The Role of Section 115 Trusts in Rethinking Reserves

17 Jun 2024

In the complex domain of local government finance, the traditional role of reserves as a safety net is undergoing significant transformation. The modern financial landscape, characterized by increasing volatility and uncertainty, demands a reevaluation of traditional reserve strategies.

This article delves into the emergence of Section 115 trusts as a modern financial instrument designed to prefund Other Post-Employment Benefits (OPEB) and defined benefit pension liabilities.

  • In the intricate world of local government finance, reserves have always stood as a cornerstone, ensuring stability, promoting fiscal responsibility, and acting as a safety net against unforeseen financial challenges. These reserves, traditionally viewed as savings accounts or insurance against risks, have been the subject of much debate and scrutiny, especially in an era marked by increasing volatility and uncertainty.

    As governments grapple with the perennial question of “how much is enough?”, there emerges a need to rethink and reevaluate traditional reserve strategies.

    Enter the Section 115 trust, a modern financial instrument designed to prefund Other Post-Employment Benefits (OPEB) and defined benefit pension liabilities. In partnership with entities such as Public Agency Retirement Services (PARS), these trusts offer local governments a comprehensive solution, marrying the principles of risk management with the flexibility of investment.

  • The very essence of reserves lies in their ability to provide a financial cushion, enabling local governments to navigate unexpected fiscal challenges and maintain essential services. However, the dynamics of the 21st century have introduced a plethora of complexities that necessitate a fresh perspective on reserve strategies.

    1. An Increasingly Volatile and Uncertain World:
      The global landscape is undergoing rapid changes, with economic fluctuations, political shifts, and natural disasters becoming more frequent and unpredictable. While reserves have traditionally been the go-to solution to address such unforeseen expenses, the increasing magnitude and frequency of these events call for a more robust and forward-thinking approach.
    2. Public Perception and Trust:
      In an era of information overload, local governments face heightened scrutiny from their stakeholders. Large reserves, especially when their purpose isn’t transparently communicated, can lead to suspicion. Questions arise: Why is the government holding onto these funds instead of investing them back into the community? Is there a hoarding mentality at play? The challenge lies not just in maintaining adequate reserves but in doing so in a manner that retains public trust.
    3. The Evolving Nature of Risks:
      The risks local governments face today are not the same as those from a decade ago. From cybersecurity threats to global pandemics, the spectrum of challenges has expanded. Reserves, in their traditional form, might not be equipped to address these multifaceted risks.
    4. Financial Pressures and Commitments:
      With growing commitments towards pensions, healthcare, and other post-employment benefits, local governments are under pressure to ensure they have the funds to meet these obligations. The rising costs associated with these commitments further underscore the need for a reimagined reserve strategy.

    In light of these challenges, the call to rethink reserves is not just timely but imperative. It’s about ensuring that local governments are not just reactive but proactive in their financial planning, equipped to face the uncertainties of today and tomorrow. The introduction of instruments like the Section 115 trust is a testament to this evolving mindset, offering a blend of flexibility and security in reserve management.

  • As local governments grapple with the complexities of modern-day financial challenges, the need for innovative solutions becomes paramount. The Section 115 trust emerges as a beacon in this landscape, offering a fresh approach to managing and safeguarding reserves.

    1. A Comprehensive Solution for OPEB and Pension Liabilities:
      At the heart of a Section 115 trust is its ability to prefund OPEB and defined benefit pension liabilities.
      • For OPEB, setting up a Section 115 Trust permits the local government to use a higher discount rate, thus lowering the calculated long-term liability; and contributions to the trust directly offset the liability.
      • And for pension, Section 115 Trusts operate separately from traditional pension systems, offering a dedicated avenue to address long-term pension liabilities and costs and stabilize rising contribution rates.
    2. Local Autonomy and Control:
      One of the standout features of the Section 115 trust is the autonomy it offers local governments. Agencies maintain control over their assets, deciding on the timing, risk tolerance, and strategies that align with their unique financial landscapes. This autonomy ensures that local nuances and priorities are always at the forefront of financial decision-making.
    3. Diversified Investment Potential:
      Traditional reserve funds, often limited in their investment capabilities, might not always yield the best returns. Section 115 trusts, on the other hand, open the door to diversified investing. Depending on state laws, assets in these trusts can potentially earn more than what’s possible within a general or reserve fund, optimizing returns and contributing to financial stability.
    4. Security and Long-Term Planning:
      The irrevocable nature of Section 115 trusts ensures that the funds are protected against diversions or misuse. They stand as a testament to a government’s commitment to long-term financial planning, offering a buffer against economic downturns and ensuring that funds are available to address future liabilities.
    5. Flexibility and Adaptability:
      The world of finance is ever evolving, and solutions that cannot adapt often become obsolete. Section 115 trusts are designed with flexibility in mind. Whether it is addressing rising contribution costs, managing assets based on changing risk profiles, or navigating economic fluctuations, these trusts offer the agility needed for modern financial management.

  • In the realm of local government finance, risk management stands as a pillar of stability. The traditional approach to reserves often revolved around a simple question: “How much is enough?” However, in a world characterized by unpredictability, this question demands a more nuanced answer.

    Enter risk-based reserve analysis, a method that evaluates reserves not just based on arbitrary benchmarks but on the actual risks faced by an entity. When combined with the capabilities of Section 115 trusts, this approach takes on a new dimension of effectiveness.

