HomeMy WebLinkAboutStaff Report 438-06City of Palo Alto
City Manager’s Report
TO:
ATTENTION:
HONORABLE CITY COUNCIL
FINANCE COMMITTEE
FROM:
DATE:
CITY MANAGER
DECEMBER 12, 2006
DEPARTMENT: ADMINISTRATIVE
SERVICES
CMR: 438:06
SUBJECT:INFORMATIONAL UPDATE ON FINANCIAL REPORTING
ACTIVITY AND FUNDING OPTIONS FOR RETIREE MEDICAL
GOVERNMENTAL ACCOUNTING STANDARDS BOARDS
STATEMENTS NO. 43 & 45
This is an informational report and no Council action is required.
BACKGROUND
The purpose of this report is to provide the Finance Committee with an update on the
implementation of Governmental Accounting Standards Board’s (GASB) Statements No. 43 and
45, Financial Reporting for Retiree Medical Benefits.
GASB 45 has a broader application than GASB 43 and will require the City of Palo Alto to
recognize in its financial statements any unfunded, earned retiree medical costs including that for
current active employees beginning in fiscal year 2007-08.
Palo Alto has begun taking steps to implement GASB 45. The City had an actuarial study done
by Milliman, Inc. as of July 1, 2005, which is required on a biennial basis, to determine the
retiree medical liability and how much the City should be setting aside each year to fund that
liability. The unfunded liability ranges from $83.1 million to $148.7 million based on the
discount rate assumption used which ranges from 4 percent to 7.75 percent. The lower range of
the discount rate is based on the rate of return of the City’s current investment portfolio and
assumes staff managing the funds internally without a trust. The higher range is based on staff
utilizing a trust or depositing funds with California Public Employees Retirement System
(CalPERS), with an expected rate of return of 7.75 percent on its pension fund investments.
In response to Council direction, in an effort to control health costs and in preparing for the
implementation of GASB 45, the City has: ’
Developed a two-tiered retiree medical benefit plan, increasing vesting requirements
from five to twenty years
Negotiated a cap for medical benefits in the latest SEIU contract for current
employees and future retirees
CMR: 438:06 Page 1 of 5
Implemented a cap for medical benefits for the management and professional group
and is in the process of capping future retiree medical benefits
[] Accumulated $26.5 million in the Retiree Health Benefits Internal Service Fund
reserve
[] Completed an actuarial study to determine its unfunded liability
In fiscal year 1991-92, staff established retiree medical funding of $6.1 million from a PERS
reimbursement. Since then, additional contributions have been made towards the reserve from
various funds as cash flow permitted. As of June 30, 2006, the accumulated balance was $26.5
million which includes an $8 million contribution in fiscal year 2005-06 by the Enterprise and
other funds. The Enterprise and other funds’ cost for current retirees is $1.1 million. In fiscal
years 2006-08, staff plans to allocate an additional $1.2 million, each year into the reserve to
further reduce the outstanding liability.
GASB 43 addresses the financial statement requirements for retiree medical funding held in a
trust fund and applies to those funds maintained by the plan sponsor, employer, CalPERS, or
another third party. Currently, GASB 43 does not apply to the City as the City does not have a
trust fund for retiree medical liabilities. GASB 43 would apply to the City if it establishes a trust
or a pre-funding plan through CalPERS.
Historically, the City has used a pay-as-you-go approach to fund retiree health benefits,
with&awing from the Retiree Health Benefits Internal Service Fund. The Retiree Health
Benefits Internal Service Fund was funded by the General Fund and Proprietary Funds (Utilit{es
and Internal Service Funds) each year for current year expenditures, approximately $3.3 million
in most recent years.
DISCUSSION:
Staff is reviewing several options in determining a funding plan for GASB 45, including:
[]Continuing the pay-as-you-go approach and booking the unfunded Annual Required
Contribution (ARC) on the financial statements.
Continuing with the pay-as-you-go approach, while the most economical option
in the near term on an annual cash basis, would involve the highest degree of risk
as it would hinder the City’s credit rating significantly by showing no effort by
the City to establish a plan to fund the liability. A well thought-out plan to fund
the unfunded liability is what credit agencies will be looking for to maintain the
current AAA credit rating the City enjoys. In addition, the cost for the pay-as-
you-go approach will continue to rise exponentially from year to year making the
budgeting process difficult.
Issuing debt to fund the liability:
Issuing debt would be a quick way to fund the liability. As long as debt service
requirements were met, the City would not have to report an unfunded liability in
its financial statements. On the down side, this method would be expensive and
the City would feel the effects of paying the debt service, principal and interest,
CMR: 438:06 Page 2 of 5
for many years to come depending on the life of the debt issued. Currently, the
City has very little debt on its financial statements which is a strong and desirable
attribute for the City. There are preliminary plans to issue a significant amount of
debt for infrastructure needs in the near future which would further increase the
City’s debt service requirements and decrease the City’s coverage ratio.
Setting up and funding an irrevocable trust with the accum~i~ted retiree medical
funding balance.
Setting up and funding an irrevocable trust would have many benefits including:
Significantly decreasing the City’s unfunded liability as these plans are
irrevocable and the funds would no longer appear as an asset on the City’s
financial statements.
The reduction of the City’s ARC, which lowers the cash contribution by the
City on an annual basis.
Annual contributions by the City are a set amount every two years per the
actuarial study. These contributions would be more predictable, level
payments. Per the study completed by Milliman, Inc., at a discount rate of
7.75 percent, the Annual Required Contribution (ARC) would be $6.9 million.
An increase on the rate of return on invested funds due to additional
investment options.
The decision would have to be made as to whether the assets would be managed
by internal staff or externally. The benefits with a trust would be the same as
many of the benefits recognized with the last option of a pre-funding plan through
CalPERS, but there would be significantly more work involved in the set up.
Establishing an investment policy with risk tolerance guidelines and investment
advisory group are typical steps in this process.
Participating in a pre-funding plan - operating similarly to the pension plan - by
CalPERS.
One of the most significant changes in the industry since staff’s last report has
been the development of a new holding account by CalPERS. CalPERS has been
working diligently to serve its customers who participate in the CalPERS Health
Benefits Program by creating a pre-funding plan that employers can utilize in
place of a trust to invest and safeguard their retiree medical set-aside dollars at an
anticipated rate of return of 7.75 percent. In addition, CalPERS has developed an
Other Post Employment Benefits Assumption Model (retiree medical assumption
model) in order to provide the actuarial services required by its Health Benefits
Program participants. CalPERS is working on finalizing the processes of this
model, and it is anticipated that the program will commence in early 2007.
If the City were to transfer the $26.5 million balance in its Retiree Health Benefits
Internal Service Fund to the CalPERS pre-funding plan, it could expect a return
on its investment of 7.75 percent which would lower the unfunded liability from
¯ CMR: 438:06 Page 3 of 5
$83.1 million to $56.6 million as well as the ARC that needs to be contributed
annually to approximately $6.9 million per the Milliman, Inc. study. The General
Fund’s annual share of the citywi,de ARC totals $4.8 million. Since the Fund
provides staff services to other funds, an allocati~i~ of $0.8 million reduces the
ARC to $4 million. Furthermore, prior year allocations to other funds only
included current retiree costs. Staff recalculated the allocation to include prior
year retiree medical costs for current employees which totals $3 million. To level
the impact to other funds, the cost will be spread over three years at a repayment,
rate of $1 million per year resulting in a net annual ARC of $3 million for the
General Fund. Working with CalPERS would be efficient for the City since
CalPERS manages the City’s pension plan and staff would have more confidence
in the actuarial figures if they were calculated by CalPERS because it has the
City’s data readily available and staff wouldn’t have to convert that data for a
separate actuary.
Staff will finalize a review of the options and funding recommendations for all funds and present
them to the Finance Committee as part of the budget process.
