TO:
Honorable Mayor and Members of the City Council
THROUGH:
Mark Danaj, City Manager
FROM:
Bruce Moe, Finance Director
Henry Mitzner, Controller
SUBJECT:Title
Update on CalPERS Investment Results for Fiscal Year 2015-2016; Impacts to the City’s Pension Contribution Rates and Economic Forecasts (Finance Director Moe).
RECEIVE REPORT
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Recommended Action
RECOMMENDATION:
Staff recommends that the City Council receive a report on CalPERS’ Fiscal year 2015-2016 investment results and the impacts on the City’s pension contribution forecasts and budget.
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FISCAL IMPLICATIONS:
Fiscal implications are described below.
BACKGROUND:
CalPERS reported its preliminary investment returns for FY 2015-2016 on July 18, 2016. The total return after expenses across all investment classes was 0.61%. This is below the actuarial assumed rate of return of 7.5%. Fiscal Year 2015-2016 results as well as prior years’ results were as follows:
FY15/16 0.61%
FY14/15 2.4%
FY13/14 18.4%
FY12/13 12.5%
FY11/12 1.0%
FY10/11 20.7%
Historical annual performance (as of June 30, 2015) has been as follows:
Three Year Period 10.9%
Five Year Period 10.7%
Ten year Period 6.2%
Twenty Year Period 7.8%
Based on CalPERS’ most recent results, the Mayor requested City Council hold a special study session to gather facts and understand possible implications of the 0.61% investment return, and to address the following questions:
1. What is the impact on our unfunded pension liability?
2. How does this impact our five year forecast?
3. If this creates a budgetary shortfall, where does the money come from?
4. What other impacts does, or might this, precipitate?
DISCUSSION:
CalPERS’ return of 0.61% for Fiscal Year 2015-2016 falls below the 7.5% actuarially assumed rate of return. As such, it equates to underperformance of the goal by 6.89% for this particular fiscal year.
The CalPERS investment returns are a key factor in the employer contribution rates set by CalPERS. In its simplest form, to the extent earnings come in below the assumed 7.5%, employer rates are increased to make up for earnings that were not achieved but necessary to pay benefits. To the contrary, when earnings exceed the 7.5% threshold, rates may be reduced (or not raised) in recognition of the “excess” earnings. Recent CalPERS policy changes to reduce risk now apply “good year” (>7.5%) returns towards reductions in the discount rate with the goal of lowering it from 7.5% to 6.5% over time.
The following are answers to the questions posed above regarding the 0.61% return for FY 2015/2016:
1. What is the impact on our unfunded pension liability?
While CalPERS’ valuation of unfunded liabilities for the year ended June 2016 will not be officially stated until the valuation report issued in October 2017, the independent actuary hired by the City, Bartel Associates, has provided projections.
Bartel Associate’s first projections were issued in May 2016 during the budget process. Because CalPERS FY 2015-2016 results were unknown at the time, those projections conservatively assumed CalPERS would lose 3% for the year. With the FY 2015-2016 CalPERS results in, Bartel Associates has updated the projections to reflect the real return of +0.61%. This means the actual rate of return is 239 basis points (or 20%) higher than we had estimated in our budgeting calculations, since we assumed -3.0% when, in fact, the final rate of return was a slight gain of +0.61%.
Attachment #1 lists the unfunded liabilities projected in May 2016 as well as those updated in August 2016 with actual results. Because the FY 2015-2016 results were better than originally predicted, the updated unfunded liabilities are projected to be approximately 12% less than originally estimated by FY 2021-2022 ($89 million versus $101 million). As previously noted, these unfunded pension liabilities are due in part to the FY 2014/2015 return of 2.4% and various risk mitigation steps enacted by CalPERS.
2. How does this impact our five year forecast?
The City’s five year forecast created for the FY 2016-2017 biennial budget used the May 2016 Bartel Associates projections, which have now been determined to be more conservative than the actual results for FY 2015-2016. Using the updated projections, the City will reduce estimated pension contributions by $1.35 million through FY 2021-2022, and $3.81 million through FY 2025-2026. See Attachment #2 for updated employer rate and pension contributions, including comparisons of the May 2016 and August 2016 projections.
3. If this creates a budgetary shortfall, where does the money come from?
No budget shortfall is created through these results because we assumed a -3.0% return while then actual rate of return was +0.61%. However, as noted in the last two years of budget cycles, pension costs will continue to rise as shown in Attachment #2.
4. What other impacts does, or might this, precipitate?
While CalPERS’ results of 0.61% for FY 2015-2016 were better than the City projected, and therefore have positive impacts on the City’s fiscal outlook, it was still below the assumed discount rate of 7.5%. Long term, the CalPERS discount rate is scheduled to be lowered to 6.5% over the next 20 years, this in an effort to mitigate contribution volatility. It is possible CalPERS will, over the next year or so, realign long term investment expectations with market realities, reducing the assumption further lower. However, if below par investment results continue, regardless of the discount rate, it will exacerbate unfunded liabilities and necessitate increased pension contributions by the City.
Pension Stabilization Trust Fund
In an effort to proactively address rising pension costs, the City Council is separately considering establishment of a Pension Stabilization Fund program. If approved, this tool will assist in smoothing annual pension contributions so as to balance rising rates against other important needs and services. This instrument, in conjunction with the effects of the Public Employee Pension Reform Act of 2012 (PEPRA) which lowers benefits for new CalPERS members, and risk mitigation strategies employed by CalPERS, in the long term will improve the funding ratios and reduce costs of providing pension benefits. The trust has the following benefits:
A Pension Rate Stabilization Fund (PRSF) has several benefits:
• The City maintains oversight of investment management and control over the risk tolerance level of the portfolio
• Assets can be accessed at any time to offset rate increases thereby stabilizing on-going pension expenditures
• Assets held in the fund allow for greater investment flexibility and risk diversification compared to the City’s general investments, and has greater earning potential
• Funds deposited into the trust offset the City’s Net Pension Liability which is now reported on the City’s balance sheet in accordance with Government Accounting Standards Board (GASB) Statement No. 68
• Depositing assets in a trust will be a positive development to Moody’s and Standard and Poor’s in the City maintaining Triple-A credit ratings from both of these entities
This item is also on the agenda for consideration.
PUBLIC OUTREACH/INTEREST:
After analysis, staff determined that public outreach was not required for this issue.
ENVIRONMENTAL REVIEW
Not required.
LEGAL REVIEW
The City Attorney has reviewed this report and determined that no legal analysis is necessary.
Attachments:
1. Unfunded Pension Liability Projections
2. Projected Employer Contribution Rates and Amounts
3. Bartel Associates PowerPoint (Updated from May 2016)
4. Wall Street Journal Article: <http://www.wsj.com/articles/calpers-reports-lowest-investment-gain-since-financial-crisis-1468862249>
5. Los Angeles Times Editorial: <http://www.latimes.com/opinion/editorials/la-ed-calpers-returns-20160726-snap-story.html>
6. CalPERS Press Report on FY 2015-2016 Investment Returns: <https://www.calpers.ca.gov/page/newsroom/calpers-news/2016/preliminary-investment-returns>
OTHER:
Video: CalPERS Chief Operating Investment Officer Offers Perspective About Investment Performance:
<https://www.youtube.com/watch?v=_L5D5LKI-b0>