City Manager's Blog

Understanding the Town’s Long-Term Liabilities

Capital Projects

Capital projects represent the Town’s largest “single-project” expenses. The Town maintains a “save-spend” philosophy with respect to public projects and expenses. The Town accumulates funds within the Capital Improvement Budget to fund large-scale capital infrastructure projects. Borrowing funds is not a part of the Town’s budget philosophy.

Specific funding for the Town’s Capital Improvement Plan comes various sources all of which have specific and targeted eligibility requirements for projects.

• Parcel Tax (approx. $740,000 per year at the current rate)
• Measure A (approx. $250,000 per year)
• Measure M (approx. $75,000 per year)
• Surface Transportation Program (varies year to year by formula, in FY 13/14 - $350,000)
• ABAG Grants (varies, FY 13/14 - $7,500)
• Gas Tax Funds (formulaic allocation, approx. $200,000 per year)
• Atherton Channel Fund (approx. $80,000 per year)

Expenditures for FY 13/14 Capital Improvements total $2.1 million with revenue coming in at approximately $1.7 million. The difference comes from “saved” funds year to year. While the Town could certainly do more capital projects in any given year, the Town moderates the amount of capital improvements done in any given fiscal year depending on available resources. With a “save-spend” philosophy, the Town does not have any established long-term debt for capital projects.

That said, one way to evaluate long-term liabilities is in terms of the financial outlay required to “maintain and improve” the Town’s capital infrastructure. From this perspective, the Town has identified long-term capital improvement needs to enhance accessibility and safety throughout the community. These areas of improvement include bridges, roadways, buildings, vegetation, utilities, pathways, drainage, and transportation (pedestrian, bicycle, and vehicular). While these improvements do not represent current “debt” they do represent long-term liabilities that the Town must address over time. In any given year, if the Town’s high-priority capital improvements do not have sufficient funding sources, the Town must “augment” the capital improvement fund with a subsidy from the Town’s General Fund or General Fund reserves depending on the size of the capital project.

To assist with the identification of long-term liabilities with respect to capital infrastructure, the Town develops a 5-Year Capital Improvement Plan with revenue and expenditure projections. The 5-Year Plan includes the “high-priority” projects that the Town needs to address within the coming 5 years. There are additional projects that could be included but are either lower priority due to need or are lower priority due to funding.

At this time, within the Town’s 5-Year Capital Improvement Plan (FY 13/14 – FY 17/18) there are no necessary contributions identified as coming from the Town’s General Fund to subsidize capital projects.

Pension Benefits

An explanation of the Town’s long-term liabilities for its pension obligations first entails an explanation of the Town’s pension benefits that it provides to its employees.

The Town provides its employees with a defined benefit pension program through the California Public Employees Retirement System (CalPERS). The Town does not provide Social Security benefits or enrollment beyond basic Medicare. For employees working for the Town of Atherton, employment does not represent “qualifying quarters” for the purposes of obtaining Social Security.

A defined benefit plan is a type of employer-sponsored retirement plan. In a defined benefit plan, the amount of retirement an employee is eligible to receive is determined according to a formula based on age at retirement, years of service, and compensation. Under the CalPERS defined benefit plans, the employer and the employee are responsible for making contributions to the plan. Much like under Social Security, there is an employer and employee cost. For non-safety employees, the employee share is 7% and the employer share is approximately 11.5% (compared to 6.2% for social security only - not including any employer contribution to a 401K or other plan). For local safety, the employee share is 9% and the employer share is approximately 27.7%.

In contrast, a defined contribution plan is a retirement plan, again with responsibilities of both employer and employee with respect to financial contributions to the plan; but the benefits received by the employee after retirement are determined solely by the amount of contributions made to the plan and any returns from investments on the contributions. Typically, there are employer-matching contributions and a cap on the amount an employee can contribute to the plan during the course of a calendar year.  The employer may match that amount or at least contribute a fixed percentage of that capped amount. . For these plans, the employer pays the match in addition to social security. For example, if an employer provided a 401K plan with a 3-5% match, the employer cost would be 6.2% for Social Security and another 3-5% for the 401K plan. That is commensurate with the local non-safety plan. There are no private sector comparisons for public safety plans as there are no private sector comparisons for the role itself.

The State Legislature started CalPERS in 1932 via State law as a retirement system for State employees. In 1939, other public agencies were allowed to contract with CalPERS for retirement benefits. Of the 478 cities in California, over 450 contract with CalPERS for benefits. In addition to cities, CalPERS has 1,029 Special Districts & Other Public Agencies, and 36 Counties. The sheer size of the CalPERS benefit pool allows CalPERS to capitalize on more substantial investment strategies by aggregating employer and employee contributions. For fiscal year 2011/2012, CalPERS received $3,598,437,000 in employee contributions and $7,772,913,000 in employer contributions.  The market value of the CalPERS portfolio as of December 31, 2012 was $248.8 billion.

