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HomeMy WebLinkAbout2019-10-15 Finance Committee Agenda PacketFinance Committee 1 MATERIALS RELATED TO AN ITEM ON THIS AGENDA SUBMITTED TO THE CITY COUNCIL AFTER DISTRIBUTION OF THE AGENDA PACKET ARE AVAILABLE FOR PUBLIC INSPECTION IN THE CITY CLERK’S OFFICE AT PALO ALTO CITY HALL, 250 HAMILTON AVE. DURING NORMAL BUSINESS HOURS. Tuesday, October 15, 2019 Special Meeting Community Meeting Room 5:30 PM Agenda posted according to PAMC Section 2.04.070. Supporting materials are available in the Council Chambers on the Thursday 12 days preceding the meeting. PUBLIC COMMENT Members of the public may speak to agendized items. If you wish to address the Committee on any issue that is on this agenda, please complete a speaker request card located on the table at the entrance to the Council Chambers/Community Meeting Room, and deliver it to the Clerk prior to discussion of the item. You are not required to give your name on the speaker card in order to speak to the Committee, but it is very helpful. Public comment may be addressed to the full Finance Committee via email at City.Council@cityofpaloalto.org. Call to Order Oral Communications Members of the public may speak to any item NOT on the agenda. Action Items 1. Discussion and Direction to Staff Regarding the Establishment of a Pension Funding Policy 2. Consideration of Revenue Generating Ballot Measure and Potential Recommendation to City Council to Approve Framework and Direct Staff to Proceed With Stakeholder Outreach and Initial Polling Future Meetings and Agendas Adjournment AMERICANS WITH DISABILITY ACT (ADA) Persons with disabilities who require auxiliary aids or services in using City facilities, services or programs or who would like information on the City’s compliance with the Americans with Disabilities Act (ADA) of 1990, may contact (650) 329-2550 (Voice) 24 hours in advance. City of Palo Alto (ID # 10645) Finance Committee Staff Report Report Type: Action Items Meeting Date: 10/15/2019 City of Palo Alto Page 1 Council Priority: Fiscal Sustainability Summary Title: Review, Discuss, and Recommend Establishment of a Pension Funding Policy Title: Discussion and Direction to Staff Regarding the Establishment of a Pension Funding Policy From: City Manager Lead Department: Administrative Services Recommendation Staff recommends that the Finance Committee review and discuss the options for a Pension Funding Policy and recommends elements to include in the establishment of a Pension Funding Policy to be reviewed and adopted by the City Council. Executive Summary This report continues the City’s work on the City Council’s Fiscal Sustainability priority and corresponding workplan through the development of a pension funding policy. Four example policies, including a CalPERS example as a baseline, are outlined for discussion by the Finance Committee and refinement prior to returning to the City Council for adoption. A brief analysis of each example policy is included to inform the conversation and discussion regarding the impacts and outcomes of each. Also included is a list of the funding components and levers that the City can use to address its long-term pension liability. The development and establishment of a pension funding policy is just one element of City’s overall fiscal sustainability workplan. As discussed in CMR 10267, the City’s fiscal sustainability ecosystem is comprised of service delivery, resources, and the cost of doing business. As the City works to develop a pension funding policy, it is important to keep in mind that the goal is to keep the ecosystem balanced; significant impacts on one area of the ecosystem, such as reducing the cost of doing business, will have a corresponding impact on the other areas of service delivery and resources. This report contains a brief description of the work the City has already done to proactively address its long-term pension liability before presenting draft policies for consideration and City of Palo Alto Page 2 discussion by the Finance Committee. Attachment A to this report provides additional background on the City’s pension liability, including a summary of the reports and discussions with the Finance Committee and City Council to date, and variables and factors that impact the City’s liability. When the CalPERS actuarial reports were transmitted to the Finance Committee on September 24th, the committee made a request to see the differences in the annual payments between the current CalPERS required payments and a “Fresh Start”, which would reamortize the Unfunded Accrued Liability over a shorter horizon. Attachment B provides a table showing the Fresh Start payment schedules, as calculated by CalPERS, for the Miscellaneous and Safety Plans. Background The City of Palo Alto has been discussing its options for prefunding its long-term pension obligations as part of its work towards addressing the ‘Fiscal Sustainability’ workplan. Significant progress has been made over the past three years towards better understanding the challenges the City faces and proactively identifying and implementing tools to better position the City to address its long-term liabilities. The establishment of a pension funding policy is an important segment of the City’s Fiscal Sustainability workplan and the City’s continued progress towards addressing long-term pension liability. The pension funding policy is a tool to guide pension funding decisions within the context of service delivery and resources. The ecosystem is depicted in the diagram below. It is important to remember that the City cannot work in isolation to address its pension obligations given our needs to remain a competitive employer and for our retirement benefits and costs to be understandable and relevant to the marketplace. As a part of the CalPERS system, the central actions that CalPERS takes impact our pension costs. To date, CalPERS has taken the following actions: - lowered their expectations for investment returns and inflation rates to better align with the rates they have experienced over the past ten years (from 7.5% to 7.0% discount rate); - changed how they calculate the annual payment for the Unfunded Accrued Liability (UAL) from a percentage of payroll to a flat-rate dollar amount thereby guaranteeing a certain level of contributions from member agencies; and City of Palo Alto Page 3 - changed the timeline for amortizing new bases (gains/losses) from investment returns from 30 years to 20 years and eliminated the ramp-up and ramp-down of these bases beginning with the valuation reports as of June 30, 2019. These actions have resulted in increases to the City’s costs for funding the defined benefit pension plan but will better position the City on a long-term basis. Parallel to the actions being taken centrally by CalPERS, the City of Palo Alto has also individually implemented