    1. Addressing Revenue Instability with Section 115 Trusts:
      • Revenue Fluctuations:
        Local governments often face revenue fluctuations due to economic cycles, changes in tax bases, or unforeseen events. While traditional reserves offer a buffer, they might not be sufficient to handle prolonged periods of revenue instability.
      • Role of Section 115 Trusts:
        By setting aside funds in a Section 115 trust, governments can create a dedicated pool of resources to address revenue shortfalls. The diversified investment potential of these trusts can also generate returns, providing an additional layer of financial security.
    2. Guarding Against Catastrophic Events:
      • The Unpredictable Nature of Catastrophes:
        Whether it’s a natural disaster, a global pandemic, or a major infrastructure failure, catastrophic events can strain local government finances significantly.
      • Role of Section 115 Trusts:
        These trusts act as a financial safety net, ensuring that funds are available when most needed. Their irrevocable nature means that the funds are protected and can’t be diverted for other purposes, ensuring that they are available to address emergencies.
    3. Buffering Against Volatility:
      • The Changing Financial Landscape:
        Economic volatility, fluctuating interest rates, and global financial crises can impact local government revenues and expenditures, especially defined benefit pension contributions.
      • Role of Section 115 Trusts:
        With their diversified investment strategies, Section 115 trusts can potentially offer better returns even in volatile markets. They provide a cushion, allowing governments to navigate economic downturns without resorting to drastic measures like service cuts or tax hikes.
    4. A Proactive Approach to Risk Management:
      • Beyond Reactive Measures:
        While traditional reserves are often used reactively, risk-based reserve analysis encourages a proactive approach, identifying potential risks and planning for them in advance.
      • Role of Section 115 Trusts:
        These trusts can be tailored based on the specific risks identified in the analysis, ensuring that funds are allocated efficiently. Their flexibility allows for adjustments based on changing risk profiles, ensuring that reserves are always aligned with the current risk landscape.

    In essence, risk-based reserve analysis, when complemented with the capabilities of Section 115 trusts, offers local governments a dynamic tool to navigate the uncertainties of the financial world.

    It’s not just about having reserves; it’s about having the right reserves, optimized for the challenges of today and tomorrow.

  • In the intricate tapestry of local government finance, a well-defined reserve policy serves as a guiding star, illuminating the path forward and ensuring that financial decisions are made with clarity, consistency, and foresight. As the financial landscape evolves, integrating innovative tools like Section 115 trusts into this policy framework becomes crucial.

    1. The Imperative of a Clear Reserve Policy:
      • Guided Decision-Making:
        A clear policy provides a roadmap for decision-makers, ensuring that reserves are used judiciously and in alignment with long-term financial goals.
      • Stakeholder Trust:
        Transparency is key to building and maintaining public trust. A well-articulated policy communicates the government’s commitment to fiscal responsibility, assuaging concerns about the misuse or hoarding of funds.
      • Consistency Across Tenures:
        Governments witness changes in leadership and administration. A robust reserve policy ensures that the approach to reserves remains consistent, irrespective of these changes.
    2. Integrating Section 115 Trusts into the Reserve Policy:
      • Tailored Solutions for OPEB and Pension Liabilities:
        A comprehensive reserve policy should address specific liabilities. Section 115 trusts are designed for prefunding OPEB and pension liabilities. They offer a targeted solution that can be seamlessly integrated into the broader policy framework.
      • Flexibility and Adaptability:
        Section 115 trusts are inherently flexible, allowing governments to adjust their strategies based on changing financial landscapes. This adaptability can be codified within the reserve policy, providing guidelines on when and how to leverage these trusts.
      • Risk Management:
        As governments adopt a risk-based approach to reserves, Section 115 trusts can be positioned within the policy as tools for managing specific risks, such as revenue instability or catastrophic events.
    3. Operationalizing the Policy with Section 115 Trusts:
      • Regular Reviews and Adjustments:
        A dynamic reserve policy should be reviewed periodically. With the data and insights provided by Section 115 trusts, governments can make informed adjustments to their policy directives.
      • Stakeholder Engagement:
        As part of the policy development and review process, engaging with stakeholders can provide valuable feedback. The transparency and clarity offered by Section 115 trusts can facilitate these engagements, ensuring that all parties have a clear understanding of the government’s reserve strategies.

    In all, a comprehensive reserve policy is not just a document; it’s a commitment to fiscal prudence, transparency, and forward-thinking. By integrating Section 115 trusts into this framework, local governments can enhance their financial resilience, ensuring that they are well-equipped to navigate the challenges and uncertainties of the modern world.

  • As we navigate the complexities of the 21st century, the role of reserves in local government finance is undergoing a transformative shift. No longer just a safety net, reserves are evolving into dynamic tools that, when optimized, can drive fiscal stability, enhance public trust, and position governments for long-term success.

    The emergence of Section 115 trusts underscores this evolution. These trusts, designed to prefund specific liabilities, represent a fusion of tradition and innovation. They offer local governments a way to address the challenges of today while preparing for those of tomorrow.

    From their flexibility to their investment potential, they offer a plethora of benefits that local governments would do well to explore and integrate into their broader financial strategies.

    In closing, the future of reserves in local government finance is bright, marked by innovation, adaptability, and a commitment to long-term fiscal prudence. Section 115 trusts stand at the forefront of this evolution, offering a path forward that can chart a course towards a stable, prosperous, and resilient future.

About the Author

Charles Francis
Senior Consultant & Retired Municipal Finance Director

Charles is a local government finance expert who helps public agencies in pension and OPEB policy development. He provides local and state governments with real solutions – both short and long-term financial solvency, stability and fiscal resiliency.

Learn more about Charles and other members of the PARS team on our Who We Are page.