Pensions in Santa Barbara County

Conclusions 13

• CL1
  The 12 PEPRA plans in the cities of the County of Santa Barbara have a funded ratio of 0.90 and the 20 non-PEPRA plans have a funded ratio of 0.68. This is a small, but positive, sign that the 9 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY PEPRA law is having the intended effect of strengthening the security of pension benefits in the County.
• CL2
  The City of Santa Maria faces greater pension risks because of its comparatively low General Fund revenue per capita, which is less than 50 percent of that of the City of Santa Barbara and less than 67 percent of that of Lompoc. Santa Maria has taken steps to end employer contributions in lieu of employee contributions in its pension plans; this step moves some of the burden of repaying its unfunded pension liabilities from the City to its active employees.
• CL3
  While the City of Santa Barbara does not have a “PEPRA Police Plan,” it does respect the 2013 PEPRA Law for those hired after December 31, 2012. Therefore, the absence of a “PEPRA Police Plan” does not adversely affect the funded ratio or other risk indicators for the City of Santa Barbara system.
• CL4
  Pension solvency risks are moderate in Buellton and Goleta; pension liquidity risks, as indicated by projected years of negative cash flow under projected CalPERS actuarial returns, are nil.
• CL5
  In Carpinteria, Guadalupe and Solvang, pension solvency risks are minimal to moderate, except in the closed Carpinteria Safety Plan. Pension liquidity risks in those cities are higher, with several years in all three cities having projected negative cash flows under projected CalPERS actuarial returns.
• CL6
  In Lompoc, Santa Maria and the City of Santa Barbara, solvency risks are high in the pre-PEPRA plans that have most of the Actuarial Liabilities in the municipal plans.
• CL7
  Liquidity risks in Santa Maria are lower than in Lompoc and the City of Santa Barbara, in that Santa Maria projects no years of negative cash flows. However, Santa Maria would have negative cash flow if CalPERS investment returns fall below their projected actuarial values. Managing that liquidity risk requires that Santa Maria maintain high total employer contributions to its pension plans until at least 2034.
• CL8
  In Lompoc and the City of Santa Barbara, liquidity risks are high as measured by projected years of negative cash flow. Managing those risks will require employer’s pension contributions of 40 percent of payroll in Lompoc and 50 percent in the City of Santa Barbara at least until 2030.
• CL9
  The SBCERS policy of not participating in the CalPERS risk pool is appropriate because SBCERS has achieved portfolio returns comparable to those of CalPERS over the past 25 years.
• CL10
  Funded ratios of the municipal pension systems in Santa Barbara County are sensitive to the discount rate applied by CalPERS. A cut in that rate to 6 percent, from the 2018-19 rate of 7 percent, would push the funded ratios of several municipal systems close to 0.5 and might impose further increases in the employer’s contributions in Lompoc, in the City of Santa Barbara and in Santa Maria.
• CL11
  It is unlikely that the largest municipal plans - Lompoc Safety; City of Santa Barbara Miscellaneous; City of Santa Barbara Fire; City of Santa Barbara Police; and City of Santa Maria Miscellaneous - can apply the revised CalPERS amortization schedule of 20 years to all their unfunded liabilities without higher new employer’s contributions. Such new contributions would be particularly problematic in Lompoc and in the City of Santa Barbara given the high employer’s contribution rates that already apply in those cities.
• CL12
  The solvency risks to the SBCERS plans are moderate and manageable. The SBCERS decision to apply an accelerated amortization schedule to the unfunded liabilities generated during the 2007- 09 period of low asset returns is appropriate because it will shorten the period in which high employer contributions are necessary.