practices to better address its long-term pension liabilities. Actions taken by the City include: - No longer paying any portion of the employee share of pension costs (also referred to as “EPMC” or “Employer Paid Member Contribution”); - Employees now “pick-up” a percentage of the employer share of pension costs (also known as “cost sharing”); - Establishment of an irrevocable IRS Section 115 Pension Trust Fund; and, - Adoption of a more conservative discount rate than CalPERS (currently 6.2%) that is used to calculate the normal cost of pensions for all financial planning across all funds. These actions are described in further detail below. A chart showing the currently approved employee pick-up of the employer share rates at the end of the current labor agreements, as well as the expiration date of the current agreement, is shown below in Table 1. TABLE 1: Employee Pick-Up of Employer Share Labor Group Employee Cost Share Rate (by the end of Current Labor Agreements) Current Labor Agreement Expiration SEIU 2.0% 12/31/2021 UMPAPA 1.0% 6/30/2020 MGMT 1.0% 6/30/2020 FCA/IAFF 4.0% 6/30/2021 PAPOA 3.5% 6/30/2021 PAPMA 4.0% 6/30/2021 Additionally, the City Council authorized the establishment of an irrevocable Section 115 Supplemental Pension Trust Fund (“Pension Trust Fund”)with the Public Agency Retirement Service (PARS) through CMR 7553 in January 2017. The Pension Trust Fund is irrevocable because the City can deposit funds into this fund and those contributions may only be used for paying City’s pension costs. From January 2017 through FY 2020, the City will have invested more than $22.0 million in principal contributions into the PARS Trust. Contributions were initially made on an ad-hoc basis, using one-time savings or excess revenues. However, the City has since incorporated a structural change to its budgeting practice and financial planning. Per City of Palo Alto Page 4 City Council direction on October 29, 2018 through CMR 9740, the City now calculates the normal cost, or “pay-as-you-go” cost of pensions using a lower Discount Rate than CalPERS, currently 6.2%. This change in methodology generated approximately $6.2 million in contributions for FY 2020 across the organization and is anticipated to generate approximately $5.0 million in ongoing contributions above those currently projected by CalPERS. Discussion Through staff’s work to extensively research the strategies and tools to draft and implement a policy to more proactively address growing pension costs, four guiding principles and questions have emerged. They are listed below and were used to inform the policy examples that follow. 1) What is the desired funding target? What is the desired timeline to achieve that target? (While 100% funding would be the presumptive goal, achieving this quickly could require drastic service reductions with corresponding workforce and community impacts. A balanced and thoughtful strategy is therefore necessary.) 2) The policy should be “evergreen” (similar to the Budget Stabilization Reserve (BSR) policy); it should guide staff and the Council when certain parameters are met and require action when those parameters are not met. The more conservative the policy, the more accountability will need to be included in the policy. 3) What can the City afford? What is the most efficient use of its funding? Based on those answers, what payment options and tools best align with those considerations? 4) It is important to remember that this is a state-wide issue and that CalPERS invests over a very long-term time horizon. Although the City is currently experiencing cost volatility and increases in its pension costs, it has also experienced “superfunded” status in the past. The City should position itself to take advantage of potential changes in the pension landscape over the medium- and long-terms. Overall, staff recommends that the goal of the City’s pension funding policy is to reach 100% of funding necessary for its pension liabilities as calculated by CalPERS. The goal of 100% funding is based on conversations with actuarial consultants; full funding provides the most resilience to changes in the market that would impact pension costs. Using CalPERS’ calculated funding requirements ensure that the City remains aligned with the fourth guiding principle. There are different timelines, mechanisms, and options available to pursue this goal. The purpose of a fiscal policy, which a potential pension funding policy would be effectively guiding, is to establish practices and procedures that will guide City Council and staff when certain parameters are met and require certain levels of action when those parameters have not yet been met. Staff has outlined example pension policies with variations between each based on research of other jurisdictions, conversations with actuaries, and reviews of existing best practices from industry publications. City of Palo Alto Page 5 Each of the example policies makes progress towards addressing the City’s pension liabilities; the first example models the strategies that CalPERS is implementing while the remaining examples go above and beyond what CalPERS is currently requiring. The minimum funding level and the timeline to achieve that minimum funding level vary among the examples. As a result, the tools to reach the funding level over the desired timeframe differ slightly from example to example. Each example outlines different applied uses of the funding to align with the funding level and the timeline target. Finally, each of the different policies will have a different impact on the City’s Fiscal Sustainability ecosystem and require different levels of structural adjustment, service delivery impacts, and/or the generation of new revenue in order to meet the funding goal. These example policies are intended to prompt discussion among the Finance Committee and ultimately recommend a set of parameters for the basis of a draft policy. A brief analysis of each of the different options is detailed below Table 2. A further discussion of potential funding components follows after the analysis: some of the components are recommended, some of them are potential tools that could be used depending on the desired funding level and target, and still others are not recommended because of the disadvantages associated with them. Table 2 outlines examples of what a potential pension funding policy may include. Reading from left to right, the first column identifies the different elements of a pension funding policy. Moving from left to right the components of each element are building in the next. For demonstration, a policy under “example 3” would be inclusive of all elements and the components of them in Examples 1, 2, and 3. The elements to be contemplated as part of the adoption and implementation of a funding policy are described below. Funding Goal: The first element of a