ENVIRONMENTAL REVIEW
The action recommended is not a project for the purposes of the California Environmental
Quality Act.
PREPARED BY:
PATRICIA REAVEY
Management Talent Exchange Participant
Administrative Services
TRUDY’E~I~ ~ENBERRY
Accounting Manager, Administrative Services
DEPARTMENT HEAD APPROVAL:
Director, Administrative Services
CITY MANAGER APPROVAL:
EMILY HARRISON
Assistant City Manager
CMR: 438:06 Page 4 of 5
ATTACHMENTS
Attachment A: CMR:272:06, June 20, 2006, Results of Actuarial Study for Retiree Medical
Benefits - Governmental Accounting Standards Board Statements Numbers 43
& 45
AttachmentB: CMR:318:05, September 20, 2005, Overview of Financial Reporting for
Postemployment Benefits Plans Other Than Pensions -Governmental
Accounting Standards Boards Statements No. 43 & 45
CMR: 438:06 Page 5 of 5
TO:
ATTACHMENT A
City of Palo Alto
City Manager’s Report
HONORABLE CITY COUNCIL
ATTENTION:FINANCE COMMITTEE
FROM:
DATE:
SUBJECT:
CITY MANAGER
JUNE 20, 2006
DEPARTMENT: ADMINISTRATIVE
SERVICES
CMR: 272:06
R~SULTS OF ACTUARIAL STUDY FOR RETIREE MEDICAL
BENEFITS - GOVERNMENTAL ACCOUNTING STANDARDS
BOARD STATEMENTS NUMBERS 43. & 45
This is an informational report and no Council action is required.
BACKGROUND
The purpose of this report is to provide the Council with the actuarial study results required by
the Governmental Accounting Standards Board’s (GASB) Statement No: 45,. Accounting and
Financial Reporting by Employers for Post Employment Benefits Other Than Pensions. In
addition, an explanation and potential use of Statement No. 43, Financial Reporting for Post
Employment Benefit Plans Other Than Pension Plans, is provided.
The basic purpose of GASB 45 is to require that public entities measure and report the long-term
costs of non-pension retiree benefits, or Other Postemployment Benefits (OEEB). In the .City of
Palo Alto’s case, medical coverage is the only OPEB offered to retirees. Therefore, this report
refers to "retiree medical liability" rather than to OPEB liability.
Since these benefits are a form of employee compensation, GASB 45 states that they should be
recognized as an expense as the employee earns them--rather than waiting until the employee
retires and his or her medical premiums are paid, An actuarial valuation is required every two
years to determine the amount of the liability resulting from the City’s postemployment benefit
package (retiree medical liability). Retiree medical liabilities will vary considerably from
jurisdiction to jurisdiction based on the benefit levels provided and the agency’s demographics.
Once the retiree medical liability is determined, the City must decide how best to manage it,
taking into account multiple factors such as: the size of the liability; the resources available to
fund it; the impact on the City’s .budget Of pre-funding the benefits; legal issues involved in
changing any benefits to reduce the liability; whether to establish a trust fund; the, need to
continue offering competitive benefit packages to attract and retain qualified staff; and the
potential impact of a funding plan on bond, ratings. At a minimum, rating agencies will look for a
well-thought-ont plan for addressing the long-term liability under the new rules. Although GASB
CMR:272:06 Page 1 of 5
45 requires that public entities account for--but not necessarily prepay--the, unfunded liability,
the financial community will expect jurisdictions to proactively address the liability via some
form of funding plan.
GASB 45 replaces the pay-as-you-go method which most governments currently use with
accrual accounting (recognizing an expense when it is earned). Rather than simply paying for its
current retirees’ medical premiums, the City must also recogniz~o in its financial statements the
"earned" cost of current employees’ future retiree medical pren.aj~ms. If the City were not to
recognize these earned costs, as the nmnber of retirees increases (particularly as the "baby
boomer" generation leaves the work force), the City would eventually face a huge cash outlay to
meet its medical premium obligations. GASB 45 forces jurisdictions to recognize these
obligations early through actuarial studies and their recommended annual set-asides, Amaual
Required Contribution (ARC), so as to avoid the need for huge cash outlays in the future.
DISCUSSION
As required by GASB 45, the City contracted with Milliman, Inc. to perform an actuarial
valuation to determine the City’s retiree medical liability and how much the City should be
setting aside each year to fund that liability. The valuation was completed in April 2006, with a
valuation date of July 1, 2005. In addition to determining the unfunded liability (what the City’s
employees have earned in retiree medical benefits to-date), the actuarial valuation determines
what the City should be setting aside each year.
The actuarial valuation’s assumptions and methods comply with GASB 45, yet as Milliman
states in its report, "actual costs will vary from those presented in the valuation to the extent that
actual experience differs from that projected by the actuarial assumption." Any actuarial
valuation must be understood as the "best estimate at the time." Renewing the valuation every
two years addresses the fact that real experience invariably differs from projections.
When comparing different actuarial valuations, one must examine the assumptions used for each
valuation. For example, every valuation assumes a specific interest rate, based on the expected
rate of return on investments set aside to pay for the benefit. The interest rate is used in
calculating a single "present value" dollar mnount for all future payments and has a significant
effect on the valuation result. A higher interest rate results in a lower accrued liability; a lower
interest rate yields a higher liability. When staff compared the results of the Milliman study with
the results of the Aon study of 2001, using the same interest rate of 6 percent (which is close to
the average interest on City investments over the last ten years), the unfunded liability provided
by Milliman Inc. was $106.6 million, and the unfunded liability provided by Aon was $93.5
million. Given the identical interest rate assumption, the difference between the two valuations
must be explained by other assumptions used in the analyses.
In deriving its assumptions, Milliman relied on data provided by staff with respect to budgeting
processes and actual employee turnover information, and on data provided by CalPERS
regarding demographic information from all of its agencies. Updated information on mortality,
disability and termination rates contributed to the increased unfunded liability of the Milliman
study. Milliman also projected higher health care cost increases for 2006-2016 than did Aon as a
result of recent experiences.
CMR:272:06 Page 2 of 5
With the unfunded liability at $106.6 million, the recommended annual set-aside is $10.0
million. Currently, the City pays approximately $3.2 million per year in retiree medical
premiums. Once the City implements GASB 45 in fiscal year 2007-08, if it sets aside any less
than $10.0 million per year--an additional $6.8 million per year--the difference between what it
funds and $10 million will appear on the City’s financial statements.
GASB 43 and the Trust Fund Option
GASB 43 outlines the potential impacts of creating an irrevocable trust for retiree medical
premiums. Although it does not require that a trust be created, there are significant advantages to
doing so. First, establishing a trust and contributing to it annually would allow assets to be
invested in higher-yielding portfolios than the City’s. This would raise the interest rate used to
calculate the present value of the unfunded liability and reduce the required annual set-aside.
Secondly, as the trust assets grow, a larger share of the required retiree medical resources would
come from investment income. Third, any funds placed in the trust would reduce the amount of
the unfunded liability, and therefore the City’s annual required set-aside would again be reduced.
Lastly, establishing a trust-based funding plan would demonstrate to rating agencies evidence of
a "well-thought-out" plan to address the retiree medical liability. The City .would avoid a
potential bond rating downgrade with resulting higher borrowing rates and cash outlays.
As of June 30, 2005, the City had a balance of $18.2 million in the Retiree Health Benefits
Internal Service Fund. If this fund balance were transferred to a newly established irrevocable
trust, the unfunded liability would be recalculated using a 7 percent interest rate, dropping it
from $106.6 million to $92.1 million. Next, the $18.2 million in the trust would be subtracted
from the unfunded liability, which would then drop to $73.9 million; $32.7 million (31 percent)
lower than the original unfunded liability. In turn, the annual set-aside would drop from $10
million to $8.1 million. Therefore, given the scenario outlined above, the City stands to save $1.9
million per year by establishing an irrevocable trust.