• CL13
  There are substantial liquidity and solvency risks to the sustainability of many of the public defined benefit pension plans in the County. Management of those risks may require new policy measures. The 2017-18 Santa Barbara County Grand Jury concludes that the State of California, in passing the new PEPRA law, which went into effect on January 1, 2013, has already imposed a statewide measure which has had a modest positive effect on the liquidity and solvency of the Santa Barbara County public pension systems. However, if there are additional fiscal shocks, such as an exogenous fall in tax revenue or a period of low returns on pension assets held by CalPERS, then other new policies may be required. Such measures could be to reduce salaries and other non- pension benefits, to raise employee and employer contributions or to cut benefits, apply fiscal measures to fund higher employer contributions, as well as start new negotiations with labor unions to raise contributions from employees, or to otherwise modify benefits not covered by the new PEPRA Law of 2013. 14 The estimated SBCERS valuation on March 31, 2018 was roughly $2.8 billion. 8 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY FINDINGS AND RECOMMENDATIONS Finding 1 Pension solvency risks are moderate in Buellton and Goleta; pension liquidity risks, as indicated by projected years of negative cash flow under projected CalPERS actuarial returns, are nil. Finding 2 In Carpinteria, Guadalupe and Solvang, pension solvency risks are minimal to moderate, except in the closed Carpinteria Safety Plan. Pension liquidity risks in those cities are higher, with several years in all three cities having projected negative cash flows under projected CalPERS actuarial returns. Finding 3 In Lompoc, Santa Maria and the City of Santa Barbara, solvency risks are high in the pre-PEPRA plans that have most of the Actuarial Liabilities in the municipal plans. Finding 4 In Lompoc and the City of Santa Barbara, liquidity risks are high as measured by projected years of negative cash flow. Managing those risks will require employer’s pension contributions of 40 percent of payroll in Lompoc and 50 percent in the City of Santa Barbara at least until 2030. Finding 5 While the City of Santa Barbara does not have a “PEPRA Police Plan,” it does respect the 2013 PEPRA Law for those hired after December 31, 2012. Therefore, the absence of a “PEPRA Police Plan” does not adversely affect the funded ratio or other risk indicators for the City of Santa Barbara system. Finding 6 Liquidity risks in Santa Maria are lower than in Lompoc and the City of Santa Barbara, in that Santa Maria projects no years of negative cash flows. However, Santa Maria would have negative cash flow if CalPERS investment returns fall below their projected actuarial values. Managing that liquidity risk requires that Santa Maria maintain high total employer contributions to its pension plans until at least 2034. Finding 7 The City of Santa Maria faces greater pension risks because of its comparatively low General Fund revenue per capita, which is less than 50 percent of that of the City of Santa Barbara and less than 67 percent of that of Lompoc. Santa Maria has taken steps to end employer contributions in lieu of employee contributions in its pension plans; this step moves some of the burden of repaying its unfunded pension liabilities from the City to its active employees. Finding 8 The 12 PEPRA plans in the cities of the County of Santa Barbara have a funded ratio of 0.90 and the 20 non-PEPRA plans have a funded ratio of 0.68. This is a small, but positive, sign that the 9 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY PEPRA law is having the intended effect of strengthening the security of pension benefits in the County. Finding 9 Funded ratios of the municipal pension systems in Santa Barbara County are sensitive to the discount rate applied by CalPERS. A cut in that rate to 6 percent, from the 2018-19 rate of 7 percent, would push the funded ratios of several municipal systems close to 0.5 and might impose further increases in the employer’s contributions in Lompoc, in the City of Santa Barbara and in Santa Maria. Finding 10 It is unlikely that the largest municipal plans - Lompoc Safety; City of Santa Barbara Miscellaneous; City of Santa Barbara Fire; City of Santa Barbara Police; and City of Santa Maria Miscellaneous - can apply the revised CalPERS amortization schedule of 20 years to all their unfunded liabilities without higher new employer’s contributions. Such new contributions would be particularly problematic in Lompoc and in the City of Santa Barbara given the high employer’s contribution rates that already apply in those cities. Finding 11 The solvency risks to the