pension funding policy is articulating the funding goal of the policy, and staff recommends inclusion of an acceptable range as well as a target funded level (like the City’s General Fund Budget Stabilization Reserve “BSR” policy). The percent funded a plan is would be calculated by the total assets divided by the total liabilities. If the lower end of the range was not met (“floor”), the funding components section of the funding policy would be required to be invoked. In general, the higher the floor, the greater need the need for additional funding to be dedicated towards proactive pension contributions which will require structural adjustments (revenue increases, or expense reductions; the latter would have impacts on service delivery). Timeframe: The second element is the timeframe; this represents the timeframe to meet the desired funding level in the context of the many variables used in actuarial analysis and calculations. Examples of additional variables include but are not limited to demographic changes - the shift from a workforce comprised mostly of ‘Classic’ members to PEPRA members, mortality estimates, and workforce size and tenure. The shorter the timeframe, the greater structural adjustments would be necessary to achieve the goals. Funding Components: These are the actions that would be required when the funding “floor” was not met. As the examples move from Example 1 to Example 2, to Example 3, and Example City of Palo Alto Page 6 4, the additional funding components are noted. As outlined above, each example includes the elements in the earlier examples. (Example 3 includes everything in Examples 1 and 2 as well as the additional components detailed in the Example 3 column.) Allowable Uses of Funding: This element of a pension funding policy details the allowable uses of the funding generated through the funding components. Depending on the ultimate policy goals here, further refinements such as investment strategy and reporting will need to be added. Service Delivery Outcomes: In order to implement the elements of each of the examples outlined, there will be implications on the organization. This section outlines the adjustments necessary to meet the policy elements outlined in each example; the impacts and actions needed to contribute sufficient funding to meet the goals. Any further structural adjustments will necessitate service delivery impacts. Fiscal Impacts: Any further structural adjustments will have additional impacts on the City’s fiscal sustainability; this element begins to articulate the scope or magnitude of structural adjustments necessary to achieve a funding goal. City of Palo Alto Page 7 TABLE 2: Pension Funding Policy Examples Pension Funding Policy Elements Example 1: CalPERS (Baseline) Example 2: Lower Funding Target (Current Practice) Example 3: Medium Funding Target Example 4: Higher Funding Target % Fu n d e d Go a l (R a n g e ) 100%; no lower element of range 80% - 100%; Target of 85% 80% min - 100%; Target of 95% 90% - 100%+; Target of 100%+ Ti m e fr a m e 30 years Within 10 years Within 10 years Within 10 years Fu n d i n g C o m p o n e n t s Normal Cost (NC) calculated at 7.0% Discount Rate (+) Cost-sharing with employees (see table above for specific rates) (+) Additional cost- sharing with employees (+) Recalculate the UAL with the same lower DR (phase-in) Changes in actuarial assumptions amortized over 20 years (+) Using a more conservative discount rate (DR) for calculation of normal cost (+) Identify funding for the pension obligation through Budget (+) Amend existing BSR policy, 100% excess BSR allocated for pension costs (all funds contribute a commensurate amount) UAL amortized over 30 years for gains/ losses; calculated at 7.0% Discount Rate (20 years beginning 6/30/2019) (+) Amend existing BSR policy, 50% excess BSR can be allocated for pension costs (all funds contribute a commensurate amount) (+) Reach one-year of funding for CalPERS ADC in 115 Trust Fund (invest moderately conservatively); subsequent proactive funding to CalPERS as ADP Al l o w a b l e U s e s of F u n d i n g Co m p o n e n t s NC covers pay-go portion; UAL portion pays off unfunded liability in 30 years if CalPERS investment returns met (+) Use of 115 Trust Fund funding to be addressed through annual budget process or separate City Council approved action. Pension Rate Stabilization Program (+) Fresh start in concept for the Safety group, beginning in a target year (-) Contractual Partial Fresh Start for the Safety group beginning in a target year in-lieu of fresh start in concept Se r v i c e D e l i v e r y O u t c o m e s Continue services throughout the City including the ability to keep up with the cost of doing business as well as limited strategic investments. Continue current constraints and limitations on service delivery including an inability to keep up with the cost of doing business. Prioritization would continue to be necessary annually through the budget process. (+) City Manager to identify plan to address additional contributions to pension as part of annual budget process (+) Significant adverse impacts on service delivery levels; additional revenue (+) Impacts on Service Delivery and/or structural additional revenue Fi s c a l Im p a c t Savings to the City Continue $5.0 million structural adjustments necessary to maintain contributions Additional structural adjustments Estimated at ___%* of the General Fund Significant additional structural adjustments Estimated at ___%* of the General Fund (+) Indicates that this is in addition to the step to the left while (-) indicates that this is instead of the step to the left. * This information is not available at the time of the printing of the report; however, staff is working to provide a metric for context. City of Palo Alto Page 8 Example 1: CalPERS Methodology Example 1 shows the baseline elements of CalPERS methodology. CalPERS has a funding goal of 100% of the City’s pension liability over the next 30 years. To meet this goal, it actuarially calculates what the City’s normal cost should be given the CalPERS actuarial assumptions, as well as the Unfunded Accrued Liability annual payment for the City. In a year when CalPERS meets its investment return the UAL will shrink since the City has made its payment, it will shrink more when CalPERS exceeds its investment return. Conversely, when CalPERS fails to meet its investment return, the UAL will grow. CalPERS will be changing its amortization timeline from 30 years to 20 years beginning with the June 30, 2019 valuation which will shorten the City’s horizon to pay off its UAL. If the City were to use this methodology, it would result in savings of approximately $5.0 million compared to the City’s current practice. These savings could be used for service delivery enhancements and/or to lower rates in the City’s enterprise activities. Example 2: Lower Target/More Flexibility Example 2 provides the most flexibility of any of the policies, with the lowest funding floor, fewest restrictions on budgetary additions, the least amount of additional impacts to the City’s service delivery, and the lowest additional fiscal impact of the three non-CalPERS examples. This example stipulates that the City Council has a range of between 80% and 100% funded, a target of 85%, and a minimum funding level of 80% necessary within 10 years. When the City’s overall funded status is less than 80%, the tools detailed under the option would be required actions. For Example 2, this would result in continued cost-sharing with employees, calculating the Normal Cost portion of the pension at a more conservative rate than CalPERS, and transmitting half of the excess BSR above City Council’s 18.5% target to either PARS or CalPERS. The recalculation of the Normal Cost portion is included under each pension funding policy Example other than the CalPERS example; it is recommended that the City Council set its desired discount rate to use in the calculation every two years to avoid excessive volatility. In Example 2, the City would transmit the costs beyond the CalPERS annual ADC to the PARS trust until one year’s worth of ADC was accumulated in the trust. In each option, the PARS Trust assets would still be invested in the PARS ‘moderately conservative’ portfolio. After one year of ADC funding was reached, the City would transmit the funding to CalPERS as an Additional Discretionary Payment to pay down the Unfunded Accrued Liability. Once the PARS fund reached its target, use of its accumulated funding would be discussed as part of the annual budget process or separately through a City Council approved action. This example would have a relatively low additional impact on Service Delivery, since it largely aligns with current practices, but it would maintain the ongoing structural adjustments and service delivery impacts articulated in the FY 2020 Operating Budget. As a result, although no additional restrictions would need to be enacted to restrict new services throughout the organization, they would likely need to be offset either by corresponding reductions of services that were lower priority or structural revenue changes. City of Palo Alto Page 9 Example 3: Medium Funding Target Example 3 provides a combination of the elements seen in Examples 2 and 4. It would have a higher floor than Example 2 but have a more aggressive timeframe of 10 years. This option stipulates that the City Council has a desired range of between 80% and 100% funded, with a target funding level of 95%. As such, it would expand on the tools used in Example 2 by drawing on some of the funding components listed in Example 4. In addition to each of the tools described in Example 2, this policy would also include pursuing further cost-sharing with the labor groups through the standard negotiating process. This policy would also require the City Manager to identify additional funding for the pension obligation through the Budget process; to the extent that these were further expense reductions they would cause additional service delivery impacts. As with Example 2, the City would transmit the costs beyond the CalPERS annual ADC to PARS until one year of ADC was accumulated before transmitting the ongoing funding generated by the tools to CalPERS to reduce the UAL. This option also includes a fresh start in concept for the Safety group in a target year, which would allow the City to re-amortize specified bases over a certain timeline with CalPERS but not contractually obligate the City to make those payments to CalPERS. (The partial Fresh Start detailed in Example 4 would be contractually required payments). Given the higher funding floor for Example 3 than Example 2, further structural adjustments to the City’s revenue and expenses would be necessary. As such, it would be important for the City to carefully weigh the implications of service delivery changes against its pension obligation. Example 4: Higher Funding Target/Less Flexibility Example 4 provides the least flexibility of any of the policies, with the highest funding floor, most restrictions on budgetary additions, the greatest additional impacts on the City’s service delivery, and the greatest additional fiscal impact of the examples. This example stipulates that the City Council has a target range of between 90% and 100%+ funded, with a target level of 100%+. When the City’s overall funded status is less than 90%, the tools included in this policy would be required actions. In addition to each of the funding components included in Examples 2 and 3, this policy would also include a phase-in of calculating the City’s annual UAL payment at a more conservative discount rate (this would be tied to the same discount rate used for the Normal Cost). As with Examples 2 and 3, the City would transmit the costs beyond the CalPERS annual ADC to PARS until one year of ADC was accumulated before transmitting the ongoing funding generated by the tools to CalPERS to reduce the UAL. This option also includes a partial fresh start for the Safety group, which would require the City to re-amortize specified bases over a certain timeline with CalPERS and contractually obligate the City to make those payments. Since this option has the highest funding target, it correspondingly offers the least flexibility. It would City of Palo Alto Page 10 effectively impair the City’s ability to add services and would have significant impacts on service delivery due to the further structural adjustments necessary to maintain contributions. The example policies included in this CMR are meant to be a starting point for discussion with the Finance Committee regarding the establishment of a pension funding policy. Further description of the funding components included in the chart and examples above and some of the allowable uses of those components, as well as additional funding components that are not recommended are included below. Pension Funding Policy Funding Components: Recommended The City is currently using some of these funding components, including ongoing expense reductions to fund contributions to the Pension 115 Trust Fund, as well as employee cost- sharing (employee pick-up of the employer share) to help limit the City’s exposure on the Unfunded Accrued Liability. Section 115 Trust Fund: In the FY 2020 Operating Budget, $6.2 million in contributions to the PARS Trust was included, bringing total contributions to the PARS Trust to more than $22.0 million since its inception in 2017. It is anticipated that approximately $5 million a year will be transmitted to the PARS Trust as a result of the City’s current practice of budgeting a lower, and thereby costlier, discount rate to calculate the Normal Cost contributions than the one CalPERS uses for its actuarial