REPORT TO COUNCIL
SUBJECT
Title
Authorization to Establish a Pension Trust Fund, Authorize the City Manager to Negotiate and Execute an Agreement with PFM Asset Management, LLC, and U.S. Bank National Association for the Sunnyvale Post-Employment Pension and Retiree Healthcare Benefits Program, Authorize the City Manager or his/her designee to serve as the Benefits Administrator, and Adopt an Investment Policy Statement for the Pension Trust Fund
Report
BACKGROUND
The City of Sunnyvale provides pension benefits to eligible employees through the California Public Employees’ Retirement System (CalPERS). Pensions are funded through a combination of contributions from both employees and the City, with a majority of the cost being paid by the City.
Over the past ten years, the City’s required payments to CalPERS for pensions have increased dramatically, rising approximately 65% from $24 million per year to $40 million per year. These increases have been caused by a variety of factors that include investment losses at CalPERS, benefit enhancements by the City, and strategies by CalPERS to stabilize the agency’s ability to ensure future benefits are funded.
Sunnyvale has had a strong tradition of taking actions to address its long-term pension costs and liabilities. Strategies included carrying a Pension Uncertainty Reserve to address pension cost volatility, closing the amortization period on a significant portion of the City’s unfunded liabilities, and making additional one time payments to pay down the unfunded liability.
On December 6, 2016, the City Council considered the creation of a Pension Trust Fund during a study session, which represents an additional new strategy to stabilize the City’s pension expense. On May 19, 2017, during the Budget Workshop for the FY 2017/18 Recommended Budget, the City Council provided feedback to City staff to move forward with the creation of a Pension Trust Fund.
EXISTING POLICY
Fiscal Sub-Element E.2.6 An Actuarial Retiree Medical Reserve will be maintained at a level that is deemed adequate to meet projected liabilities as determined by an actuarial evaluation. This reserve should meet financial reporting requirements for these future costs.
DISCUSSION
Currently, the City’s only option for committing additional funds in-excess of its annual required contributions to reduce its CalPERS unfunded pension liability is limited to sending excess contributions to CalPERS. Establishing a separate trust to “pre-fund” the CalPERS unfunded liability would provide the City with an alternative that will allow for investment by a separate professional fund management team selected and monitored by the City, with future excess contributions transferred to CalPERS at the City’s discretion.
Expected benefits offered by a separate pension trust include 1) increased investment diversification of the City’s retirement contributions through additional and different asset management, 2) oversight and control of fund management selection, monitoring of performance and ability to replace fund management based on performance criteria, 3) increased flexibility on use of trust assets as a budget stabilization tool, and 4) potential for positive rating agency and investor consideration.
The City currently has an Other Post-Employment Benefit (OPEB) Retiree Medical Trust with PFM Asset Management, LLC serving as the fund manager and U.S. National Bank Association serving as the trustee. As part of the Sunnyvale Retiree Healthcare Plan Report approved by the City Council on December 12, 2017, the financial statements and independent audit report through June 30, 2017 reported assets of $83 million compared to a liability of $166.7 million retiree healthcare liability. This represented a funding ratio of 49.7%. Updated for performance through December 31, 2017, since the inception of the trust in February 2011, the fund on average has returned 7.88% annually compared to a blended policy benchmark of 7.16%. The total market value of the OPEB Retiree Medical Trust is approximately $92 million.
In February 2018, the City received preliminary actuarial information from the City’s Actuary, Bartel Associates, LLC. Based on the June 30, 2017 valuation, the CalPERS Miscellaneous unfunded pension liability totaled $175.3 million with a funding ratio of approximately 68%. The CalPERS Safety unfunded pension liability totaled $180.4 million with a funding ratio of approximately 65%.
Based on the City’s experience with the OPEB Retiree Medical Trust, and a review of other single employer options available, staff recommends establishing a Pension Trust Fund and executing a trust agreement that incorporates the Pension Trust with the OPEB Retiree Medical Trust currently under management with PFM Asset Management, LLC and U.S. National Bank Association as the trustee. Below is a brief summary of the roles and responsibilities of each of the three parties:
The City (Employer):
- Fund the Trust.
- Determine the amount of benefits to be paid into and out of the assets of the Trust.
- Appoint an accounting firm to audit the Trust annually.
U.S. National Bank Association (Trustee):
- Maintain sole custody of cash, securities, and other assets of the Trust.
- Execute investment transactions at the written direction of the Trust Administrator.
- Keep accurate and detailed records of all investments, receipts, disbursements, and all other transactions and provide this information to the Trust Administrator and Employer on a quarterly basis.
PFM Asset Management, LLC (Investment Advisor):
- Maintain exclusive authority and responsibility for the investment of Trust assets in permitted investments.
- Reassess and alter, if necessary, the asset allocation of the Trust annually to maintain the established asset allocation ratios.
- Report on performance quarterly.
Trust Agreement
The Post-Employment Benefits Trust Agreement between the City, U.S. Bank, and PFM Asset Management is provided as Attachment 1. This agreement outlines the administration of the trust, the structure, and the fees associated with the trust.
