Pension costs are expected to increase by about $670,000 next year. Strategies to address presented to the City Council in February 2023, including the issuance of pension obligation bonds. Additional information about pensions can be found immediately following this letter.
PENSIONS
The City of Laguna Beach has contracted with the California Public Employee Retirement System (CalPERS) for pension benefits since 1945. The City has approximately 298 active and 406 retired employees (members) enrolled in the pension plan. In these plans, members earn service credit towards a lifetime retirement allowance after employment (defined benefit), calculated under a formula that accounts for the employee’s years of credited service, the employee’s “final compensation,” and age at retirement. For example, with 30 years of service, a “3 at 50” safety pension formula provides 90% of final compensation at age 50, and a “2.5 at 55” non-safety pension formula with 30 years of service provides 75% of final compensation at age 55. The CalPERS Board of Administration has absolute authority and fiduciary responsibility to ensure the System’s integrity, the investment of monies, and the overall administration of CalPERS.
An unfunded liability for pension benefits generally exists when the value of all projected benefits payable to members exceeds the projected value of assets available to pay those benefits. The amount can change over time due to changes in benefits, pay levels, demographics, actuarial assumptions, and return on investments. State and local governments, including Laguna Beach, typically reduce their unfunded liability over time as part of their annual required pension contributions.
Risk pooling was implemented by CalPERS effective with June 30, 2003, actuarial valuations to protect small employers (those with less than 100 active members in the plan) against large fluctuations in employer contribution rates caused by unexpected demographic events. Costs are allocated to Pooled plans on the actual increases or decreases to the individual plans. It is the policy of CalPERS to ensure equity within the risk pools by allocating the pool’s experience gains/losses and assumption changes in a manner that treats each employer equitably and maintains benefit security for the members of the System while minimizing substantial variations in employer contributions. If an agency voluntarily or involuntarily terminates its contract with CalPERS, the agency member benefits are adjusted in proportion to the amount the employer can pay, and the plan is moved into a Terminated Agency Pool. This mechanism is designed to protect other agencies by eliminating the unfunded liabilities of employers who cannot, or will not, pay pension obligations.
Several events have contributed to the increase in unfunded liabilities for agencies in the CalPERS system. In 1999, Senate Bill 400 (SB400) passed overwhelmingly permitting more generous pension benefits to employees, both prospectively and retroactively. CalPERS also incurred negative investment returns due to the “dotcom” bubble in 2000 and again in 2008 during the great recession. On December 21, 2016, based on the expectation of lower investment return rates over the next decade, the CalPERS Board voted to lower the discount rate (investment rate of return) from the current 7.5% to 7% over three years. The impact on the City’s budget is an increase in the normal cost by 1% to 3% as a percentage of payroll for the miscellaneous plan and 2% to 5% increase for safety plans. Additionally, the City is expected to experience a 30% to 40% increase in its required unfunded liability payment. These increases are phased in over five years, beginning, and were expected to add approximately $3.0 million to the budget by FY 2024-25.
City Council Actions to Address Pension Costs.
The Unfunded Accrued Liability (UAL) for Laguna Beach as of June 30, 2021 (the most recent information available) for all CalPERS pension plans is $51.2 million. This includes Police Safety of $17.4 million, Fire Safety of $14.4 million, Lifeguard Safety of $1.4 million, and Miscellaneous plan of $18.0 million. The City’s plans are currently 84.1% funded. The City is contractually obligated to enroll all full-time employees in theCalPERS system with few exceptions. If the City Council wanted to offer an alternative pension plan, CalPERS would require the City to terminate its contract at the cost of over $500 million, which is financially prohibitive.
Over the past ten years, the City Council has been proactive in addressing the City’s unfunded pension liability. In 2010, the City Council approved borrowing funds internally to pay off its $10 million CalPERS “Side Fund” for Police, Fire, and Lifeguard safety plans. In 2013, the City Council approved higher employee contributions ranging from 8% to 12% of their salary. In 2014, the City Council approved a strategy to pay approximately $10 million over five years to accelerate the City’s unfunded pension liability payoff. These strategies are expected to save the City $31 million over thirty years and significantly reduce the City’s unfunded liability over time. This is in addition to the State’s pension reform (PEPRA) legislation. CalPERS requires higher contribution rates toward unfunded liability and reduced retirement benefits for new employees intended to completely resolve the CalPERS unfunded liability (including Laguna Beach) in about twenty years.
In 2022, the City Council evaluated the opportunity to issue Pension Obligation Bonds to pay off the City’s unfunded liability. The City Council elected not to pursue this opportunity due to rising interest rates and unfavorable market conditions. There is some concerning news. Recently, CalPERS earned a -6.1% net return on investments for the 12 months ended June 30, 2022. This brings the total fund performance to an average investment return of 6.7% for five years, 7.7% for a 10-year period, and 6.9% for a 20-year period.
City of Laguna Beach Page 12/13 of 276 Adopted Budget.
For more on City Pension Costs, click here