Of the $18.2 million in the Retiree Health Benefits Internal Service Fund, $13.3 million came
from the General Fund; $4.7 million came from Enterprise Funds, and $0.2 million from Internal
Service Funds. The unfunded liability for Enterprise Funds (using a 7 percent interest rate) is
$24.3 million. If the Enterprise Funds were to contribute to the trust the remaining $19.6 million
of its unfunded liability, the balance in the trust would jump to $37.8 million. It should be noted
that the Enterprise Funds have only contributed the pay-as-you-go amounts for retired General
Fund administrative support staff who had done Enterprise Fund work; they have not contributed
the rest of the earned benefits for those retirees and current employees working on their behalf.
Therefore, staff will calculate the amount of unpaid past allocated costs for future adjustments.
There are several types of trusts the City may pursue, including a 501(C)(9) or Voluntary
Employees’ Beneficiary Association (VEBA) trust, a 115 trust or special purpose government
trust, among others. In addition, the California Employees Retirement System (CalPERS) and
California PuNic Agency Retirement System (CalPARS) are exploring the feasibility of
managing a trust. Staff will continue to research all the trust options and make recommendations
in early FY 2006-07.
CMR:272:06 Page 3 of 5
Additional Options for Reducin~ the Liability
The process of undergoing two actuarial valuations brought to light two points: one, the City’s
retiree medical benefit is generous compared to those of many other California cities; and two,
this benefit will become increasingly costly, perhaps unaffordable, in the future. To diminish
future costs, additional steps must be taken to modify current medical plan options. The City has
taken a first step in changing vesting requirements for retiree medical benefits for newer hires.
As of 2005, all bargaining units except Pa!o Alto Police Officers Association (PAPOA) have
adopted a two-tiered structure. The current agreement with PAPOA expires on June 30, 2007,
and staff wilt negotiate for a two-tiered plan at that timel For management employees, IAFF and
Chiefs members hired on or after January 1, 2004, and SEIU employees hired on or after January
1, 2005, the City pays for 50 percent of medical benefits after 10 years of service, with the City’s
portion increasing by 5 percent for each additional year of service up to 20 years. Each actuarial
valuation includes only current employees - not future hires. Therefore, the two-tier structure
will limit increased additional liability resulting from employees entering the employee pool in
the future, yet will do virtually nothing to reduce the current unfunded liability.
Another area of concern is the high cost of the PersCare health care option currently available to
a limited number of SEIU employees and to all future retirees. Staff is addressing health care
costs in negotiations with the labor groups as contracts expire.
Conclusion
Staff has determined the liability for retiree medical benefits and the amount the City must set
aside each year to fund this liability. Staff concludes that establishing a trust is the most
beneficial immediate course of action. Staff is also developing strategies to further reduce the
liability and will return to Finance Committee in early fiscal year 2006-07 with. options and
recommendations both for establishing a trust and for reducing the liability.
RESOURCE IMPACT
This is an informational report, for Council’s information with no immediate impact upon City
resources beyond what is discussed above.
POLICY IMPLICATIONS
There are no policy implications beyond what is discussed above.
ENVIRONMENTAL REVIEW
The action recommended is not a project for the purposes of the California Environmental
Quality Act.
CMR:272:06 Page 4 of 5
PREPARED BY:
TRUDY’EIKENBERRY
AL c~ilntp~EREZ/ ervices
Assistant Director, Administrative Services
DEPARTMENT HEAD APPROVAL:
CARL YEAT
Director,Services
CITY MANAGER APPROVAL:
HARRISON
istam City Manager
ATTACHMENTS
Attachment A: Milliman, Actuarial Report
CMR:272:06 Page 5 of 5
ATTACHMENT A
City of Palo Alto
GASB 45 Actuarial Valuation of
Post Employment Benefits Other than Pensions
As of July 1, 2005
Prepared by:
John R. Botsford, FSA, MAAA
April 17, 2006
April 17, 2006
City of Palo Alto
250 Hamilton Avenue
Palo Alto, California 94301
City of Palo Alto -
GASB 45Actuarial Valuation of Post E~nployment Benefits as of July 1, 2005
At the request of the City of Palo Alto, we have completed an actuarial valuation of post employment
benefits as of July 1, 2005.
The purpose of this report is to determine the Armual Required Contribution and required financial
disclosures under the Governmental Accounting Standards Board Statement No. 45 - Accounting
and Financial Reporting by Employers for Postemployment ~?enejqts Other Than t~ensions
(GASB 45). Ore" determinations reflect the procedures and methods prescribed in GASB 45.
In preparing our report, we relied on financial information and employee data furnished to us by the City
of Palo Alto. The actuarial cost method and assumptions used as well as the supporting data and
principal plan provisions upon which the analysis is based are set forth in the following report. While
Milliman has not audited the financial and census data, they have been reviewed for reasonableness
and are, in our opinion, sufficient and reliable for the purposes of our calculations. If any of this
information as surmnarized in this report is inaccurate or incomplete, the results shown could be
materially affected and this report may need to be revised.
The actuarial cost method and assumptions used as well as the supporting data and principal plan
provisions upon which the valuation is based are set forth in the following report.. All costs, liabilities,
rates of interest, and other factors under the Plan have been determined on the basis of actuarial
assumptions and methods which are reasonable and consistent with our understanding of GASB 45. All
assumptions should represent a best estimate of anticipated experience under the Plan. Nevertheless, the
emerging costs will vary from those presented in this report to the extent that actual experience differs
from that projected by the actuarial assumptions.
Actuarial computations under GASB 45 are for purposes of fulfilling employer accounting
requirements. Determinations for purposes other than meeting employer financial accounting
requirements may be significantly different from the results reported herein. Accordingly, additional
determinations are needed for other purposes, such as judging benefit security at termination or
adequacy of funding for an on-going plan. The results of this valuation are applicable only for the
current year and are intended to be used only by the City for the specific purposes described herein.
Accordingly, this report may not be distributed to any third papacy without Milliman’s prior written
City of Palo Alto
April 17, 2006
Page 2
consent, in which case the report must be distributed in its entirety. Reliance on information contained
in this report by anyone for anything other than the intended purpose puts the relying entity at risk of
being misled.
On the basis of the foregoing, we hereby certify that, to the best ofour knowledge and belief, the report
is complete and accurate and has been prepared in accordance with generally recognized and accepted
actuarial principles and practices which are consistent with the applicable Actuarial Standards of
Practice of the American Academy of Actuaries. The undersigned is a member of the American
Academy of Actuaries and meets the Qualification Standards of the American Academy of Actuaries
to render the actuarial opinion contained herein.
Sincerely,
JRB :tab
n:\cpa\val~2005rev60-apr06\ws\cpa05retval.doc
John R. Botsford, FSA, MAAA
Principal and Consulting Actuary
TABLE OF CONTENTS
Section Page
Management Summary
Introduction .........................................................................................................................1
Background .........................................................................................................................
As sumptions ........................................................................................................................2
Actuarial Cost Method ........................................................................................................3
Advanced Funding ......................................................................................
Results of Study ..................................................................................................................5
Variability of Results ..............................................................................i ...........................6
II Exhibits
Exhibit 1.
Exhibit 2.
Exhibit 3.
Exhibit 4.
Exhibit 5.
Exhibit 6.
Exhibit 7.
Exhibit 8.
Exhibit 9.
Exhibit 10,
Projected Benefit Payments ......................................................................7
Projected Benefit Payments ......................................................................8
Liabilities and Normal Cost. .............i .......................................................9
Unfunded Actuarial Accrued Liability ....................................................10
Required Financial Statement Disclosures ..............................................11
Required Supplementary Information ............................................ .........12
Valuation Results - Alternative Discount Rates .....................................13
Valuation Smmnary by Bargaining Group .............................................14
Valuation Breakdown by Fund ...............................................................15
Valuation Breakdown by General Fund Departments ............................16
III Appendices
Appendix A.