SBCERS plans are moderate and manageable. The SBCERS decision to apply an accelerated amortization schedule to the unfunded liabilities generated during the 2007- 09 period of low asset returns is appropriate because it will shorten the period in which high employer contributions are necessary. Finding 12 The SBCERS policy of not participating in the CalPERS risk pool is appropriate because SBCERS has achieved portfolio returns comparable to those of CalPERS over the past 25 years. Recommendation 1 That in view of the 12 Findings, the governments of the cities of Buellton, Carpinteria, Goleta, Guadalupe, Lompoc, Santa Barbara, Santa Maria and Solvang and of the County of Santa Barbara analyze capital spending, employer/employee contribution rates, staffing levels, and all existing taxes and revenue sources under their control to identify potential revenue gains and cost savings. Recommendation 2 That the governments of the cities of Buellton, Carpinteria, Goleta, Guadalupe, Lompoc, Santa Barbara, Santa Maria and Solvang and of the County of Santa Barbara issue public reports, to be discussed at open sessions of their respective governing bodies, on the potential revenue gain and cost-saving measures that may be necessary to ensure continued adequate funding of their pension plans. 10 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY REQUEST FOR RESPONSE Pursuant to California Penal Code §933 and §933.05, the Grand Jury requests each entity or individual named below to respond to the enumerated Findings and Recommendations within the specified statutory time limit: Responses to Findings shall be either:  Agree  Disagree Wholly, with an explanation  Disagree Partially, with an explanation Responses to Recommendations shall be one of the following:  Has been implemented, with a brief summary of the implemented actions  Will be implemented, with an implementation schedule  Requires further analysis, with an explanation and the scope and parameters of an analysis or study, and a completion date that is not more than 6 months after the issuance of this report  Will not be implemented because it is not warranted or is not reasonable, with an explanation City Council of Buellton - 90 Days Finding 1, 8, 9 Recommendation 1, 2 City Council of Carpinteria - 90 Days Finding 2, 8, 9 Recommendation 1, 2 City Council of Goleta - 90 Days Finding 1, 8, 9 Recommendation 1, 2 City Council of Guadalupe - 90 Days Finding 2, 8, 9 Recommendation 1, 2 City Council of Lompoc - 90 Days Finding 4, 7, 8, 9, 10 Recommendation 1, 2 City Council of Santa Barbara - 90 Days Finding 3, 4, 5, 6, 7, 8, 9, 10 Recommendation 1, 2 11 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY City Council of Santa Maria - 90 Days Finding 3, 6, 7, 8, 9, 10 Recommendation 1, 2 City Council of Solvang- 90 Days Finding 2, 8, 9 Recommendation 1, 2 Santa Barbara County Board of Supervisors – 90 Days Finding 11, 12 Recommendation 1, 2 12 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY APPENDIX A

Observations 1

• OB1
  Risks to the Pension Systems Solvency and Liquidity of Pension Risks 6 5 Notes to Table 1: "FTE" is Full Time Employee. "Contributions" include employee contributions, normal cost employer contributions, and contributions to repay unfunded liabilities. "Accrued Liability" means, "The total dollars needed as of the valuation date to fund all benefits earned in the past for current members," as shown in Appendix A ("Glossary"). "Market Value of Assets" is the net present value of assets held by a pension date on the stated valuation date. "Unfunded accrued liability" means, "When a plan or pool’s Value of Assets is less than its Accrued Liability, the difference is the plan or pool’s Unfunded Accrued Liability." Sources: CALPERS Valuation Reports, 2015-16, for municipal plans, aggregated to system levels, and municipal CAFR 2016-17; SBCERS Valuation Reports and SBCERS Annual Reports. 6 Appendix B gives some simple pension analytics for this report. 3 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY The Jury defined “solvency risks” as threats to the long-term capacity of the plan to pay benefits. The indicator of this risk is its “funded ratio” -- the market value of assets (MVA) divided by the value of actuarial liabilities (AL) at the end of a fiscal year.7 A plan with a funded ratio less than 1 is said to be “underfunded.” The Jury defines “liquidity risks” as threats to a plan’s annual cash flow. One specific measure of liquidity risk is that benefit payments to retirees will exceed the sum of contributions - employee, normal cost employer, and payments on the unfunded actuarial liabilities (UAL) - plus the return on the MVA in any given year. A second measure of liquidity risk is that total employer’s contributions - normal cost employer plus payments on the UAL - exceed some threshold ratio to municipal payroll. The first indicator of liquidity risk used in this report is the number of years, between 2018 and 2047 with plan negative cash flow, meaning benefit payments are greater than the sum of contributions plus return on MVA in a given year. A second indicator is the number of years following 2017-18 in which the employer’s contribution to payment of the UALs exceeds the employer’s normal cost contribution, both expressed as a share of municipal payroll.8. Solvency Risks in the Municipal Plans Appendix C gives funded ratios for the 32 municipal plans. The Jury defines three categories of solvency risk for this Report: high risk, moderate risk and minimal risk. Plans with funded ratios less than 0.7 are said to be at “high risk” because they have elevated ratios of unfunded liabilities to assets. Plans with funded ratios greater than or equal to 0.7 and less than 0.9 are said to be at “moderate risk” because they have lower ratios of unfunded liabilities to assets. Plans with funded ratios greater than or equal to 0.9 are said to be at “minimal risk” because their ratios of unfunded liabilities are low compared to their assets. There are six large municipal plans with high solvency risks: Carpinteria Safety9; Lompoc Safety, City of Santa Barbara Miscellaneous, City of Santa Barbara Fire, City of Santa Barbara Police, and City of Santa Maria Miscellaneous. Those plans show a weighted average 2017-18 funded ratio of 0.67 (range of 0.63 to 0.68) and hold 75 percent of municipal liabilities in the County, not counting SBCERS liabilities. The six plans at high risk have 78 percent of the total of unfunded liabilities among the 32 municipal plans. Santa Maria has taken steps to end their policy of employer contributions in lieu of employee contributions in its pension plans; this step moves some of the burden of repaying its unfunded pension liabilities from the City to its active employees. 7 The CalPERS Valuation Reports define the AL “as the total dollars needed as of the valuation date to fund all benefits earned in the past for current members.” The Valuation Reports further define the Present Value of Benefits (PVB) as the “total dollars needed as of the valuation date to fund all benefits earned in the past or expected to be earned in the future for current members.” For the new PEPRA plans, which began in 2014, the PVB is higher than the AL because the former counts expected future benefits for current members and the latter does not. 8 We use “municipal payroll” rather than “plan payroll” because municipal revenue is fungible and can be used to pay pension liabilities from any plan in a given system. 9 Among the six plans with “high” risk, the Carpinteria Safety Plan is closed with no active members and no payroll. Projecting with the current CalPERS actuarial discount rate, the Carpinteria Safety Plan will fully amortize its UAL by 2047. 4 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY There are 18 municipal plans at moderate risk. They have a weighted average 2017-18 funded ratio of 0.71 (range of 0.70 to 0.90), 25 percent of the total amount of all municipal liabilities and 22 percent of all unfunded liabilities. There are eight municipal plans10 at minimal risk. They have a weighted average 2017-18 funded ratio of 0.95 (range of 0.91 to 1.00) and less than 1 percent of actuarial liabilities in the 32 plans. PEPRA is the California Public Employee’s Pension Reform Act, which reduced pension benefits for employees hired on or after January 1, 2013. The 12 PEPRA plans have less than 1 percent of the municipal liabilities and a weighted average funded ratio of 0.90. The 20 non-PEPRA plans have more than 99 percent of municipal liabilities and an average funded ratio of 0.68. CalPERS Risk Analysis CalPERS analyzes pension fund risks with respect to “discount rate assumption.” The actuarial discount rate is a nominal rate that converts the flow of future annual liabilities – payments to pension holders – into net present value terms, as given by the term AL in equation (1). See Appendix B. The CalPERS Valuation Reports present funded ratios for each plan at discount rates of 6 percent, 7 percent, and 8 percent. The resulting funded ratios are shown in Appendix C (column labelled “Funded Ratio (range by discount rate)”). At a discount rate of 6 percent, the lowest rate modeled by CalPERS, the Safety Plans of Lompoc and the City of Santa Barbara, and the Miscellaneous Plan of Santa Maria have funded ratios less than 0.6; at a discount rate of eight percent, the highest rate modeled by CalPERS, the plans at greatest solvency risks (Lompoc Safety, Santa Barbara Safety Police and Safety Fire) do have