Funded for the Future? Retirement Costs and Obligations in Santa Cruz County

Continually rising retirement costs and obligations put funding of jurisdictions' services and projects at risk. Response from the Santa Cruz County Board of Supervisors: DISAGREE ­ The County has taken significant and impactful steps that have ​ contained, and in some cases capped, rising costs. The Grand Jury Report vastly understates the savings to the County resulting from the many changes mandated by AB340, the Public Employees Pension Reform Act of 2013 (PEPRA), and ignores several other County measures designed to reduce and stabilize pension and retiree healthcare costs. The Report also makes inaccurate assumptions regarding future retirement contribution levels. PEPRA­Related Savings: ● Pensionable Compensation Cap. The PEPRA caps pensionable salaries at ​ 100% of the Social Security Contribution and Benefit Base for employees who participate in Social Security and at 120% of that amount for employees who do not. These caps are well below the previous IRS cap and will result in on­going long term savings. ● Increased Employee Contributions/Employee "Pick Up" of Employer Contributions. The Grand Jury Report ignores the PEPRA's provisions on ​ retirement contributions by classic (existing) members. While the PEPRA only requires new employees to contribute at least 50 percent of normal cost, it sets that contribution rate as the standard expected of all employees and permits employers to unilaterally impose that contribution rate as of January 2018. The PEPRA also lets employers and employees agree to share the cost of the employer contribution, previously only allowed if tied to a past benefit enhancement. Based on these changes, the County has negotiated increased pension contributions for all employees, not just those hired after January 2013, as well as several employee “pick­ups" of part of the employer contribution. Since the implementation of the PEPRA, the County has negotiated the following contribution changes with the General Representation Unit, representing approximately 70% of the County's workforce: ○ Since September 2014, Miscellaneous Tier 1 and Tier 2 employees (who previously did not contribute toward their retirement benefit) have contributed 3.5% toward retirement. Employees in Tiers 1 and 2 of the County Peace Officer plan increased their contribution to 9.5% (a 0.5% increase). This increase constituted an employee "pick­up" toward the employer contribution, and would not have previously been allowed. ○ In September 2015, employees in Miscellaneous Tiers 1 and 2 will double their retirement contribution to 7%, while County Peace Officers in Tiers 1 15 and 2 will increase their contribution to 10%. The added 0.5% County Peace Officer contribution is a further employee pick up of the employer contribution, for a total employee pick up of 1%. ○ In September 2015, Miscellaneous Tier 3 employees will increase their retirement contribution from 6.25% (50 percent of normal cost) to 7%. The additional .75% is an employee "pick up” toward the cost of the employer contribution. Similar changes negotiated with most other bargaining units have already significantly reduced the County's pension contributions, and will lead to long­term savings. ● Effective Date of PEPRA Impacts & Timing of PEPRA Savings. The Report ​ erroneously states, "These new impacts of PEPRA go into effect FY 2015/16." All PEPRA provisions listed in the Report went into effect in January 2013 and none are scheduled to go into effect during FY 2015/16. The Report's statement that “the real savings of PEPRA will come many years in the future as the percentage of PEPRA employees increases" underestimates the savings the County has already realized from PEPRA­related changes, such as increased employee pension contributions and employee pick­ups of a portion of the employer contribution. Further, the Report assumes that very few current County employees are in one of the lower retirement tiers. In fact, just two years into PEPRA, already 20 percent of County employees are subject to Tier 2 or Tier 3 retirement benefits. Non­PEPRA­Related Cost­Saving Measures. ● Lower Pension Tier for all Employees. The Report notes that prior to the ​ implementation of the PEPRA the County adopted a second retirement tier for Safety (aka County Peace Officer) and Sheriff's Safety employees with benefits based on the average of the highest three consecutive years' salaries (FAE3), rather than the single highest year (FAE1), as benefit levels were previously calculated. However, the Report fails to mention that for the Miscellaneous Plan, which accounts for 85 percent of County employees, a second tier also went into effect in December 2012 for all new Miscellaneous employees. Miscellaneous Tier 2 employees do not qualify for full retirement until age 60 (compared to age 55 for Tier 1 