Appendix B.
Appendix C.
Summaa~ of Benefits ..............................................................................17
Actuarial Cost Method and Assumptions ...............................................19
Summary of Participant Data ..................................................................22
CiO, of Palo Alto GASB 45 Actuarial [%ffuation as of July 1, 2005
SECTION I. MANAGEMENT SUMMARY
Introduction
Milliman, Inc. ("Milliman") has been retained by the City of Palo Alto ("City") to provide a
GASB 45 actuarial valuation of its post employment benefit (OPEB) plans. In our valuation we:
Project expected payouts and number of retirees for future years
Calculate the present value of total benefits
Calculate the actuarial liability (present value of benefits attributable to past service)
Determine the Annual Required Contribution (ARC) and annual OPEB expense under GASB
Statement No. 45
Prepare the financial statement disclosures relating to the funded status of the plan
Provide a breakdown of the City’s OPEB costs by department mad bargaining group
Background
Employees who retire directly from the City are eligible for retiree health benefits if they retire on or
after age 50 with 5 years of service and are receiving a monthly pension from CalPERS.
For employees hired before January 1, 2004, and all PAPOA employees, the City pays for the entire
cost of retiree health benefits for retirees for their lifetimes. The City also pays a portion of medical
.costs for spouses of retirees equal to 60% of the premiums for 2005 and increasing 5% per year until
the City’s share reaches 100% of spouse premiums for 2013 and beyond.
For management employees, IAFF and Chiefs members hired on or after January 1, 2004, and SEIU
employees hired on or after January 1, 2005, the City pays for the 50% of the above described
benefits after 10 years of service, and the city’s portion increases by 5% for each additional year of
service up to 20 years.
The City contracts with CALPERS to provide medical benefits for its retirees.
Appendix A provides a more detailed summary of benefits.
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION I. MANAGEMENT SUMMARY
Assumptions
With any valuation of future benefits, assumptions of anticipated future events are required. If actual
events differ from the assumptions made, the actual cost of the plan will vary as W~ll. The following
assumptions should be reviewed for appropriateness.
Discount Rate. GASB 45 requires that the interest rate used to discount future benefit payments back
to the present day be based on the expected rate of return on any investments set aside to pay for these
benefits. The City has set aside $18.2 million (as of June 30, 2004) for this purpose, and the funds
are held in an Internal Service Fund. The City is currently considering whether to contribute this
money to a separate, irrevocable trust from which future retiree health benefits will be paid. Since the
City has not committed to establishing a separate trust, we have used a discount rate of 4.0% for this
valuation based on the long term expected return on assets held in the ISF. Note that a higher or
lower discount rate may ultimately be more appropriate depending on how the City actually invests
its funds set aside to pay benefits. Also, Exhibit 7 shows the impact that the selection of a discount
rate has on the actuarial liability and ARC.
Health Cost Trend. We have assumed health costs will increase 10% in the first year (from the 2006
premium year to the 2007 premium year), 9% the next year, and grading down 1% per year, to 5%
per year after the sixth year.
Retirement and Withdrawal Rates. Our rates are based on the California Public Employees
Retirement System (PERS) in its actuarial valuations of retirement benefits under a 2% @ 55 formula
for miscellaneous employees and a 3% @ 50 formula for Police and Fire employees.
A complete summary of the actuarial assumptions is presented in Appendix B.
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION I. MANAGEMENT SUMMARY
Actuarial Cost Method
Although other non-pension post-employment benefits (OPEB) are paid by the City after employees
separate service from the City, the new GASB standards will require the City to recognize the cost of
OPEB benefits during an employee’s service with the City based on the premise that employees earn
the right to OPEB benefits during their employment service. An actuarial cost method is, therefore,
used to allocate the cost of OPEB benefits for each year of employment service. Since a significant
portion of benefits have already accrued for prior service for both current retirees and actives, a cost
method also defines how unrecognized OPEB costs attributed to prior service (i.e. Unfunded
Actuarial Liability) will be amortized. Finally, actuarial cost methods define how changes in
unfunded actuarial liability due to experience gains or losses, changes in actuarial assumptions, or
changes in benefit plan design affecting liability attributed to past service are recognized in current
and future years’ OPEB expenses.
The Projected-Unit Credit (PUC) cost method is one of several methods prescribed by GASB 45 to
allocate OPEB costs. This method establishes a "normal cost" (the cost allocated to the current year
of service for actives) pattern for each pm~icipant that increase with age. The PUC normal costs for
each individual generally increase each year at a rate slightly higher than the discount rate. The
aggregate change in PUC normal costs for the active population depends on whether the employee
population as a whole matures or remains fairly constant. For. a constant population, the aggregate
PUC normal cost would be expected to increase by the medical trend. The Unfunded Actuarial
Liability (or liability attributed to past service) is amortized over a period of up to 30 ydars. The
amortization method may be level dollar a level percentage of expected payroll increases (i.e.
amortization amounts increase each year in proportion to expected payroll increases), and for each
valuation, the amortization period may decline or be reset to the initial period.
Note, that the value of projected benefits is the same regardless of the cos~ method used. Cost
methods only allocate the costs by year differently. Therefore, a cost method that produces higher
annual costs in early years relative to other methods would eventually produce lower annual costs in
future years for the same benefit program. For illustrative purposes, the results of this valuation are
based on the projected unit credit cost method (based on discussions with the City), and a 30 year
amortization of the UAL as a level percentage of payroll. Note, that the ultimate responsibility of
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION MANAGEMENT SUMMARY
selecting/approving the actuarial cost method and assumptions for accounting under GASB 45 lies
with the City and its auditor.
Advanced Funding
Although not required, advanced funding of OPEB obligations can significantly impact the Annual
Required Contribution amount under GASB 45 as illustrated in Exhibit 7. GASB 45 describes
advanced funding to be amounts set aside in a separate, irrevocable trust for purposes of paying post-
employment benefits. The advantages of advanced funding include the ability to invest assets in
higher yielding asset classes than assets held in the City’s general account, the use of a higher
discount rate to value future benefit payments, and the avoidance of a balance sheet liability if the
ARC is funded each year. The City should consider whether to adopt an advance.funding policy, and
if so, decide on a funding policy consistent with City goals (i.e. fund the ARC each year). Also, the
City currently has $18.2 million held in an internal service fund for future post-employment benefit
payments. This amount may not be considered as assets that reduce the UAAL unless the earmarked
amount is transferred to a separate trust. Exhibit 7 also shows the impact of an initial $18.2 million in
funding o.n the UAAL and ARC.
If the City elects to establish a separate trust to fund its future OPEB benefits, it could establish either
a Voluntary Employees’ Beneficiary Association account (VEBA) under IRC Section 501(c)(9) or a
special purpose government trust under IRC Section 115. Each of these funding vehicles would
permit the City to set aside amounts up to its OPEB liability. The City would need to establish a
Board of TruStees to oversee the management of assets and administration of benefit payments. Also,
the City should with the assistance of its legal counsel consider seeking an opinion letter from the IRS
with regard to the exempt status ofa VEBA or Section 115 trust established for this purpose.
Another funding vehicle option may be a trust managed by CalPERS for purposes of funding OPEB
liabilities. At this time, CalPERS has not established such a trust, although it may consider doing so
in the future.
Results of Study
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION I. MANAGEMENT SUMMARY
The valuation results are summarized in the following exhibit and use the following terms:
The Present Value of Benefits is the present value of projected benefits (projected claims less retiree
contributions) discounted at the valuation interest rate (4.0%).
The Actuarial Accrued Liability (AAL) is the present value of benefits that are attributed to past
service only. The portion attributed to future employee service is excluded. For retirees, this is equal
to the present value of benefits. For active employees, this is equal to the present value of benefits
prorated by service to date over service at the expected retirement age.
