Pension Costs The Everchanging Landscape

NHA Advisors’ Pension Group has historically identified important information on the financial impacts of CalPERS (PERS) changes when, in our view, it warrants consideration by all California public agencies. In 2015, NHA Advisors alerted local government to PERS’s change in treatment of “side-fund” amortization base payoffs. In 2017, NHA Advisors alerted public agencies to the 3-year phased discount reduction and developed financial models capable of projecting the cash flow impact to our public agency clients. Potentially one of the largest public agency financial challenges of this decade, pension liabilities are quickly consuming both financial and human resources. Public agencies continue to turn to NHA Advisors to proactively address the cost of rising PERS contributions. As the 2020-21 budget cycle begins in a few months, now is the time to consider investigating options and alternatives to address the PERS impacts and plan for the long-term future.

Some of the critical steps that can help manage the messaging and financial impact of pension costs are:

1. Properly educating stakeholders and strategically evaluating cost management and alternative repayment strategies;
2. Leveraging the new interactive tools that PERS is now making available to agencies and;
3. Carefully addressing and mitigating the risks inherent in any creative unfunded accrued liability (UAL) restructuring option, such as a pension obligation bond.

Pension liabilities are one of the most complex financial components for a public agency. How did we get here? Whose fault is this? What have we done to address the problem? What is a UAL? Why is our repayment shape so steep and un-even? Can we get out of PERS? If GFOA doesn’t recommend pension bonds, why are other public agencies issuing them?

These are just a few of the typical questions NHA Advisors answers for our clients. Public agencies should consider using proactive workshops to methodically educate key stakeholders (whether it is staff, councilmembers, bargaining unit representatives or outside stakeholders) to create an atmosphere of transparency that lays the foundation for productive budgeting, capital planning and labor negotiations.

Translating the complexities of PERS actuarial reports into understandable material builds trust and helps create a better understanding of the impact pension liabilities have on the public agency’s financial condition. Utilizing clear graphics and defining key terms early in the education process helps build mutual understanding of important “actuarial jargon” and reduces confusion. NHA Advisors developed the NHA Summary Pension Report in 2018 (excerpted page from report depicted to the right) that provides a third-party analysis and simplified explanation for the impact of PERS costs. This report has been well received by many of our public agency clients and we are excited to prepare the new 2019/20 version starting in late November/early December of 2019. The customized and concise (generally 10 page) report, analyzes 8 years’ worth of PERS actuarial reports, using clear graphics on cost trends, funding ratios, projected costs and cost management strategies. NHA Summary Pension Reports are economical, can typically be delivered in 2-3 weeks, and are often great material for the budget process, public education, new council members and outside stakeholders. For an example of a recent sample
report, please contact Mike Meyer at Pensions@NHAadvisors.com.

Up until the last few years, most of the older PERS-generated annual reports lacked some crucial information for proper financial forecasting. For a while, the “peaking” UAL repayment schedules were not included in the actuarial reports and would require complex analysis to calculate the projections. The new PERS reports and tools are more efficient and user-friendly. Now, 30-year UAL repayment schedules are clearly shown in the report as well as projected payments under a Fresh Start payment option.

Since 2018, PERS has also offered a helpful Excel tool called the Additional Discretionary Payment (ADP)Spreadsheet (excerpted page from spreadsheet depicted to the right). This tool breaks down each individual amortization base repayment schedule and is interactive, allowing a user to understand the impact of an ADP on future payments, as well as how the Normal Cost, UAL, and associated payments (and % of payroll) would change based on additional discount rate reductions from CalPERS.The ADP Spreadsheet is helpful for budgeting under various scenarios, as well as determining which amortization base has the greatest impact on future contributions. To request this ADP Spreadsheet from PERS, please contact your assigned PERS actuary.

In 2019, PERS also began offering their Section 115 Trust option comparable to the 3rd party administrator programs currently available. Also expected to be released in early 2020 from PERS, a new tool named “Pension Outlook”, accessible through the MyCalPERS client portal of the PERS website. We understand that this tool will allow for long-term projection modeling.

In the 1990s and 2000s, pension bonds were widely used across the nation. Pension bonds began falling out of favor after the bankruptcy judges for Stockton and San Bernardino placed PERS contributions in a priority position to pension bond payments. Additional negative sentiment arose with the GFOA position of discouraging the use of pension bonds to arbitrage the pension liability. Over the last few years, pension bonds and other types of UAL restructuring tools (internal loans, lease revenue bonds, private placements, utility revenue bonds) have re-emerged. What changed?

Historically low interest rates, increasing market receptivity, and new “payment smoothing” techniques have all contributed to a re-emergence. As a fiduciary advisor, NHA views the ability to “re-shape” one’s payments to help enhance budget predictability and fiscal sustainability as more prudent reason to execute a UAL restructuring. A mere bet on interest rate “arbitrage” carries risk. Granted, historically low interest rates (many recent POBs have been issued at 3 to 4% interest rates) clearly helps reduce re-investment risk, but such risk still exists.

Investors and rating agencies are accepting the bond structure and credit for highly rated issuers. The majority of the pension bonds in 2017 and 2018 were rated in the “AA” category or were enhanced by a dedicated pension tax override (about two dozen cities in California have this special revenue source). Recently, however, several issuers in the “A” category were also able to successfully issue pension bonds. More importantly, rating agencies have focused on “affordability” (pension costs as % of budget) as an important factor, thus making the “smoothing” strategy a potential credit strength. If you are considering a UAL restructuring, NHA encourages you to take a comprehensive approach to analyzing the risks, benefits, and structuring options. The following questions may help in developing an optimal solution.

• Does the higher potential savings for a larger UAL payoff outweigh the increased market timing risk?
• Can I somehow pay off only 50% of my UAL but derive 75% of the near-term savings that a full pay off could generate?
• Which amortization bases should I pay off? Short or long ones? Pro-rata or selective bases?
• What are the drawbacks of an “overfunded” (>100%) plan?

• What are the pros and cons of each structure?
• Is there a way to execute an “internal pension bond” at a lower interest rate?
• If I’m a special district, can I issue utility revenue bonds to pay UAL? How much could it enhance rate management?

• At what level of a near term “market crash” would I still be better off under a pension bond scenario vs. without any bond?
• Are there structuring techniques or dollar cost averaging funding strategies to mitigate these risks?
• How does this “break-even” analysis change with different pension bond sizes, amortization shapes and different re-investment assumptions?
• Am I properly educating my stakeholders on reinvestment risks in addition to the very “attractive benefits”?