Investment Policy Statement for City of Sunnyvale Pension Trust
A draft Investment Policy Statement for the Pension Trust Fund is included as Attachment 2 and is also Exhibit C to the Trust Agreement. This statement is modeled after the current adopted Investment Policy Statement for OPEB, recently approved by the City Council on October 3, 2017. This Statement serves as a guideline for investment strategy for managing all Trust assets, including investment time horizon, risk tolerance ranges, and asset allocations, controls risk and liquidity, and establishes periodic performance requirements. It should be noted that the Statement encourages investments that support environmentally and socially responsible investments.
115 Trust Structure and Legal Opinion
The City received an Internal Revenue Service (IRS) tax determination for the OPEB Retiree Medical Trust upon establishment in 2010. While similar 115 Trust structures are being used to fund future OPEB-specific benefits, it appears there are few precedents established for the use of the trust structure as a pension funding trust. In January 2018, the IRS ceased the issuance of private letter rulings for 115 Trust (IRS Circular 2018-3, Section 3.01 (21), (22)). As the issuance of a private letter ruling is no longer an option, the City Attorney asked Pillsbury Winthrop Shaw Pittman LLP, outside counsel retained to provide advice on the establishment of the Trust, to provide the City with an opinion letter that the 115 Trust structure is appropriate for both pension and OPEB uses. A copy of the opinion letter is attached as Attachment 3.
Benefits Administrator
Pursuant to the Post-Employment Benefits Trust Agreement the Benefit Administrator has the exclusive authority and responsibility to determine the amount of OPEB Obligations or Pension Obligations to be paid out of the assets of the Trust. It is recommended that the City Council authorize the City Manager or his/her designee to serve as the Benefits Administrator,
ENVIRONMENTAL REVIEW
The action being considered does not constitute a "project" with the meaning of the California Environmental Quality Act ("CEQA") pursuant to CEQA Guidelines section 15378 (b) (4) in that is a fiscal activity that does not involve any commitment to any specific project which may result in a potential significant impact on the environment.
FISCAL IMPACT
Based on current OPEB Trust Fund balances, custody account fees and expenses paid to U.S. National Bank Association as the trustee total approximately $25,000 per year based upon current assets under the OPEB Trust. Investment management fees paid to PFM Asset Management, LLC under the current agreement total approximately $230,000 annually. Investment management administrative fees total 0.28% for assets under management up to $50 million and 0.20% above $50 million. Under the management fee structure, any new funds deposited into the new Pension Trust would be charged administrative fees at 0.20%, combining assets from the current OPEB Trust.
In parallel with the establishment of the Pension Trust Fund, City staff is working with the City’s consulting actuary and will recommend initial and annual contributions as part of the FY 2018/19 Recommended Budget, as well as propose a funding policy (as an amendment to the City Council’s fiscal policies) which may include annual funding as well as opportunities to provide one-time funding (e.g., from annual operating savings).
PUBLIC CONTACT
Public contact was made by posting the Council agenda on the City's official-notice bulletin board outside City Hall, at the Sunnyvale Senior Center, Community Center and Department of Public Safety; and by making the agenda and report available at the Sunnyvale Public Library, the Office of the City Clerk and on the City's website.
ALTERNATIVES
1) Authorization to Establish a Pension Trust Fund, 2) Authorize the City Manager to Negotiate and Execute a Post-Employment Benefits Trust Agreement with PFM Asset Management, LLC, and U.S. Bank National Association for the Sunnyvale Post-Employment Pension and Retiree Healthcare Benefits Program in substantially the same form as Attachment 1 to the report, 3) Authorize the City Manager or his/her designee to serve as the Benefits Administrator, and 4) Adopt an Investment Policy Statement for the Pension Trust Fund in substantially the same form as Attachment 2 to the report
2) Do not authorize the establishment of a Pension Trust Fund and do not take any of the associated actions regarding the Pension Trust Fund.
RECOMMENDATION
Recommendation
Alternative 1: 1) Approve a Pension Trust Fund, 2) Authorize the City Manager to Negotiate and Execute an Agreement with PFM Asset Management, LLC, and U.S. Bank National Association for the Sunnyvale Post-Employment Pension and Retiree Healthcare Benefits Program in substantially the same form as Attachment 1 to the report, 3) Authorize the City Manager or his/her designee to serve as the Benefits Administrator, and 4) Adopt an Investment Policy Statement for the Pension Trust Fund in substantially the same form as Attachment 2 to the report
Staff
Prepared by: Kenn Lee, Assistant Director of Finance
Reviewed by: Timothy J. Kirby, Director of Finance
Reviewed by: Teri Silva, Assistant City Manager
Approved by: Kent Steffens, City Manager
ATTACHMENTS
1. Draft Trust Agreement between the City of Sunnyvale, U.S. Bank national Association and PFM Asset Management LLC
a. Exhibit A: Investment Advisory Agreement
b. Exhibit B: Fee Schedule for Trustee
c. Exhibit C: Investment Policy Statement
2. Investment Policy Statement for City of Sunnyvale Pension Trust
3. Pillsbury Winthrop Shaw Pittman LLP 115 Trust Legal Opinion