higher funded ratios but they rarely increase above 0.75. CalPERS further reports the effects of “future investment returns” on participating plans. CalPERS simulated returns at a plus 7 percent long-term average, a plus 3 percent average (called here the “second worst rate”), and a minus 3 percent average (called here the “worst rate”) over the period 2019-20 to 2022-23. Table 2 summarizes the CalPERS analyses of investment returns, as presented in its June 30, 2016 Valuation Reports for each of the 32 funds, aggregated to the system level for each city. The CalPERS liquidity risk analysis for each plan first “determine[s] the effects of various future investment returns on required employer contributions” over the period 2017-18 through 2022-23. The “required employer contributions” are the employer’s normal cost contributions plus required payments of the UAL, expressed as a percentage of the municipal payroll in each system. The lower returns have weak effects on the ability of most plans to sustain benefits; for example, cutting the CalPERS return from the actuarial average of plus 7.0 percent to the postulated “worst” of minus 3 percent would only increase the ratio of employer contributions to total payroll by more than 1 percentage point in five of the eight municipal systems (this is the change from column (1) to column (2) in Table 2). The weak effect of low returns on employer contributions is partly due 10 Among the eight plans with “minimal” risk, the Solvang Safety Plan is closed with no active members and no payroll. Projecting with the current CalPERS actuarial discount rate, the Solvang Safety Plan will fully amortize its UAL by 2026. 5 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY to the structure of the CalPERS analysis, which assumes that returns revert to the actuarial investment return of 7 percent after only four bad years. Table 2: Pension System Liquidity Risks Caused by Revenue Growth and CalPERS Investment Returns Average revenue growth (3% /year) Negative revenue growth (- 2 % year) CalPERS average return CalPERS worst return CalPERS average return CalPERS worst return (1) (2) (3) (4) Buellton Employer's contributions of pay 15.8 16.7 15.2 16.1 Years of negative cash flow 0 9 2 16 Carpinteria Employer's contributions of pay 17.9 19.0 17.9 19.0 Years of negative cash flow 9 10 9 10 Goleta Employer's contributions of pay 7.9 8.3 8.0 8.3 Years of negative cash flow 0 0 0 0 Guadalupe Employer's contributions of pay 10.6 11.2 10.6 11.2 Years of negative cash flow 6 6 6 6 Lompoc Employer's contributions of pay 40.5 41.7 40.5 41.7 Years of negative cash flow 8 7 8 7 City of Santa Barbara Employer's contributions of pay 50.2 51.9 50.2 51.9 Years of negative cash flow 8 8 8 8 Santa Maria Employer's contributions of pay 30.0 31.2 30.0 31.2 Years of negative cash flow 7 7 7 7 Solvang Employer's contributions of pay 23.7 24.8 24.8 26.0 Years of negative cash flow 5 5 5 5 Source: Calculated by 2017-18 Grand Jury. In Santa Maria, liquidity risks are lower than in Lompoc and the City of Santa Barbara in that Santa Maria projects no years of negative cash flows. However, Santa Maria would have negative cash flow if CalPERS investment returns fall below their projected actuarial values. Complementary Risk Analysis The Jury did a complementary risk analysis that considered the effects of “revenue shocks” on the municipal pension plans. A “revenue shock” is an unexpected fall in municipal revenue, due to, for example, the effects of the Thomas Fire on property valuations and business activity. Revenue shocks are modeled for the eight municipal plans as follows:  A six-year period from 2017-18 through 2022-23 in which municipal revenue, from all sources, grows at a rate of minus 2 percent per year; compared to  A six-year period from 2019 through 2024 in which municipal revenue, from all sources, grows at the rate as projected by CalPERS of plus 3 percent per year 6 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY  Both scenarios are computed under an average CalPERS “future investment return” of plus 7 percent and again under a “worst” investment return of plus 3 percent. Table 2 shows that cutting revenue projections from the CalPERS projected average of plus 3 percent to minus 2 percent would not add much to the fiscal burden of the plans consolidated at the city levels under a “worst return” scenario; this is the change from column (2) to column (4) in Table 2. However, the effect of lower revenue projections would be much stronger for the Lompoc (3 percent), Santa Barbara (4 percent), and Santa Maria systems (2.20 percent) in increased employer’s contributions, as shown by the change from column (2) to column (4) in Table 2. The City of Santa Barbara is the only one of the