CC 2018-04-24_11b Budget Balancing Strategies_2018-20 Biennial BudgetMEMORANDUM
TO: CITY COUNCIL
FROM: JIM BERGMAN, CITY MANAGER
DEBBIE MALICOAT, DIRECTOR OF ADMINISTRATIVE SERVICES
SUBJECT: CONSIDERATION OF BUDGET BALANCING STRATEGIES FOR THE
2018-20 BIENNIAL BUDGET
DATE: APRIL 24, 2018
SUMMARY OF ACTION:
Approval of the budget balancing strategies will provide a plan for developing a
balanced budget.
IMPACT ON FINANCIAL AND PERSONNEL RESOURCES:
There is no direct financial impact of the action other than the staff time required to
prepare the report, however based on the General Fund 10 Year Fiscal Forecast,
significant financial impacts are projected to the City’s budget.
RECOMMENDATION:
It is recommended the City Council approve the budget balancing strategies presented
for the FY 2018-20 Biennial Budget.
BACKGROUND:
The City’s budget provides funding for all City services, infrastructure investments and
activities performed during each fiscal year. The City Council discussed the results of
the General Fund 10-Year Fiscal Forecast on January 23, 2018, which indicated that
the City’s expenditures are expected to exceed revenues and without intervention, all
Fund Balance would be depleted within five years. At their February 13, 2018 meeting,
the City Council discussed priorities and approved the following budget concepts for
developing a draft FY 2018-20 Biennial Budget:
Budget Concepts
1. Correct and reverse the expenditure/revenue gap within two years by making
services more efficient, more effectively recovering the true cost of services,
and/or reducing non-core and non-essential services and attempting to shift the
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provision of these wanted and needed public services to entities that are better
able to perform them.
2. Increase revenues through strategic economic development efforts that
encourage development of numerous vacant and underutilized parcels to not
only fulfill desired retail and service needs of the community but also to ensure
wise fiscal benefits to the City to fund inevitable cost increases of providing core
and essential services.
3. Reduce exposure to volatility of pension payments from potential future actions
by CalPERS such as further reduction of the discount rate or re-amortization of
unfunded liabilities.
4. Once long-term economic and fiscal sustainability is achieved, start to build a
community vision of future wants (i.e. long-term use of Camp Arroyo Grande,
better sports facilities and fields, etc.) and identify new revenue sources to build
and support these efforts such as increased taxes or bond measures.
The City Council also approved the following priorities and goals for the upcoming
budget:
1. Within two years, reverse the expense/revenue gap by doing the following:
a. Within the first year of the budget, reverse the gap between expenditures
and revenues to result in approximately $157,000 surplus to be added to
the reserves. This equates to reducing expenses by $450,000.
b. By the end of the second year of the budget, reverse the gap between
expenditures and revenues to result in a $1,386,000 surplus to be added
to the reserves. This equates to further reducing expenses by $450,000.
c. Goals a and b shall be accomplished by:
i. Focusing City resources first to services identified as “Core and
Essential” and fund these services to fully meet adopted City
policies.
ii. Ensuring that Core and Essential services are “Right Sized” based
upon accepted metrics of service outcomes.
iii. Analyzing “non-core and non-essential” services and make budget
recommendations of how the City can more efficiently provide the
service, find another entity to provide the service, or find additional
revenues to support the service.
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2. Increase revenues by:
a. Analyzing City costs to provide services and consider achieving full cost
recovery for a wider range of services.
b. Encouraging economic development in order to achieve identified service
outcomes for core and essential services (this will require the addition of
$180,000 in revenue above and beyond normal assumptions starting in
year three growing to total new revenue of $390,000 by year 10).
3. Reduce exposure to volatility of pension payments by the end of year two by:
a. Analyzing and making recommendations on tools such as pension
prepayments and Section 115 Trusts.
4. Begin to study options to develop new revenue sources such as a future tax
measure for new or expanded services.
DISCUSSION:
Balancing the budget will require a multi-faceted approach that includes both revenue
increases and expenditure reductions. The chart below represents the four major
components proposed in balancing the budget, which are:
1. Reduction of operating budgets and development of efficiency measures
2. Prepayment of the CalPERS unfunded liability (debt)
3. Revenue enhancements including significant fee increases in Recreation
Services and Community Development
4. Staffing reductions, eliminations and restructuring
Operating savings,
9%
$86,000
Revenue
enhancements, 27%
$243,000
CalPERS cost savings,
14%
$126,000
Staffing reductions,
50%
$450,000
Proposed Budget Balancing Components to Offset the
$900,000 Revenue/Expense Gap
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ANALYSIS OF ISSUES:
Reduction of Operating Budgets and Efficiency Measures
Each department reviewed its operating budget to identify reductions that could be
made to supplies and services. Overall, this resulted in reduced expenditures by about
$86,000 in FY 2018-19 and $164,000 in FY 2019-20. Significant reductions and impacts
are identified below.
Eliminate OpenGov software license $4,900 - Minimal impact as full
implementation has not been achieved yet and upgraded financial management
software will be able to provide this functionality
Two year hiatus in memberships to specific organizations:
o League of California Cities and Channel Counties Division $7,400
o Economic Vitality Corporation membership $5,000
o Five Cities Diversity Coalition membership $1,500
Prepayment of CalPERS Unfunded Liability
The City’s unfunded accrued liability (UAL) for promised defined pension benefits is
analogous to a debt with a 7.0% interest rate. The most significant element that is
causing an increase in costs is the future payments required by CalPERS for the UAL.
Staff reviewed proactive approaches to paying down the City’s UAL and managing
future costs including contributing a lump sum payment toward the UAL, spreading the
same prepayment amount over a 10 year period of time, contributing the amount
towards an irrevocable Section 115 trust for pension stabilization, and amortizing the
City’s PERS plans over a new 20 year period.
