FEBRUARY 26, 2005 EMPLOYEE PENSION PLAN FEBRUARY 26, 2005 EMPLOYEE PENSION PLAN

TO: HONORABLE MAYOR & CITY COUNCIL

FROM: CITY MANAGER

DATE: FEBRUARY 26, 2005

SUBJECT: EMPLOYEE PENSION PLAN

RECOMMENDATION:

Delay any decision on revising the current City employees’ pension plan pending decisions on the proposed legislation by Governor Schwarzenegger, Assemblyman Richman and the Jarvis Taxpayer Association regarding changes to the State public employees pension plan law.

BACKGROUND:

Mayor Clark and Mayor Pro Tem Wolowicz have asked staff to present a defined contribution pension plan to replace the existing defined benefit plan now offered to our employees.

The City’s full-time employees participate in the CalPERS defined benefit retirement system. The City’s contract with PERS provides our employees with the 2% at 55 plan based on the highest one year of salary. To calculate the employee’s approximate pension the formula is:

# of years of service x 2% x highest year salary

For a 55-year-old retiring employee with 30 years of service and a salary of $50,000, the initial annual pension would be about $30,000. For the remainder of the employee’s life he/she would receive an annual benefit that is adjusted annually based on a COLA index. The employee may also purchase a survivor benefit by taking a reduced pension.

Historically the plan was designed to require a 14% contribution rate, based upon the sum of a 7% employer contribution and a 7% employee contribution. The employee contribution rate remains constant at 7% while the employer contribution fluctuates based on annual actuarial studies. Over the years most local agencies, including Rancho Palos Verdes, have negotiated agreements with their employees in which the employer pays the entire cost of the pension program. For the past ten years the cost of the program has varied significantly based on the CalPERS investment results. A summary of costs to the City of Rancho Palos Verdes for the ten-year period is shown below.

Fiscal Year

Employer Contribution

Employee Contribution

Total City Contribution

Total Cost to City

1994-95

0.00%

0.00%

0.00%

0

1995-96

2.26%

7.00%

9.16%

$145,319

1996-97

2.29%

7.00%

9.29%

$198,056

1997-98

4.26%

7.00%

11.26%

$236,063

1998-99

0.00%

6.14%

6.14%

$126,780

1999-00

0.00%

6.42%

6.42%

$135,001

2000-01

0.00%

6.40%

6.40%

$133,460

2001-02

0.00%

5.90%

5.90%

$144,783

2002-03

0.00%

5.76%

5.76%

$167,423

2003-04

2.78%

7.00%

9.78%

$267,684

2004-05

8.54%

7.00%

15.54%

$428,821

2005-06

12.45%

7.00%

19.45%

$558,350

2006-07

12.80%

7.00%

19.80%

$591,073

Note: The years after 2004-05 are estimated.

When the investments of the retirement system performed better than was projected over an extended period of time (as in the period 1990-2000), the employer’s subsequent contributions were reduced; but when the investments did not perform as well as expected (as in the 2000-2002 period), the employer’s contributions were increased. CalPERS current actuarials are based on a 7.75% return on investment. Since 1929, and until 2000, CalPERS never had less than a 4½ % return on its investments. However, during the recent stock market drop (2000-2002) CalPERS lost 35% of its fund.

The City’s FY 04-05 Budget was based upon a contribution rate of 15% (8% employer and 7% employee). Based upon information recently provided by CalPERS, the City’s contribution rate is projected to be 19.5% and 19.8% for FY 05-06 and FY 06-07, respectively. The FY 2004-05 cost of the PERS program to the City is about 3% of the General Fund budget and will increase to about 4% next year.

DISCUSSION:

Defined Benefit vs. Defined Contribution Pension Plans

There are generally two types of pension programs that are provided by employers for their employees, defined contribution pensions and defined benefit pensions. Defined contribution pension programs permit employees to contribute a portion of their salaries to a special account for their future retirement. In some cases these employee contributions are matched by employer contributions. An employer commits to paying the employee a specific benefit for life beginning at his or her retirement.  Contributions to a defined benefit plan are based on a computation of what is needed to provide determinable benefits to each plan participant.  Actuarial assumptions and computations are required to calculate these contributions.  The specific benefit, committed to by the employer, is provided to each plan participant regardless of plan portfolio performance.  Market risk is borne by the employer. Defined benefit programs provide employees with clearly stated retirement benefits that may vary depending on the employee's age at retirement and length of service to that employer. These benefits are paid to the retired employee from the time of retirement as long as the employee, or in some cases the employee's surviving spouse, lives. The average PERS member retires after 20 years of service with a pension of $1,592/month.