employees), and their retirement benefit is based on FAE3, rather than FAE1 like their Tier 1 Colleagues. Under the PEPRA, a person who became a member of CalPERS or a reciprocal retirement program before January 1, 2013 and subsequently joins a different CalPERS agency with less than a six month break in service is a “classic" employee who qualifies for the retirement benefit that was in effect at the new agency on December 31, 2012. The December 2012 implementation of a lower tier of benefits for Miscellaneous employees precludes "classic" employees from other CalPERS or reciprocal agencies from qualifying for Tier 1 benefits at the County of Santa Cruz. Savings from the implementation of the Tier 2 benefit formula for all bargaining units is anticipated to total $9.7 million in the first ten years, $37 million over 20 years, and $93.5 million over 30 years. ● Reduced Retiree Healthcare Costs through Structural Reform. The County ​ provides pay­asyou­go health benefits to retirees. The value of benefits to be paid in the future and how much of that value remains unfunded is known as the Unfunded Actuarial Accrued Liability (UAAL). Since 2007, the County has implemented several structural changes that have reduced both the pay­as­you­go costs and the UAAL. ● Cafeteria plan and cap on retiree health benefits. The 2007­08 implementation ​ of a cafeteria plan and cap on retiree health benefits reduced the UAAL from $216 million, in January 2007, to $181.5 million, by January 2009. ● Retiree health longevity schedule. In January 2012 the County implemented a ​ retiree health longevity schedule that links the level of benefits to years of County service and age at retirement. Before then, the County's retiree medical benefit for most employees was $507/month for single, $557 with one dependent, and $613 with more than one dependent. As of 2012, retirees with five or fewer years of service qualify for only the "PEMHCA minimum," which is currently $112/month. Depending on years of County service and age at retirement, retirees may receive up to a "cap" of $507/month single or $557/month with any number of dependents. ● Reduced healthcare contributions to Medicare­eligible retirees. In 2012, the ​ County reduced its contributions when retirees attain Medicare eligibility and qualify for lower cost health premiums. Even if a person qualifies for the maximum $507/month contribution based on years of service and age at retirement, when that person qualifies for Medicare, the County's contribution is reduced by 25% to $380/month. As a result of these structural reforms, the County's pay­as­you­go benefit payments, estimated in 2009 to hit $12.5 million by 2019, are now projected to reach only $7 million by then and the UAAL has been reduced by an additional $36.5 million to $145 million. Inaccurate Assumptions Regarding Future Retirement Contribution Levels. The ​ Grand Jury indicated that, “Employer and employee Contribution levels are expected to continue to increase unless exceptional investment returns are ​ experienced..." and footnotes this comment to a November 2014 CalPERS report. The report referenced in the footnote actually reads, "Contribution rates are expected to remain high for an extended period unless there is a period of ​ ​ exceptional returns in the markets." In this context, there is a notable difference between the words “remaining high" and "increasing.” The rates will remain high for approximately four to five years because PERS has recently implemented conservative demographic, amortization, and investment assumptions designed to complement the PEPRA's structural benefit reductions. After the initial phase­in 17 period, rates are expected to decline. Response from the Capitola City Council: PARTIALLY DISAGREE ­ As with any projected expenditure increase, the City ​ agrees that rising pension costs will either have to be offset with future revenue increases or reductions in services or projects. The City partially disagrees with the finding as the City has taken a number of proactive steps to address this issue. For example this fiscal year the City established a PERS Contingency Fund. The Fund was set up to help stabilize the City’s finances and to help manage future increases in PERS contributions. In addition, current long­term projections show the City with a balanced budget position in future years, due to current fiscal policies, increased revenue, and the payoff of Pension Obligation Bonds. However, given the potential for an economic downturn or other revenue contractions, these projections must be consistency analyzed and monitored and City services levels evaluated in the face of changing economic conditions. Response from the Santa Cruz City Council: AGREE Response from the Scotts Valley City Council: PARTIALLY DISAGREE ­ Rising retirement costs do put pressure on the budget, ​ but it is not the only factor. Personnel