Based on the analysis of these options, staff recommends utilizing the General Fund
reserve above the 20% goal in FY 2018-19 and FY 2019-20 to make lump sum
payments to CalPERS toward the UAL. This would result in a payment of $3 million in
FY 2018-19 and an additional $2 million in FY 2019-20, for a total of $5 million during
the Biennial Budget period. Staff recommends the full payment be allocated to the
Safety Police CalPERS plan as this will result in the greatest total savings to the
General Fund.
An analysis of the City’s pension obligations and the impact of the prepayment is
included as Attachment #1. Essentially, utilizing the City’s excess reserves to pay off
this debt will result in lower ongoing CalPERS payments. This ongoing savings reduces
the financial obligations of the General Fund and helps reduce the gap between
revenues and expenditures. The $5 million prepayment will generate total savings of
$7.45 million over the 30 year UAL amortization period. During the Biennial Budget this
is a reduction of approximately $130,000 in FY 18-19 and $200,000 in FY 2019-20.
When viewed in the context of the 10 year fiscal forecast, the average annual savings
provides $240,000 of the necessary $900,000 of ongoing cost reductions. Actual
payments during the 10 year period will be between $106,000 and $430,000 less.
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Revenue Enhancements Including Fee Increases
In nearly all cases, the fees charged for services provided are less than the total cost of
providing the services. In some circumstances this is expected, perhaps even desired
in order to achieve compliance with certain policies; however, given the fiscal
circumstances, increasing fees for services received by the community is necessary.
The Council adopted a strategy by which fees in the Community Development
department would be incrementally increased by an additional 5% per year until 75%
cost recovery was achieved. This was expected to take 4 years. With the current fiscal
conditions, staff is recommending accelerating the time frame to accomplish cost
recovery and increasing the percentage of cost recovery achieved. Staff recommends a
strategy of increasing these fees by 15% in FY 2018-19 and an additional 15% in 2019-
20. This will result in cost recovery of about 80% of the department’s costs, assuming
the level of development activity remains relatively stable. This will generate $121,000
to $137,000 in additional revenue.
The Recreation Services department has analyzed the activities provided and revenues
generated and identified a number of revenue enhancement options for consideration.
Some of these ideas will be more fully explored during the coming months, others are
recommended for immediate implementation. Staff recommends:
Increasing Preschool fees from $4.50/hour to $6.05/hour (36% increase)
beginning FY 2018-19
Increasing Children in Motion fees by 25%, approximately $1/hour depending on
the number of days per week enrolled, beginning FY 2018-19
Increase youth sports field rental from $2/hour to $3/hour in FY 2018-19 and to
$4/hour in FY 2019-20
Increase fees for youth and adult sports beginning in FY 2018-19
Ideas for further consideration and evaluation include:
Adopt a park use policy to enhance the class program, minimize impacts on
maintenance schedules at parks, and increase the security and safety of
community members
Initiate a Recreation Foundation to offer scholarships for youth programming,
support and fund community events, facilities, and supplies
Raise or initiate fees at events such as Father/Daughter Dance, Family Fun Day,
Halloween Maze, Turkey Trot, and Holiday Decorating Contest
Raise fees for facility and park rentals
Develop a formal sponsorship program to recruit additional sponsors for events
and programs
Initiate a banner program at the Soto Sports Complex in FY 2019-20
Charge for parking at Soto Sports Complex on weekends
Contract with a concessionaire to operate a business out of the snack bar/Jaycee
Room at the Soto Sports Complex
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Attract traveling teams and host large tournaments 1 to 3 times per year in FY
2018-19 and increase to 5 tournaments in FY 2019-20
The recommended revenue enhancements are anticipated to generate an additional
$130,000 to $250,000 per year, depending upon participation. The analysis assumes
some level (between 10% and 30%) of participation decline with the increased fees;
however, the actual participation could decrease more than this, which would result in
lower revenue generation. Consistent and timely monitoring of actual results compared
to these assumptions will be critical during the Biennial Budget to ensure that
Recreation fees are generating sufficient revenue to recover costs.
The Soto Sports Complex provides a unique facility in the region and also presents
challenges. The facility costs approximately $250,000 per year to operate and maintain,
however field rentals are recovering just $18,000 per year. This revenue is barely
enough to offset the cost of the staff time to coordinate field reservations and schedule
play. It does not recoup any of the costs of maintenance or operations. Staff is working
on several ideas in addition to those mentioned above to increase the revenue
generated by this facility, thus making it more self-sustaining.
Staffing Reductions, Eliminations and Restructuring
While eliminating staff positions is always difficult and all other options are considered
first, they are also an opportunity to examine business practices and identify possible
areas for consolidation, change or efficiency. Discussion of these opportunities and
proposed changes, as well as a brief analysis of mitigations or impacts, is provided in
the following section.
The following positions are proposed for elimination:
FTE Position Department Savings
1.0 Associate Planner Community Development $ 141,300
0.8 Part Time Planning Technician Community Development 50,800
0.6 Part Time Planning Intern Community Development 17,400
1.0 Administrative Secretary Community Development 104,000
2.1 Part Time Maintenance Workers (3 positions) Public Works 83,100
0.3 Part Time CIP Associate Engineer/Intern Public Works 18,700
1.0 Property & Evidence Technician Police (non-sworn) 124,200
0.6 Part Time Administrative Intern Police (non-sworn) 17,400
0.2 Police Reserve Police (sworn) 40,000
Total Savings* $ 596,900
*After accounting for mitigations, which are discussed below, net savings from staffing is $447,000
Community Development
The Planning Division assists the community, the Planning Commission, and the City
Council, in preparing for the City’s future growth and development, as well as reviewing
current development plans for consistency with local ordinances. The Planning Division
administers the Development Code and deals with transportation, housing, community
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facilities, public safety, open space, design, and the use of land. The Planning Division
is crucial to public health, safety, and wellness of the City and serves as a major
community communication channel through the Planning Commission, Traffic
Commission, Architectural Review Committee, Downtown Parking Advisory Board, and
Historical Resources Committee. The Planning Division is currently staffed by a full time
Planning Manager, full time Associate Planner, part time Planning Technician, part time
Planning Intern, a volunteer (unpaid) Planning Intern, and an Administrative Secretary
all reporting to the Community Development Director.