The Normal Cost is that portion of the City provided benefit attributable to employee service in the
current year. Employees who are not eligible for benefits are assumed to have an equal portion of the
present value of benefits attributed to each year of service from date of hire to expected retirement
age.
The Annual Required Contribution (ARC) is the amount the City would be required to report as an
expense for the 2005-2006 fiscal year under GASB 45. The ARC is equal to the Normal Cost plus an
amount to amortize the unfunded AAL over 30 years. Note, the ARC represents an accounting
expense, but the City is not required to contribute the ARC to a separate trust. If the City does not set
aside funds equal to the ARC each year, then the ARC (less actual benefit payments) will accumulate
as a liability (Net OPEB Obligation) on the City’s balance sheet.
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION ~[. MANAGEMENT SUMMARY
Active Employees
Retirees
Total Particip ants
Covered Retired Spouses
Present Value of Benefits
Actuarial Accrued Liability
Assets
Unfunded Actuarial Accrued Liability
Normal Cost (as of end of year)
Annual Required Contribution (ARC)
Annual benefit payments
Variability of Results
July 1, 2005
1,038
592.
1,630
217
236,055,204
148,732,361
0
148,732,361
7,801,991
13,139,999
3,291,668
The results contained in this report represent our best estimates. However, variation from these or
any other estimates of future retiree medical costs is not only possible but probable. Actual future
costs may vary significantly from estimates in this report.
Valuation results are particularly sensitive to the assumptions used to project future health plan cost
increases (medical inflation trend) and to discount projected benefits to the present (discount rate).
To illustrate this variability, Exhibit 6 shows a comparison of valuation results based on best estimate
assumptions and on alternate discount rates.
CiO’ of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION II. EXHIBITS
Exhibit 1. Projected Benefit Payments
The table below illustrates the projected pay-as-you-go City costs of providing retiree health benefits.
The projections only consider the closed group of existing employees and retirees and is based on the
current labor agreements.
FY Ending Current Future
Year June 30 Retirees Retirees Total
1 2006 $3,167,878 $123,790 $3,291,668
2 2007 3,390,061 309,682 3,699,743
3 ’2008 3,611,193 561,987 4,173,180
4 2009 3,790,374 864,147 4,654,521
5 2010 3,962,493 1,235,121 5,197,614
6 2011 4,102,372 1,662,962 5,765,334
7 2012 4,182,315 2,092,774 6,275,089
8 2013 4,245,330 2,596,983 6,842,313
9 2014 4,288,781 3,119,920 7,408,701
10 2015 4,263,649 3,621,827 7, 885,476
11 2016 4,265,582 4,109,867 8,375,449
12 2017 4,268,515 4,653,959 8,922,474
13 2018 4,233,302 5,214,828 9,448,130
14 2019 4,218,617 5,773,166 9,991,783
15 2020 4,157,983 6,363,405 10,521,388
16 2021 4,111,028 6,949,909 11,060,937
17 2022 4,053,600 7,583,997 11,637,597
18 2023 4,014,962 8,233,787 12,248,749
19 2024 3,964,959 8,857,852 12,822,811
20 2025 3,878,072 9,500,385 13,378,457
21 2026 3,800,964 10,129,795 13,930,759
22 2027 3,688,303 10,719,751 14,408,054
23 2028 3,574,467 11,226,801 14,801,268
24 2029 3,450,356 11,745,543 15,195,899
25 2030 3,336,525 12,233,077 15,569,602
26 2031 3,213,079 12,684,556 15,897,635
27 2032 3,077,491 13,117,638 16,195,129
28 2033 2,922,159 13,577,822 16,499,981
29 2034 2,775,782 13,956,316 16,732,098
30 2035 2,620,394 14,231,480 16,851,874
City of Palo Alto Retiree Itealth Care Valuation as of July 1, 2005 7
SECTION II. EXHIBITS
Exhibit 2. Projected Number of Retirees
The table below illustrates the projected number of retirees. The projections only consider the closed
group of existing employees and retirees.
FY Ending Current Future
Year June 30 Retirees Retirees Total
1 2006 583 17 60t
2 2007 568 43 611
3 2008 553 70 622
4 2009 537 98 635
5 2010 521 130 651
6 2011 504 163 668
7 2012 487 196 683
8 2013 470 229 699
9 2014 452 263 715
10 2015 435 296 730
11 2016 416 3.27 743
12 2017 398 357 755
13 2018 379 387 767
14 2019 361 416 777
15 2020 342 440 782
16 2021 324 464 788
17 2022 305 487 791
18 2023 287 507 793
19 2924 268 523 792
20 2025 250 538 788
21 2026 232 551 784
22 2027 215 561 776
23 2028 198 567 765
24 2029 182 571 753
25 2030 167 570 736
26 2031 151 567 718
27 2032 137 561 698
28 2033 123 556 678
29 2034 110 545 655
30 2035 98 533 631
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 8
SECTION II. EXHIBITS
Exhibit 3. Liabilities and Normal Cost
The Present Value of Benefits is the actuarial present value of benefits expected to be paid for all
retirees and covered employees.
The Actuarial Accrued Liability (AAL) is the actuarial present value of benefits attributed to
employee service rendered prior to the valuation date. The AAL equals the present value of benefits
multiplied by a fraction equal to service to date over service at expected retirement.
The Normal Cost is the actuarial present value of benefits attributed to one year of service. This
equals the present value of benefits divided by service at expected retirement. Since retirees m’e not
accruing any more service, their normal cost is zero.
Julp 1, 2005
Benefits < Age 65 Benefits > Age 65 Total
Present Value of Benefits
Actives $42,984,288 $119,561,314 $162,545,602
Retirees 17,003,111 56,506,491 73,509,602
Total $59,987,399 $176,067,805 $236,055,204
A ctuarial A cerued Liability
Actives $20,468,638 $54,754,121 $75,222,759
Retirees 17,003,111 56,506,491 73,509,602
Total $37,471,749 $111,260,612 $148,732,361
Normal Cost $2,095,219 $5,~406,695 $7,501,914
CiO~ of Palo Alto Retiree Health Care Valuation as of July 1, 2005
SECTION II. EXHIBITS
Exhibit 4. Unfunded Actuarial Accrued Liability
The Unfunded Actuarial Accrued Liability (UAAL) is the actuarial liability offset by any assets set-
aside to provide retiree health benefits. This is equal to the value of the retiree health benefits accrued
to date that has not been funded. The UAAL must be amortized over a period not exceeding 30 years
and included in the ARC amount (shown in Exhibit 4) each year. For illustrative purposes, we have
calculated the amortization of UAAL as a level percentage of payroll over 30 years. This means the
amortization amount would be expected increase at the same rate as payroll increases each year. We
have assumed the City’s payroll will increase 3.75% per year for this purpose.
Unfunded Actuarial Liability (UAAL)
Actuarial Accrued Liability
Reserve Fund
Unfunded Actuarial Accrued Liability
Funded percentage
Amortization of UAAL for ARC
UAAL
Amortization Period
Level % of Payroll Amortization Factor
Amortization Amount - July 1, 2005
Interest to end of year
Amortization Amount - June 30, 2006
July 1, 2O05
$148,732,361
0
$148,732,361
0.0%
$148,732,361
30 years
28.9774
$ 5,132,700
$ 205,308
$ 5,338,008
City of Palo Alto ~Retiree Health Care VaTuation as of July 1, 2005 10
SECTION II. EXHIBITS
Exhibit 5. Required Financial Statement Disclosures
The following table shows the calculation of the Annual Required Contribution and Net OPEB
Obligation.