Public or private, a pension program serves two objectives for any agency: 1) it induces individuals to enter and continue service within the system; and 2) provides subsistence to retired individuals that have performed their obligations under the employment contract. A retirement system provided by any agency for its employees enables that agency to attract and retain high quality personnel and encourages those individuals to continue in service with that agency. 

Specific Benefit Plans

The CalPERS retirement system provides several levels of retirement benefit plans. An agency selects and contracts with CalPERS for a designated retirement plan for its employees. Upon retirement, the plan provides the employee with a specified percentage of pay based on retirement age, compensation, and length of service. Because the CalPERS plan is portable only amongst member agencies, the length of employment is cumulative within the entire system. The CalPERS retirement plan is not portable outside of participating agencies. Each agency is only responsible for the years of service of the employee within that particular agency at that particular agency’s plan formula. 

For local government, CalPERS retirement plans are divided between employees defined as “local miscellaneous” and employees defined as local safety (fire and police). The benefit formulas are calculated the same, but the benefit rates are different. 

For local miscellaneous, CalPERS historically offered five (5) different levels of retirement benefit. This has changed under AB340 and CalPERS now only offers three (3). All plans have a minimum-vesting requirement of five (5) years and employees become eligible to draw a retirement under the plans at age 50 – albeit at a significantly reduced rate. For identification purposes, the names of the different levels of retirement plan indicate what percentage is received at a mid-level age range. For example, the plan “2% at 62” indicates that the benefit rate is 2% if the member retires at age 62. The public safety plans for police and fire are similar, although because of the physical demands and risks involved in the positions, the plans encourage an earlier retirement from service. This is largely due to the assumption that with increased age there are often physical limitations that prevent an employee from meeting the full service demands of the job. At that point, there is likely more risk for both the employee and the employer that there will be a disability or workers’ compensation claim or worse, loss of life to the employee or the public.

Basic plans are:

The majority of the Town’s existing local miscellaneous staff are under the pre-AB340 plan, 2% at 55. The rate table for this plan looks as follows:

As new employees are hired they are moved into the AB340 plans. When an employee retires, the retirement benefit is calculated via a formula using years of service credit (with each agency at that agency’s formula plan), age at retirement, and a 3-year average of compensation.

Excluding the City Manager, there are 14 local miscellaneous employees ranging from Office Specialist to Finance Director. The median salary of an Atherton local miscellaneous employee is approximately $77,314 per year. The median is used here for representative purposes as the Town has limited staff and a couple of director level positions that skew the average disproportionately. The average years of service for current local miscellaneous staff is approximately 5 years and the average age is 43. To calculate a basic benefit, let’s assume that the preceding employee stays with the Town until they retire at age 60 (another 17 years). For ease of calculation let’s assume that the pay rate remains about the same (22 years of service to Atherton, age 60, and the salary as stated). The retirement benefit that the Town would be responsible for equates to $77,314 per year times 2.262% times 22 years of service = $38,475.  For the years of service with the Town of Atherton, the retired employee would receive a monthly retirement benefit of $3,206 – less a deduction for healthcare costs since the Town no longer provides this benefit into retirement for new staff employees – the basic monthly rate for employee-only Kaiser is $743 – making the monthly retirement allowance $2,463 or $29,559 per year.

As discussed, local miscellaneous and public safety are similar in the methods of calculation, but differ in the percentage associated with each.  For public safety, the benefit plan is 3% at age 50 and beyond (no table required) with a 90% of salary cap.

This results in the same calculation. The median salary of an Atherton public safety employee is approximately $101,628 per year. Again, the median is used here for representative purposes as the Lieutenant and Chief positions would skew the average disproportionately. Presently, the average years of service for current safety staff is 9 years and the median age is 41. To calculate a basic benefit, let’s assume that the preceding employee stays with the Town and retires at age 55 (another 14 years). For ease of calculation let’s assume that the pay rate remains about the same (23 years of service to Atherton, age 55, and the salary as stated).  The retirement benefit would be $101,628 per year times 3% times 23 years of service = $70,123. The retired employee would receive a monthly retirement benefit of $5,844 – less a deduction for healthcare costs since the Town no longer provides this benefit into retirement for new employees – the basic monthly rate for employee-only Kaiser again being $743 – making the monthly retirement allowance $5,101 or $61,207 per year.