Net reductions of $82,000 are possible by restructuring the department by eliminating
the Associate Planner and Planning Technician positions and replacing these positions
with a full time Assistant Planner position. Eliminating the part time Planning Intern and
moving to all volunteer intern positions will save an additional $17,400. Eliminating the
Administrative Secretary position and reclassifying the existing part time Senior Office
Assistant position to a full time Permit Technician will save $69,000.
These proposed reductions and consolidation of Planning staff will require shifts to
major aspects of land use planning including reduction or elimination of selected
commissions, revisions to selected lower impact land use regulations and streamlining
of review processes. More specifically, it is anticipated that less or no permit review will
occur for some Minor Use Permits or design review.
The reduction of the Associate Planner Position will delay the City’s ability to
accomplish long range planning initiatives including master plans (such as the East
Grand Avenue Master Plan, the Halcyon Road Complete Streets Plan, East Branch
Phase II), required programs (such as the Climate Action Plan, housing monitoring and
reporting, and as needed water conservation programs), as well as General Plan work
including the Housing Element, Circulation Element, Safety/Local Hazard Mitigation
Plan, and Land Use Elements. This is due to the shifting of work to the Planning
Manager.
Associated with this proposed reduction of staff at City Hall, staff also recommends
closing City Hall to walk in customers one day per week, and to shorten counter hours
on the other four days, to allow for longer periods of uninterrupted task completion. The
functions of the Administrative Secretary position that are not covered by the increase in
eight hours per week by the reclassification of the part-time Senior Office Assistant will
result in additional workload for other divisions and management staff in the Community
Development Department.
Public Works
Staff reductions in Public Works include eliminating four part time positions.
Part time Associate Engineer/Intern position. This position is currently vacant and
assists the Capital Improvement Project Manager with several of the Capital
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Improvement Program projects along with data collection and updating records.
Eliminating this position will save $18,700 and result in additional workload for
the Capital Improvement Project Manager and other managers in the Public
Works department.
Three part time Maintenance Worker positions are also proposed for elimination.
Two of these positions perform parks maintenance duties. These duties include
daily trash/recycling pickup of over 150 trash cans and all public restroom
maintenance in addition to mowing and landscaping. They also support the other
crews in emergency situations such as a downed tree in the roadway and traffic
control. This support extends to facilitating the multiple community events with
equipment delivery and setup.
The third position proposed for elimination is a part time Maintenance Worker in
the Streets Division. A minimum crew of four is needed to conduct safe road
closures and traffic control on medium to large jobs. The City’s full time employee
crew of three relies upon this part time position to schedule larger types of
projects such as multiple pothole patching, striping and red curbing and other
work on busier streets.
Each of these positions work 2.5 days per week and are responsible for mainly one set
of duties (i.e. mowing all parks, all trash pickup and all public restroom maintenance,
filing, data entry, records updating, etc.) the main impacts are:
These responsibilities will fall to permanent and more senior staff increasing the
cost of those duties and delaying other more technical and special jobs.
Support to the Streets Division that currently has 3 staff will be lost, which will
delay medium and larger street repair jobs due to lack of a safety team for street
closures and traffic control. Three to four projects per week will be delayed.
There will be about a 30% reduction on the mowing, trash and trash can pick
up, restroom maintenance and maintenance of facilities such as BBQ pits, parks
picnic areas and other facilities rented out to the public. Example: Trash cans
emptied about 30% less frequently and public restrooms will be cleaned about
30% less frequently – noticeable service reductions.
A similar reduction in our ability to contribute staff to the Special Events
throughout the year – especially the events that take place on weekends.
Alternately, overtime for permanent staff will have to be used, increasing the cost
of these events.
This reduction will also affect our ability to maintain City Hall and Recreation
Services since the department will have no back up or other staff to help with
urgent issues like toilets that are backed up, trash that is overflowing, leaks, pest
issues, and restroom maintenance. These responsibilities may transfer to the
staff who work in these buildings and/or service will be delayed.
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These reductions will certainly have a visual impact on the streets, Village and
parks, since these areas will not have the attention and routine maintenance
currently provided.
Our CIP programs are in full swing. The elimination of the Associate Engineer
position will mean that more tedious and basic duties will be performed by the
CIP Project Manager.
Police Department
An independent audit of the property and evidence function in the department
determined that the volume of property and evidence does not warrant a full time
position and further analysis determined that these duties could be reassigned to a
records/evidence function. Elimination of the full time Property and Evidence Technician
position with compensation adjustment for the Records Clerk that will likely assume
these functions will result in net savings of approximately $109,000.
The Police Department has utilized a part time administrative intern to assist with crime
mapping and data analysis. Currently the position is unfilled. Elimination of the position
will result in greater reliance on the GIS Technician in the Community Development
Department for assistance with mapping and other analysis. This is likely to result in
reduced capacity for data analysis or delay in performing the analysis as the workload
increases for the GIS Technician.
