Title
Discussion of a Funding Goal for the City’s Other Post-Employment Benefits (OPEB) Plan
Staffreport
SUMMARY AND RECOMMENDATION
Staff recommends that the Finance Committee (Committee) review the report and provide feedback regarding a funding goal for the City’s OPEB Plan.
BACKGROUND
One of the City Council’s highest priorities has been to place San Leandro on a firm foundation for long term fiscal sustainability. A key component in achieving this goal is to reduce the City’s Unfunded Liabilities related to employee benefits (primarily pensions and retiree health care). Other factors that meet the goal of sustainability include stable and diversified revenue sources, cost containment, and exposure/risk management.
Unfunded Liabilities fall into two main categories: Pensions and Other Post-Employment Benefits. Pension liabilities refer to the City employee’s pension plan with the California Public Employees Retirement System (CalPERS). Other Post-Employment Benefits (OPEB) typically refer to health benefits for employees who have retired from the City of San Leandro. The City provides its employees with a retiree health care plan that is relatively modest in scope which has fortunately limited its long-term financial liability associated with this benefit.
In September 2015, the City Council adopted a Prioritizing Unfunded Liability Liquidation (PULL) Plan with a 5-year goal of allocating $5 million toward reducing unfunded liabilities. The PULL Plan calls for the City to direct up to 50% of all annual General Fund carryover toward funding of unfunded liabilities; the City may also direct up to 50% of all General Fund land sales toward the PULL Plan. The PULL Plan supports funding the full Actuarial Determined Contribution (ADC), as determined by the actuaries for each fiscal year. ADC includes normal cost for benefits earned during the same fiscal year and funding shortfall/unfunded liability payments that has occurred over time. Funding OPEB liability based on ADC will result in a fully-funded plan over time.
Following the adoption of this proactive funding plan, the Council authorized several large contributions into the City’s OPEB Trust in addition to a $750,000 annual budget allocation. As a result of these additional contributions, the OPEB Trust generated significant investment earnings. The $5 million goal has been exceeded. These funds can be used toward retiree health care benefits in the future. At the end of June 30, 2021, the portfolio assets total $21.8 million. The City’s OPEB Plan achieved a healthy funding ratio.
As the funded status for the retiree health care plan improved significantly, the Finance Committee recommended the establishment of a Section 115 Pension Trust to pay down the City’s unfunded pension liability. The Council approved the recommendation in June 2021, and the Pension Trust was set up with PARS in the first quarter of current fiscal year. Also, the $750,000 annual budget allocation to the OPEB Trust was redirected to the Pension Trust starting in fiscal year 2020-21.
The Committee continued to evaluate funding strategies to pay down the City’s unfunded liabilities. The Committee requested staff to conduct an actuarial analysis on the City’s OPEB Plan and develop a funding goal.
DISCUSSION
Analysis
Following the Committee’s directives, staff engaged Bartel and Associates to prepare an actuarial valuation report for the fiscal year ended June 30, 2021. The purpose of this study is to provide an update regarding the OPEB Plan’s assets and liability and projected actuarial contributions for future years. A representative from Bartel presented the results to the Committee at the February 16, 2022 meeting.
The table below labeled as “Actuarial Obligations” summarizes the present values of benefits, actuarial accrued liability, value of assets, and the funded ratio for the City’s OPEB Plan. At the end of June 30, 2021, the OPEB Plan’s funded ratio was close to 95%, a significant improvement from 2019 and prior years.
Actuarial Obligations
(000’s Omitted)
Funded position typically measured by relationship of Assets to Actuarial Accrued Liability (AAL) since AAL is a target asset value:
• Present Value of Benefits (PVB) is the amount that would pay for all benefits (for current employees/retirees) if all assumptions are met.
• Actuarial Accrued Liability (AAL) is portion of PVB that has been accrued representing a target asset value.
• Difference between PVB and AAL will be recognized in future costs via the Normal Cost (cost of benefits accruing during the year for active employees).
100% AAL funded plan means:
• Plan is on track to pay benefits from trust.
• Future plan cost expected to equal Normal Cost (cost of benefits accruing for active employees), i.e. no catch-up payments expected for prior service and retirees.
• No intergenerational taxpayer shifting - current taxpayers have paid for cost of services provided to them.
Scenarios for Funding Goals
During the presentation, the actuary presented three funding scenarios (as described below) for the Committee’s consideration and recommended that the City target a 100% Funding Goal/Full Actuarial Determined Contribution (ADC) since the City’s OPEB prefunding has resulted in good Assets/Actuarial Accrued Liability funded position at June 30, 2021.
The actuary also pointed out that the City Pay-Go and Full ADC funding strategies are very similar. Direct annual contribution from the City may not be required since the investment earnings from the trust may be able to cover the annual ADC. The City can consider using a 10, 12, or 15-year amortization periods to pay off the liability as presented in the “Pay-Go and ADC” table below.
Three funding scenarios:
• City Pay-Go
o The City pays benefit payments outside of the OPEB Trust, with no further contributions to the trust.
o Trust would grow with investment earnings. This was the City’s strategy in 2020/21 and is planned for 2021/22.
• Full Actuarial Determined Contribution
o The City pays the full ADC annually, with a 15-year amortization of the unfunded liability. The City may also select a 10-year or 12-year amortization to pay off the liability.
Pay-Go and Actuarially Determined Contribution (ADC)
(000’s Omitted)
• 90% Funded Target
o Contributions determined so that 90% funded status is expected in 20 years. The trust would annually reimburse the City for approximately 18% of the Pay-Go costs.
Staff Recommendation
Staff recommends a 100% Funding Goal/Full ADC using a 12-year amortization to pay off the unfunded liability. Investment earnings are expected to be sufficient to cover the projected annual ADC. Therefore, targeting a 100% funding goal would not have a direct impact on the City’s operating budget. The average annual investment earnings over the past three to five fiscal years is about $1.5 million and $1.1 million.
The City would continue to fund the pay-go amount outside of the trust until the OPEB liability is paid off. This amount is projected to be about $1.2 million for fiscal year 2022-23. Once the OPEB Plan is fully funded in about 12 years (around fiscal year 2033-34), the City could use the funds from the trust to pay for the pay-go portion. At that time, the City would only need to contribute toward the normal cost. Normal cost represents benefits accrued during the year for active employees. If investment earnings are sufficient to cover normal cost, no annual budget allocation would be required from the City.
Next Steps
After receiving feedback from the Committee, staff will develop a comprehensive funding policy incorporating the OPEB Plan funding goal and the goals and objects of the PULL Plan. The funding policy will be presented to the Committee for consideration at a future meeting. After receiving feedback from the Committee, staff will finalize the funding policy and present it to the City Council for consideration.
Fiscal Impacts
The Committee and the Council’s proactive approach to fund unfunded liabilities will help the City generate investment income and achieve significant savings over time. These prudent steps will ultimately have a positive impact on the City’s overall budget and its long-term financial stability.
PREPARED BY
Susan Hsieh, Finance Director