Defined contribution pension programs offer employees the opportunity to enjoy the rewards of a successful investment strategy, but employees bear the entire risk of any investment strategies that are not as successful as planned, as some people discovered over the past several years. Benefits to the employee are not guaranteed and are determined by the amount contributed and portfolio performance.  The Defined Contribution is deposited into an individual account for each plan participant.  If the individual account does not perform well, the employee's benefit will decrease.  Market risk is borne by the employee. Defined benefit plans do not offer the potential for the employees to enjoy the extra benefits of an investment strategy that outperforms expectations, but employees covered by defined benefit programs do not bear any risk from an investment strategy that does not perform as expected.

State Employee Retirement Programs
Each year the Board of Administration for CalPERS determines the total amount that must be paid by the State and by State employees in each retirement category. When CalPERS makes these determinations, the "normal cost" (actuarial cost of future benefits), as well as the unfunded liability charges for each retirement category are projected. The Board of Administration determines the combined rate (as a percentage of salaries) employees and the State (or local agency) will pay for each retirement category. The employees' contributions to CalPERS are based on fixed percentages that do not vary when the total amount due to CalPERS increases or decreases. On the other hand, the rate paid by the State, and ultimately the taxpayers, changes each year after the Board of Administration determines the normal cost and unfunded liability costs. This methodology for adjusting contributions to the PERS program each year avoids catastrophic "underfunding" problems such as the recent well-publicized City of San Diego situation. The City of San Diego manages their own pension fund, as do many large cities and counties in California.

Currently the CalPERS Board is working on a program of "rate stabilization." Under this program there would never be a year when agencies would have a contribution "holiday" such as occurred in fiscal years 1995,1999, 2000, 2001, 2002 and 2003. The result of enjoying reduced rates in years when investment returns soar is increased rates when the market turns down. In addition, the new PERS rates will be designed to "ramp" up or down gradually as the investment portfolio either exceeds or fails to meet a rate of return goal.


Governor’s Plan

There are at least three proposals for revising State pension plans. The most publicized plan comes from the governor’s office. Under Governor Schwarzenegger’s plan, starting in the budget year, employees will be expected to pay one-half of the total charges approved by the CalPERS Board of Administration, including both the charges for normal costs and the charges for any unfunded liability. This will cause both the employees and the taxpayers (through the State as the employer) to share the future benefits and risks associated with variances in future benefit costs, and future investment returns. New employees would be offered a "defined contribution" plan.

This new method of funding the State’s defined benefit pension plans will be phased in as collective bargaining agreements are renegotiated. The State is also proposing to permit State employees to opt out of CalPERS, in which case the State will share the savings by paying the employee an extra stipend equal to 50 percent of the normal retirement cost for that employee.

The two options being proposed for State employees will permit employees to decide how valuable a defined benefit retirement program is as they look to the future, and spread the risks associated with defined benefit programs across all employees who determine that it is a valuable benefit. The combined General Fund savings from the changes is estimated, by the Governor’s office, to be $296 million in 2005-06.

ACA 5 (Richman)

Assemblyman Keith Richman has introduced a constitutional amendment that would require that new state and local government employees (beginning in 2007) be provided a "defined contribution" pension package - a 401 (k) self-directed savings package - in lieu of the "defined benefit" pension currently available to virtually all public sector employees working in federal, state and local governments.

Jarvis Plan

The Howard Jarvis Taxpayers Association has submitted a proposal to the State Attorney General in the form of a statewide ballot initiative. The proposal is similar to the Richman plan. The Attorney General is expected to issue a title and summary for the measure by mid to late February clearing the way for signature gathering to start to qualify the measure for the ballot.

Analysis of the Plans

Comments and further descriptions of each of the plans described above are included as attachments to this report. Also included is a response from CalPERS regarding the merits of the current plan over the proposed Governor’s plan and the Richman and Jarvis plans.

This report to the City Council is intended to be as objective as possible and not advocate one plan over another. However, it may be premature for the City Council to begin the implementation of a new pension plan for City employees until the legislature, or the voters, make their choice. A matrix comparing the various new plans is provided below. Note that the Governor’s plan retains a "defined" benefit option for current employees who wish to share the cost of the plan. Based on the current contribution to PERS, the Governor’s plan would cost the State employee who wished to remain in PERS about 10% of his/her salary. It is not clear how current local government employees would fare under the Richman or Jarvis plans.

 

HIGHLIGHTS

EFFECTIVE DATE

CURRENT EMPLOYEES

ISSUES

GOVERNOR’S PLAN

All current State employees would pay ½ of PERS cost.

A Constitutional Amendment would prohibit "defined benefit" plans for new public employees.

New budget year.

May opt out of PERS in favor of a cash stipend equal to the State share of PERS cost or remain in the PERS defined benefit plan be contributing 50% of the cost of the plan.