Those are examples of the costs and benefits related to Atherton alone for an average employee’s retirement when retiring from Atherton and CalPERS concurrently. The Town does not participate in social security and in order to earn retirement benefits through social security the employee must work 40 qualifying quarters (10 years). In addition, the calculation does not take into account the inflationary costs of health insurance or salary but balances that out as a static salary calculation against a rise in healthcare cost. That balance may or not be real but is intended here only for ease of calculation. Lastly, the retirement amount does not take into account any separate employee contributions toward a 457 deferred compensation plan or separate individual retirement account(s).

As explained earlier, because of the sheer size of the CalPERS plans and member agencies, the benefit is portable from agency to agency. An employee may work for multiple agencies prior to reaching an actual financially feasible retirement age (far beyond the teaser benefit rate at age 55). Each agency for which the employee works throughout their career is responsible in the long-term for their share of the retirement benefits applicable to their service retirees. Actuaries take on the hard task of calculating the amounts attributable to each agency based on employee census data and assumptions. Each employee receives an “Annual Member Statement” identifying their total CalPERS service credit with all agencies in the system (only PERS agencies and only PERSable service – i.e. not hourly or non-PERS agencies). As an example, my 2013 Member Statement would show the following:

Upon a potential retirement at age 60 (14 years from now), the City of La Mirada would be responsible for 6.105 years of service credit toward my retirement. Theoretically, while employed with the City of La Mirada, the City and I both paid toward my retirement in an amount calculated by the actuaries (given assumptions for investment returns, demographics, life-span, age, etc.) sufficient to cover the City’s share upon my retirement date 14 years into my future today and 27 years from my last employment with La Mirada. 

As an aside, none of the above listed agencies participate in Social Security as the PERS pension system is a qualifying IRS alternative – none of my last 20.324 years of service are qualifying quarters in order to receive a Social Security benefit because each agency choose not to participate in Social Security. My last qualifying quarter for social security benefits was in 1992 right before I entered full-time employment with a local government. Because the pension system is an IRS alternative and the cities chose not to participate in Social Security, upon retirement, if I were at any time to qualify for social security, Federal law requires those benefits to be reduced by an amount equal to two-thirds of my pension and could be reduced to zero.

Summary data for CalPERS as of June 2012 shows the average monthly service retirement allowance for all CalPERS retirees was $2,420 or $29,040 per year. The average age at service retirement for all members was 60. 

Actuary Reports and Underfunded Liabilities

Every year the Town receives an actuary report for both the local miscellaneous and safety retirement plans.  The most recent reports are available on the Town’s website in the Archive Center.

The actuarial reports are required and provide the Town with the Employer Contribution Rates for the retirement plans for the upcoming fiscal year(s) and set for the employer’s side fund amount (i.e. their outstanding liability with respect to their plan). The actuary’s reports are plan-specific for each CalPERS agency and calculate that agency’s annual required contributions (ARC). The actuarial (and the Town’s Audited Financial Statements) are all completed in compliance with Governmental Accounting Standards Board rules.  The Pension System Actuarial Reports, Town Audited Financial Statements, Staff Salary & Benefit Resolutions, and the Town’s Annual Budgets are all available via the Town’s website in the Archive Center.

The Governmental Accounting Standards Board (GASB) is the independent organization that establishes and improves standards of accounting and financial reporting for federal, state and local governments. Accounting and financial reporting standards designed specifically for the government environment are essential because governments are fundamentally different from for-profit businesses. GASB is the official source of generally accepted accounting principles (GAAP) for state and local governments. GASB establishes the reporting requirements for pension trust funds through GASB Rule 25, 26, & 27. 

When determining the ARC for an employer, the actuarial calculates the employer’s net normal cost (the amount required to be contributed for current employees), plus or minus any costs for special benefit classes, plus the amortization of any payments to the employer side fund (the outstanding underfunded liability – more on that later). Numerous assumptions are made in determining costs that causes fluctuation in the annual employer rate. To help “smooth out” employer rates and combat rate volatility, CalPERS has adopted rate stabilization formulas that assist in smoothing out an employer’s costs over time. Because actuarial calculations are based on a number of assumptions about very long term demographic and economic behavior, without the smoothing, rates could be extremely volatile year to year with significant effect on a Town’s ability to budget – given that assumptions year to year are almost never actually exactly realized. 

For example, actuarial assumptions for Atherton’s local miscellaneous plan include the following:

• A 7.5% compounded annual rate of investment return.
• Annual salary growth of 3.30% to 14.20% based on entry age, category, and duration of services (different for all ages, job categories, and predicted duration of employment).
• Overall payroll growth of 3.00% compounded annually.
• Inflation of 2.75% compounded annually.
• Standard and agency specific demographic assumptions for pre-retirement mortality, post-retirement mortality (male and female), marital status, age of spouse, terminated member statistics, length of service, pre-vesting termination, vested termination, non-industrial disability, and industrial disability.