modeling. Cost share with Employees: The City has successfully negotiated employee pick-ups of the employer share of pension costs in its bargaining agreements with its pensioned employee groups. Each group in the Miscellaneous plans currently picks up 1%, while groups in the safety plan are transitioning from a 3% pick-up of the employer share to higher rates of between 3.5% and 4.0%. Additional Discretionary Payments: Another recommended tool would be to make Additional Discretionary Payments (ADPs) to CalPERS once the PARS Trust reaches a certain funding level. CalPERS does not recognize the funding in PARS in its actuarial analysis, as such once a certain level is reached in PARS funding the additional contributions should be transmitted to CalPERS. Once it is sent to CalPERS it could be applied to a specified amortization base, in essence paying down the principal on the City’s Unfunded Accrued Liability. This accomplishes two things simultaneously: 1) Transmitting the funding to CalPERS records the asset on CalPERS’ balance sheet, which lowers the City’s unfunded accrued liability, thereby lowering the future annual expenses as calculated by CalPERS, and 2) it limits the City’s exposure to future investment return volatility since the principal amount is lower. Fresh Start in Concept: The City could use the ADPs discussed above to either pay down specific bases (removing a specific liability from CalPERS completely) as discussed above or to re- amortize over a shorter time period. This latter option is what is referred to as a “Fresh Start in Concept” because it mirrors the action taken by a Fresh Start. However, a formal Fresh Start, as City of Palo Alto Page 11 discussed below, requires a contract amendment and handcuffs the City to that new amortization schedule. A “Fresh Start in Concept” would confer many of the benefits of reducing the UAL without the disadvantages and risk. One-time Funding (Additional Revenues/Expense Savings): In certain instances, one-time funding may emerge that has not been appropriated for ongoing commitments. In such instances, whether from expense savings or Revenue windfalls, funding could be used to partially address the City’s long-term pension liability. Amend Existing Policies: The City Council has the authority to amend existing policies, such as the Budget Stabilization Reserve Policy. If it chose to amend that policy, the City Council could include pension pre-funding as an eligible item that excess BSR (above City Council’s target of 18.5%) could be spent on instead of Capital Infrastructure. Currently, Capital Infrastructure is the only allowable use of excess BSR. The revised policy could even be narrowed further to say that half of excess BSR remaining at year-end could be used for pension pre-funding and half could be used for Capital Infrastructure purposes. Pension Funding Policy Funding Components: Other Options There are other funding components that the City could choose to pursue to address its long- term pension liability. These tools are listed below along with a brief description. Partial Fresh Start (Formal): The City could choose to enter a partial Fresh Start with CalPERS. This would re-amortize certain specified bases over a shorter time period. However, it would be contractually binding and would be irreversible. If the City chose to pursue this instead of a “Fresh Start in Concept” it would be a significant work effort to identify which bases to include in a partial fresh start. Further Cost Sharing with Employees: Each employee bargaining unit currently includes an employee pick-up of the employer share in its bargaining agreement. If the City chose to continue to expand this tool it would need to negotiate in good faith with its bargaining units in order to develop the rate of the pick-up as well as the timeline. Revenue Generation: The City could choose to pursue the generation of additional revenue in order to fund some of the strategies discussed above. Options could include a parcel tax or other mechanism to generate additional income which could be earmarked specifically for addressing the City’s long-term pension liability. Further Expense Reduction: The City has taken steps to contain costs over the past few years. Any further reduction would have a corresponding impact on service delivery. However, if the City Council chose to prioritize additional pension pre-funding over current service levels then expenses could be reduced, and those reductions could be used to partially address the City’s long-term pension liability. City of Palo Alto Page 12 Pension Funding Policy Funding Components: Not Recommended A brief explanation of the other pension funding policy funding components that are not recommended, including why they are not recommended, follows below. Investments in Other City Reserves: The City could choose to bolster its reserves and use them to address the City’s long-term pension liability. This action is not recommended because of the City’s investment policies, which could limit the growth of an asset when compared to a Section 115 Trust Fund administered by PARS, and because the investment in the City’s reserves is revocable. The funding put into a reserve could be repurposed for something else depending on the reserve polices. In contrast, funding paid into the Section 115 Trust Fund is irrevocable and cannot be used for any purpose other than addressing the City’s pension liability. Pension Obligation Bonds: The City Council could choose to issue Pension Obligation Bonds (POBs). POBs are taxable bonds that would be issued by the City, which would then invest the proceeds from the issuance and hope to achieve a greater rate of return on the investment than promised by the bonds. This is not recommended due to the inherent risk in such an investment and due to the increase, it would have on the City’s bonded debt burden and potential impacts on the City’s credit rating. Formal Fresh Start: The City could choose to formally alter its contract with CalPERS to enter into a “Fresh Start”. This would re-amortize the entire obligation for either the City’s miscellaneous plan or safety plan (or both) over a shortened time period. This is not recommended because once the contract with CalPERS is altered it cannot be rescinded. This could significantly impact costs and service delivery since the City would be obligated to pay according to the new schedule. Many of the benefits of the formal fresh start could be realized by a “Fresh Start in Concept” without the adverse impacts. Next Steps After discussing the potential draft policies with the Finance Committee, Staff hopes to refine a formal pension funding policy for consideration and adoption by the full City Council. Feedback on the example policies will be incorporated into the drafting and presentation of a formal pension funding policy. Engagement As staff