A New Tool for Pension Budgeting

Categories: California Developments,PARS News,Pension Rate Stabilization
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The Alert – Public Agency Coalition  by Amy Brown,  March 15, 2016

With our maturing public pension plans, we know that we should expect greater fluctuations in required contributions from year to year. And since we know big fluctuations are coming, our actuaries are warning employers to plan for it in order to ease the burden when big contribution increases do arrive. But how exactly does one do that? It’s not like big portions of your annual budget are discretionary spending.

If you’ve been in the position of sitting on extra cash, you will have quickly learned that there’s little you can do with that money to “prepare” your agency for fluctuating contribution requirements. If you give that extra money to CalPERS, CalPERS will apply it toward your unfunded liabilities, and it will probably make only a small dent in your annual required contributions due to their amortization rules. While paying down unfunded liabilities is always worthwhile, it won’t help you manage future year-to-year changes in required contributions. You could stash some cash in a rainy day fund, but that has its drawbacks as well. The good news is: we’ve got an answer for you. Duh, dah, dah, duh…. The Section 115 trust!

There’s a new kid in town who doesn’t yet have a catchy nickname, so we’ll refer to it by its official name – the Section 115 trust. Do you remember seeing a survey from CalPERS asking about your interest in a new pension savings account? Of the agencies that responded, 60 percent said they’d never heard of a prefunding trust for pensions. It’s so new that this comes as no surprise, yet this is an important tool that every agency should be evaluating. Depending on your agency’s priorities, this might be a valuable tool for your budgeting strategies.

Historically, Section 115 trusts have primarily been used for prefunding OPEBs. All of the OPEB prefunding plans, including the one offered by CalPERS, are operated under IRC Section 115. Once employer assets are placed in the trust, the assets may only be used for the designated purpose of prefunding OPEBs.

However, in a private letter ruling, the Internal Revenue Service said that Section 115 trusts could also be used for prefunding pension benefits, and that created a whole new tool for employers. Private financial service providers, namely PARS (Public Agency Retirement Services), were quick to create and offer this tool to public agencies starting in 2015. Their 115 trust can be used to prefund both OPEBs and pensions, although assets must be separately accounted for and used for their respective obligations only.

Aside from responsible budget planning, there’s another very good reason to consider a Section 115 trust for pensions. With GASB 68 pension reporting requirements just around the corner, agencies are beginning to understand the implications of those new rules. GASB 68 requires the liability for pension obligations to be included on an employer’s balance sheet (though calculated differently than your pension valuation). Those new liabilities cannot be offset with any assets over which the employer retains discretionary control. To offset that liability, an employer has only two choices: it can pay down its unfunded liabilities, or it can offset liabilities using an irrevocable Section 115 trust. The trust provides a mechanism and ability for employers to reduce their pension liabilities while also reserving those funds to assist in future years’ budgeting.

So, if at the end of the fiscal year you discover that your agency has a surplus, 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?
A one-time contribution to CalPERS will reduce your unfunded liability and will also save you the 7.5 percent in-terest that you’re paying on that liability. We’re guessing most of your other debt doesn’t come close to 7.5 per-cent. There are definite reasons for just plunking the money down and chipping away at the big goal, but with this strategy, employers won’t see a big reduction to their annual payments since CalPERS will spread the contribution out over the remainder of the amortization period.

If instead you choose to establish a Section 115 trust, you are not necessarily paying down unfunded liabilities as far as your pension fund is concerned. Those funds will be reserved for a time down the road when CalPERS is asking for an annual contribution payment that would otherwise create heartburn. However, and we realize this may be confusing, the assets in a Section 115 trust for pensions can also be used to offset your unfunded pension liabilities at least as far as your financial statements are concerned. When weighing which option is right for you, you must consider your agency’s unique circumstances and long-term funding strategies.

The one and only John Bartel, aka resident actuarial expert, has been talking about these “prefunding” accounts for at least a year now. He says an agency could use a Section 115 trust for rate stabilization, which can be used to mitigate pension investment volatility more effectively than any tool out there. Also, if you’re still thinking a rainy day fund might be the way to go (in order to retain that discretionary control), consider that 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 to produce much higher investment returns – 3 to 7 percent annually – given the in-creased flexibility and range of investment choices.
There are some downsides to consider. Access to these types of trusts can only be used for transferring proceeds to CalPERS directly or to reimburse the employer for CalPERS (or your retirement system) contributions. y. In other words, assets cannot be used for any other purpose than paying your agency’s pension obligations.

More than 20 employers have already signed up for the Section 115 trust offered by PARS, which they call the Pension Rate Stabilization Program (PRSP). Why should you consider a prefunding account for pensions? PARS’ quick summary of the trust’s benefits sounds like this:

  • Assets in the trust will offset unfunded pension liabilities.
  • Agencies control the risk tolerance of the portfolio.
  • Assets held in trust allow for greater investment flexibility and risk diversification compared to an agency’s general fund investments.
  • Assets can be used to stabilize rates – to offset unexpected contribution rate increases or be used as a rainy day fund when revenues are impaired based on economic or other conditions.
  • There’s the potential of improving an agency’s bond rating.
  • Employers have flexibility to access trust assets any time, as long as it’s used to pay employer pension obligations.

CalPERS is interested in getting in on the action… um, we mean offering this service to its participating employers… but won’t be sponsoring legislation do to so this year. You see, labor and management couldn’t come to terms with an agreed upon approach, so CalPERS scrapped the idea, for now. The earliest that we could see a similar program from CalPERS would be delayed until early 2018.

Labor said that they will not support CalPERS offering such plans (aka, the legislation will get squashed before it could get approved), unless there is a restriction requiring employers to obtain labor’s agreement before an employer could contribute funds. Labor believes agreement is necessary to ensure that employers do not bargain to impasse or unilaterally implement a contribution to the trust over labor’s objection. At the end of the day, they don’t want so called “surplus” funds diverted to the account before contract negotiations begin.

It should come as no surprise that employer representatives say such language would make the trust fund substantially less attractive and feasible for employers. CalPERS staff tried to work out a compromise between the two sides to see if it can come up with bill language that everyone can get behind, to no avail.

Thus, the only game in town as far as we know is the PARS PRSP. Might be worth considering.

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