Beyond the actuarial assumptions used to create the net employer cost, CalPERS places the Town into a “risk pool” to calculate a net cost for the difference between the funded status of the pool and the funded status of Atherton’s specific plan. The fund is credited annually with the actual actuarial investment return and is amortized across a funding horizon so that it is paid down over time. The amortization amount is added to the employer’s net normal cost to make up the entire ARC necessary each year. 

For example, the June 30, 2011 Actuarial Report for local miscellaneous employees had the following projected for FY 13/14:

A similar calculation is done for the local safety plan. The contribution to the “Amortization of Side Fund” is based on a stated funding horizon and serves to reduce the Town’s underfunded liability. 

As of June 2011, the balances in the Town’s side funds were:

To address the side funds and reduce the Town’s long-term financial debt the City Council opted to pay off both the local miscellaneous and local safety side fund balances – both have been paid as of June 2013. As a result, the Town’s ARCs have been reduced to 11.104% and 27.877%, respectively.

The Town no longer has pension liability beyond the Annual Required Contribution. However, there remains debate about the viability of CalPERS’ investment rates of return and any adjustments in the assumption, as noted above, will have a direct impact on the Town’s contribution requirements.

CalPERS is evaluating options for modifying the expected rate of investment return from its present 7.5% to 7.25%. The Town’s Finance Committee has been tasked with evaluating exactly what the Town’s downside risk is in relation to CalPERS’ investments and investment strategies. It is hoped that by identifying this downside risk, the Town can contribute to an internal “side fund” that can be used to weather significant fluctuations in the ARCs or used to pay-down any future created liabilities. That approach is just one of many the Committee may consider.

Other Post-Employment Retirement Benefits

Some agencies have offered a benefit to their staff of the payment of all or a portion of health benefits into retirement. In years past, these future liabilities were calculated on a “pay as you go” basis – meaning that the agency paid the cost each year and did not have to calculate the future cost of benefits as an item on their financial statements. GASB Rule 45 changed that methodology and requires agencies to recognize the long-term financial liability on their financial statements.

Atherton conducted an actuarial to comply with the requirements of GASB Rule 45 and identified that future liability. In prior years, the Town provided for the payment of healthcare premiums into retirement for its retiring staff. With the most recently adopted Salary and Benefit Resolution for non-safety staff, the Town has stopped this practice and now pays only the State-required minimum contribution. If the retiree chooses to participate in the retiree healthcare program, the retiree must pay the healthcare premium. This modification applies to all new employees. The Town is adopting this same philosophy for all employee classifications.

However, the damage has already been done with respect to the Town’s long-term liability for post-employment retirement benefits. The Town must account for the present and future cost of post-employment retirement benefits for those employees that are already retired and those that remain eligible for the benefit. It is important to note existing employees that are eligible for the benefit must retire from CalPERS and the Town concurrently in order to receive the benefit. This is important because as articulated earlier, the median age of Town local miscellaneous staff is 43 with a median service of 5 years. Most employees eligible for this benefit have to continue with the Town for a significant period of time in order to receive this benefit. For many, this potential benefit may never be obtained. Nevertheless, the Town must account for the liability as if it would be attained.

There are two components to the long-term liability. The first is the long-term liability already on the books for existing retirees receiving the benefit. The second component is the long-term liability identified for future retirees. The actuary calculates the amount of this current and future liability as $6.6 million (about $5.9 million of that number is for current retirees). The Town’s annual cost is calculated based on an Annual Required Contribution (ARC), an amount actuarially determined in accordance with GASB Rule 45. The ARC represents a level of funding that, if paid on an ongoing basis, is projected to cover the normal cost each year and amortize any unfunded actuarial liabilities (or funding excess) over a period not to exceed 30 years. The Town’s ARC is approximately $582,000. This amount is based on a 25 year remaining funding horizon. As mentioned earlier, there are benefits for paying down and/or paying off this liability earlier, to include a reduction in the Town’s ARC. The Finance Committee has been tasked with providing the City Council with options in this regard.

Summary

For large agencies, the underfunded actuarial liabilities can be astronomical and daunting.  For Atherton they are manageable and being reduced each year. In reality, it is unlikely that an employee just starting their career in Atherton would retire from Atherton.  For many, Atherton is a stepping-stone in their career path. Staff that are younger in their career are more likely to see Atherton as a training venue for larger organizations that they perceive would give them more career promotional opportunity.  Nonetheless, Atherton seeks to attract skilled, competent, and experienced staff and we believe we have done so.

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For more information feel free to contact me at (650) 752-0504 or via email at grodericks@ci.atherton.ca.us.