Reducing the number of hours for Reserve police officers will save $40,000. Reserve
officers supplement police operations by providing specialized police service in the
areas of traffic enforcement, traffic regulation and control, parking enforcement, special
event operational planning and coordination and the implementation of special event
plans. The Reserve Officer also provides civic, community, and school presentations
and training on issues related to traffic safety, DUI, and the role of law enforcement in
the community. Additional reliance on motorcycle officers from neighboring jurisdictions
may help mitigate this reduction. No reduction is proposed for the number of hours that
supports the Reserve Officer that performs the City’s cyber-crime analysis.
Implementing these strategies will be impactful to the City’s ability to provide service to
the community in a number of areas; however it will result in a budget that is
sustainable. Community expectations related to response times, park and facility
conditions, services provided, and staff availability will need to be adjusted. Reduced
public counter hours and additional investment in technology solutions may be required
in order to maximize productivity; however, it is unlikely that current service levels will
be maintained.
Although the decision to reduce or eliminate positions is not negotiable, the City may
have to negotiate the impacts with employee organizations affected by the reductions.
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The chart below illustrates the General Fund forecast revenues and expenditures over
the next five years. Before implementing any changes or adjustments, expenditures
were forecast to exceed revenues each year by an average of about $1.3 million during
the five year period. After implementation of the recommended strategy, revenues will
exceed expenditures by an average of about $440,000 each year during the same
period. The fund balance will be used to prepay the CalPERS liability, drawing it down
to the 20% policy goal and it will remain at or above this level.
Next Steps
Staff is seeking City Council direction related to the components of the balancing
strategy in order to continue developing the Biennial Budget. The budgetary review of
proposed capital projects will be presented to the City Council on May 8, 2018 and the
Preliminary Budget will be presented at a special meeting on May 29, 2018.
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PAGE 11
ALTERNATIVES:
1. Approve the budget balancing strategy presented for the FY 2018-20 Biennial
Budget;
2. Do not approve the budget balancing strategy presented; or
3. Provide other direction to staff
ADVANTAGES:
Approving the budget balancing strategy will assist staff in developing a Biennial Budget
that is responsive to the City Council and community priorities, while maintaining
economic feasibility.
DISADVANTAGES:
There are no disadvantages to providing information for the community, City Council
and staff regarding the City Council’s priorities and strategies for balancing the Biennial
Budget.
ENVIRONMENTAL REVIEW:
No environmental review is required for this item.
PUBLIC NOTIFICATION AND COMMENTS:
The Agenda was posted at City Hall and on the City’s website in accordance with
Government Code Section 54954.2.
Attachment:
1. Memorandum: CalPERS Unfunded Accrued Pension Liability
Item 11.b. - Page 11
MEMORANDUM
TO: JIM BERGMAN, CITY MANAGER
FROM: DEBBIE MALICOAT, DIRECTOR OF ADMINISTRATIVE SERVICES
SUBJECT: CALPERS UNFUNDED ACCRUED PENSION LIABILITY
The City of Pismo Beach recently completed an analysis of their pension costs and
strategies for managing them. The City of Arroyo Grande’s situation is very similar and
many of the overall concepts are not employer specific. The following memorandum is
based on the City of Pismo Beach’s analysis, but with City of Arroyo Grande-specific
data. Many thanks go to Nadia Feeser, the Administrative Services Director in Pismo
Beach for sharing her report and analysis.
EXECUTIVE SUMMARY:
The City of Arroyo Grande provides retirement benefits for full-time employees through
the California Public Employees Retirement System (CalPERS). Unfortunately,
CalPERS is underfunded meaning that as of January 2018, CalPERS had only 68% of
the funds required to pay estimated retirement benefits. There are several factors
contributing to the underfunding of the CalPERS system, largely due to past investment
performance in the past two national recessions. Although the 2013 pension reform and
CalPERS more conservative investment changes have reduced the potential for further
decline in CalPERS funded status, there still remains large unfunded accrued liabilities
(UAL) from promised defined benefits compared to the fiscal health of the CalPERS
system.
The City of Arroyo Grande has taken a proactive approach to managing the City’s UAL,
which is essentially debt with a 7.0% interest rate. The most significant element of the
City’s management of these costs is maintaining level staffing, followed by a controlled
spending plan. The City Council also renegotiated new retirement tiers and increased
employee contributions. However, the City’s funded status still hovers around the 68%
mark. Based on what CalPERS is requiring from the City to pay down its UAL assuming
reduced investment earnings performance, staff projects that these future payments
could require the City Council to make tough decisions on maintaining current
operations or paying into its retirement system.
Staff reviewed four additional proactive approaches to paying down the City’s UAL and
manage future costs including contributing $2.0 million to $3.0 million towards the UAL
in a lump sum, spreading this prepayment over 10 years, contributing $2.0 million
towards an irrevocable 115 trust for pension stabilization, and changing the City’s plans
to a 20 year amortization period. The impacts of these strategies are outlined below.
Based on the impacts of these strategies, staff recommends prepaying $3.0 million in
FY 2018-19 and $2.0 million in FY 2019-20 toward the Safety plan.
ATTACHMENT 1
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CalPERS Unfunded Accrued Pension Liability Page | 2
Background
The City of Arroyo Grande provides retirement benefits for full-time employees through
the California Public Employees Retirement System (CalPERS). These retirement plans
provide a defined benefit to each retired employee based on a set percentage of an
employee’s salary multiplied by the number of years that the employee contributed to
the CalPERS system, starting at the stated retirement age of each Plan tier. The City
has two main retirement plans, each with three benefit tiers:
Miscellaneous Plan (All Employees except Sworn Police Officers)
1. First tier provides a benefit of 2.5% at age 55
2. Second tier provides a benefit of 2.0% at age 55
3. Third tier provides a benefit of 2.0% at age 62
Safety Police Plan (for Sworn Police Officers)
1. First tier provides a benefit of 3.0% at age 50
2. Second tier provides a benefit of 3.0% at age 55
3. Third tier provides a benefit of 2.7% at age 57
Each tier within each plan calls for a different Employer and Employee cost, with the
first tier costing the most and the third tier costing the least to the employer. The third
tier plans came about as a result of the California Public Employees’ Pension Reform
Act, commonly referred to as PEPRA, which took effect in 2013.
