Loading...
HomeMy WebLinkAboutIR 9335INFORMAL REPORT TO CITY COUNCIL MEMBERS No. 9335 To the Mayor and Members of the City Council December 7, 2010 Page 1 of 1 • SUBJECT: PENSION UPDATE ■A r�Ts Pursuant to the Pension presentation that was made to the City Council on November 16th, staff asked the City's actuary to provide written responses for Council's consideration. Attached to this Informal Report you will find two memos from Doug Anderson, Area Vice President with Gallagher Benefit Services. If you have any questions, please contact Karen Montgomery, Assistant City Manager, at 817/392 -6222. Dale A. Fissel r, P.E. City Manager Attachments ISSUED BY THE CITY MANAGER FORT WORTH, TEXAS To: Karen Montgomery, Assistant City Manager From: Doug Anderson, EA, ASA, MAAA Subject: Actuarial Response to Pension Related Questions Date: December 2, 2010 The following are responses to questions related to potential changes to the Employees' Retirement Fund of the City of Fort Worth (ERF). What is the effect on the Fund if the investment return assumption is changed from 8.5% to 8.0 %? First it is important to distinguish the difference between the investment return assumption used to value liabilities (this is known as a discount rate) versus the assumption used to project assets. All of the projections shown to the City Council within the past year have compared liabilities that have been determined by discounting future benefit payments to the valuation date using an 8.5% discount rate. Whereas, the assets have been projected at various interest rates ranging from 6.0% to 10.0%. For example, when measuring the funded status in the year 2020, we are comparing the present value of benefit payments made after year 2020, discounted back to the year 2020 at 8.5 %, with assets that have been projected forward from year 2010 to 2020 at various interest rates. The consistent use of 8.5% to discount liabilities reflects that the Fund's assumed discount rate (currently 8.5 %) does not tend to change from year to year. On the other hand, the use of various rates to project assets reflects a range of opinions about future investment growth. When viewing projections based on an 8.5% discount rate for liabilities and assuming an 8.5% investment return on assets, the funded status if no benefit changes occur is expected to remain fairly constant at around 80 %. The funded status will not improve above approximately 80% due to the triggering of Ad Hoc COLAs. If the liabilities continue to be measured at an 8.5% discount rate, and assets are assumed to earn 8.0% instead of 8.5 %, the funded status is still expected to remain at approximately 80 %. Ad Hoc COLAs will continue to be triggered, but would not be as much as if the Fund earns 8.5 %. 'An H H! www gallagherhenefits r,om /minneapolis If ERF changes its assumed discount rate used to value liabilities from 8.5% to 8.0 %, it will increase the January 1, 2010 liability estimate by approximately $125 million. As a result, the Unfunded Liability, when measured on a market value basis, would increase from $717 million to about $842 million and the funded status would decrease from 69% to 65 %. Normally, the assumptions used to estimate defined benefit liabilities do not have any impact on the ultimate benefits paid from the plan. However, due to the unique Ad Hoc COLA provisions of the Fund, a change to a more conservative assumption may result in fewer Ad Hoc COLA payments. This is a rare case of assumptions actually having a direct impact on the benefits that will be paid from the Fund. The Fund will initially appear to be less well funded, but because the assumption is more conservative, there is greater opportunity for the funded status to improve. However, the funded status still could not improve beyond 80% due to the Ad Hoc COLA provision. Because it is more likely that this assumption change would delay the triggering of Ad Hoc COLAs, fewer Ad Hoc COLAs would be granted. Therefore, from the City's perspective, the more conservative assumption would be favorable as it helps to control the granting of additional benefits and provides greater opportunity for gains due to actual returns above the assumed rate. What are the current earnings of the Fund? The year to date earnings through October 31, 2010 reported on the ERF website is 8.37 %. The return so far in 2010 is consistent with the average return for the Fund from 1990 to 2010 which was 8.5 %. However, when measured on a compounded growth rate basis, the return for that period was closer to 7.5 %. The Fund becomes increasingly vulnerable when periods of low investment returns come before periods of high returns. In other words, the Fund can experience an average rate of return of 8.5% for an extended period. However, if the returns are not consistent or if low returns precede high returns, the funded status still could deteriorate. How has the RIF impacted the Fund's Liability? Based on data provided for 92 members affected by