incorporates feedback from the Finance Committee into the development of a pension funding policy, engagement will occur with both the workforce and the community to inform them of developments and solicit additional feedback. Additionally, the City's interest in meeting its pension funding obligations necessitates ongoing engagement with the State legislature to give cities more tools such as the ability to change benefits prospectively for current employees, and/or defined contribution plans. Staff examined pension prefunding policies from other jurisdictions and confirmed that the City City of Palo Alto Page 13 of Palo Alto is among very few cities with sustained contributions to Section 115 Trust Funds built into their budgeting practice and their operations. Many other cities in California that are proactively funding pensions continue to do so on an ad hoc basis, using fund balance at year- end, or a certain portion of remaining fund balance above a minimum amount to generate their contributions. Some examples of other California cities that have ongoing contributions include Fountain Valley, which earmarked a portion of a local sales tax measure for unfunded pension liabilities, Sausalito, which uses a lower discount rate to calculate its pension obligation and transmits the difference to its Section 115 Trust Fund, and Pasadena, which transmits the savings from paying the UAL as a lump sum at the beginning of the year to its 115 Trust. Additionally, Staff consulted with its outside actuarial consultant, Bartel and Associates, as well as its pension modeling software vendor (GovInvest) regarding implications of various strategies. Staff also consulted with CalPERS to learn more about pension prefunding options. Industry groups for government finance, including the Government Finance Officers Association (GFOA) and the California Society of Municipal Finance Officers (CSMFO), were used as sources of emerging best practices for proactively funding long-term pension obligations. Each of these engagements informed the guiding principles and questions, which were placed into context for the City of Palo Alto to inform the creation of the different pension funding policy options. Resource Impact The resource impact from the development of a pension funding policy would be directly correlated to the parameters and requirements of the policy itself. To the extent changes to the City’s current budgeting practice (using a more conservative 6.2% Discount Rate for the calculation of the normal cost) are included in the policy corresponding changes would need to be included in the development of the City’s annual Long Range Financial Forecast and annual Operating Budget. It is anticipated that the establishment of a formal pension funding policy, including parameters for the use of funds beyond the CalPERS ADC, would have a beneficial impact on the long-term financial sustainability of the organization by limiting our risk from CalPERS long-term investment returns. Environmental Review This report is not a project for the purposes of the California Environmental Quality Act. Environmental review is not required. Attachments: • ATTACHMENT A: Additional Information and Background Regarding the City of Palo Alto's Pension Obligations • ATTACHMENT B: CalPERS Fresh Start Amortization Tables ATTACHMENT A Attachment A Page 1 Attachment A: Additional Information and Background Regarding the City of Palo Alto’s Pension Obligations As discussed in the body of CMR 10645 the City of Palo Alto has been discussing its options to address its long-term pension liability. A brief timeline of the CMRs and discussions with the Finance Committee and the City Council over the past few years is included below to offer additional context. After the timeline, a few of the more critical inputs that impact the City’s long-term pension liability are discussed for further background on the subject. Timeline: • 9/2017 Finance Committee, “Review and Discuss CalPERS Pension Annual Valuation Reports as of June 30, 2016 Including Assumptions, Financial Disclosures and Next Steps” 8509 • 10/2017 Finance Committee, “Review and Recommend Strategies to Address the City’s Pension Liability” 8579 • 12/2017 Finance Committee “FY2019 - FY2028 Long Range Financial Forecast & City Pension Liabilities” 8676 • 1/2018 City Council, “Approval of the FY 2017 Comprehensive Annual Financial Report (CAFR) and Approval of Conforming Amendments to FY 2017 Budget in Various Funds; Acceptance of the FY2019 - FY2028 Long Range Financial Forecast; and Discussion and Potential Direction Regarding Budgeting for City Pension Liabilities” 8754 • 9/2018 Finance Committee, “Accept CalPERS Pension Annual Valuation Reports as of June 30, 2017 and Review and Confirm Pension Funding and Reporting Policy Guidelines” 9604 • 10/2018 City Council, “CalPERS Pension Annual Valuation Reports as of June 30, 2017 and Pension Funding and Reporting Policy Guidelines” 9708 • 10/2018 City Council, “Direct Staff to Amend Budget Assumptions for Pension Benefit Costs and Complete the Workplans to Address the City Council FY 2019 Adopted Budget Referral to Identify $4 Million in General Fund Savings” 9740 • 9/2019 Finance Committee, “Accept CalPERS Pension Annual Valuation Reports as of June 30, 2018” 10641 Through the various discussions, the City has been able to better understand and analyze many of the inputs and factors that impact the City’s pension liability. A few of the most important inputs are detailed below to offer additional context regarding the City’s long-term pension obligations. Inputs – Discount Rate: The CalPERS pension plan is built on the assumption that assets will generate a certain rate of return over the career of an individual; these returns make up the bulk of an individual’s pension benefit. The long-term investment assumption is called the Discount Rate. As a result, the assumptions for the discount rate have a significant impact on the City’s pension liability. If a higher investment return is assumed, the City’s contributions can be lessened compared to a lower investment return. The Discount Rate is comprised of both the “real” investment returns as well as inflation assumptions. If the inflation assumption changes, then there would also be an impact on the City’s liability. ATTACHMENT A Attachment A Page 2 Salary Growth: The salary growth of the City is another important variable; to the extent that the City’s salary growth is higher or lower than CalPERS’ projections the City’s contributions would need to be higher or lower to ensure adequate funding. Mortality Rates: The mortality rates also impact the City’s long-term pension liability. This is because as individuals live longer, they draw on their pension for a longer period, thereby increasing the cost of the benefit. As CalPERS refines mortality rates to reflect people living longer, the