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HomeMy WebLinkAbout1999-05-04 City Council (3)BUDGET ’99- ’01 City of Palo Alto City Manager’s Report TO:HONORABLE CITY COUNCIL ATTENTION: FINANCE COMMITTEE FROM:CITY MANAGER DEPARTMENT:ADMINISTRATIVE SERVICES DATE:MAY 4, 1999 CMR:226:99 SUBJECT:RECOMMENDATION TO APPLY REDUCTION IN PUBLIC EMPLOYEES RETIREMENT SYSTEM (PERS) COST TO UNFUNDED LIABILITY FOR RETIREE HEALTH BENEFITS REPORT IN BRIEF The Public Employees Retirement System (PERS) has notified the City that its pension contribution rates in 1999-00 and 1999-01 will be approximately $3.0 million lower annually than the City’s rates in 1998-99. Rather than reduce the 1999-01 Proposed Budget by this amount, staff recommends that the Council apply this savings to the City’s unfunded liability for retiree health benefits. The City’s total obligation for post-employment health benefits is currently estimated at $49.0 million. The City has begun to set aside funds ($8.1 million) for a portion of this post-employment health benefit obligation. Future accounting standards are expected to require the City to fully fund the total obligation. Until these standards are issued, the $8.1 million could be utilized to offset increases in retiree health benefit costs in future years. CMR:226:99 Page 1 of 4 RECOMMENDATION Staff recommends that the Council apply PERS pension rate reductions of approximately $3.0 million annually to the City’s unfunded liability for retiree health benefits in the 1999- 01 Proposed Budget. These funds would be utilized to offset increases in retiree health benefit obligations in future years. To the extent that retiree health benefits exceed 1.5 percent of gross payroll costs, these funds would be drawn upon as previously approved by Council. BACKGROUND In the private sector, the Financial Accounting Standards Board (FASB) requires employers to set aside funds for post-retirement employee health benefits. This ensures that all post- employment health benefits are paid to retirees, regardless of the future financial condition or continued existence of the employer. In the public sector, setting aside funds for post- employment health benefits is optional. The Government Accounting Standards Board (GASB) provides the accounting and reporting methods to be used by public sector employees who choose to establish funded plans for retiree health benefits. While establishing such a plan is now optional, GASB has announced its intention to require governments to fully fund retiree health benefits in the future. In November 1993, the City’s actuarial consultant, William M. Mercer, Inc., estimated the City’s unfunded liability for retiree health benefits at $45.7 million. At that time, the City provided retiree health benefits on a "pay-as-you-go" basis, and there was nothing set aside for any portion of the unfunded liability. In April 1994, the Council directed staff to apply a $6.1 million refund from PERS (AB 702) towards the funding of retiree health benefit obligations, maintaining the funds in an Expendable Trust Fund. The Council approved the use of these funds only in the event that actual retiree health benefits in a given fiscal year exceeded 1.5 percent of the gross citywide payroll. Since 1994, the City has remained on a "pay-as-you-go" basis and made no other contributions to the Expendable Trust Fund. In fiscal year 1997-98, the actual costs nearly reached the 1.5 percent level, at 1.49 percent of payroll. Due to interest earnings, the amount in this Expendable Trust Fund totaled $7.6 million in 1997-98 and is projected to reach $8.1 million by the end of 1998-99. In March 1999, the City contracted with another actuary, AON Consulting & Insurance Services, to update the 1993 actuarial study. Using the 1993 actuarial assumptions, AON estimated the City’s current obligations for post-retirement health benefits at $49.0 million. Net of the projected $8.1 million in the Retiree Health Benefits Expendable Trust Fund, the unfunded liability for post-retirement employee health benefits is estimated to be $40.9 million at June 30, 1999. DISCUSSION Over ten years ago, the GASB required public employee retirement systems to fully fund pension benefits. At that time, the City’s contribution to PERS was increased in order to CMR:226:99 Page 2 of 4 fully fund pension benefits by 2011. Employer contribution rates are determined by periodic actuarial valuations, which consider such factors as expected retirements, estimated length of retirement, and assumed rates of return on investment. Based on PERS’ most recent valuation, the City’s required annual contribution has been reduced. The City has been notified by PERS that its pension contribution rates will be reduced by approximately $3.0 million in fiscal year 1999-00. PERS has informed staff that the reduction in the City’s ammal contribution is expected to continue for two to three years, and possibly beyond. Staff recommends that the Council apply the cost savings resulting from the reduction in PERS rates to the significant, existing unfunded liability for retiree health benefits, in anticipation of GASB requiring governments to fully fund such benefits. Palo Alto’s external auditor, Maze and Associates, estimates that GASB will issue the expected requirement in three to five years. Since it is anticipated that it will take many years to fully fund these benefits, staff believes it is prudent to utilize the resources generated by the PERS rate reduction to begin funding this obligation now. Both the optional and the expected future GASB requirements would eliminate the "pay-as- you-go" method of funding retiree health benefits and the current practice of using the Expendable Trust Fund as a reserve for operating budget overruns (the 1.5 percent of gross payroll threshold established by Council’s April 1994 action). Actual payments for retiree health benefits would be handled directly through the Expendable Trust Fund, while the General and Enterprise Funds would transfer annual amounts into the Fund, sufficient to maintain a fully funded balance. While waiting for the final GASB requirement, the City has the option to implement the current GASB procedures for funding retiree health benefit obligations. This would be accomplished through the establishment of a formal trust agreement. Staff does not recommend implementing the optional procedures at this time, since it would likely reduce the City’s flexibility and result in duplicative implementation efforts when the final GASB procedures are issued. Staff plans to reexamine this issue during the 2001-2003 budget process. ALTERNATIVES TO STAFF RECOMMENDATION The City could reduce the budget by the amount of the estimated $3.0 million PERS pension rate reduction, of which approximately $2.0 million is related to the General Fund and approximately $1.0 million is related to the Enterprise Funds. Staff does not recommend this option because of the large obligation still remaining for retiree health benefits. RESOURCE IMPACT Retiree health benefits constitute a large, unfunded liability which could significantly impact the City’s available operating resources in the future. Taking action now to reduce this unfunded liability Will mitigate the budget impact, should the GASB require municipalities CMR:226:99 Page 3 of 4 to fully fund these benefits in the future. It also provides increased assurance that the City can meet its retiree health benefit obligations to current and future employees. Further, it is prudent fiscal planning to set aside today’s savings to fund future obligations. POLICY IMPLICATIONS This recommendation is consistent with prior Council action regarding funding post- retirement health benefit obligations. In addition, by applying the PERS rate reductions to the City’s health benefit obligations, a nexus is maintained between the source and the use of funds. ENVIRONMENTAL REVIEW This is not a project under the California Environmental Quality Act (CEQA) PREPARED BY: Stanley Arend, Accounting Manager DEPARTMENT HEAD APPROVAL: Director, Administrative Services CITY MANAGER APPROVAL: CC:N/A FLEMING, City Manager CMR:226:99 Page 4 of 4