Options to Address Unfunded Pension Liability Presentation to City Council September 14, 2010 Karen Montgomery, Assistant City Manager Actuarial Information Prepared by Doug Anderson, EA,ASA, MAAA Gallagher Benefit Services, Inc. 1
Agenda Key Issues Suggested Plan Objectives Updated Funding Status & Cash Flow Forecast Solutions City Manager s Recommendation 2
Key Issues 3
Key Issues "If funding levels are insufficient, staff will update the City Council of the deficiency and make recommendations for corrective action. Financial Management Policy Statements, Adopted November 3, 2009 Benefit payments exceeding contributions Liabilities exceeding plan assets Result: Growing unfunded pension liability 4
Conclusion Statement From Financial Advisors Conclusion Liability can "Never" be paid off Actuarial Valuation, for the year beginning January 1, 2010 Statement Pension benefits are vested, and the pension liability is not projected to amortize over any finite period of time The City must have a workable strategy that addresses the liability or be willing to face crowding out essential operational and infrastructural needs of the city in future years. First Southwest Co. & Estrada Hinojosa, September 14, 2010 If governments consistently ignore postretirement benefits and underfund contributions in the hope that future economic growth will bolster their finances sufficiently, they could be setting themselves up for greater hardship. Standard & Poor s Pension Funding and Policy Challenges Loom for U.S. States, June 30, 2010. 5
City Debt Summary by Funding Source GOs, COs, & Other Pension Benefits 2010 Asset Losses Pre 2010 Deferred Asset Losses $576 No Funding Source Unfunded Liability on Actuarial Value Basis $275 Expected to be Funded by City Contributions Funding Source 6
ERF Amortization Period Infinite Infinite Infinite Infinite 40.0 40.5 17.0 13.8 The amortization period is projected to stay infinite in the future. This means that the expected contributions and investments returns are never expected to be sufficient to meet all of the expected benefit payments for all employees. 7
Suggested Retirement Program Objectives 8
Suggested Retirement Program Benefit Objectives Benefit Objectives Provide a reasonable standard of living for career employees Provide benefits that are competitive with other Texas cities for employee recruiting and retention Provide benefits that are fair across the employee classes (General, Fire, & Police) Share a reasonable amount of investment risk with employees 9
Suggested Retirement Program Cost Objectives Cost Objectives Achieve and maintain an appropriate funded status Attain a manageable amount of contribution volatility & risk of future increases Attain a reasonable balance of contribution sharing with the employees Attain a cost that the City Council considers affordable with respect to all other competing priorities 10
Funded Status and Cash Flow Projections 11
Funded Status Under Different Investment Returns Without immediate and consistent returns above the 8.5% assumption, the funded status will deteriorate more rapidly than expected. Relying on investment returns alone is not a viable solution. The YTD investment return through June 30, 2010 was negative 0.69%. 12
Liabilities & Assets Under Different Investment Returns Unfunded Liability at January 1, 2060 is $10 Billion Unfunded Liability at January 1, 2040 is $3 Billion Unfunded Liability at January 1, 2010 is $432 Million According to GASB Liabilities are present obligations to sacrifice resources that the government has little or no discretion to avoid. - GASB Concepts Statement No. 4 13
Expected Cash Flow In and Out of Fund The gap between benefit payments out of the fund and contributions into the fund must be met by investment returns to maintain the Fund s asset level. Total annual benefit payments (black line) are currently higher than total City (green bars) and employee contributions (yellow bars). The gap is expected to increase. When insolvency occurs, the total contribution must increase to meet the annual expected benefit payments (red bars). The above results are based on a 7% return 14
Solutions Increase City's Contributions 1. Add 26% to 15.97% = 42% to pay liability in 30 yrs (includes cost of Ad Hoc COLAs and 7.0% return) 2. Ad Hoc Committee recommended 6% increase 3. City Manager's Proposed Budget includes 4% increase AND Reduce Benefits 1. New Hires only - requires significant changes to benefits 2. Non-vested & New Hires - fewer changes 3. All employees - future service - fewest changes 15
Increased Contribution Rates & Reduced Benefits Reviewed at August 13 th Budget Retreat Contribution Increases Considered: 15.97% 19.97% of payroll after 2010 (Proposed Budget Recommendation) Reduced Benefits Considered (all changes applied to future service only): Multiplier reduced from 3% to 2.75% Earnings changed to exclude all overtime and other pay Reduced early retirement benefit Eliminated the ability to elect the DROP Eliminated the fully subsidized survivor benefit Changed vesting from 5 to 7 years 16
Benefit Reduction Options Change Current Benefit Formula Current formula: 3.00% x $80,000 x 30 years = $72,000/year New Formula: (3.00% x $80,000 x 10 yrs) + (2.75% x $80,000 x 20 yrs) = $24,000 +$44,000 = $68,000/year Create New Benefit - Cash Balance Plan 17
15.97% Contribution & Reduced Benefits If benefits are reduced, and the Fund earns 8.5%, the Funded Status will improve. If the Fund does not earn 8.5%, the benefit reductions alone will not be sufficient to improve the funded status. 18
