Options to Address Unfunded Pension Liability Presentation to City Council August 13, 2010 Karen Montgomery, Assistant City Manager
Agenda Purpose Pension Funding Issues Actuarial Review & Options City Manager's Recommendation 22
Purpose of Today s Presentation The City shall continue to monitor contribution levels of both the City and employees, along with retirement benefits, to ensure that the Retirement Fund is sufficiently funded and benefits can be paid as they become due. If funding levels are insufficient, staff will update the City Council of the deficiency and make recommendations for corrective action. Source: City of Fort Worth, Financial Management Policy Statements, Adopted November 3, 2009 33
Outlining the Pension Funding Issues Benefit payments exceeding contributions Liabilities exceeding plan assets Result: Growing unfunded pension liability Liability can "Never" be paid off Unfunded pension liability = $432 million Total City long term debt = $1,084 million Requires long term solutions 44
City of Fort Worth Budget Workshop Employees Retirement Fund Discussion August 13, 2010 Prepared by Doug Anderson, EA, ASA, MAAA Gallagher Benefit Services, Inc. 5
Agenda Funding Status Projections Approaches to Improve the Funded Status Impact of Different Investment Returns Suggested Retirement Program Objectives Benefit Objectives Funding Objectives What is an Appropriate Funding Status Goal? Options Under Consideration Option #1 Additional Contributions Option #2 Reduced Benefits with and without Additional Contributions Option #3 New Hires Enter Texas Municipal Retirement System (TMRS) Option #4 - New Hires Enter a Defined Contribution (DC) Plan Option #5 New Hires Receive a Cash Balance Benefit 6
Funding Status Projections (all projections assume 8.5% rate of return) Without benefit or contribution changes, the Fund is projected to become insolvent (i.e. no assets remaining to pay benefits). 7
Approaches to Improve the Funded Status Increase Investment Returns Increase Contributions Current Employee Rates Police 8.73% All Others 8.25% Blended 8.40% Current City Rates Police 16.46% All Others 15.74% Blended 15.97% Both (vote required for employee rate increase) Reduce Benefits Future Hires Non-Vested Employees Vested Employees for future service 8
Impact of Different Investment Returns Without 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. 9
Suggested Retirement Program Objectives 10
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 11
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 12
What is an Appropriate Funding Status Goal? Public Sector Plans Historically has ranged from 80% to 90% Government Accounting Standards Board (GASB) Promotes 100% funding status Recommends amortizing the unfunded liability over no more than 30 years Considering a 20 year amortization and a more conservative measurement of the liability The market decline of 2008 demonstrated: Significant funding status declines put many plans on a path to insolvency Suggests that the old standard of 80% - 90% puts plans in a vulnerable position A plan can not recover from even one bad year of losses 13
ERF Amortization Period Infinite Infinite Infinite Infinite 40.0 44.2 17.0 13.8 The amortization period is projected to stay infinite in the future. 14
Why Does GASB Promote 100% Funding? The cost of employee retirement benefits is considered part of an employee s total compensation for services they provide to the City (Taxpayers). The City s (Taxpayer s) payment to the employee should occur over the same period that services are rendered. (Ex. An annual salary is provided for work completed during the year). If the City s (Taxpayer s) payments do not match the period that services are provided, there is an intergenerational shift of costs. 15
What Does Fully Funding Mean? A public sector pension plan is considered fully funded (100% Funding Ratio) if the Actuarial Value of Assets (AVA) equals or exceeds the Actuarial Accrued Liability (AAL). Present Value of Future Benefits (PVFB) $3,000 M * Actuarial Accrued Liability (AAL) $2,300 M Actuarial Value of Assets (AVA) $1,868 M City s Annual Required Contribution (ARC) = $61.9M or 16.80% of payroll Unfunded AAL $432 M The UAAL is amortized over a 30-year period = $27.4M 7.43% PV of Future Normal Cost $700 M* (PVFNC) PV of City NC $375 M* + PV of EE Cont $325 M* $34.5M 9.37% The PVFB is the value of all past and future service benefits for current Members. The AAL is the value of benefits attributable to Member s past service. The goal of actuarial funding is to maintain assets equal to the AAL. If Fully Funded, the ongoing cost is equal to the Normal Cost (the value of benefits earned each year by active employees). Member Contributions $30.9M 8.40% These two components combined are the Normal Cost and represent the value of benefits earned during the year by active employees. *GBS Estimate. All other results are from the January 1, 2010 Actuarial Valuation 16
Options Under Consideration 17
Options Under Consideration Option #1 Increased Contribution Rates Option #2 Increased Contribution Rates and Reduced Benefits Option #3 New Hires Enter Texas Municipal Retirement System (TMRS) Option #4 - New Hires Enter a Defined Contribution (DC) Plan Option #5 New Hires Receive a Cash Balance Benefit 18
Option #1 - Increased Contribution Rates (8.5% Return) Increased contributions, if sustained for extended periods, will improve the funding status, but only to the point that they trigger Ad Hoc COLAs. 19
Option #1 - Increased Contribution Rates (8.0% Return) If contributions are increased for extended periods, there is little difference in funded status between the 8.5% return assumption and the 8.0% return assumption. 20
Option #1 - Increased Contribution Rates (7.0% Return) If contributions are increased, but the Fund only earns 7.0%, the Fund will still be projected to become insolvent and no Ad Hoc COLAs will be triggered. 21
