HomeMy WebLinkAboutStaff Report 288-08
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TO: HONORABLE CITY COUNCIL
ATTENTION: FINANCE COMMITTEE
FROM: CITY MANAGER DEPARTMENT: ADMINISTRATIVE
SERVICES
DATE: JUNE 17, 2008 CMR: 288:08
SUBJECT: ANALYSIS OF CALIFORNIA PUBLIC EMPLOYEES’
RETIREMENT SYSTEM (PERS) PORTFOLIO YIELD AND PRE-
PAYMENT OPTION
This is an informational report and no Council action is required.
BACKGROUND
On November 19, 2007, City Council directed staff to investigate the use of Certificates of
Participation (COP’s) to finance the purchase of a 1.27 acre parcel and construction of a Public
Safety Building (PSB). On January 15, 2008, staff outlined (CMR 114:08) for the Finance
Committee, options for paying COP debt service for a new PSB. COP debt service must be paid
from existing resources or from new General Fund revenues. Pre-paying the annual PERS retiree
payment was one of the options identified that would enable the City to make debt payments
from existing resources.
DISCUSSION
Currently, the City makes bi-weekly payments to PERS to fund employee retirement. These
payments are pooled with other agency payments and invested by PERS. Historically, PERS has
achieved a higher average yield than most local agencies’ (including Palo Alto) portfolio due to
PERS ability to better diversify its investments. By exercising its option to pay the full amount
of its annual PERS obligation at the beginning of a fiscal year rather than on a periodic basis, the
City’s retirement contribution can be reduced by the higher PERS earnings resulting in an annual
expenditure savings. The savings is essentially measured by the difference between the PERS
and City’s portfolio rate. This savings, estimated at approximately $300,000 annually of which
$188,000 is attributable to the General Fund, is based on the expected, higher yields the PERS
investment portfolio will earn over the long-term and after subtracting the anticipated yields on
the City’s portfolio. Historical information shows PERS’ past five and ten year average yields at
12.9 percent and 9.4 percent and the City’s at 4.4 percent and 5.2 percent, respectively.
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As the table below shows, the PERS portfolio has yielded an average return of 11.2 percent since
1983-84. In favorable market conditions, as in 2006-07, annual yield was 19.1 percent. During
the past 25 years, however, there have been 4 years, including the current year, in which negative
returns were realized. For example, during the dot-com bust period of 2000-01 and 2001-2002,
the portfolio yield was negative 7.2 percent and 5.9 percent, respectively. Through March 31,
2007-08, the PERS portfolio yield was negative 1.8 percent. In the near term and given current
economic uncertainty, PERS yields are anticipated to be muted. Over the long term and based
on PERS and equity market history, yields would be expected to rise to the historical average
annual rate of return.
Fiscal Year
Fiscal
Year End
6/30 Fiscal Year
Fiscal
Year End
6/30
(%) (%)
1) 1983-84 (3.1)14) 1996-97 20.1
2) 1984-85 35.4 15) 1997-98 19.5
3) 1985-86 24.6 16) 1998-99 12.5
4) 1988-87 13.8 17) 1999-00 10.5
5) 1987-88 3.9 18) 2000-01 (7.2)
6) 1988-89 15.7 19) 2001-02 (5.9)
7) 1989-90 9.7 20) 2002-03 3.9
8) 1990-91 6.5 21) 2003-04 16.7
9) 1991-92 12.5 22) 2004-05 12.7
10) 1992-93 14.5 23) 2005-06 12.3
11) 1993-94 2.0 24) 2006-07 19.1
12) 1994-95 16.3 25) 2007-08 (1.8)*
13) 1995-96 15.3
Average Rate of Return for 25 years 11.2%
* As of 03/31/08 for 2007-08
Source: California Public Employees' Retirement System.
Public Employees' Retirement System (PERS)
Historical Rates of Returns
PERS methodology to determine the City’s savings is to reduce the City contribution by a half
year’s interest earnings forecast which is based on an actuarially determined and assumed 7.75
percent annual interest rate. The difference between projected and actual interest earnings for
2007-08 will then be reflected in the City’s contribution rates in later years or starting in 2011-
12. Regardless of the actual PERS yield in 2007-08, the City would realize operating budget
savings in 2008-09 through 2010-11. Should the portfolio continue to yield negative returns
from April 2008 through 2008-09, savings from pre-payment would be expected to decline. As
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indicated in prior reports, prepayment of retirement costs is based on the assumption that future
PERS portfolio yields will conform to their average annual historical result. There is a risk that
such an outcome may not materialize (e.g., continued and severe economic dislocation, poor
portfolio management), but over the next 15-25 years, staff believes one of the public employees
largest public employee investment portfolios will continue to show solid results.
Staff has administrative authority to make the pre-payment, but decided to present the
information since questions were made on how the PERS pre-payment was calculated.
PREPARED BY:
TARUN NARAYAN
Senior Financial Analyst
DEPARTMENT HEAD APPROVAL:
LALO PEREZ
Director, Administrative Services
CITY MANAGER APPROVAL:
KELLY MORARIU and STEVE EMSLIE
Deputy City Managers