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HomeMy WebLinkAboutIR 9285INFORMAL REPORT TO CITY COUNCIL MEMBERS %g To the Mayor and Members of the City Council No. 9285 July 27, 2010 Page 1 of 1 SUBJECT: QUESTIONS AND ANSWERS ABOUT THE CITY'S UNFUNDED PENSION LIABILITY The purpose of this Informal Report is to provide City Council with some information prior to Tuesday's Pre - Council discussion on the City's unfunded pension liability. The information is in a question and answer format, and will be supplemented by a PowerPoint presentation on Tuesday. The questions originated from previous discussions with the City Council, the Audit & Finance Advisory Committee, and the City Managers Pension Ad hoc Committee. The answers were developed by the City's actuary, Doug Anderson, Area Vice President for Gallagher Benefit Services, Inc., in conjunction with City staff. Mr. Anderson will be present on Tuesday to provide additional information. If you have any questions about this IR, please contact Karen Montgomery, Assistant City Manager, at (817) 392 -6222. Dale A. Fisse er, P.E. City Manager Attachment ISSUED BY THE CITY MANAGER FORT WORTH, TEXAS 01 Frequently Asked Pension - related Questions Answers by: Gallagher Benefit Services, Inc. City of Fort Worth staff As of July 22, 2010 1. Q: What options are available to address the unfunded pension liability? A: There are three ways to improve the funded status of the plan, (1) increase contributions, either from the City or the employees; (2) consistently earn a rate of return greater than 8.5 %; and (3) reduce future benefits. Some combination of these can also improve the funded status of the plan. Impact of Different Investment Returns 2. Q: What investment return would be needed to improve the funded status? A: The Fund would need to earn 10% per year on a consistent basis for 15 years to improve its funded status to be 85% funded. However, once the Fund reaches a funded status of 85 %, Ad Hoc COLAs are triggered. So continued returns of 10% would be offset by Ad Hoc COLA increases, and the Fund would stay only about 90% funded (i.e. it would never be fully funded at 100 %). 3. Q: What happens if the earnings in the Fund do not exceed 8.5 %? A: If the Fund consistently earns 8.5% per year, the funded status will slowly deteriorate and the Fund would become insolvent in about 70 years, without any additional changes in contributions or benefits. If the Fund's returns are less than 8.5 %, the additional contributions and /or benefit changes will be needed much earlier to avoid insolvency. For example, a consistent return of 7.5% will result in the Fund's insolvency before the year 2050. 4. Q: Can the Fund actually go "insolvent" and if not, why do we keep using that term? A: For these discussions, the term insolvency reflects the point in time when there are no more assets to pay the benefits, yet the earned benefits would still have to be paid. Therefore, all of the legal obligation for the benefits would become the City's responsibility. Use of the term "insolvent" is an indicator of the direction the Fund is headed, without additional measures taken to change contributions and /or benefits. It is similar to the 5 year forecast of the General -1- Fund which illustrates that sustainable budget solutions are needed in order to avoid eroding reserves, and ultimately having a negative fund balance. 5. Q: What happens if the Fund returns are not consistent from year to year? A: Earnings volatility has an adverse impact on total investment returns. For example, the average return for the Fund from 1990 to 2010 was about 8.5 %. However, when measured on a compounded annual growth rate basis, the return was closer to 7.5 %. The Fund becomes increasingly vulnerable when periods of low investment returns precede 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. Impact of Different Contribution Rates 6. Q: What contribution rate is necessary to improve the funded status? A: Any increased contributions are helpful towards improving the funded status. If all other assumptions are met, an additional 2% per year contribution would be needed for 40 years to get the plan to 80°x6 funded. An additional 4% per year would reach this level by about 2035. An additional 6% would get the Fund there by about 2025. 7. Q: Would these examples of increased contributions ever get the fund to 100% funded? A: No. Once the funded ratio reaches about 85 %, Ad HOC Colas become effective, and the funding ratio stops increasing. Thus a decision to increase contribution rates has a direct impact on the timing of Ad hoc COLAs. A higher sustained contribution rate will trigger additional benefits earlier than if there is not contribution change. 8. Q: What level of contribution is needed to keep the funded status at its current level? A: There are many contribution patterns that would achieve this goal. For example, if the contribution is increased 2% in 2011, another 2% in 2012, another 2% in 2013 (for a total increase of 6% from the current level), and then reverts back to its current level, the funded ratio would stay fairly constant at about 70% for about 50 years (assuming all other assumptions are met). 9. Q: What contribution level is needed to eliminate the unfunded liability in 30 years? A: The current total contribution level would need to increase about 7% per year for about 30 years. If all actuarial assumptions are met, the unfunded liability would be gone and the AML remaining City contribution rate would be about 9 %. -2- 10. Q: Why would the City contribution rate drop to about 9% after the unfunded liability is paid off? A: Because there would no longer be a portion of the contribution rate needed to pay off the unfunded liability. So, the only remaining cost is the cost to provide benefits for active employees as they are earned. Currently, that is approximately 17°x, of which the employees pay about 8% and the City pays about 9 %. 