Town Pensions Information

Introduction

The following informational items provide an overview of pension and unfunded liability issues, including additional links for further exploration.  The Town of Los Gatos is committed to providing information access and transparency on these and other issues.  The community is encouraged to sign up for “Notify Me” to subscribe to the items of interest (such as upcoming Town Council, Council Finance Committee, and other Commission meetings):  www.losgatosca.gov/list.aspx.

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 You can find information on the following pension related areas below:

 Town of Los Gatos Retirement Plans

The Town of Los Gatos provides a defined benefit pension plan for all full-time employees as part of their total compensation package.  Defined benefit plans provide a fixed, pre-established benefit payment for employees in retirement based on a formula which takes into account an employee’s years of service and highest average annual salary.  The defined benefit pension has been a standard part of compensation in governmental organizations and in Los Gatos is in lieu of participating in Social Security.

The Town’s pension plans are administered by the Board of Administration of the California Public Employees’ Retirement System (CalPERS).  The Board of Administration is responsible for the management and control of CalPERS.  In addition, the Board has exclusive control of the administration and investment of funds.  Sworn employees are covered under the Safety Plan which is a pooled plan, while all other employees are covered in the Miscellaneous Plan, which is a separate plan.  The Miscellaneous Plan is administered by CalPERS in the Public Employees’ Retirement Fund (PERF).

For more information on CalPERS and PERF, please refer to: https://www.calpers.ca.gov/page/home

https://www.calpers.ca.gov/docs/forms-publications/facts-pension-retirement.pdf

For more information about the pension and other benefits offered to Town employees, see:

https://ca-losgatos2.civicplus.com/DocumentCenter/View/18949

Calculating the Town’s Pension Obligation

In order for the Town to understand the value of future pension benefit payments, an actuarial valuation is performed each year.  The CalPERS actuary estimates the payments that will be made for all potential retirees from the plan in each future year.  The actuary calculates the present value of future benefits the plan will be required to pay to its current participants: those still working who will retire in the future, retirees, and those who have terminated employment but have not yet begun drawing benefits.  

Although an estimate, considering these payments as a certain stream of future cash flows is helpful to understand the pension obligation.  Expressing the value of this future series of payments as a single amount on a specific date annually is useful for several purposes, including financial statement preparation, annual funding decisions, and regulatory compliance.  This single amount is referred to as the Actuarial Accrued Liability (AAL) and is an estimate of the present value of the benefit obligation.  To calculate the present value of the obligation, the actuary uses a discount rate which is the interest rate used to bring future cash flows to the present to account for the time value of money.

The 2016 Annual Valuation for the Miscellaneous Plan calculated an AAL of $94.6 million for Los Gatos.

The 2016 Annual Valuation for the Safety Plan calculated an AAL of $79.8 million for Los Gatos.

For more information on the Town’s actuarial valuations and pension obligation, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

What is the Discount Rate?

As previously noted, the discount rate is the long-term interest rate used in determining funding for future pension benefits.  The discount rate is also known as the assumed rate of return because it is what CalPERS expects its investments to earn during the fiscal year.  State and local government plans, multiemployer plans, and some private sector plans not subject to the Pension Protection Act funding rules commonly use expected return-based methods.  Using an expected return-based method, a discount rate is selected by looking at the asset allocation of the pension plan investment portfolio and estimating the average return the portfolio is expected to produce during the time period in which benefits are paid.

CalPERS is currently in the process of lowering the discount rate from 7.375% to 7.00% over the course of the next three years.

For more information regarding CalPERS discount rate and asset allocation, see:

https://www.calpers.ca.gov/docs/forms-publications/facts-investment-pension-funding.pdf

For more information on the expected-return based method, see:                  https://www.actuary.org/content/measuring-pension-obligations-0

How does the Town Fund the Pension Plan?       

 Once the Town knows the current value of the benefit obligation, the Town can budget accordingly to accumulate the appropriate amount of assets to meet that obligation.  The obligations are prefunded to account for the benefits that accrue over the lifetime of an employee.  Assets for defined pension plans are accumulated in three ways: employee contributions, employer contributions, and investment gains.  

Basic Retirement Funding Equation:

C + I = B + E

(Left Side = Right Side)

                                         • C = Contributions (employer and employee)

                                         • I  = Investment Income

                                         • B = Benefits Paid

                                         • E = Expenses (administrative)

Town employees contribute a percentage of their salary in what’s referred to as the normal cost.  The normal cost is the annual cost of service accrual for active employees and can be viewed as the cost of benefits earned by employees in the current year.  The second source of funding is provided by employer contributions.  The employer normal cost rates for all cities/towns in CalPERS are established annually.  These rates are the minimum contractual obligations the Town must pay, and are also applied as a percentage of salaries. The balance of the funding is earnings from the investment of CalPERS assets in stocks, bonds, real estate, and other investment vehicles.  According to CalPERS, every dollar paid out of the fund is shared in the approximate ratio of employers (26 cents), employees (13 cents), and investment earnings (61 cents).