changes adversely impact the City’s long-term liability. Maturity Measures: As pension plans mature, they become more susceptible to risk than less mature pans. One of the methods to show the maturity level of a CalPERS plan is to examine the ratio of actives to retirees. A pension plan that is just beginning will have a very high ratio of active to retired members. As the plan continues and members retire the ratio starts declining. CalPERS consider a plan to be mature when the ratio is near or below 1.0. The average support ratio for CalPERS public agency plans is 1.25, meaning that 1.25 active employees are supporting each retiree. For the City of Palo Alto, as an institution that was founded 125 years ago, the active:retiree ratio is 0.72 for Miscellaneous, and is .39 for the Safety group. PEPRA: The Public Employee Pension Reform Act (PEPRA) will have an impact on the City’s long-term pension liability because it mandates a different retirement formula to employees in the PEPRA tier and limits the maximum annual compensation eligible for pension calculations for employees in the PEPRA tier. Employees fall into the PEPRA tier if their first date of employment was after January 1, 2013 and they had no prior membership in another California Public Retirement System, or they have a break-in service of more than 6 months. As the City’s workforce continues to shift demographically from “Classic” members to PEPRA members, the City’s long-term liability will likely contract accordingly. Other: Other elements also impact the City’s long-term pension liability, including the upcoming change in CalPERS’ amortization policy. They will be shifting from a 30-year amortization with a 5-year ‘ramp-up’ at the beginning and a 5-year ‘ramp-down’ at the end to a 20-year amortization with a 5-year ‘ramp-up’ and no ‘ramp-down’. This will have an impact on the City’s annual Actuarial Determined Contributions (ADC) and the pension liability that will vary depending on whether it is a gain or a loss that is being amortized. City of Palo Alto Unfunded Pension Liability - Safety As of June 30 2018 Unfunded Balance Payment Unfunded Balance Payment Difference From Current Unfunded Balance Payment Difference From Current 6/30/2020 176,810,640 11,210,740 176,810,640 13,079,551 1,868,811 176,810,640 15,947,209 4,736,469 6/30/2021 177,590,903 12,598,401 175,657,792 13,439,239 840,838 172,691,464 16,385,757 3,787,356 6/30/2022 176,990,378 13,825,697 174,052,181 13,808,818 (16,879) 167,830,308 16,836,365 3,010,668 6/30/2023 175,078,292 14,694,686 171,951,881 14,188,560 (506,126) 162,162,758 17,299,365 2,604,679 6/30/2024 172,133,468 15,421,340 169,311,752 14,578,746 (842,594) 155,619,549 17,775,098 2,353,758 6/30/2025 168,230,853 15,845,427 166,083,203 14,979,661 (865,766) 148,126,213 18,263,913 2,418,486 6/30/2026 163,616,378 16,258,249 162,213,945 15,391,602 (866,647) 139,602,709 18,766,170 2,507,921 6/30/2027 158,251,858 16,705,350 157,647,725 15,814,871 (890,479) 129,963,021 19,282,240 2,576,890 6/30/2028 152,049,340 17,164,748 152,324,036 16,249,780 (914,968) 119,114,729 19,812,502 2,647,754 6/30/2029 144,937,439 17,636,782 146,177,815 16,696,649 (940,133) 106,958,548 20,357,346 2,720,564 6/30/2030 136,839,428 18,121,791 139,139,115 17,155,807 (965,984) 93,387,845 20,917,173 2,795,382 6/30/2031 127,672,863 17,622,496 131,132,748 17,627,591 5,095 78,288,102 21,492,395 3,869,899 6/30/2032 118,381,115 17,537,542 122,077,918 18,112,350 574,808 61,536,364 22,083,436 4,545,894 6/30/2033 108,526,816 16,625,803 111,887,812 18,610,440 1,984,637 43,000,626 22,690,730 6,064,927 6/30/2034 98,925,829 16,285,453 100,469,170 19,122,227 2,836,774 22,539,196 23,314,725 7,029,272 6/30/2035 89,004,832 15,649,262 87,721,827 19,648,088 3,998,826 (15,649,262) 6/30/2036 79,047,446 14,573,328 73,538,215 20,188,410 5,615,082 (14,573,328) 6/30/2037 69,505,998 13,957,164 57,802,836 20,743,592 6,786,428 (13,957,164) 6/30/2038 59,934,015 13,296,089 40,391,696 21,314,041 8,017,952 (13,296,089) 6/30/2039 50,375,812 12,812,833 21,171,700 21,900,177 9,087,344 (12,812,833) 6/30/2040 40,648,424 12,595,936 (12,595,936) (12,595,936) 6/30/2041 30,464,477 10,720,552 (10,720,552) (10,720,552) 6/30/2042 21,507,566 10,084,590 (10,084,590) (10,084,590) 6/30/2043 12,581,512 9,249,935 (9,249,935) (9,249,935) 6/30/2044 3,894,010 2,256,558 (2,256,558) (2,256,558) 6/30/2045 1,832,389 1,008,317 (1,008,317) (1,008,317) 6/30/2046 917,644 949,218 (949,218) (949,218) 354,708,287 342,650,200 (12,058,087) 291,224,424 (63,483,863) Current Amortization 20 Year Amortization 15 Year Amortization Date ATTACHMENT B Attachment B Page 1 City of Palo Alto Unfunded Pension Liability - Miscellaneous As of June 30 2018 Unfunded Balance Payment Unfunded Balance Payment Difference From Current Unfunded Balance Payment Difference From Current 6/30/2020 286,363,666 23,432,860 286,363,666 25,828,203 2,395,343 286,363,666 35,308,545 11,875,685 6/30/2021 282,169,983 25,768,686 279,692,222 26,538,479 769,793 269,885,680 36,279,530 10,510,844 6/30/2022 275,266,546 27,775,842 271,819,062 27,268,287 (507,555) 251,249,840 37,277,217 9,501,375 6/30/2023 265,803,649 29,093,334 262,639,861 28,018,165 (1,075,169) 230,277,476 38,302,340 9,209,006 6/30/2024 254,315,525 30,450,533 252,042,436 28,788,664 (1,661,869) 206,776,650 39,355,655 8,905,122 6/30/2025 240,619,337 28,631,100 239,906,181 29,580,352 949,252 180,541,209 40,437,935 11,806,835 6/30/2026 227,846,449 25,356,875 226,101,459 30,393,812 5,036,937 151,349,768 41,549,979 16,193,104 6/30/2027 217,566,346 26,054,188 210,488,957 31,229,642 5,175,454 118,964,620 42,692,603 16,638,415 6/30/2028 205,845,327 26,770,680 192,918,992 32,088,457 5,317,777 83,130,572 43,866,650 17,095,970 6/30/2029 192,562,693 27,506,872 173,230,763 32,970,890 5,464,018 43,573,697 45,072,982 17,566,110 6/30/2030 177,588,753 28,263,313 151,251,563 33,877,589 5,614,276 (28,263,313) 6/30/2031 160,784,169 25,566,093 126,795,922 34,809,223 9,243,130 (25,566,093) 6/30/2032 145,593,290 25,078,301 99,664,696 35,766,476 10,688,175 (25,078,301) 6/30/2033 129,843,622 22,968,475 69,644,094 36,750,055 13,781,580 (22,968,475) 6/30/2034 115,173,901 21,972,705 36,504,628 37,760,681 15,787,976 (21,972,705) 6/30/2035 100,507,333 20,503,251 (20,503,251) (20,503,251) 6/30/2036 86,334,117 18,042,492 (18,042,492) (18,042,492) 6/30/2037 73,714,206 16,794,746 (16,794,746) (16,794,746) 6/30/2038 61,501,581 15,464,725 (15,464,725) (15,464,725) 6/30/2039 49,809,855 14,472,775 (14,472,775) (14,472,775) 6/30/2040 38,325,790 13,874,452 (13,874,452) (13,874,452) 6/30/2041 26,656,752 10,174,002 (10,174,002) (10,174,002) 6/30/2042 17,998,655 9,509,422 (9,509,422) (9,509,422) 6/30/2043 9,421,939 8,211,777 (8,211,777) (8,211,777) 6/30/2044 1,587,145 1,641,756 (1,641,756) (1,641,756) 523,379,255 471,668,975 (51,710,280) 400,143,436 (123,235,819) Current Amortization 15 Year Amortization 10 Year Amortization