costs in general are 80% of the City’s General Fund budget. Retirement costs are a part (13%) of that overall cost. The City needs to stay competitive with salaries to keep qualified employees. Salaries are a much larger part of the budget at 42%. The economy is another large factor to having the resources to provide services. The City has endured two economic downturns in the last 10 years. These were prior to the latest increase in retirement costs. The City needed to take measures during those time periods to maintain its budget. The City will continue to take necessary steps in the future due to any factors affecting its budget. Response from the Watsonville City Council: AGREE ­ The City recognizes the risk rising costs of retirement obligations in the ​ short term and in the long term. Budget and Financial presentations made as part of Public Hearings to the City Council each budget year have emphasized this issue as one which needs addressing and planning into the future. Examples of these presentations can be found in the City’s website. ● February 10, 2015, Audited Statements Financial Presentation to City Council (see pages 11 and 12 of this document). In addition, the full audited financial report was provided to the City Council as part of that public hearing. The financial audit contains information related to the unfunded liability and its status on pages 82 through 84. The document was also made available to the public 18 for review. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/021015/Item%206.2a%20Mid%20Year%202014­15%20Budget%20Report.pdf ● May 26, 2015, Budget Study Session Presented to City Council (refer to pages 7 and 8 of the report). The report highlights the challenge to continue funding continually rising retirement costs and obligations in the current year and future years. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/052615/Item%208.3%20Proposed%20Budget%202015­16%20&%202016­17 %20Report.pdf ● June 9, 2015, Budget Public Hearing conducted by the City Council (refer to pages 9 and 10 of the report). The report highlights the challenge to continue funding continually rising retirement costs and obligations in the current year and future years. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/060915/Item%206.2a%20Budget%20Summary%20Report.pdf Response from the Board of Directors, Soquel Creek Water District: PARTIALLY DISAGREE ­ The Soquel Creek Water District’s total Unfunded ​ Liability (UL) for pension and OPEB as of June 30, 2013 was $9 million. Required employer contributions are estimated at $682,000 for the 2015/16 fiscal year and projected to rise over four more years before flattening out. If the District pays according to CalPERS amortization schedule, the pension UL costs would total $14.9 million over 30 years. This is the first year that small employers in the mandated CalPERS risk pools have the ability to effectively manage their pension liabilities. The Fiscal Year 2015/16 Budget adopted by the Board on June 16, 2015 includes funding for accelerated payment of the UL. The smaller liability associated with the Second Tier plan will be paid off and the District intends to pay down the liability for the First Tier plan in ten years instead of thirty in order to achieve significant long term savings. Retirement costs certainly contribute to the District’s financial pressures. However, as noted in the 2015 Ten­Year Finance Plan (Attachment 1), the District faces financial challenges on a number of fronts that combined, put significant upward pressure on future water rates. Future anticipated projects and costs include: ● $80 million (in escalated $) to develop a supplemental water supply project. New and ongoing annual maintenance costs to operate the project once it’s placed into service are estimated to be $1.3 million starting in 2022/23. ● $70 million (in escalated $) of water system capital needs in the current and next ten years, along with $1 million to $2 million each year for capital outlay, studies, and planning efforts. ● The District will be required to issue additional debt, which will increase debt service payments, in order to fund the supplemental supply project. 19 ● $875,000 for Conservation Program expenses in 2015/16 increasing annually to $1.3 Million in 2024/25 depending upon the degree of implementation. ● $350,000 starting in 2017/18 in ongoing annual operational costs for hexavalent chromium treatment. The District is currently operating in an environment of declining water sales and will need to raise rates to meet its financial obligations and ensure long term financial stability. Retirement costs must be acknowledged and properly managed but are not the District’s sole source of financial pressure. To state that these costs alone put services and projects at risk is not a fair and accurate assessment of the District’s overall financial outlook.

