DISCUSSION
The intent of the City of Garden Grove Pension Funding Policy (the Policy) is to establish a formal methodology for financing the current and future pension liabilities. The purpose of the methodology is to ensure that current assets plus future contributions from both employees and employer, as well as investment earnings will be sufficient to finance all defined pension obligations provided in the City’s plan documents. The Policy is intended to reflect a reasonable and fiscally conservative approach with intergenerational equity.
Following the best practices for sustaining defined benefit pension plans, the Policy requires paying down unfunded liability or stabilizing future contribution rates, considering full pension costs when making hiring decisions, applying Actuarially Determined Contribution (ADC) as the basis for annual contribution, contributing 100% of the ADC, and prohibiting any pension benefit increases until funded status reaches 100%.
The 2018 League Study provided six options for California cities to address the growing unfunded pension liability, including:
1. Pay down unfunded liability by shortening amortization period or contributing additional funds above the ADC.
Staff observation:
Under this option, the City would contribute funds directly to CalPERS. All additional contributions would be subject to the same investment strategies applicable to existing plan assets. Therefore, funds contributed to CalPERS could not be applied to future ADC’s.
2. Consider local ballot measures to enhance revenues.
Staff observation:
Voter approved the passage of Measure O in November 2018.
3. Create a Pension Rate Stabilization Program by establishing an IRC Section 115 Trust Fund.
Staff observation:
IRC Section 115 Trusts are irrevocable trust accounts that can be used by local governments to fund pension contributions and liabilities. Recent statistics show that over 150 cities and counties use IRC Section 115 Trust as a rate stabilization vehicle.
Trustee of the IRC Section 115 Trust is not CalPERS, the investment of trust assets are not subject to CalPERS investment policies and thus diversifies the investment. The funds in the trust can only be used for pension related costs. The City would retain full control over the funds, subject to investment options offered by trustee. Funds could be used to offset spikes in employer contributions, making this a desirable option for the City.
4. Change service delivery methods and levels of certain public services.
Staff observation:
The City has contracted certain services and reduced the levels of some services in past years to battle a structural deficit. This approach would contradict the City Council’s goal to maintain and enhance our service levels on critical services such as public safety.
5. Use procedures and transparent bargaining to increase employee pension contributions.
Staff observation:
The City has negotiated with certain bargaining groups and increased employee contributions in the past.
6. Issue Pension Obligation Bonds (POB).
Staff observation:
This approach is not recommended as it only delays and compounds the financial impact of unfunded pension liability. Financial experts including the GFOA strongly discourage local agencies from issuing POB’s.
The proposed Policy does not preclude any of the six options discussed above. However, in comparing all six options, Option 3, creating a pension rate stabilization program by establishing an IRC Section 115 Trust Fund is more desirable, as it commits the City to allocate additional funding to reduce its pension liability, yet provides flexibility for smoothing out the required employer contribution when significant rate increase occurs. This option also allows diversification on investment thus reduces the risk due to market fluctuation. In order to implement the pension rate stabilization program through IRC Section 115 Trust, direction is needed on plan funding.
Effective Fiscal Year 2019-20, the City started pre-paying its annual Unfunded Actuarial Liability (UAL). This is an option provided by CalPERS. By prepaying the UAL, cash flow savings can be realized. Based on the June 30, 2017 CalPERS actuarial valuation, cash flow savings for the Miscellaneous Plan is $256,092, and $417,067 for the City’s Safety Plan, with a total of $673,159 for Fiscal Year 2019-20. Staff is recommending investing these funds into the respective plans through IRC Section 115 Trust. Staff also recommends the City commit a certain percentage of the General Fund surplus each year to be invested in pension pay down or rate stabilization. Staff will bring a General Fund Reserve Policy to the City Council for consideration in December 2019, the reserve policy will discuss the possible additional contribution towards unfunded pension liability from the General Fund’s operating surplus.