19.97% Contribution & Reduced Benefits If benefits are reduced, and contribution are increased, and the Fund earns 8.0% or 8.5%, the Funded Status will improve, but only until Ad Hoc COLAs are triggered. If the Fund does not earn at least 8.0%, the combination of benefit reductions and contribution increases will not be sufficient to improve the funded status. 19
The Cash Balance Option 20
Benefit Changes Previously Considered vs. Cash Balance Plan Benefit Reductions Previously Considered Implication to Cash Balance Design 1 Reduce Multiplier from 3% to 2.75% No multiplier needed 2 Change earnings to exclude all overtime and other pay Overtime and other pay excluded from proposed design 3 Reduce early retirement benefit No early retirement subsidies and Minimum retirement age of 55 4 Eliminate the ability to elect the DROP No DROP program 5 Eliminate the fully subsidized survivor benefit Survivor benefits are only available if the employee is willing to pay for the coverage 6 Change vesting from 5 to 7 years Increased to 7 year vesting 7 Change eligibility from Rule of 80 to Rule of 85 or 90 No Rule of 80, 85, or 90 8 Change from high 3 to high 5 Change from high 3 to a full career average 21
New Hires Receive a Cash Balance Benefit Resembles a Defined Contribution (DC) plan: The account balance increases each year by An annual pay credit An annual interest credit At retirement the account balance is converted an annual benefit payable for the life of the employee But is still considered a Defined Benefit (DB) plan: City retains investment responsibility and most of the investment risk. City retains mortality risk. 22
Why Consider this design for New Hires? Benefits comparable to those provided by Texas Municipal Retirement System No more new hires receiving the Ad Hoc COLA Liabilities better aligned with plan assets in the future Employee benefits more consistent with funding for the benefits Spiking is no longer a risk to the Fund Avoids problems associated with closing the Fund Increased Annual Required Contribution (ARC) Earlier Insolvency Avoids the need for ERF to administer two separate plans Allows the City to contribute at a single rate for all employees 23
Defined Benefit Current and Hybrid Designs ERF Defined Benefit Current Plan Design ERF Defined Benefit Cash Balance Hybrid Investment Responsibility Maintained by City Maintained by City Investment Risk Maintained by City Shared with Employees Mortality Risk Maintained by City Maintained by City Key Retirement Benefit Variables Advantaged Participants Final Pay & length of service Young retirees or employees with large pay increases near end of career Pay throughout career, length of service, age at retirement Employees with a long career and/or a relatively late retirement age Benefit Accrual Pattern Accruals are relatively small early and relatively large near retirement Accruals are more consistent throughout career Retention & Portability Greater retention of employees (due to valuable accruals near retirement) Greater portability for employees (due to more valuable early accruals) 24
Defined Benefit Current and Hybrid Design Current Plan Design Proposed Cash Balance Design Employee Contribution 8.40% 7.0% Retirement Benefit Form of Benefit Disability and pre-retirement death benefits Cost of Living Adjustment (COLA) 3.0% x Compensation Base x Credited Service 75% Joint & Survivor if married, Life annuity if single Minimum accrued benefits 2.0% guaranteed or Ad Hoc COLA (0 to 4%) City Contribution Current 15.97% Proposed 19.97% City Cost to Provide Benefit (actuarially determined rate) Account Balance = 7% EE contributions +14% ER Contribution + Annual Interest Credits* *Credits to range from 0.0% to 5.25% based on a treasury rate index Account Balance converted to Life annuity at retirement Minimum accrued benefits None Current 15.97% Proposed19.97% 9.42% 7.50% City Unfunded Liability Payment 6.55% or 10.55% 8.47% or 12.47% 25
Income Replacement Ratios at Retirement 120% 100% Retirement with 20 Years of Service Retirement with 25 Years of Service Income Replacement Ratio 80% 60% 40% 20% 0% Retire at 55 Retire at 65 Retire at any age Retire at 55 Retire at 65 Retire at any age 5.25% Interest Credit ERF Benefit Results based on employee receiving 3.0% annual salary increases. 26
Income Replacement Ratios at Retirement Retirement with 30 Years of Service Retirement with 35 Years of Service Results based on employee receiving 3.0% annual salary increases. 27
Cash Balance Account vs. Funding Assuming investment returns exceed the minimum interest credit, there will be sufficient funding to allow for some of the contribution to be used to pay the UAAL. The chart above shows results for an employee with starting salary of $40,000 receiving 3.0% salary increases. 28
7.00% return & Maximum Interest Credits (All new hires) 120% 100% Funded Percentage 80% 60% 40% 20% 0% Fully Funded 15.97% ER -Cash Balance for New Hires 15.97% ER -No Benefit Changes 17.97% ER -Cash Balance for New Hires 17.97% ER -No Benefit Changes 2010 19.97% ER -Cash 2020 Balance for New Hires 2030 2040 2050 2060 19.97% ER -No Benefit Changes Year 29
Recommendations Recommendation 1. Increase City s contribution by 4% From 15.97% to 19.97% (General Fund $11.4 million, other funds $8.6 million). 2. Conduct employee election to increase contributions by 1% or 2% From 8.25% (General and Fire) and 8.73% (Police) Proposed Date Effective October 1, 2010 Fall of 2010 3. Conduct Ad Hoc COLA election to replace with 2% guaranteed COLA Allow vested employees, retirees, and those receiving benefits to elect to receive a 2% guaranteed COLA 4. Offer new hires the option of designating a survivor To receive benefits in an actuarially neutral manner (could be for a domestic partner) Fall of 2010 Effective October 1, 2010 5. Implement a cash balance plan for new hires Effective January 3, 2011 30
Questions 31