A clear and complete statement of the total retirement costs and obligations has not been provided in the budget narrative for either the public or elected officials. Response from the Santa Cruz County Board of Supervisors: AGREE ­ In accordance with the Governmental Accounting Standards Board, these ​ obligations are reported in great detail in the Comprehensive Annual Financial Report (CAFR). In the budget documents, costs are disclosed on Schedule 9 for each department under Salaries & Benefits. Pension costs are provided on the “PERS" line item; retiree health benefit costs (OPEB) are included with active employee health benefit costs in the “Employee Insurance and Benefits" line item. Response from the Capitola City Council: AGREE ­ The City agrees with this finding. The City believes we have previously ​ included detail of pension costs in several different areas of the budget but the City agrees that having the information in one section would improve the transparency of the City’s Budget. A new chart showing the total retirement costs, along with funding ratios and funded status will be included in the Final Fiscal Year 2015­16 Budget and all future budget documents. Response from the Santa Cruz City Council: PARTIALLY DISAGREE ­ Already contained in the May 12, 2015 Proposed Fiscal ​ Year 2015 Budget was a description of the total unfunded retiree obligations (see the Finance Director's Overview within the Budget in Brief summary, attached). This discussion portrayed the total obligations as compared to funding levels and detailed the benefit levels provided for retiree health. An additional financial schedule was added to the Adopted (final) Fiscal Year 2015 Budget that provides the details of the total annual costs and total obligation for retiree obligations. Response from the Scotts Valley City Council: AGREE ­ The City does provide more information in its annual financial statements ​ as required disclosures directed by the Governmental Accounting Standards Board. The budget provides budgeted line items for each department, but also provides a General Fund recap of total amounts for each budget line item, including retirement. The budget is primarily a document for that fiscal year’s budgeted revenues and expenditures, but information regarding future costs could be incorporated into the narratives. Response from the Watsonville City Council: PARTIALLY DISAGREE ­ Budget and Financial presentations made as part of ​ Public Hearings to the City Council each budget year have emphasized this issue as one which needs addressing and planning into the future. Examples of these presentations can be found in the City’s website. ● February 10, 2015, Audited Statements Financial Presentation to City Council (see pages 11 and 12 of this document). In addition, the full audited financial report was provided to the City Council as part of that public hearing. The financial audit contains information related to the unfunded liability and its status on pages 82 through 84. The document was also made available to the public for review. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/021015/Item%206.2a%20Mid%20Year%202014­15%20Budget%20Report.pdf ● May 26, 2015, Budget Study Session Presented to City Council (refer to pages 7 and 8 of the report). The report highlights the challenge to continue funding continually rising retirement costs and obligations in the current year and future years. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/052615/Item%208.3%20Proposed%20Budget%202015­16%20&%202016­17 %20Report.pdf ● June 9, 2015, Budget Public Hearing conducted by the City Council (refer to pages 9 and 10 of the report). The report highlights the challenge to continue funding continually rising retirement costs and obligations in the current year and future years. [accessable 9/15/015] http://cityofwatsonville.org/download/City_Council/City_Council_Documents/201 5/060915/Item%206.2a%20Budget%20Summary%20Report.pdf The City will enhance what is already being presented to make a more complete statement about the retirement costs and obligations of the City. Response from the Board of Directors, Soquel Creek Water District: PARTIALLY DISAGREE ­ At the April 21, 2015 regular meeting of the Board of ​ Directors, Staff presented an informational report on California Public Employees’ Retirement System (CalPERS) Risk Pool Changes (Attachment 2). The report provided an overview of the District’s retirement benefits under its contract with CalPERS and information regarding revisions to the risk pool that affect benefits costs. A clear and complete statement of pension retirement costs and obligations was presented. The report was intended to serve as a resource for the discussion and development of funding strategies during May’s budget discussions. Staff released the information ahead of the budget discussions to allow time for the 21 Board (and public) to digest the information and formulate questions. The 2015­16 Budget contains information regarding OPEB expenses but does not address the unfunded liability. More complete information regarding retirement costs and obligations (pensions and retiree health or OPEB) is appropriately located in the District’s annual audited financial statements.