four cities11 that has not created a separate PEPRA plan for new members of its police force hired after December 31, 2012. (It has created a PEPRA plan for new fire department employees hired after that date.) Effects of the PEPRA Law The PEPRA law of 2012 that went into effect in 2013 made significant changes in California pension systems. PEPRA plans typically increased the retirement age at which members became eligible for a given benefit formula, changed the annual benefit factor for which members become eligible, capped the annual salary used to calculate the benefit base, and forbade the practice of “Employer Paid Member Contributions” for new PEPRA members. While specific PEPRA options vary within each plan and system, the general effect of the PEPRA law will be to reduce future liabilities. Though specific PEPRA plans do not yet cover 1 percent of the total liabilities across the 32 municipal plans in the County, they do seem to be more solvent than the older plans; the 12 PEPRA plans have a funded ratio of 0.90 and the 20 non-PEPRA plans have a funded ratio of 0.68. It is not possible with the information available to the Jury to calculate funded ratios for PEPRA options within the Miscellaneous Plans of the largest cities (Lompoc, Santa Maria and the City of Santa Barbara),12 in which most of the AL are held. Policy Measures Beyond the PEPRA Law Funding the SBCERS and many of the municipal plans could, at some point, require new policy measures by governments. Such new measures might include freezing public salaries or drawing on General Fund (GF) reserves to pay employers contributions.13 Accordingly, we have modeled the pension systems of the three largest cities (Lompoc, Santa Barbara and Santa Maria), noting that those systems hold 96 percent of the AL in the eight cities.  Freezing public payrolls -- the Jury examined the effect on total employer’s contributions rates of freezing public payrolls for 5 years, beginning in 2019-20; and  Drawing on GF Reserves -- the Jury considered the effect on total employer’s contributions rates of lowering the GF reserve target from 25 percent of GF revenue to 20 percent. 11 Buellton, Carpinteria, Goleta and Solvang contract with the County of Santa Barbara for public safety services and therefore do not have municipal pension plans for their safety services. 12 Lompoc, Santa Maria and the City of Santa Barbara include PEPRA options for new hires in their Miscellaneous Plans without having separate “PEPRA Miscellaneous Plans,” as do Buellton, Carpinteria, Goleta, Guadalupe, and Solvang. 13 Increases in employees’ contributions cannot be modeled because they are part of labor negotiations and hence feasible solutions are unknown. 7 2017-18 Santa Barbara County Grand Jury PENSIONS IN SANTA BARBARA COUNTY Neither measure had any significant effect on total employer’s contribution rates in Lompoc, Santa Maria or the City of Santa Barbara. One other possible measure would be to freeze capital spending. The Jury was unable to examine the effect on total employer’s contributions rates of freezing public capital due to the wide disparities in relative capital spending among cities and between the cities and the County. Moreover, because much of capital spending at all levels depends on grants from the State and from the Federal Government, such spending has a random element outside the control of city and County governments that cannot be easily modeled. Another measure might be to cut numbers of staff by attrition or layoffs. The Jury did not look at the potential impact of staff layoffs given that the terms of any future layoffs would have to be negotiated with labor unions and it is impossible to predict the outcome. The Jury notes that city and County governments could analyze all existing taxes and revenue sources under their control for possible increases. SBCERS Risk Analyses SBCERS managed about $2.16 billion dollars in assets on the valuation date of June 30, 2017.14 The funded ratio was 0.78 on that valuation date. The SBCERS analysis done of its discount rate sensitivity gave values from 0.66 at a discount rate of 6 percent to 0.86 at a discount rate of eight percent. SBCERS has done a comprehensive analysis of its systemic risks, in addition to modeling the discount rate, and the Jury has nothing different to complement the SBCERS analysis. It further notes that SBCERS has achieved portfolio returns comparable to those of CalPERS over the past 25 years.

Agency Responses 8

Government agencies' official responses to this report's findings and recommendations. Click on a response to see the structured breakdown.

No Responses Found 2

Government entities assigned to respond to this report. No response documents have been linked in our database.