The UAL as of June 30, 2016 for the Miscellaneous Plan tier 1 is $12.3 million and for
the Safety Police Plan tier 1 is $9.4 million. The City also has a Safety Fire Plan for
employees assigned to the Five Cities Fire Authority which has a total UAL of $1.3
million as of June 30, 2016, but is not the subject of this memorandum. The following
table illustrates the funded status of the 6 main retirement plans, including the total UAL.
Table 1: Funded Status of Each Retirement Plan
ABC = A‐BB/A
Plan Name Tier Accrued Liability
Market Value
of Assets
Unfunded
Accrued Liability
(UAL)
Funded
Ratio
Miscellaneous Plan Tier 1 36,672,064$ 24,384,997$ 12,287,067$ 66.5%
Miscellaneous Plan Tier 2 164,775 156,870 7,905 95.2%
Miscellaneous Plan PEPRA 89,380 80,647 8,733 90.2%
Safety Police Plan Tier 1 30,069,932 20,628,187 9,441,745 68.6%
Safety Police Plan Tier 2 370,473 350,368 20,105 94.6%
Safety Police Plan PEPRA 53,118 47,233 5,885 88.9%
67,419,742$ 45,648,302$ 21,771,440$ 67.7%
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CalPERS Unfunded Accrued Pension Liability Page | 3
Notes/Definitions:
Accrued Liability – The total value of earned benefits; measures the full value of
supporting the City’s active and retired employees
Market Value of Assets – The current market value of the City and employee
contributions plus investment earnings
Funded Status – An assessment of the need for future employer contributions based
on the selected actuarial cost method used to fund the plan
Unfunded Accrued Liability (UAL) – the difference between the estimated cost to pay
retirement obligations and the market value of the assets currently set aside to fund
them. It is the present value of future employer contributions for service that has
already been earned and is in addition to future normal cost contributions for active
members; which represents the City’s debt or pension liability
Factors Contributing to CalPERS System Unsustainability
There are several factors contributing to the unsustainability of the CalPERS system,
largely due to past investment performance, and exacerbated by other factors including
demographic changes, automatic cost of living adjustments for retirees, and enhanced
retiree benefits.
CalPERS Past Investment Performance and Rate of Return
Prior to 2017, CalPERS provided pension benefits based on a 7.5% annual long-term
rate of return. This meant that CalPERS expected to earn 7.5% on average each year
on the contributions into CalPERS. However, in the last two recessions, CalPERS has
suffered significant losses.
During the recession in 2000 and 2001, CalPERS had losses of 7.2% and 6.1%,
respectively, in investment earnings.
During the Great Recession in 2008 and 2009, CalPERS suffered losses of 5.1%
and 24.0%, respectively, of investment earnings and since then, has been struggling
to recover those losses.
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CalPERS Unfunded Accrued Pension Liability Page | 4
The following chart illustrates CalPERS historical investment performance at the end of
each year, demonstrating the two significant losses.
Chart 1: CalPERS Historical Investment Returns 1994 –2017
As retirement benefits payments are made up by 62% from investment earnings, 25%
from CalPERS employers, and 13% from CalPERS employee member contributions,
the two recessions have led to a larger UAL for most CalPERS member agencies.
When the pension plan’s investment earnings are lower than expected, the fund needs
to make better than expected earnings in future years, request higher contributions from
employers and employees, or reduce retiree benefits.
Other Factors
Although past investment performance is the primary factor in the current
unsustainability of CalPERS, the UAL is intensified by other factors including
demographic changes, automatic cost of living adjustments (COLAs) for retirees, and
enhanced retiree benefits. Regarding demographic changes, the number of annual
retirees drawing down from CalPERS for pension payments is increasing compared to
active employees contributing into CalPERS with reduced contributions. This factor
decreases the amount of funds paid into CalPERS. In addition, several actuarial factors
including mortality rates are improving, creating a larger liability. Regarding retiree cost
of living adjustments (COLAs), these COLAs are automatic, increasing in years even
when there is flat or negative inflation, which draws funds out of CalPERS. Finally, each
Great
Recession Recession
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CalPERS Unfunded Accrued Pension Liability Page | 5
plan has several enhanced benefits, including earlier retirement ages and larger
compensation packages and resulting pensions as a percentage of salaries. All these
factors contribute to an increase in the UAL and negatively impact the future stability of
CalPERS.
What Has the State/CalPERS Done to Fix the Problem? CalPERS Pension Reform
and Investment Changes
Due to the dramatic losses in the CalPERS system after the most recent two
recessions, there was significant support for pension reform.
In 2012, Governor Jerry Brown signed into law the California Public Employees’
Pension Reform Act (PEPRA), which changed the way CalPERS retirement and
health benefits are applied, and placed compensation limits on members hired after
January 1, 2013. The cost savings of this legislation will be realized over 20 years as
more PEPRA employees are hired.
Beginning in July 2015, CalPERS changed the way employers contributions into the
plan were calculated, placing an increased burden on employers. This resulted in
requiring larger contributions by public agencies into the CalPERS system.
In December 2016, the CalPERS Board voted to reduce the expected rate of return
(discount rate1) on CalPERS investments from 7.5% to 7.0% over the next 3 years.
This change is intended to reflect more realistic future investment returns. But
because the retirement system is based on defined benefits, with a lower expected
earnings rate, the result is that CalPERS member agencies will need to pay higher
employer rates. This change also increases the City’s UAL.