Enrollment in the CalPERS Employers Retiree Benefit Trust Fund reduces employer contributions, prevents retiree health obligations from becoming a significant budget liability, and contributes to a positive credit rating. Response from the Santa Cruz County Board of Supervisors: PARTIALLY DISAGREE ­ Enrollment in the California Employers' Retiree Benefit ​ Trust (CERBT), or any Other PostEmployment Benefits (OPEB) trust, in and of itself will not have any impact on contributions for current or future retirees. Contributions to the trust would not reduce current year benefit ("PayGo") costs for retired annuitants. Depending upon the total amount accumulated in the trust and the investment returns realized, reductions to the portion of the Annual Required Contribution (ARC) attributable to amortization of the unfunded liability could be achieved. Prefunding OPEB would be viewed favorably by rating agencies and could positively impact the County's longterm debt rating. If, however, the County had to borrow funds in order to pre­fund the OPEB liability, there could be negative impacts to the County's short­term debt rating which could increase the interest rate associated with the annual Tax Revenue Anticipation Note (TRAN) financing. If one­time money could be identified for funding an OPEB trust, there would be no associated negative impacts on the short­term debt rating. Response from the Santa Cruz City Council: PARTIALLY DISAGREE ­ We agree that enrollment in Retiree Benefit Trust Funds ​ is a valuable and essential tool for government agencies to dedicate general funding for the restricted purpose of offsetting future retiree liabilities. However, there are other options than CalPERS that can have lower entry and maintenance Costs. Regarding lowering employer contributions, the City would not see a reduction in employer contributions to CalPERS but rather would contribute additional general purpose funding towards unfunded obligations. Finally, without a significant funding strategy, a Trust will have a marginal impact to mitigate future liabilities or enhance the City's credit rating. Response from the Scotts Valley City Council: PARTIALLY DISAGREE ­ Enrollment is only part of the solution. There are no ​ mandatory contributions for this Trust Fund. Contributions can be made as the City wants or has the resources to do so. Having sufficient funds to invest in the Trust Fund is the main issue. This relates back to Finding #1 above regarding budget 22 impacts on the City and having sufficient funds to meet the various competing needs in the budget. Employer contributions are reduced through investment earnings from City funds invested in the Trust Fund. Without sufficient resources to invest, any meaningful reduction in employer contributions will not happen. The same holds true for preventing the retiree health obligations from becoming a significant budget liability and contributing to a positive credit rating. Response from the Watsonville City Council: PARTIALLY DISAGREE ­ The California Employers' Benefit Trust (CERBT) Fund ​ is a Section 115 trust fund dedicated to refunding Other Post Employment Benefits (OPEB) for all eligible California public agencies. While the City of Watsonville has reported a net OPEB obligation of $4.5 million for fiscal year ending 06/30/2014; this liability will be significantly reduced in FY 2014­15 and future years due to changes made by the City to its health plan and how it segregates the costs and premiums associated with retirees. The City offers employees who have retired from service the option to continue receiving health care benefits at their own cost until age sixty­five. For the retiree to be fully eligible to participate in the plan offered by the City of Watsonville, the employee must be at least 50 years of age and have at least five years of service. Retirees pay for their benefit at 105% of the active per­capita health costs, as reset by the administrator every January 1st. In the past the City self­funded this plan by paying for the actual costs of claims received under the plan. Effective July 1, 2013; the City migrated to a pooled plan which limits the liability to the City to the monthly premium paid for each participating member of the City’s plan. This limits the current and future year obligations of the City for active employees and helps more closely align the cost paid for health care costs for retirees each fiscal year and their employee paid premiums. This shift will result in a significant reduction in the OPEB liability.