Ad Hoc (Conditional) COLA Tier COLA % Increase Funding Period Trigger (in Years) Comparable Funding Ratio at 15.97% City Contribution Comparable Funding Ratio at 21.97% City Contribution 1 0.0% 28.1 or greater 85% or less 72% or less 2 2.0% 24.1 to 28.0 85% - 87% 72% - 76% 3 3.0% 18.1 to 24.0 87% - 89% 76% - 80% 4 4.0% 18.0 or less 90% or more 80% or more A higher contribution rate will trigger Ad Hoc COLAs at lower funding ratios. 22
Cumulative Cost of Ad Hoc COLAs (8.5% Return) If increased contributions are significant enough to trigger Ad Hoc COLAs, higher levels of contributions will not improve the funding status because larger Ad Hoc COLAs will be granted. 23
Option #1 - Conclusions & Questions Higher contributions will help avoid or delay insolvency, but do not ensure a funded status over 80%. Higher Contributions + Investment Returns over 8% = Large Ad Hoc COLAs. What is an appropriate trade off of increased contributions and Ad Hoc COLAs? What is an appropriate funding status to attempt to achieve and maintain? 24
Option #2 Increased Contribution Rates & Reduced Benefits Contribution Increases Considered: +4% (19.97%) of payroll after 2010 (Proposed Budget Recommendation) +4% (19.97%) of payroll in 2011, and +6% (21.97%) of payroll after 2011 (Ad Hoc Committee 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 25
Option #2 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. 26
Option #2 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. 27
Option #2 19.97% Contribution and 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. 28
Comparative Cost of Cumulative Ad Hoc COLAs (8.5% Return) Given the same level of investment returns and additional contributions, Ad Hoc COLAs are larger if future benefits are reduced for active employees. 29
Options #3 & #4 New Hires Enter a Defined Contribution (DC) Plan or TMRS Contributions Considered: 8% for new hires and 15.97% for ERF Members 8% for new hires, 15.97% for ERF Members, and $40M/year to maintain the unfunded liability (no Ad Hoc COLAs) 8% for new hires, 15.97% for ERF Members, and contributions sufficient to fully fund the liability over 30 years (Ad Hoc COLAs would apply) Benefits Considered: No change for current ERF Members Future Hires enter either a DC Plan and receive an 8% City Contribution, or enter TMRS under a set of benefit options that would be designed to cost the City 8% if all assumptions are met. 30
Options #3 & #4 - ERF Funding Ratio (8.5% Return) If new hires enter a DC or TMRS, City contributions of 15.97% of pay for new hires will not go into the Fund and insolvency would be greatly accelerated. The City could contribute an additional amount to the Fund to either maintain a level funding status (without triggering Ad Hoc COLAs), or contribute enough to reach 100% funding status which would trigger Ad Hoc COLAs. 31
Option #5 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 to An annual benefit payable for the life of the employee A COLA granted at a rate tied to the Consumer Price Index But is still considered a Defined Benefit (DB) plan: City retains investment responsibility and most of the investment risk. City retains mortality risk. 32
Option #5 Why Consider this design for New Hires? The change in the COLA method for new hires will: Slowly help contain the Ad Hoc COLA issue Will create a COLA that is tied directly to inflation, rather than funded status The variable interest credit will: Spread the sharing of the investment risk to a broader group (both future actives and current Ad Hoc COLA Members) Allow liabilities to managed so they will stay closer to assets A benefit structure comparable to other cities could be designed Continued administration by ERF will: Avoid the need for two plans Allow the City to contribute at a single rate for all employees 33
Recommendations 1. Increase City contribution rate by 4% to 19.97% effective 10/1/10 (General Fund $11.4 million, other funds $8.6 million). 2. Ad Hoc COLA election: Allow vested employees, retirees, and those receiving benefits from the Retirement Fund to elect to receive a 2% guaranteed simple COLA, regardless of whether they previously elected the Ad Hoc COLA. 3. Implement a cash balance plan (Option #5) for new hires effective 1/1/11 with plan provisions to be determined. 4. Offer new hires the option of designating a domestic partner for survivor benefits in an actuarially neutral manner. 34
Questions 35
City Contributions to Achieve 100% Funding (Ad Hoc Basis) If the City were to make steady progress towards 100% funding in 30 years, Ad Hoc COLAs at the 4% level would be triggered within a few years. This in turn, increases the contribution needed to fully fund the plan. 36
City Contributions to Achieve 100% Funding (Prefunding Basis) If the City were to recognize and prefund future Ad Hoc COLAs at the 4% level. This in turn, increases the contribution needed to fully fund the plan. 37
City Contributions to Achieve 30 Year Amortization Period The lines above show the City contribution needed to achieve and maintain a funding period less than 30 years. This funding level would not trigger Ad Hoc COLAs. 38
Intergenerational Shift of Costs Example Benefits Earned by Employee as Early as 1980 Benefits Paid by Taxpayers as Late as 2070 { Benefits Earned } { COLA Funded } { Benefits Paid } 1980 Age 20 2010 Age 50 2040 Age 80 2070 39
Option #5 - Observations If investment returns are high (above 8.5%), the Fund will be able to provide competitive benefits to new hires, maintain an 80% funded status, and provide Ad Hoc COLAs If investment returns are slightly below 8.5%, interest credits can be reduced for new hires to maintain the funding level If investment returns are significantly below 8.5%, the interest credit can be reduced and Ad Hoc COLAs will not occur. The combination of these two limitations will help maintain the funding status above what would be possible under the current plan The Fund would have broader ability (and responsibility) to control the funding status via the setting of the interest credit. A balance between interest credits that affect active members benefits and the funding period affecting Ad Hoc COLAs will need to be met. This may require implementation of objective criteria. 40