For the Fiscal Year Ending
June 30, 2006 June 30, 2005
Determination of Annual Required Contribution
Normal Cost at year end $
Amortization of UAAL
Annual Required Contribution (ARC)$
7,801,991 $n/a
5,338,008 rda
13,139,999 $rda
Determination of Net OPEB Obligation
Annual Required Contribution
Interest on prior year Net OPEB Obligation
Adjustment to ARC
Annual OPEB Cost
City Contributions made *
Increase in Net OPEB Obligation
13,139,999 $n/a
0 n/a
0 n/a
13,139,999 n/a
3,291,668 n/a
9,848,331 nia
Net OPEB Obligation - beginning of year.
Net OPEB Obligation- end of year
$0 $rda
$ 9,848,331 $rda
*For illustration purposes, we have shown contributions to be equal to expected benefit payments during the 2005-06
fiscal year. GASB 45 defines contributions for this purpose to be actual benefit payments during the year and
contributions made to a separate, irrevocable ~rust.
The following table shows the annual OPEB cost and net OPEB obligation for the prior 3 years.
Percentage of
Fiscal Annual OPEB Cost Net OPEB
Year Ended OPEB Cost Contributed ,Obligation
06/30/2004 rda n/a rda
06/30/2005 n/a n/a n/a
06/30/2006 $13,139,999 25.1%$9,848,331
Funded Status and Funding Progress. As of June 30, 2005, the most recent actuarial valuation
date, the plan was zero percent funded.- The actuarial accrued liability for benefits was $148.7
million, and the actuarial value of assets was $0.0 million, resulting in an unfunded accrued liability
of $148.7 million.
City of Palo Alto Retiree Health Care Valuation as of J, dy 1, 2005 11
SECTION II. EXHIBITS
Exhibit 6. Required Su.pplemeniary Information
The following table shows a schedule of Funding Progress required under GASB 45.
Actuarial Actuarial UAAL as a
Valuation Value of AAL Funded Covered % of Covered
Date Assets Unit Credit UAAL Ratio PaFroll Payroll
06/30/2003 n/a n/a n/a n/a n/a
06/30/2004 n/a n/a n/a n/a n/a
06/30/2005 0 $148,732,361 $148,732,361 0.0%n/a
n/a
n/a
n/a ¯
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 12
SECTION II. EXHIBITS
Exhibit 7. Valuation Results - Alternative Discount Rates
The following exhibit shows the results of the valuation based on alternative discount rates of 4%,
6%, 7%, and 7.75%. The discount rate is used to calculate the p~esent value of expected future
benefit payments. The lower the discount rated used, the higher the present valued will be. GASB 45
requires that the discount rate be reflective of the assets used to pay benefits. For unfunded OPEB
liabilities, the rate would be the expected return on the City’s general funds. For funded OPEB
liabilities (ARC set aside in a separate trust each year), the discount rate would be the expected return
on assets invested in such a trust. A higher expected return and discount rate would result a much
lower OPEB liability and ARC for the City. To illustrate the effect of alternative discount rates on
liabilities and costs, the following table shows a comparison of valuation results based on discount
rates of 4%, 6%,7%, and 7.75%:
4% Discount 6% Discount 7% Discount 7. 75% Discount
Rate Rate Rate Rate
Present Value of Benefits $236,055,204 $156,221,166 $130,385,317 $114,990,111
Actuarial Accrued Liability $148,732,361 $106,598,459 $ 92,065,229 $ 83,115,613
Assets 0 0 0 0
Unfunded Actuarial Accrued $148,732,361 $106,598,459 $ 92,065,229 $ 83,115,613
Liability (UAAL)
Normal Cost (end of year)$7,801,991 $4,985,246
Amortization of UAAL 5,338~008 5,053,362
$4,076,577 $3,537,059
4,957,095 4,899,662
Annual Required $ 13,139,999 $ 10,038,608 $ 9,033,672 $ 8,436,721
Contribution (ARC)
Annual benefit payments $3,291,668 $3,291,668 $ 3,291,668 $3,291,668
The following table illustrates the impact on the Annum Required Contribution (ARC) if the City set
aside an initial reserve of $18.2 million. GASB 45 states that only assets set aside in a separate
irrevocable trust may be considered for purposes of determining the ARC. If the City does not
segregate this reserve in a separate trust, then the City’s ARC would be the amount shown above
without regard to a reserve:
4% Discount Rate 6% Discount 7% Discount 7. 75% Discount
Rate Rate Rate
Actuarial Accrued Liability $148,732,361 $106,598,459 $92,065,229 $83,115,613
Assets 18,200,000 18,200,000 18,200,000 18,200,000
UAAL $130,532,361 $88,398,459 $73,865,229 $64,915,613
Normal Cost (end of year)
Amortization of UAAL
$7,801,991 $4,985,246 $4,076,577 $3,537,059
4,684,810 4,190,580 3,977,147 3,826,773
ARC $12,486,801 $9,175,826 $8,053,724 $7,363,832
City of Palo Alto Retiree Health Care Valuation as of July 1,. 2005 13
SECTION II. EXmBITS
Exhibit 8. Valuation Summary by Bargaining Group
Valuation results shown below are based on a 4% discount rate.
FCA IAFF
Mgmt/
Conf PAPOA SEIU Total
Counts
Actives
Retirees and Dependents
Total
6
0
6
107 265 80 580 1,038
96 141 74 281 592~
203 406 154 861 1,630
Present Value of Benefits
Actives
Retirees
Total
1,164,613 22,478,428 41,370,277 15,229,845 82,302,376 162,545,539
0 12,693,177 16,906,626 13,132,932 30,776,804 73,509,539
1,164,613 35,171,605 58,276,903 28,362,777 1t3,079,180 236,055,078
Actuarial Accrued Liability
Actives
Retirees
Total
904,161 11,085,818 20,950,302 6,067,888 36,214,655 75,222,824
0 12,693,177 16,906,626 13,132,932 30,776,804 73,509,539
904,161 23,778,995 37,856,928 19,200,820 66,991,459 148,732,363
Annual Required Contribution
Normal Cost (EOY)
Amortization UAL
ARC
43,787 1,012,139 2,109,528 631,890 4,005,101 7,802,445
32,450 853,429 1,358,686 689,118 2,404,325 5,338,008
76,237 1,865,568 3,468,214 1,321,008 6,409,426 13,140,453
Annual Benefit Payments 8,003 528,083 793,848 474,065 1,487,669 3,291,668
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 14
SECTION II. EXHIBITS
Exhibit 9. Valuation Breakdown by Fund
Valuation results shown below are based on a 4% discount/ate. The counts, Actuarial
Liability, and ARCs include actives and retirees.
Actuarial
Fund Count LiabiliO,ARC
GAS 52 $3,922,918 $485,261
C.rp 20 1,155,021 172,075
STORM Dr.6 715,389 65,114
ELEC 123 10,764~406 1,117,393
General Fund 1,105 ’108,823,830 8,962,531
WQCP 1 181,172 6,502
;rSF- Printing 3 325,659 39,694
External SVC 5 236,435 53,091
Refuse 38 2,883,883 353,236
]SF- Technology 28 2,025,876 275,066
UTL - A dmin 67 6,933,208 348,901
)SF- Vehicle 20 1,401,143 173,896
WATER 30 2,589,065 301,748
WWC 22 1,459,887 201,311
WWT 69 5,314,471 584,634
Unknown Fund (Rets) *41 n/a n/a
Total 1,630 $148,732,363 $13,140,453
* Actuarial Liability and ARC for 41 retirees with no Fund code were allocated to each Fund in proportion to the Actuarial
Liability and ARC fund allocation for current employees, as requested by the City.
City of Palo Alto Retiree Health Care l/aluation as of July 1, 2005 15
SECTION II. EXHIBITS
Exhibit 10. Valuation Breakdown by General Fund Departments
Valuation results shown below are based on a 4% discount rate. The counts, Actuarial
Liability, and ARCs include actives and retirees.