In February 2018, the CalPERS Board voted to change the amortization period for
any prospective gains/losses on investments to a 20 year amortization period
(compared to a 30 year amortization period) starting with the FY 2019 valuation.
This change will have the impact of increased volatility in the amount that Cities
would need to contribute to CalPERS as the impacts are spread over a shorter time
frame.
1 Discount Rate
The Discount rate, or the long-term expected rate of return, is based on the CalPERS
actuarial assumptions that they will earn a certain percent investment return on all of the
amount it invests as well as on all the amounts that are owed. If the actual rate of return
is less than this amount and all other factors remain the same (i.e., number of annual
retirements, mortality, compensation adjustments, etc.), later annual valuations will
reflect a greater UAL. There is discussion among CalPERS staff that this discount rate
could be further reduced from 7.0% to 6.5% or 6.0% as CalPERS changes the mix of
investments from more growth earnings to fixed earning investments. CalPERS has
stated that it expects to earn about 6.1% per year over the next 10 years, which will
result in even higher pension costs.
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CalPERS Unfunded Accrued Pension Liability Page | 6
Each time changes are implemented into member agencies’ pension plans, they are
reflected in the plans over a period of 20 years to minimize the impact of the investment
losses and resulting impact in increased contributions by CalPERS member agencies.
Although a smoothing policy is least impactful on a fiscal year basis, spreading out the
losses means that member agencies will continue to pay interest costs equal to the
discount rate over a longer term, ultimately costing more to member agencies.
What is the Fiscal Health of the City of Arroyo Grande’s Pension Plans?
Every year, CalPERS performs an actuarial study to determine how much the City
should contribute based on the most recent valuation of the Plan’s funded status. Based
on CalPERS actuarial valuation for the fiscal year ending on June 30, 2016, the June
30, 2018 estimated balance of the Miscellaneous Plan tier 1 has an UAL of $12.5 million
and the Safety Police Plan UAL is $9.1 million.
CalPERS provided estimated payment schedules to the City for both tier 1 plans. Both
of these plans have “side funds” that will be paid off in the next four years. After taking
those into consideration, staff projects that the fiscal impact to the City for all plans will
increase each year until it peaks in FY 2032 at 45% higher than current amounts, then
ramp down until it is paid off in FY 2048. This represents an increase of about
$100,000 per year compared to the previous year, or an ongoing increase of over $1.1
million by FY 2029. A $1.1 million ongoing increase in cost is unsustainable and could
require the City to either increase taxes or support other ongoing revenue measures or
decrease operations in order to support this cost. Further, this amount does not include
pension related costs in the Five Cities Fire Authority, which will require additional
contributions from the City.
City’s Proactive Approach to CalPERS
The City recognizes that pension costs are rising, which places an increased burden on
local taxpayers and the City to come up with funds sufficient to support its pension
obligations. Although not in a critical situation compared to several public agencies who
are facing large reductions in staff and operating costs or facing bankruptcy, the City
continues to look for ways to be proactive and reduce this burden.
What We’ve Done So Far
So far, the City has taken the following steps:
Maintained level staffing: The City has maintained level full-time staffing despite
increased workloads. This factor has allowed the City to keep pension costs from
rising as each new full-time employee is enrolled in CalPERS.
Creation of 2nd and 3rd Tiers with Reduced Benefits for New Employees: The City of
Arroyo Grande has taken a proactive approach to handling the increased cost of
providing pension benefits to its employees. In 2012, the City successfully
negotiated with its employees and labor unions to create a second tier of reduced
retirement benefits, including a later retirement age, for new employees to the City.
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With PEPRA in 2013 came a third tier of further reduced benefits and an even later
retirement age.
Employees Increase Contributions: In addition, the total contribution made by the
City to CalPERS is made up partially from contributions by the City based on a
percentage of payroll from taxpayer and rate payer dollars as well as the employee
paying into the system as a percentage of their salary. Since 2011, the City
successfully negotiated with its employees and labor unions for employees to
increase their contribution to the full amount of the employees’ portion and in some
cases, a small part of the City’s employer contribution.
What We Can Do Now
Going forward, the City continues to take a proactive approach to reduce its UAL.
Status Quo Option: If We Do Nothing: If we continue to contribute to CalPERS by
paying a fixed amount towards the City’s UAL and a percentage of salaries for the
City’s normal ongoing costs, then the City can expect to see pension payments
increase by 45%, or $1.1 million per year, until FY 2032 at its peak, and then ramp
down until it is paid off in FY 2048. The majority of these costs are borne by the
General Fund, or taxpayer dollars. In addition, there would likely be a similar
increase in retirement costs as part of the City’s participation in Five Cities Fire
Authority. In order to support this $1.1 million plus ongoing cost, the City may need
to increase taxes or put forward other ongoing revenue measures, or decrease
operations and service levels. A $1.1 million ongoing cost could represent about 8 to
10 FTEs. As this cost is unsustainable and the City has the means to reduce this
cost today, staff does not recommend doing nothing.
Prepay UAL in Lump Sum: The City Council could use money from the General
Fund unassigned fund balance to help manage future CalPERS discount rate
reductions. The adopted minimum fund balance policy is 15% of appropriations,
with a Council goal of 20%. Currently, the General Fund has reserves that equal
about 38% of appropriations. During the FY 2018-20 Biennial Budget period, the
General Fund is forecast to have $5 million more than the 20% goal ($3 million in FY
2018-19 and $2 million in FY 2019-20). This total of $5 million could be used to
support a prepayment to CalPERS to reduce the City’s unfunded accrued liability
balance, save millions on interest costs, and save hundreds of thousands of dollars
each year.