Date Attachment B Page 2 City of Palo Alto (ID # 10743) Finance Committee Staff Report Report Type: Action Items Meeting Date: 10/15/2019 City of Palo Alto Page 1 Council Priority: Fiscal Sustainability Summary Title: Stakeholder Outreach, Initial Polling, and Discussion of a Potential Ballot Measure Title: Consideration of Revenue Generating Ballot Measure and Potential Recommendation to City Council to Approve Framework and Direct Staff to Proceed With Stakeholder Outreach and Initial Polling From: City Manager Lead Department: Administrative Services Recommendation Staff recommends that the Finance Committee review the stakeholder outreach and initial polling framework as outlined in this report and recommend to Council that Council approve the framework and direct staff to begin stakeholder outreach and conduct initial polling for a potential ballot measure. Background As part the 2019 Fiscal Sustainability City Council Priority, the Finance Committee has served as the working body throughout development process for a potential revenue measure, including reviewing revenue ballot measure options; reviewing staff, consultant, and stakeholder feedback; and forwarding the Committee’s recommendations to Council for review and direction. Throughout this iterative process, several relevant reports were presented to the Committee and Council and are linked below: 2019 Fiscal Sustainability Workplan, 4/22/19, CMR ID 10267: - https://www.cityofpaloalto.org/civicax/filebank/documents/70506 City Council Approve Workplan for a Potential Revenue Generated Ballot Measure, 4/22/19, CMR ID 10261: - https://www.cityofpaloalto.org/civicax/filebank/documents/70507 Finance Committee Review, Comment, and Accept Preliminary Revenue Estimates for Consideration of a Ballot Measure, 6/18/19, CMR ID 10392: City of Palo Alto Page 2 - https://www.cityofpaloalto.org/civicax/filebank/documents/72101 Finance Committee Evaluation and Discussion of Potential Revenue Generating Ballot Measures, 8/20/19, CMR ID 10445: - https://www.cityofpaloalto.org/civicax/filebank/documents/73071 City Council Evaluation and Discussion of Potential Revenue Generating Ballot Measures and Budget Amendment, 9/16/19, CMR ID 10615: - https://www.cityofpaloalto.org/civicax/filebank/blobdload.aspx?t=59472.38&BlobID=73287 Finance Committee Approve Revised Workplan to Address the City Council Direction for Further Consideration of a Ballot Measure, 10/1/19, CMR ID 10712: - https://www.cityofpaloalto.org/civicax/filebank/documents/73494 Discussion Based on direction provided by Council on September 16, 2019, on October 1, 2019 the Finance Committee reviewed and approved the revised workplan timeline (as outlined in CMR ID 10712). At the October 1st Finance Committee meeting, the Committee provided staff with input, general guidelines, and a proposed framework on how to proceed with polling and outreach efforts. As summarized in this report, staff recommends that the Committee review the polling and outreach framework described in this report and forward this framework to Council for review and approval and direction to proceed. Proposed Polling According to the revised workplan, polling will be performed in two phases. The first round of polling will occur in November where the goal of this survey will be to ascertain public opinion and mood towards a revenue generating ballot measure. The questionnaire will be an exploratory 15- to 20-minute survey to assess public reactions to various components of a potential business tax, such as methodology of tax (employee headcount, square footage or payroll), tiering, rates, and exemptions, and mood of the electorate. In mid-November, the Finance Committee will also receive more refined analysis from the City’s consultant, Matrix Consulting Group, on narrowed options, scenarios for rates, exemptions, and tiers. A second refined survey will test the selection of more fully developed model measures later, using analysis and data collected from the initial poll. Based on the discussion with the Committee, the initial poll should begin with the same methodology used in the 2016 Funding Transportation Improvements Citywide Voter Survey. The general framework of polling should address and/or include the following and the actual polling questions will be developed by the consultant and staff: - Concern about taxation and the economy and whether a business tax ballot measure will be supported if a recession were to occur - Community opinion of City service delivery, maintaining infrastructure, fiscal management, need for additional funding, responsible spend of resources - Include open-ended questions about what a potential tax will fund and whether the tax City of Palo Alto Page 3 should be general or specific - Questions that compel survey responders to choose options or consider trade-offs - Types of possible exemptions, tiers, and rates to determine the level of taxation and ranges voters believe is appropriate - Voter opinion on types of exemptions and whether these exemptions will impact certain industries - Data collection of business segments’ demographic profiles Results of the initial poll will be presented to Council in December 2019 where Council can provide feedback and direction to the City’s polling consultant and staff for the second round of polling. Stakeholder Outreach Stakeholder outreach was also discussed in the last Finance Committee meeting and, like direction provided to staff for polling, the Committee discussed the general framework for stakeholder outreach and what to consider. As outlined in the revised workplan, stakeholder outreach will occur beginning in late-October and November with the goal of results presented to the City Council in December 2019. The general framework for stakeholder outreach should: - Consider the types of businesses to survey and conduct discussions - Conduct surveys that target small businesses and medium/large businesses - Strategically select groups and focus - Engage the community at large and conduct an ongoing dialogue throughout the process - Ask open ended questions and/or questions that focus on trade-offs The actual questions and selection of groups and focus will be developed by the consultant and staff. Resource Impact Staff expects consulting services of an additional $175,000 for polling and outreach services. Funding for these services is not currently budgeted, therefore, it is anticipated that staff will bring forward funding requests to Council later this month when the Council reviews this recommended plan. Policy Implications This recommendation aligns with existing City policy and City Council direction as part of the 2019 Fiscal Sustainability Workplan. City of Palo Alto Page 4 Environmental Review This report is not a project for the purposes of the California Environmental Quality Act (CEQA). Environmental review is not required. .