11. Q: How can we determine the impact of other possible contribution changes or see the results under different rates of investment return? A: A projection model has been created that can demonstrate the impact of different rates of return and contribution rates on the Fund's Annual Required Contribution (ARC), the Unfunded Actuarial Accrued Liability (UAAL), and the Funded Ratio. This model will be available on Tuesday to demonstrate various scenarios if desired. Potential Benefit Options 12. Q: What options are available to change benefits for new hires? A: One option is that new hires could continue to enter the Fund, at either current or reduced benefit levels. Alternatively, the City could set up a Defined Contribution (DC) Plan for new hires. 13. Q: Why do Defined Contribution Plans appeal to employers? A: The most attractive feature of a Defined Contribution (DC) Plan is usually the ability to have a fixed contribution rate. Once the contribution is made to an employee's account, the City has fulfilled its retirement benefit obligation. There is no Unfunded Liability associated with a DC plan. The City's cost is simply the contribution to the employee's account. 14. Q: How does a DC Plan work? A: A DC plan would require that the employee contribute a percentage of his or her pay, and that the City contribute a percentage of that pay as well. The City contribution would likely match or slightly exceed the employee's contribution. The contribution would go into individually maintained employee accounts. The employees would be responsible for the investment selections and therefore, would bear the risk of investment returns on their accounts. The account balance would be paid at retirement or could be transferred to another -3- qualified plan upon an employee's termination (i.e. it's portable, subject to any vesting requirements in the City's contributions). 15. Q. How does Social Security factor into the contribution rate? A. Since the City does not participate in Social Security, we believe the City's contribution rate would have to be equivalent to the non - medicare portion of the Social Security rate at a minimum, which is 6.2 %. And the City may want to consider purchasing a disability plan for those employees in the DC Plan. 16. Q: How could a DC Plan be implemented? A: The City could establish a new DC Plan and require new hires to enter. Non - vested Members could either continue in the ERF, be required to enter the new DC Plan, or be given an option to choose which plan they want to be in. 17. Q: If a non - vested Member transfers from ERF to a DC Plan, what happens to their ERF benefit? A: There may be several options, but most likely, the value of their contributions plus interest would be allowed to transfer to the DC plan. 18. Q: How many employees would be affected? A: As of January 1, 2010, there were 1,613 General, 375 Police, and 169 Fire non - vested Members. 19. Q: How would a DC Plan affect the funding for the ERF? A: If the City continues it's current contribution rate of 15.97 %, the ERF funded status would deteriorate rapidly and the Fund would be insolvent by about 2040. At that time, the unfunded liability would be approaching $5 billion. 20. Q: Why would the ERF funded status deteriorate so rapidly? A: The change to a DC Plan does not eliminate or change the current unfunded liability. What would change, is the level of contribution to the Fund from both future employees and from the City on behalf of future employees. A significant portion of this contribution rate is committed to reducing the unfunded liability. If that portion of the contribution is no longer made to ERF, the unfunded liability will rise significantly. 21. Q: Could the City contribute more than 15.97% per employee and less than 15.97% to a DC Plan benefit? -4- A: Yes. The contributions to the two plans do not need to be similar and probably should not be similar. The reason the Annual Required Contribution (ARC) for the Fund is so high is due to the cost of the benefits combined with the cost to reduce the unfunded liability. Therefore, the contribution rate to ERF will likely need to be much higher than the contribution to the DC plan, but this increase could be partially offset by the City choosing to contribute less than 15.97% to the DC Plan. Benefit Changes within ERF 22. Q: What benefit changes may be made to ERF Members? A: The ability to change benefits is not entirely clear for certain groups of employees. Many believe that retiree benefits may not be changed. While that is true in part, for vested members, it is only the benefits earned to date that may not be changed. But future benefits may be reduced, which would simply require a formula taking the change into account. This will be illustrated in Tuesday's presentation. 23. Q: What types of changes are possible? A: Possible changes include changing the formula or the components of pay that are used to calculate the retirement benefit amount, or changing the eligibility date for when benefits may be paid. Generally speaking, benefit changes would need to be fairly significant, and apply to a large group of employees to have an impact on lowering the unfunded liability. 24. Q: What impact does the Ad Hoc COLA have on the funded ratio? A: The Ad Hoc COLA is not currently reflected in the unfunded liability since it is not expected to be granted under the current contribution rate and current actuarial assumptions. However, if the funded status improves, for any reason, Ad Hoc COLAs may be granted and the ERF liability will increase and the funding status will drop. The Governmental Accounting Standards Board (GASB) is currently looking at this issue to see if Ad Hoc COLA's which are consistently granted should, in fact, be reflected in the liability. -5-