Prepaying the UAL in a lump sum provides the highest amount of interest savings
compared to making the annual payments in the current payment schedule. The
City’s independent actuaries have calculated that this option would save the city
$7.45 million in interest costs. This is a net annual average savings of $240,476,
which reduces the payment that must come from the General Fund each year. It will
increase the percentage of assets in the fund, therefore improving the funded status
by $5 million. It does not require committing to a new amortization period.
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CalPERS Unfunded Accrued Pension Liability Page | 8
The payment to CalPERS is comprised of several “bases” of annual gains and
losses. Each of these is amortized, or paid off, over a 20 or 30 year time period,
depending on the adopted policy of the CalPERS Board. Recent policy changes
indicate that all future gains and losses will be amortized over a 20 year period,
rather than 30 years. Each “base” can be viewed as an independent payment plan,
when combined they make up the total UAL. When prepaying the UAL, paying off
the debt with the longest payment period results in the maximum amount of interest
earnings. The Miscellaneous Plan and Safety Plan schedule of amortization bases
is extracted from the full actuarial report and reproduced below.
Miscellaneous Plan:
Safety Police Plan:
Since 2013, CalPERS assigns gains and losses each year to three different
categories or bases. Gains and losses due to changes in market value or assets,
gains or losses due to changes in CalPERS assumptions/methods (such as
demographic changes, longevity assumptions) and gains or losses due to non-asset
changes (such as larger than expected payroll growth, more or less actual
retirements than expected). In addition, City specific bases, such as Side Funds and
Golden Handshake agreements are included. Paying off any one loss base is akin
to paying off a household credit card. If you pay just the monthly minimum (or
annual required payment) you will pay a significant amount of interest compared to
paying the balance in full. Paying off one loss base doesn’t prevent future years
from incurring losses, just as paying off your current credit card doesn’t ensure you
don’t get another credit card in the future. However, ongoing proactive debt
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CalPERS Unfunded Accrued Pension Liability Page | 9
management and evaluation of the amortization bases with each budget should be
undertaken to ensure that the City is minimizing interest costs.
Staff further recommends that the prepayment be applied to the Safety Plan
because this cost is attributed solely to the General Fund. Similar interest savings
could be realized by paying the Miscellaneous Plan; however it would require the
participation of the Water Fund, Sewer Fund and Streets Fund. At this time, staff
has not had the opportunity to calculate the required contribution from these other
participating funds. This may be an option for the 2019-20 fiscal year prepayment if
staff workload permits.
Staff recommends this option as it provides the most overall benefit: reduced annual
payments, reduced UAL balances by $5 million, improved funded status, and
savings on interest payments.
Prepay UAL Over Time: The City could choose to take a portion of the City’s net
operating surplus each year and contribute an amount towards the UAL, which
would allow the City to benefit from reducing the outstanding UAL balance, reduce
interest costs without the risk of locking in a higher annual payment, and reduce
future annual payments. In this option, staff recommends that all funds that have
personnel costs submitting funds to CalPERs contribute to future prepayments
rather than just drawing down from the General Fund.
An example of a flexible procedure could state that if the funded status of the Plan
tier is below 85%, operating revenues exceed the budget and operating
expenditures are under budget for the previous year, and a large portion of the
expenditure savings are from personnel costs, then 75% of salary and benefit
savings over $250,000 could be used to prefund the City’s UAL up to a maximum of
$500,000 per year. In the event that there are extenuating circumstances that do
not warrant an additional payment such as other financial obligations that take
precedence, such as the desire to accumulate funds to support new large capital
projects, debt avoidance, or other occurrences, the policy would need to remain
flexible to account for these circumstances. Alternatively, staff could recommend that
after the close of the fiscal year, that a certain amount be allocated towards paying
down the City’s UAL. Staff recommends this more flexible option after looking back
at FY 2018-19 in order to avoid setting a strict policy that may not end up being the
best fiscal option due to extenuating circumstances.
Reduce Amortization Period or Speed up Payments: The City could reduce the
amortization period (reduce the term) of its UAL from the current 30 year schedule to
a shorter time frame, such as 20 years. This has the effect of increasing annual
contributions with the benefit of saving in interest costs. If the City formally
requested to shorten the amortization period, the City would be locked into the
higher annual payments. This is not desirable as the ongoing costs could become
unmanageable after an economic downturn. Staff does not recommend this option.
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Establish Section 115 Trust: City staff could establish an Irrevocable Pension Trust
Internal Revenue Service Section 115 to prefund future CalPERS contributions and
help the City stabilize its contributions to CalPERS. The City could transfer the same
amount from the General Fund unassigned fund balance into this Trust account. The
$5 million plus earnings could be drawn upon in future years to support CalPERS
pension costs, but cannot be used for any other purposes. If this was implemented,
staff could draw from this account in future years to offset future rate spikes and
pension costs increases, while still maintaining operations and earning a better rate
of return than in the City’s managed portfolio. As the funds are placed in a trust
where the funds can only be used for pension costs, these would show up as an
asset on the City’s balance sheet. Establishing a Trust would allow the City to earn a
greater rate of return on the $5 million than the City’s investment policy allows per
California Government Code.
However, like any higher yielding investment, this Trust is subject to the same
economic downturns as CalPERS investments. The benefit of investing in the Trust
would be if the Trust could potentially achieve a greater rate of return than the 7.0%
interest cost on the UAL, but that also means that it could lose even more. Looking
at historic earnings rates offset by administrative fees, a 4.9% earnings would be the
City’s most likely investment strategy. As such, based on past investment earnings
history, it is more beneficial to pay down the City’s debt/UAL with 7.0% interest costs
rather than invest in the market earning 4.9%. Further, in the event of an economic
downturn, the CalPERS pension costs would increase, which is when the City would
want to draw funds from this account to offset those spikes. However, it is likely that
the Trust would be experiencing the same economic hit as evidenced by historic
losses, which would reduce the amount the City would have to offset those spikes in
costs.