General Fund Actuarial
Department Count LiabiliO~ARC
ASD 89 $7,291,233 $671,975
ATT 15 1,126,904 132,235
A UD 5 297,893 60,799
CLK 10 973,154 96,066
COU 17 1,492,834 160,262
CSD 159 12,655,123 1,116,214
F_tR 243 29,390,410 2,159,371
HRD 25 2,277,140 181,412
LIB 47 3,536,679 477,165
MGR 17 1,830,413 158,289
PLN 67 5,065,794 549,301
POL 273 29,571,911 2,244,081
PWD 138 13,314,343 955,361
Total 1,105 $108,823,830 $8,962,531
* Actuarial Liability and ARC for 41 retirees with no Fund code were allocated to each Fund in proportion to the Actuarial
Liability and ARC fund allocation for current employees, as requested by the City.
City of Palo Alto Retiree Health Care f57luation as of July 1, 2005 16
SECTION IlL. APPENDICES
Appendix A. Summary of Benefits
The following description of retiree health benefits is intended to be only a brief summary. For
details, reference should be made to Summary Plan Descriptions, Plan Documents, labor agreements,
and employee booklets.
Eligibility
Employees hired before January 1, 2004 and PAPOA members (Tier 1 employees) are eligible for
retiree health benefits if they retire from the City after age 50 with at least 5 years of service, and are
eligible for a PERS pension. Management, IAFF, and Chiefs employees hired on or after January 1,
2004, and SEIU employees hired on or after January 1, 2005 (Tier 2 employees), are eligible for
retiree health benefits if they retire from the City with at least 10 years of CALPERS service,
including 5 years of service with the City, and are. eligible for a PERS pension.
Health Benefits
The City contracts with the CALPERS health plan to provide retire health benefits to its retirees and
spouses. For Tier 1 retirees, the City pays for the entire cost of health benefits for retirees and a
portion of their spouses’ premiums for their lifetimes. The portion of spouse premiums paid by the
City is 60% for 2005, and will increase by 5% per year until the City pays the entire spouse’s
premium in 2013 and beyond.
Tier 2 employees are entitled to a portion of the Tier 1 benefits depending on their years of service.
After 10 years of service, Tier 2 employees are entitled to 50% of Tier 1 benefits, and this portion
increases by 5% with each additional year of service beyond 10 years up to a maximum of 100%.
Surviving Spouse Benefits
Upon the death of a retiree, Benefits continue to surviving spouses of retirees for their lifetimes.
City’s portion of premiums is the same as the portion paid on behalf of the retiree.
The
Dental and Vision
The City does not pay Dental or Vision Benefits for retirees.
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 17
SECTION III. APPENDICES
Appendix A. Summary of Benefits (continued)
Health Insurance Premium Rates
The following table shows monthly retiree health insurance premiums for the 2006 premium year for
coverage under the CalPERS Health Plan:
Bay Area
Blue Shield HMO
Kaiser Permanente
PERSCare
PERSChoice
PORAC
Monthly Premium Rates - 2006
Single 2-Party
Under 65 Over 65 Under 65 Over 65
425.50 $286.49 $ 851.00 $572.98
389.38 218.59 77.8.76 437.18
680.43 347.20 1,360.86 694.40
404.59 322.03 809.18 644.06
399.00 351.00 748.00 701.00
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 18
SECTION III. APPENDICES
Appendix B. Actuarial Cost Method, and Assumptions
The actuarial cost method described below is one of several acceptable costs methods described in
GASB 45, and the assumptions represent our best estimate of anticipated future experience based on
information provided to us. Note, that the ultimate responsibility of selecting/approving the actuarial
cost method and assumptions lies with the City and its auditor.
Actuarial Cost Method
The actuarial cost method used for determining the benefit obligations is the Projected Unit Credit
Cost Method. Under this method, the actuarial present value of projected benefits is the value of
benefits expected to be paid for current actives and retirees and is calculated based on the
assumptions and census data described this report. The Actuarial Accrued Liability (AAL) is the
actuarial present value of benefits attributed to employee service rendered prior to the valuation date.
The AAL equals the present value of benefits multiplied by a fraction equal to service to date over
service at expected retirement. The Normal Cost is the actuarial present value of benefits attributed to
one year of service. This equals the present value of benefits divided by service at expected
retirement. Since retirees are not accruing any more service, their normal cost is zero. In determining
the Annual Required Contribution, the Unfunded AAL is amortized as a level percentage of expected
payrotl over 30 years.
Economic Assumptions
Discount Rate (liabilities)
Expected Payroll Increases
Health Cost Trend
4.0% effective annual rate
3.75% effective annual rate (for actuarial cost method)
10% in the fu’st year (fi’om 2006 premium year to 2007
premium year), 9% in the second year, and graded down 1%
per year to 5% per year in the sixth year and beyond.
Demographic Assumptions.
Demographic assumptions regarding retirement, disability, and turnover are based on statistics taken
from pension valuations for California PERS under a 2% @ 55 formula for Miscellaneous employees,
and a 3% @ 50 formula for Police and Fire employees. Below is a summary of the assumed rates for
retirement, disability, and turnover.
Disability
Misc. 2% @ 55 Safety 3% @ 50
Age Males Females Police Fire
¯ 30 0.02%0.04%0.58%0.22%
35 0.08%0.10%0.87%0.32%
40 0.15%0.16%1.16%0.42%
45 0.24%0.23%1.45%0.53%
50 0.37%0.35%1.75%0.67%
CiO’ of Palo Alto Retiree Health Care Valuation as of July 1, 2005 19
SECTION III. APPENDICES
Appendix B.
Retirement
Actuarial Cost Method and Assumptions (continued)
Misc. 2% @ 55 Safety 3% @ 50
Age Males Females Police 1 Fire ~
50 3.5%4.8%17%15%
51 1.6%3.4%17%18%
52 2.4%3.7%18%20%
53 2.2%4.1%18%22%
54 3.1%4.2%18%22%
55 6.6%7.3%11%11%
56 5.2%6.0%7%9%
57 6.1%5.4%8%11%
58 6.7%8.3%8%10%
59 8.0%7.6%100%100%
60 14.5%11.1%100%100%
61 13.5%9.4%
62 24.8%19.8%
63 21.0%17.7%
64 14.3%12.9%
65 24.4%23.8%
70 100.0%100.0%
~ t~olice andFire rates are set to ]00% at 30years ofsera,ice.
Withdrawal Sample probabilities of miscellaneous employees terminating
within one year for an employee with five years of service are
shown below for selected ages:
Misc. 2% @ 55
Age Males Females
30 5.5%7.5%
35 3.9%5.5%
40 2.9%4.1%
45 2.2%3.1%
50 0.6%0.9%
55 0.4%0.6%
City of Palo Alto Retiree H~alth Care Valuation as of July 1, 2005 20
SECTION III. APPENDICES
Appendix B. Actuarial Cost Method and Assumptions (continued)
Sample probabilities of Safety employees terminating within
one year for an employee with a given number of years of
service are shown below:
Service
Safety 3 % @ 50
Poliee Fire
1 8.2%7.4%
3 3.3%3.2%
5 3.0%2.6%
10 2.1%0.9%
!5 1.3%0.8%
20 1.0%0.7%
25 0.8%0.6%
Mortality
Spouse Coverage
Spouse Age
Rates used by California PERS in its actuarial valuation of
retirement benefits.
60% of employees and retirees are assumed to have a
covered spouse in retirement (no dependent children are
assumed).
Female spouses are assumed to be three years younger than
male spouses, on average.
City of Palo Alto Retiree Health Care Valuation as of July 1, 2005 21
SECTION III. APPENDICES
Appendix C. Summary of Participant Data
The following census of participants was used in the actuarial valuation and provided by the City of Palo
Alto. The data was collected as of October 2005, and is assumed to represent census as of June 30,
2005.
