Options to Consider When Facing Increasing Liabilities and Contribution Rates

Categories: California Developments,OPEB/GASB 45/75,PARS In the News
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Public Retirement Journal by Amy Brown, March 15, 2015

Lately, I have been traveling around California speaking to public sector finance and labor relations professionals about my observations on pensions, other post employment benefits (OPEBs), municipal bankruptcy etc. The crowds at these conferences have been massive; everyone wants to know the state of affairs of their benefits. Are they secure? What are the chances of pension reform crusaders qualifying a statewide initiative? Are their CalPERS rates going to increase if they are in a risk pool?

The repeated theme among audience member questions that stuck in my head long after the presentations and went something like this: “I work for a city with a population of about 45,000. We have a full time staff, including police and fire. We have three tiers. We have most of our employees paying all of their employee contributions as well as five percent of the employer share. And then there’s the PEPRA – the Public Employees’ Pension Reform Act of 2012 – which includes about twenty or so of our employees. Our rates will double in two years. What else can we do? This isn’t sustainable.”

Cut to a recent seminar segment presented by the one and only John Bartel, aka resident actuarial expert. A big topic on his list of presentation items was called “Paying Down Unfunded Liability and Rate Stabilization.” He outlined six options for audience members to consider when they are faced with increasing unfunded liability and contribution rates. John stressed he didn’t recommend all of them, but did detail the pros and cons of each.

Pension Obligation Bonds (POBs)

We are well aware of pension obligation bonds and the advantages of floating one to pay off increased pension obligations. Most of our readers have either purchased them or inquired as to their implications long term. Bartel cautions those considering POBs to look at the interest arbitrage between CalPERS earnings and the rate paid on a POB. You may end up paying more for the POB. You must consider the volatility of CalPERS investment return on the POB as timing is very important. You could have a situation where you issue a POB and then there is a market correction (remember 2008 and 2009?). There’s also no longer a guaranteed savings for those in a CalPERS risk pool when paying off their Side Fund (due to changes CalPERS has made to their risk pools).

Creating more debt, which is exactly what the purchase of a POB does, isn’t advised especially if your CalPERS earnings are less than the rate paid on a POB.

Borrow From Your General Fund

One option is to actually borrow money from the local agency’s general fund with the intention of paying it back. Bartel suggests payments come from all funds and that this mechanism be treated like a loan with a detailed process
of how to pay it back. Be warned: your local agency may get severely scrutinized from the public for taking a loan from revenues spent on other needed services. Have a detailed game plan if you recommend this course of action.

Request A Shorter Amortization Period

This is a toughy. Requesting a shorter amortization period will only work if you have some additional funds in the short term to increase your contributions. Think of it this way: you have a 30 year mortgage on your house. Now take it down to a 15 year mortgage. The good news is that you are paying less interest. The bad news? You will be paying higher short term payments.

One Time Payments

So, at the end of the fiscal year you discover that your agency has a surplus, huh? You have some ideas about how to spend that money, right? How about getting a council or board resolution to use a portion (for instance 50 percent) of one time money to reduce your unfunded liability? Good idea, huh? If you decide to pursue this route, make sure you contact your CalPERS actuary when you decide how much and when. You don’t want to wait to see any relief for three years. If your fiscal year ends June 30, calling CalPERS prior to that will ensure the extra funds will be applied to the next fiscal year. For instance, you have an excess amount of $1 million in contributions and assume it is going to lower your 2015-16 rate, but if you don’t notify your CalPERS actuary to that effect, they will apply it to the 2017-18 rates.

Establish Internal Service Fund

Internal service funds (ISFs) are used for operations serving other funds or departments within a government on a cost-reimbursement basis. For instance, there are water resources revolving funds that account for charges for administrative services related to water delivery. Another example would be say, an equipment service fund which would charge fees for printing or procurement charges.

Bartel says that an ISF could be used for rate stabilization. The downside to establishing an ISF are the restricted investments. The likely investment returns are painfully low (e.g. 0.5 – 1 percent) because assets are restricted to short term, high quality instruments. Furthermore, assets in an ISF could also be used by your elected board or council for other purposes and, consequently, they don’t reduce your GASB 68 Net Pension Liability (NPL).

Establish Irrevocable Supplemental Trust (§ 115)

Bartel dedicated a significant portion of his presentation to the option of establishing an irrevocable supplemental trust. He noted only two agencies (County of Solano and City of Sausalito) that he was aware of having actually created a §115. Here’s what they can be used for:

An agency could use a §115 for rate stabilization and it would reduce GASB 68 Net Pension Liability if it was established using an irrevocable trust. Also, investments held in an irrevocable trust are significantly less restricted than your general fund investments. They are designed for the long term horizon and are likely much higher in investment returns – 5 to 7 percent given the increase in flexibility and range of investment choices.

There are some restrictions, however. Access to these types of trusts can only be used for transferring proceeds to CalPERS directly or to reimburse the employer for CalPERS contributions. You can’t allocate the funds to your own agency or any other entity. In other words, assets cannot be used for any other purpose. There may be a couple
of providers that offers these types of trusts for prefunding pension and retiree health care (OPEB) to public agencies. The one that stands out to us is PARS (www.pars.org). We know because we do a lot of work for PARS here in Sacramento, so we asked them about their 115 trusts.

There are some advantages to be aware of if you are considering a §115 trust. You can mitigate pension investment volatility by using it as a rate stabilization fund. It also gives you more flexibility if you contribute a large amount, thus significantly reducing the unfunded liability.The trust could also act as a rainy day fund when employer revenues are impaired based on economic or other
conditions. Ultimately, the trust gives more local control over the assets while creating a more actuarially sound retirement system.

It’s a tough time to be a local agency providing pension benefits. It appears as though options to quell increasing costs are limited. Waiting it out until the PEPRA takes its full effect isn’t a viable option in a lot of cases. Bartel in his infinite wisdom gives us all a few options to ponder.

Published by Amy Brown, the Public Retirement Journal provides a very timely source of valuable information and insight into public retirement, health care and related benefits. The Journal seeks out, and interviews, those people shaping public retirement policy and helps our readers understand just what they have planned in this field.

For more information, please visit http://www.publicretirementjournal.org


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