On April 21, 2015, we received the following question:
“Could you explain the mechanics behind the California Statewide Communities Development Authority Taxable Pension Obligation Bonds issued in 2004, the Pension Obligation Bonds issued in 2005, and the Pension Obligation Refunding Bond Anticipation Notes issued in 2014? How have these investments in CalPERS performed versus what the City’s paid in interest and fees as part of these issuances?”
In 2004, as a result of the City Council granting retroactive pension benefit increases to existing City employees (as most public agencies in California did around the same time), the City’s unfunded pension liability increased. The increase in pension rates was the result of granting a benefit that the pension actuaries at CalPERS did not anticipate in setting the prior pension rates for the City. CalPERS charges public agencies such as the City a rate in the form of a percentage of payroll each year to recover 100% of the amount of pension costs calculated by CalPERS as due that year. When actual experience differs from the actuaries’ estimates, an unfunded pension liability or a surplus of funds on hand at CalPERS will result. The City does not have the ability to pay less than the required 100% contribution set by CalPERS each year, but the City may prepay any unfunded amounts owed, either in cash or via the issuance of pension obligation bonds. Absent such a prepayment, CalPERS amortizes the unfunded amounts over a set period through higher pension rates. The amortization period in 2004 was approximately 20 years.
Options were discussed to address the unfunded liability and related increases in CalPERS rates, and it was deemed more advantageous at the time to issue pension bonds than to allow CalPERS to amortize the unfunded liability. On June 29, 2004, the City issued bonds to prepay a portion of the unfunded pension liability associated with public safety employees in the amount of $89,540,000. On June 30, 2005, the City issued bonds in two series to prepay a portion of the unfunded pension liability associated with non-public safety employees in the amount of $30,000,000 (Series A) and $30,000,000 (Series B). These bonds were all 20 year bonds, designed to mirror the amortization period then in use by CalPERS. Issuance of the bonds allowed the City to borrow funds at a lower interest rate than CalPERS would have charged the City through its rates as the unfunded liability was repaid over time, with the difference accruing to the City as savings. The annual rates charged by CalPERS decreased as a result of the issuance of the bonds, and the bond debt service took the place of a portion of the otherwise required annual payments to CalPERS.
The three series of bonds were all approved by the City Council in open session at the time of issuance, however the 2005 Series B bonds require an annual re-approval by the City Council because of the variable rate format in which this debt was issued. The issuance of a pension obligation refunding note is therefore on the City Council’s agenda annually in the spring each year. This is not new debt; rather, it is just a re-authorization of the Series B debt outstanding since 2005. All of the City’s pension obligation bonds will be paid in full by June 1, 2025. As of today, $66,320,000 remains outstanding from the 2004 bonds and $49,455,000 remains outstanding from the 2005 bonds. On June 1, 2015, the City will be making a total scheduled payment of $7,050,000 on the bonds, further reducing the balance outstanding.
The amounts paid to CalPERS back in 2004 and 2005 from the original bond proceeds are the extent of what has been used to “prepay” the City’s pension liability. No bond proceeds or other additional funds have been sent to CalPERS since that time. However, 100% of the required payments to CalPERS have been made each year as required under California law. The City receives an “Annual Valuation Report” from CalPERS each year in approximately October, which sets the contribution rates required in the following fiscal year (beginning July 1). Those rates are then entered into the City’s payroll system and appropriate amounts are remitted to CalPERS each pay period. Again, the City does not have discretion relative to the minimum contribution amount, and must contribute at a minimum the percentage of payroll outlined in the Annual Valuation Report each year. Copies of the City’s most recent Annual Valuation Reports can be found here: Safety Miscellaneous
In terms of evaluating the savings associated with these bond issuances versus allowing the unfunded pension liability to amortize with CalPERS, the City analyzes the benefit associated with these transactions each year due the variable rate structure of the 2005 Series B debt. CalPERS amortized its unfunded liabilities at 7.75% through 2012 and at 7.50% thereafter. The 2004 bonds were issued at an average rate of approximately 5.1%, while the 2005 bonds were issued at an average rate of 4.5% for Series A and 2.42% to date for Series B. While it is not possible to quantify the exact savings associated with the issuance of all three bonds, the City is comfortable saying that the savings has been considerable versus allowing CalPERS to amortize a larger unfunded liability through rates. This strategy was a cost-effective way to decrease the total cost of funding the City’s pension liability, which has allowed additional resources to be directed to core City services in lieu of higher pension costs. In 2025 when these bonds are paid in full, a significant reduction in annual pension costs is anticipated of approximately $18.5 million per year.