Covered Active Employees
Age FCA 1AFF Mgmt/Conf PAPOA SEIU Total
Under25 0 1 0 1 7 9
25- 29 0 4 3 13 42 62
30 -34 0 13 12 20 53 98
35 -39 0 26 23 11 68 128
40- 44 1 26 43 18 100 188
45- 49 2 28 52 10 88 180
50- 54 0 5 65 4 96 170
55 -59 2 4 44 1 79 130
60- 64 1 0 19 0 41 61
65 & Over 0 0 4 2 6 12
Total 6 107 265 80 580 1038
Current Retirees
Age 1AFF Mgmt/Conf PAPOA SEIU Total
Under55 10 7 24 19 60
55 -59 11 20 12 34 77
60 - 64 17 28 14 51 110
65 -69 28 33 8 60 129
70 - 74 12 18 8 42 80
75 -79 11 18 6 27 62
80 - 84 4 11 2 26 43
85 & Over ~3 6 ~22 31
Total 96 141 74 281 592
CiO~ of yPalo Alto Retiree Health Care Valuation as of July 1, 2005 22
ATTACHMENT B
City of Palo Alto
City Manager’s Report
TO:
ATTENTION:
HONORABLE CITY COUNCIL
FINANCE COMMITTEE
FROM:
DATE:
SUBJECT:
CITY MANAGER
SEPTEMBER 20, 2005
DEPARTMENT: ADMINISTRATIVE
SERVICES
CMR: 318:05
OVERVIEW OF FINANCIAL REPORTING FOR
POSTEMPLOYMENT BENEFITS PLANS OTHER THAN
PENSIONS -GOVERNMENTAL ACCOUNTING STANDARDS
BOARDS STATEMENTS NO. 43 & 45
This is an informational report and no Council action is required.
BACKGROUND
The purpose of this report is to provide the Council with an overview of the premise and
implementation requirements of Governmental Accounting Standards Board’s (GASB)
Statement No. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension
Plans, and Statement No. 45, Accounting and Financial Reporting by Employers for
Postemployment Benefits Other Than Pensions.
The new statements are similar to previous GASB guidance for pensions. In addition to pensions,
governments offer Other postemployment benefits. (OPEB) such as healthcare. The basic premise
of the two statements is to measure and report the long-term costs of non-pension retiree
benefits, with the idea that these benefits are a form of employee compensation that should be
recognized as an expense as the employee earns them.
The City employs approximately .1,090 full-time current employees and it has 565 eligible retired
employees. The City provides medical insurance coverage through the Public Employees
Retirement System (PERS). The City has a two-tiered medical benefit plan based on date of hire.
Palo Alto Police OfficersAssociation (PAPOA) does not participate in the two-tiered plan. The
current agreement with PAPOA expires on June 30, 2007 and staff will negotiate fora two-tiered
plan at that time.
Employees hired before January
apply:
1, 2004 qualify for lifetime medical benefits if the following
Employee is vested in the CalPERS system (five years combined service in
CalPERS agencies), and
Employee retires from the City of Palo Alto
In addition, an employee’s spouse receives 55.% coverage, increasing by 5% for
each year of service by the employee until 100% coverage is achieved.
CMR:318:05 Page 1 of 4
Management and professional employees, International Association of Firefighters (IAFF) and
Fire Chiefs members hired after January 1, 2004, and Service Employee’s International Union
(SEIU) members hired after January 1, 2005, have the following benefits upon retirement:
¯Employees with ten years of CalPERS service, at least five of which are at the
City of Palo Alto, receive 50% of the lifetime medical benefit.
¯Employees receive an additional 5% of the benefit for each year of service after
the first ten, until 100% eligibility and 90% of their dependent coverage is
achieved..
Currently, the City uses a pay-as-you-go approachl It draws from a Retiree Health Benefits
Internal Service Fund, which is funded by the General Fund and Proprietary Funds (Utilities and
Internal Service Funds) for current year expenditures. In 2003-04, expenditures for retiree health
care for all funds totaled $2.8 million. As of June 30, 2004, the Retiree Health Benefits Internal
Service Fund had a balance of $18.1 million, the majority of which was funded from General
Fund.
DISCUSSION
GASB 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other
Than Pensions requires an actuarial valuation every two years to calculate the amount of annual
contributions (the expense recognized in the financial statements) that would be needed to
provide the promised benefits. The actuarial calculates the following:
Actuarial Accrued Liability (AAL).. The AAL is the present value of projected future
benefits for all current and future retirees.
Actuarial Value of Assets (AVA)~ The AVA is the market-based value of plan assets
and is only taken into consideration if they are in an irrevocable trust.
Unfunded (Actuarial) Accrued Liability (UAL). The UAL is the difference between
the AAL less the AVA, in other words how much more must the City recognize as an
expense to be able to fully fund its other postemployment benefit.
Annual Required Contribution (ARC): The ARC is calculated by adding the normal
cost amount (value of benefits earned in the current fiscal year) to the amortized past
service amount (UAL). The maximum acceptable amortization period for an OPEB
plan’s UAL is thirty years. To calculate the ARC, the actuary uses cost methods and
assumptions allowable under GASB 45, such as turnover, retirement age, mortality,
healthcare cost trend data and entry age.
If the City
ARC is not
The City is
included in
contributes the ARC to the plan every year, a liability will not be recorded. If the
fully funded in a given year, a liability is reported for the unpaid portion of the ARC.
in the first phase of implementation and the actuarially determined expenses.will be
the CAFR for 2007-08.
GASB 43, Financial Reporting for Posternployement Benefit Plans Other Than Pension Plans
addresses the financial statement requirements for OPEB held in a trust fund. The trust fund
could be on the financial report of the plan sponsor, employer, PERS, or other third party.
CMR:318:05 Page 2 of 4
Currently, GASB Statement No. 43 does not apply to the City, since the City does not currently
have a trust fund for OPEB.
Preparation for Implementation:
The City has contracted for an actuarial study based on 2003-04 data. This actuarial study will
provide a baseline to establish the ARC. In addition to allowable GASB meth~ods, the City has
required that the actuarial also report results ’using the following criteria: over and under age 65,
by fund, by department, by bargaining unit, current employees, retired employee and survivors,
and different amortization periods. The actuarial will also provide strategies for funding and
reducing costs. The resulting report will provide a useful anal-ytical and management tool. The
report will be available by mid2year of 2005-06 with results reported to Council in early calendar
year 2006.
Once a base line is established, staff will look at options for reducing the liability, if needed,
before the implementation date. Such .options might be to cut spending, change the benefit
package, and/or establish a trust.
Establishing a trust means-that plan assets are dedicated to providing benefits to retirees in
accordance with the terms of the plan and are legally protected. If the City chooses to establish a
trust, the following must be considered:
An irrevocable transfer of assets to a trust means the employer loses access to those
funds permanently or until the plan is terminated.
Plan assets in a trust lower the ARC, thereby lowering the cash contribution from the
City.
Using a trust allows different investment options such as investment in equities and
longer-term maturities, possibly lowering additionally the cash contribution from the.
City.
GASB Statement No. 43 requires reporting on the trust fund in the 2006-07 CAFR.
A separate audit may be required.
Additional information must also be included in the notes of .the CAFR. Examples of the
information included in the notes are:
Plan description
Funding policy
Information regarding the actuarial valuation
Net OPEB obligation, if one exists
Staff will report in the early part of calendar year 2006 to discuss the results of the actuarial
study.
EN¥IRONMENTAL REVIEW
The action recommended is not a project for the purposes of the California Environmental
Quality Act.
Page 3of 4
PREPARED BY:
TRUDY EI~ERRY --~
Accounting Manager, Administrative Services
LALO PE~
¯Assistant Director, Administrative Services
DEPARTMENT HEAD APPROVAL:
CITY MANAGER APPROVAL:
CMR:318:05 Page 4 of 4