At this point, staff does not recommend this option. However, staff views this option
as beneficial to prefund future CalPERS payments to help stabilize future cost
increases, but not paying down the current UAL. Staff may come back to the Council
to establish the Trust to keep this option open, but not put money into the Trust until
the City’s funded status improves.
Summary of Proactive Pension Options: Of the four options outlined above, staff
recommends prepayment of the UAL by $3 million in 2018-19 and $2 million in
2019-20, assuming the General Fund unappropriated fund balance exceeds the
Council adopted goal of 20% of appropriations. In addition, staff recommends
continuation of a proactive approach to managing pension costs in the future.
Future Employee Contributions: Since pension benefits are for City employees, City
staff will work with its labor unions and City employees for further employee
contributions to CalPERS as appropriate through the negotiation process.
Voice for Pension Reform: Finally, local City Managers are working with the
California League of Cities to start discussions about pension reform as the current
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CalPERS Unfunded Accrued Pension Liability Page | 11
pension system is not sustainable. Arroyo Grande as well as other leaders in the
State are working together to be a voice for pension reform and to take measures to
resolve this upcoming crisis.
What Have Other Public Agencies Done to Pay Down Their Pension Liabilities?
Many other CalPERS member agencies are making at least one prepayment in an effort
to begin paying down their liability with whatever resources they have available at the
time. Cities typically use excess reserves or savings from unspent payroll budget to
reduce their UAL either in one lump sum payment or put a policy or procedure into
place to strategically reduce the outstanding UAL balance over time. Several cities are
also establishing Section 115 Trust accounts to help stabilize their pension costs rather
than sending full payments to CalPERS. Very few member agencies have changed their
amortization schedule to 10 or 20 years.
Item 11.b. - Page 22
CalPERS Unfunded Accrued Pension Liability Page | 12
Savings
FY Balance Payment Balance Payment
2018 9,441,745.00 788,580.00 9,441,745.00 788,580.00 ‐
2019 9,320,931.00 871,814.00 9,320,931.00 3,814,129.00 (2,942,315.00)
2020 9,104,959.35 993,771.79 6,052,351.02 2,879,958.43 (1,886,186.64)
2021 8,746,684.82 550,003.96 5,499,199.17 443,512.92 106,491.04
2022 8,821,828.19 618,120.17 3,459,274.64 327,370.15 290,750.02
2023 8,831,930.12 689,262.66 3,375,168.97 344,122.39 345,140.27
2024 8,769,057.83 743,752.83 3,267,501.48 361,665.90 382,086.93
2025 8,645,084.96 766,065.41 3,133,714.61 372,515.87 393,549.54
2026 8,488,848.38 789,047.40 2,978,818.00 383,691.37 405,356.03
2027 8,297,274.99 812,718.80 2,800,917.52 395,202.09 417,516.71
2028 8,067,044.28 837,100.36 2,597,969.23 407,058.16 430,042.20
2029 7,794,569.41 862,213.38 2,367,768.02 419,269.91 442,943.47
2030 7,475,976.96 888,079.77 2,107,935.45 431,848.00 456,231.77
2031 7,107,085.05 914,722.17 1,815,906.55 444,803.44 469,918.73
2032 6,683,379.97 942,163.84 1,488,915.83 458,147.55 484,016.29
2033 6,199,991.10 970,428.77 1,123,982.14 471,891.98 498,536.79
2034 5,651,663.67 953,439.40 717,892.37 439,946.51 513,492.89
2035 5,080,501.76 934,557.29 314,955.95 405,659.61 528,897.68
2036 4,486,782.65 896,854.26 (82,168.29) ‐ 896,854.26
2037 3,888,345.39 856,047.91 (453,070.21) ‐ 856,047.91
2038 3,288,057.66 811,986.05 (792,106.99) ‐ 811,986.05
2039 2,689,156.46 453,684.24 (1,093,047.07) ‐ 453,684.24
2040 2,417,365.47 448,352.57 (1,026,936.12) ‐ 448,352.57
2041 2,131,054.69 461,803.14 (931,919.52) ‐ 461,803.14
2042 1,809,690.75 475,657.24 (824,772.84) ‐ 475,657.24
2043 1,450,270.33 407,111.06 (704,447.83) ‐ 407,111.06
2044 1,135,371.52 394,929.23 (536,544.11) ‐ 394,929.23
2045 809,871.96 343,766.03 (379,367.80) ‐ 343,766.03
2046 513,383.09 247,007.72 (235,450.21) ‐ 247,007.72
2047 295,290.96 144,134.55 (116,539.47) ‐ 144,134.55
2048 167,713.70 130,872.97 (26,771.76) ‐ 130,872.97
2049 44,469.52 46,080.16 (9,263.04) ‐ 46,080.16
167,655,380.99 21,044,129.13 54,652,541.69 13,589,373.29 7,454,755.84
TOTAL UAL ‐ Current Payment
Schdule
TOTAL UAL ‐ Prepayments
Applied
Amortization and Payment Schedule Comparing Safety Police Plan
Current payment schedule versus prepaying $3 million in FY 2018‐19 and $2 million in 2019‐20
Item 11.b. - Page 23
CalPERS Unfunded Accrued Pension Liability Page | 13
‐
200,000
400,000
600,000
800,000
1,000,000
1,200,000
2018202020222024202620282030203220342036203820402042204420462048PaymentSafety Plan Payments ‐Current vs. Prepayment
scenario
Current
Prepayment
Item 11.b. - Page 24