the RIF, the estimated reduction in accrued liability was approximately $4.3 million from $2,300.5 million to $2,296.2 million. After consideration of the reduction in employee contributions, the net reduction in the Annual Required Contribution (ARC) is approximately $600,000 per year from about $61,900,000 to $61,300,000. -2- What happens if all employees are included in benefit changes? If the proposed ERF benefit reductions are extended from General new hires to all future hires, and investment returns are 8.5 %, there will be little change in funded status because the additional benefit reductions for future hires will be offset by additional Ad hoc COLAs to eligible current retirees and eligible current employees when they are retired in the future. The funded status will remain in the 70% to 75% range. If the proposed ERF benefit reductions are extended from General new hires to all future hires, and investment returns are 7.0%, the funded status will continue to decline over the next 40 years. The pattern will be comparable to what is expected if there were no plan changes because reduced benefits will be offset by reduced contributions to the Fund (contributions would be reduced because of the change in compensation to exclude overtime). After about 40 years, when reduced benefit payments are applicable to the majority of plan participants (post 2010 hires) and starting to be paid, the funded status will level off around 30% and may start to improve after that. If the proposed ERF benefit reductions are extended to all current members (for future service only) and all new hires, and investment returns are 8.5 %, the fund will remain around 80% funded for a while because Ad hoc COLAs would be triggered at the highest levels (4 %). After about 20 to 30 years, as the number of current and future retirees that are eligible for the Ad Hoc COLAs declines, the funded status will start to improve and can increase beyond the 80% level. If the proposed ERF benefit reductions are extended to all current members (for future service only) and all new hires, and investment returns are 7.0 %, the fund is expected to remain around 60% funded indefinitely with no Ad Hoc COLAs being triggered. -3- To: Karen Montgomery, Assistant City Manager From: Doug Anderson, Gallagher Benefit Services Date: November 29, 2010 Subject: Funding Requirements for Public Sector Plans The purpose of this memo is to summarize the funding requirements for public sector plans, contrast them with requirements for private employer plans, and discuss funding implications if the Fort Worth Employees' Retirement Fund (ERF) is closed to new employees. Key points of this memo include: • Private employer plans have strict excise tax penalties for failing to make annual minimum funding requirements. Public sector plans have no minimum funding requirement or penalty applicable for failure to fund a recommended contribution. • Private employer plans must cease benefit accruals when the funding status drops below 60 %. There are no benefit restrictions applicable to poorly funded public sector plans. • Private employer plans that become insolvent are backed up by the Pension Benefit Guaranty Corporation (PBGC). There is no such backstop for public sector plans. • If ERF is closed to new participants, the GASB Annual Required Contribution (ARC) will change slightly. However, there is no immediate requirement that the City change their funding levels. • A public sector plan sponsor is not required to fund the ARC. They may choose to fund at any level that will ultimately be sufficient to cover the benefit payments. Funding Requirements for Private Employer Plans Private employer plans (meaning all non - governmental plans with the further exclusion of church plans) are subject to federal laws regulating minimum funding standards. The minimum funding standard generally consists of (1) the normal cost plus (2) an amount necessary to amortize the unfunded liability over 7 years. The minimum funding standards have changed often since the 70's. Current requirements are a result of the 2006 Pension Protection Act. A plan sponsor is required to meet the minimum funding standard each plan year. There are various opportunities to apply credits if previous years contributions exceed the minimum requirements or to use some funding relief allowed by recent law changes. However, plans generally must keep their funded status above 80 %. Failure to maintain an 80% funding status may subject the plan to benefit payment limitations. Plans less than 60% funded must cease benefit accruals for active participants. RIn(,,,,ngtnn MP,',`,4:1' www gal Iagherhenefits .00m /minneapolis The plan sponsor must report whether they have met the minimum funding requirement each year on a filing to the Department of Labor. If a plan sponsor fails to meet the minimum funding requirement, they must pay a 10% excise tax on the deficiency. If the deficiency is not corrected in a timely manner, the