The 2016 Annual Valuation for the Miscellaneous Plan calculated a Market Value of Assets (MVA) of $64.5 million for Los Gatos.

The 2016 Annual Valuation for the Safety Plan calculated a Market Value of Assets (MVA) pool share of $58.1 million for Los Gatos.

For more information about the Town and employee contribution rates see:

https://ca-losgatos2.civicplus.com/DocumentCenter/View/18949

For more information regarding CalPERS investments, assets, and earnings, see:

https://www.calpers.ca.gov/docs/forms-publications/facts-investment-pension-funding.pdf

For more information on the Town’s actuarial valuations and pension assets, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

What is the Unfunded Accrued Liability?

The Unfunded Accrued Liability (UAL) obligation represents the market value of the assets minus the discounted value of the future liabilities.  When a plan or pool’s Market Value of Assets is less than the Actuarial Accrued Liability, the difference is the plan or pool’s UAL.  An unfunded liability results in the Town paying contributions in excess of the normal cost or the employer Unfunded Accrued Liability (UAL) annual contribution amount.  The UAL is amortized over a period of time based on CalPERS amortization policies.  The Town’s annual UAL contribution payment calculated by CalPERS is designed to pay down the UAL principal and interest over that amortization period (currently 30 years).

The 2016 Annual Valuation for the Miscellaneous Plan calculated a UAL of $30.1 million for Los Gatos ($94.6 M of AAL minus $64.5 M of Market Value).

The 2016 Annual Valuation for the Safety Plan calculated a UAL of $21.7 million for Los Gatos.

For more information on the Town’s UAL and amortization, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

What Caused this Unfunded Obligation?

The UAL is an annual actuarial estimate based on a series of complex economic and demographic assumptions associated with the pension plan’s membership.  Demographic assumptions include mortality rates, retirement rates, and employment termination rates among others.  Economic assumptions include future investment earnings, inflation, and salary growth rates.  The development of a UAL typically results from unfavorable investment returns, changes in actuarial assumptions, unfavorable demographic shifts, and other experiences that differ from those anticipated by the annual actuarial assumptions.  

The Town’s plans over the past several decades, like all other CalPERS participants, have experienced unfavorable investment returns, changes in actuarial assumptions, and unfavorable demographic shifts which have outweighed any positive plan experiences.  The table below illustrates the historic investment returns for three years, five years, ten years, twenty years, and since inception.

1

As the CalPERS chart below illustrates, over the last several decades pension plans have shifted their asset allocations toward greater equity and other asset class exposures as risk free rates of return (10 Year Treasury) steadily declined.  However, the greater volatility associated with equities was evident during the 2001 and 2007 recessions as market declines impacted pension plan funding. The subsequent pension plan investment losses from those two recessions are still a contributing factor to the Towns current UAL.

2

In addition, the CalPERS chart below illustrates how the significant asset class gains since the last recession are reducing future expectations for asset class returns.  In 2014 CalPERS estimated from their capital market assumptions that the asset allocation would yield 7.1% over the course of the next decade.  Two years later (2016), that same exercise resulted in CalPERS only forecasting that the asset allocation would yield 6.2% over the course of the next decade.  Those reduced estimates of future investment returns and other factors have led CalPERS to lower the assumed rate of return for the asset allocation.

3


The following data from the Town’s 2016 actuarial valuations help illustrate the sensitivity of changes in the discount rate to the UAL.

4

For more information on the Town’s UAL and sensitivity to changes in the discount rate, see:

http://www.losgatosca.gov/1861/CalPERS-Actuarial-Valuation-Reports

For more information on CalPERS decision to lower discount rates, view:

https://www.youtube.com/watch?v=oeokuypi7Ko

What has the Town Done to Address the Unfunded Obligation?

The Town prudently recognized the potential impacts to future service delivery if unfunded pension liabilities were not addressed and additional funding strategies not identified.  To date, the Town has taken proactive steps totaling $22.8 million of additional discretionary spending to address the current unfunded obligation.

In addition to the aforementioned strategies, the Town has also taken steps to change benefits or introduce new benefits which provide the Town with ongoing savings. To date these actions have resulted in $290,000 of ongoing annual savings.

5


6

What More Can the Town Do?

The Town Council Finance Committee is reviewing a staff recommendation to reduce the current CalPERS 30-year amortization of the unfunded pension obligation to a 20-year payment plan.  That is the equivalent of paying off a mortgage 10 years earlier.  This action alone could save the Town approximately $9.0 million in interest costs over the 20 year period by committing approximately $14.0 million in additional contributions than required by the current 30 year amortization. 

pension chart

Current and Archived Reports