenges in the near future. As an example, in the year 2000 there were 5.1 active employees for every retiree with health care. In 2013, there were 1.3 active employees for every retiree with health care. Millions RETIREE HEALTH PROJECTED PAY GO COSTS Active Versus Retired Employees Active Retirees 5 P age Unfunded Liabilities

10 To address this funding challenge, in 2010 the City created a retirement health care trust fund to set aside funds to offset future funding costs of retiree health. The retirement trust performs an actuarial valuation every two years to assess the funding progress of the retirement trust towards funding the retiree health care liability over a thirty year period. The annual required contribution (ARC) for the trust is represented by the current PAYGO costs, plus an amount to be set aside to fund future benefits. The ARC Actual Asset Liability FY ,650,000 4,640, ,000 FY ,460,000 4,040,000 2,990,000 FY ,130,000 4,380,000 5,740,000 FY ,600,000 5,090,000 8,250,000 FY ,535,000 5,116,000 12,684,000 (2014 ACTUARIAL) 6 P age Unfunded Liabilities difference between the ARC and the actual contribution is called the asset liability and represents the amount the City is in arrears towards fully funding its liability. As you will note, unlike all of the City s retirement plans, the City is currently $12.68 million dollars behind in fully funding its retiree health care long term liability. If the City would begin to fully fund the ARC it would be equivalent of 21.98% of payroll. There is currently no requirement to fund the retiree health care ARC or the unfunded liability, however sound financial practices would dictate the City should develop a funding policy to prevent the PAYGO costs from becoming a threat to having funds available for City operations. Financial Reporting of Unfunded Liabilities Prior to the fiscal year, retirement and retiree health care liabilities were reported in the financial footnotes to the City s financial statements and then only in the financial statements themselves, if the City was not paying its annual required contribution towards full funding. In the City s Comprehensive Annual Financial Report (CAFR), a net OPEB obligation of $12.68 million is shown in the Statement of Net Position which represents the amount the City is in arrears towards funding retiree health care liabilities. Beginning in the fiscal year, Governmental Accounting Standards Board Statement Number 68 (GASB 68) changes the reporting methodology for retirement unfunded liabilities. GASB 68 requires the unfunded liability to be disclosed on the face of the City s financial statement based upon the funding status of the plan. The City is working closely with CalPERS and PARS to ensure the required information will be available in time to be included in the City s Comprehensive Annual Financial Report. The most recent actuarial valuations report that the City will be adding approximately $173,424,036 in liabilities to the City s Statement of Financial Position. When fully implemented next year, we will further evaluate the impact to the financial statements, however, this large of a liability will likely make the City s unrestricted net assets a negative amount.

11 The Governmental Accounting Standards Board has also issued a technical bulletin for the accounting of other post-retirement employee benefits (OPEB) which includes retiree health care. As proposed, the effective date will be in 2017 and would provide the same financial reporting requirements for OPEB as the current GASB 68 does for retirement plans. If implemented in 2017, this yet to be approved pronouncement would add an additional $92,932,890 in liabilities to the Statement of Financial Position and potentially make the City s unrestricted net assets a further negative amount. While these liability positions for retirement plans and retiree health care will negatively impact the City s Statement of Financial Position, the larger concern is the impact this new reporting requirement will have on the City s credit rating and ability to utilize financing tools in the future. All governments will be required to comply with these pronouncements, so there will be a broader discussion in the financial industry for evaluating these impacts. This is a developing issue the City will need to follow closely in the next few years and be prepared to explain to multiple stakeholders how the unfunded liabilities will be addressed. UNFUNDED LIABILITIES POLICY DEVELOPMENT Reporting requirements of large unfunded liabilities will significantly affect the City s financial well-being in the near and long term. For financial sustainability, the City needs to develop a comprehensive policy to communicate how unfunded liabilities will be addressed. Any policy should first address meeting all of the City s annual required contributions to prevent adding to the existing unfunded liability and then address full funding. While the City is meeting its annual required contributions with all pension funds, it is falling short $4.5million short annually on its retiree health care fund. Below are three programs for the City Council s consideration. Selecting one option or a combination of options will allow staff to complete a draft policy for Council consideration. Program 1 Phase in retiree health care ARC and catch up unfunded liabilities with a percentage of any budget surpluses. Program 1 would phase in the full payment of the health care ARC by increasing the budget allocation in five consecutive budget years to eventually budget to full ARC. In addition, the program would dedicate 50% of any general fund budget surplus to make one-time catch up payments for the shortfall in past years required contributions. While this approach would address the retiree health care funding issue long-term, adding $15 million in new retiree health care funding over five years is forecasted to leave the general fund reserves below the Council s policy. 7 P age Unfunded Liabilities

12 Program 2 Continue to budget for PAYGO and use any budget surplus to pay towards unfunded liabilities while negotiating a new tier of retiree health care for new employees. Program 2 will continue current budgeting practices, but include a policy that all or a significant portion of the general fund budget surplus each year will be dedicated to unfunded liabilities. This will not accomplish retire health care ARC funding, but will allocate funds towards the funding process above current levels and will begin to accumulate funding. Creating a new tier for new hires will reduce the growth rate of the unfunded liability and position the City to catch up in the future. Any new tier consideration would need to be carefully structured to meet any PEHMCA requirements. Program 3 Adopt a four-legged stool approach to funding. Program three will take a four legged stool approach to funding unfunded liabilities. On the first leg, the City will begin budgeting a portion of the ARC for retiree health care into the budget process. On the second leg, the City will begin allocating a portion of any annual budget surpluses or one-time funds towards catching up the unfunded liabilities. The third leg will be to work with the labor groups to change the employees current retiree health care contribution to reflect a percentage of payroll approach for all employees in lieu of the current 8% of Kaiser Medical Rate for those who have health insurance through the City. The fourth leg would create a new tier for new hires which will reduce the growth rate of the unfunded liability The combination of the four approaches would create a stream of funding sources which will begin to close the gap of the ARC for retiree health care that will be both level and one-time contribution sources. Recommendation Staff recommends the City direct staff to draft a policy for City Council adoption at a future meeting date that implements Program Three as a policy to address unfunded liabilities. 8 P age Unfunded Liabilities