tax may be raised to 100 %. The tax may be waived if the employer can prove it would be a substantial business hardship. if a plan sponsor is unable to make contributions sufficient to meet liabilities, the Pension Benefit Guaranty Corporation (PBGC) will assume responsibility for the plan and ensure payments to the participants. The PBGC will seek to obtain as much funding as is possible from the plan sponsor. Generally speaking, this situation will occur when a company goes bankrupt. In the words of Joshua Gotbaum, the director of the PBGC, "in bankruptcy, the PBGC will say if you do terminate your pension plans, we are your creditors and we will not be shy about exercising our rights." Funding Requirements for Public Sector Plans Unlike private plans, there are no federal regulations setting forth minimum funding requirements. Governmental entities are left to their own discretion for establishing and following funding requirements. Often times, these are established by a Plan's board of trustees or by a pension committee. The annual actuarial valuation will then present a recommended contribution that reflects the established standard. However, there is no requirement that an entity make the recommended contribution. For accounting purposes only, the Governmental Accounting Standards Board (GASB) provides guidelines for the calculation of an Annual Required Contribution (ARC). The word "Required" is used in this context to refer to the amount needed to pay for the normal cost plus an amortization payment of the unfunded liability over no more than 30 years. Some plans will use the ARC as their recommended contribution for funding purposes, but there is no requirement for them to do so. The GASB ARC was developed to improve consistency in financial reporting and is not intended to serve as a minimum funding requirement. There is no penalty for failing to contribute the ARC. The consequence of failing to contribute the ARC is that a Net Pension Obligation must be reported on the sponsor's balance sheet. With no minimum funding requirement, it is possible for a public sector plan sponsor to fund less than the recommended contribution each year or to not fund the plan at all for many years. There are no penalties or benefit restrictions that kick in at lower funding levels. -2- Ultimately, a public sector plan may become insolvent. If that occurs, the plan sponsor (i.e. the City) would need to revert to a pay as you go approach to meet the retiree payments. For the City of Fort Worth, the transition from current funding levels to a pay as you go approach would approximately double the current rate of total contributions. Without doing any research on this matter, I suspect there are some smaller plans in this situation. I am not aware of this occurring for a major city in the United States. However, I believe that it may become likely within a short period of time as some cities are seeing insolvency in their 10 to 20 year forecasts. A city that fails to make payments that at least cover their retiree's benefit amounts is certain to face litigation from the participants. A public sector retiree must rely on the plan sponsor to provide funding for their benefit. The PBGC does not cover public sector plans. Funding Requirements if ERF is Closed to New Participants If ERF is closed to new participants, the GASB Annual Required Contribution (ARC) will change slightly. However, there is no requirement that the City change its funding methodology. If no new employees enter the plan, the ARC will continue to consist of the normal cost for remaining participants plus an amortization payment to reduce the Unfunded Actuarial Accrued Liability (UAAL). The UAAL amortization payment must be changed so that it is no longer determined using the assumption that total payroll will grow. This will change the amortization payment from one that increases over time at the assumed rate of total payroll growth to one that is a level dollar amount each year during the amortization period. This change will increase the amortization payment and thus increase the ARC. While the ARC for a closed plan would change, the plan sponsor is not required to fund the ARC. As a result, closing a plan does not require a plan sponsor to change their funding level or strategy. This means that if ERF is closed, the City may continue to fund the same dollar amounts that it was expecting to fund prior to the plan closing. In summary: 1. Closing ERF and starting a new plan for new hires will have an overall lower cost to the City in the long run. 2. The City could continue to fund ERF at the same dollar amounts that it was expecting to fund prior to the plan closing. It will just take longer to pay off the UAAL (i.e. 50 years instead of 30 years @ 8.5 %, for example). 3. The lack of strict funding requirements can give the City flexibility to fund both a closed plan and a new plan in any manner that ensures that benefit payments will ultimately be met. -3-