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HomeMy WebLinkAbout2000-04-18 City Council (3)BUDGET ’00-’01 City of Palo Alto C ty Manager’s Report TO:HONORABLE CITY COUNCIL ATTN:FINANCE COMMITTEE FROM: DATE: CITY MANAGER APRIL 18, 2000 DEPARTMENT: ADMINISTRATIVE SERVICES CMR: 214:00 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 rate in 2000-01 will be approximately $4.2 million lower annually than the City’s rates in 1998-99. Rather than reduce the 2000-01 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 ($11.0 million) for a portion of this employee benefit obligation. Future accounting standards are expected to require the City to fund fully the total obligation. Staff also recommends that the set aside funds not automatically be used for any actual retiree health benefit cosfs in future years until the accounting standards have been issued. CMR:214:00 Page 1 of 4 RECOMMENDATION Staff recommends that the Council: 1.Apply PERS pension rate reductions of approximately $4.2 million to the City’s unfunded liability for retiree health benefits (Retiree Health Benefits Trust Fund) in the 2000-01 Proposed Budget. The rate reduction is to be dalculated by comparing the 2000-01 rates to .the rates in the 1998-99 Adopted Budget. 2. Apply any future PERS pension rate reductions to the unfunded liability for retiree health benefits (Retiree Health Benefits Trust Fund). The rate reduction is to be calculated by comparing the rate for the fiscal year to the rates in the 1998-99 Adopted Budget. 3. Change the Council policy for expenditure of moneys in the Retiree Health Benefits Trust Fund so that it is not automatically utilized when actual health care costs exceed 1.5 percent of the City’s gross payroll. BACKGROUND In the private sector, the Financial Accounting Standards Board (FASB) requires employers to set aside funds fok post-retirement employee health benefits. This ensures that all employees receive post-retirement benefits regardless of the future financial condition of the employer. In the public sector, setting aside funds for post-retirement health benefits is optional. However, the Government Accounting Standards Board (GASB) has announced its intention to require full funding of retiree health benefits in the future, probably within three to five years. In April 1999, the City estimated its total obligation for post-employment health benefits at $49.0 million. The City presently pays for retire health benefits from annual operating budgets on a "pay-as-you-go" basis. In anticipation of the future GASB standards which would require the City to fully fund the total obligation, the City has begun to set aside funds in a Retiree Health. Benefits Trust Fund. In 1994, the Council directed staffto apply a $6.1 million refund from PERS (AB702) to this Trust Fund. Due to interest earnings, the amount in the Trust Fund reached $8.0 million by the end of 1998-99. In 1999-00, there was an unexpected reduction in PERS pension rates in the amount of $3.1 million, as compared to the rates in the 1998-99 Adopted Budget. During the 1999-00 budget process, Council approved a staff recommendation (CMR:226:99) to apply this savings to the liability for post-employment health benefits, rather than reducing the budget. The total contributions plus interest to the Retiree Health Benefits Trust Fund are projected to reach $11.0 million by the end of 1999-00. This leaves the City’s unfunded liability for retiree health benefits at approximately $38.0 million. CMR:214:00 Page 2 of 4 DISCUSSION PERS employer pension 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. Favorable economic conditions resulted in reductions in the rates in 1999-00. At that time, PERS informed staff that it expected the reductions to continue for two to three years. This year, PERS has notified the City of another pension rate reduction for 2000-01 in the amount of approximately $4.2 million. Once again, staff recommends applying this savings to the liability for post- employment health benefits, rather than reducing the budget. Since it is anticipated that it will take many years to fully fund these benefit obligations, it is prudent to utilize the resources generated by the PERS rate reduction to continue to reduce the unfunded liability. Staff also recommends applying any future pension cost savings to the Retiree Health Benefits Trust Fund. While waiting for the final GASB requirement, the City has the option to implement the current GASB procedures for fully funding retiree health benefit obligations. Staff does not recommend implementing the optional procedures at this time, since it would reduce the City’s budget flexibility and may result in duplicative implementation efforts When the final GASB procedures are issued. During the next two year budget cycle, staff will reexamine whether or not the City should elect to adopt the expected form of the future GASB requirements. This would replace the City’s current "pay-as-you-go" method with an annual budget transfer to the Retiree Health Benefit Trust Fund from which actual benefits would be paid. In addition to preparing for future liabilities, the Retiree Health Benefits Trust Fund is to be drawn upon when actual retiree health benefit costs exceed 1.5 percent of gross payroll costs. In 1998-99, these costs slightly exceeded this threshold (by one-tenth of one percent) resulting in $43,000 being expended from the Trust Fund. In 1999-00, these costs are projected to exceed the threshold by two-tenths of a percent. Given the significant unfunded liability, staff no longer recommends automatically utilizing the Trust Fund to offset costs that exceed 1.5 percent of payroll. To that end, staff is recommending a change in the Council-policy regarding utilization of the Trust Fund. ALTERNATIVES TO STAFF RECOMMENDATION The City could reduce the 2000-01 appropriated budget by the amount of the estimated $4.2 million PERS pension rate reduction, of which approximately $2.8 million is related to the General Fund and approximately $1.4 million is related to the Enterprise Funds. Another alternative would be to apply the cost savings to some other budget item. Staff does not recommend either of these options because of the large obligation still remaining for retiree health benefits. CMR:214:00 Page 3 of 4 RESOURCE IMPACT Retiree health benefit expenses constitute a large, unfunded liability which could significantly impact the City available operating resources in the future. Taking action to continue to reduce this unfunded liability will mitigate the budget impact, should the GASB require municipalities to fully fund these benefits in the future. It also provides increased assurance that the City can meet its retiree health benefit obligations in the future. Further, it is prudent fiscal planning to set aside today’s savings to fund future obligations. POLICY IMPLICATIONS The recommendation is consistent with prior Council action regarding funding post- retirement health benefit obligations. 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: ~’~--~ ~. EA~rn~ni str at ~v i Services CITY MANAGER APPROVAL: HARRISON Assistant City Manager CMR:214:00 Page 4 of 4