Union Contracts.

Constitutional Amendment on November ballot.

FICA issues, if contributions to a retirement plan are less than 7½ %.

 

RICHMAN (ACA 5)

New State and local employees would no longer have the option of a "defined benefit" plan.

Employees would be eligible for a 457(K) plan with a limited (by law) employer contribution

July 1, 2007

Not clear, but may be no impact on employees who are covered under PERS prior to July 1, 2007 and do not change employers.

Constitutional Amendment required.

FICA issues, if contributions to a retirement plan are less than 7½%.

JARVIS PLAN

Similar to Richman Plan, but would limit employer contributions to 6% of employee pay with an equal match by the employee if employer match exceeds 3%.

July 1, 2007

Not clear, but may be no impact on employees who are covered under PERS prior to July 1, 2007 and do not change employers.

Ballot initiative must be approved by voters.

FICA issues, if contributions to a plan are less than 7½%.

Alternatives for Council Consideration

Mayor Clark and Mayor Pro Tem Wolowicz have suggested that the City Council consider a "two tiered" plan similar to that proposed by Governor Schwarzenegger. After consultation with CalPERS staff it was determined that new legislation would be required in order to facilitate the Governor’s plan or the Clark/Wolowicz plan. There are, however, some other pension options that the City Council could implement without a change in legislation in order to reduce the cost of employee pension plans.

Option

Description

Potential Savings to City

Issues

Cancel current contract with CalPERS

The City may choose to terminate its contract with CalPERS and develop a private defined contribution plan for employees.

The projected FY 2005-06 contribution to CalPERS is over $500,000

It will take approximately one-year to complete the process for withdrawal from PERS.

Require employees to contribute to the cost of the current PERS plan.

The City may require employees to contribute up to 7% of the cost of the current plan.

Savings in FY 2005-06 could be as much as $200,000 if employees contribute a full 7%.

The City does not have to revise its contract with CalPERS to implement this option.

Establish a separate CalPERS pension plan for new hires.

The City could contract for a 2% @ 60 pension plan utilizing an average of the highest 3 years salary and reduce the survivor benefit.

Cost savings would have to be determined by an actuarial study performed by CalPERS

It may take up to a year to complete the process for the new plan.

Contribute a fixed amount to the existing PERS plan each year rather than accommodate the fluctuations inherent in the current PERS annual rate calculations.

The City may create its own employee pension account by contributing 14% of employee salaries each year to a separate interest-bearing fund. When PERS rates are low the fund would build up. When rates are high the fund would bear the cost of the higher rate.

A 14% annual contribution over the past ten years would have borne the cost of the City’s PERS contract through the high rate years PERS is now experiencing.

The risk of an extended economic decline may require a contribution greater than 14%.

Notes:

Employers do not have to join the FICA program as long as the employer plus employee contributions to a pension plan total at least 7½ % of the employee salary.

The alternatives listed above could have serious negative impacts on current employees compensation plans. If the Council decides to further study one of these alternatives a more comprehensive study of the plan and the impacts on the City, its current employees and its future employees should be undertaken.

Comparison with Other Cities

Attached are the results of a survey of pension plans offered by other South Bay cities for comparison purposes. The Cities of Carson and Hawthorne offer their employees an "enhanced" PERS plan that provides 3% @ 60. In other words, an employee with 30 years of service could retire at age 60 with 90% of salary. Rolling Hills has a 2% @ 60 plan that offers employees with 30 years of services retirement at age 60 at 60% of salary. The other eleven South Bay cities, including Rancho Palos Verdes, all offer their employees the 2% @ 55 PERS plan that provides a 55 year old employee with 30 years of service retirement with 60% of salary. El Segundo, Redondo Beach, Torrance and Rolling Hills all participate in the Social Security program that requires a 6.2% contribution from both the employer and the employee up to a maximum of $5,580 each. No South Bay city requires their employees to contribute to their PERS pension plan. Rolling Hills Estates, Hermosa Beach, El Segundo and Torrance offer employer contributions to employee 457(K) plans in addition to participating in PERS.

CONCLUSION

It seems likely that there will be a new public employees’ pension law by the end of the year. Unless the Council wants to terminate its current contract with CalPERS or require employee contributions toward the present PERS plan, waiting for the results of the proposed legislative changes may be the best course. Additionally, if significant changes are proposed to current employee compensation plans, it would seem fair to give current employees adequate time to find other employment if they choose to do so.

Respectfully Submitted,

Les Evans

City Manager

Attachment: Survey of South Bay Cities

Governor’s Pension Reform Plan

Assemblyman Richman’s Pension Reform Plan

Jarvis Pension Reform Plan

CalPERS Response to Pension Reform