Receive a presentation recommending the Public Agency Retirement Services (PARS) as the preferred Section 115 Retirement Trust provider and direct staff to prepare the authorizing resolution and other necessary documents to establish a Section 115 Trust Administered by the Public Agency Retirement Services (PARS)

Receive a presentation recommending the Public Agency Retirement Services (PARS) as the preferred Section 115 Retirement Trust provider and direct staff to prepare the authorizing resolution and other necessary documents to establish a Section 115 Trust Administered by the Public Agency Retirement Services (PARS).

The California Public Employees’ Retirement System (“CalPERS”) is the largest pension fund in the country as it manages investments for nearly 2 million members, including active, retirees and beneficiaries, and inactive members for state, school and other public agencies.  The City is one such public agency and has two primary CalPERS plans, one for miscellaneous members and one for safety, that combined, represents about 190 covered members, of which about 74 are active members, based upon the most recent actuarial data. 

Annually, the City makes a payment to CalPERS that consists of (1) the annual cost for current employees (“normal cost”) and (2) the unfunded accrued liability (“UAL”).  The UAL is the actuarial liability (the amount CalPERS needs to have to pay for retirement benefits) less the actuarial value of the assets (the amount that CalPERS currently has on hand to pay the estimated costs of the retirement benefits).  Similar to other public agencies, the City faces significant increases in pension costs. The increase in pension costs are attributed to such factors as sluggish investment performance by CalPERS, changes in expected investment returns (discount rate) and updated mortality projections.  The City’s UAL projection, as of 6/30/2021, is $24.7 million.  To address this fiscal challenge, the City has considered various strategies to mitigate its pension liability, including establishing a Section 115 Retirement Trust.

A Section 115 Trust is a tax-exempt investment vehicle authorized by the Internal Revenue Services (IRS) to prefund government expenses such as retirement plan benefits.  Assets held within the trust are designated as irrevocable, meaning that that assets must be used to fund the City’s retirement plan obligations.  Monies placed within a trust may be invested according to rules governing the trust, which are different than the investment rules pertaining to the City’s pooled investments. In theory, the funds placed within a trust can earn a higher rate of return than if the City invested the funds.

Funds placed within the trust can remain within the trust until such time that the City chooses to draw on its assets to pay an annual benefit obligation (i.e. make a payment to CalPERS) or seek reimbursement for a pension-related expense. The City Council may consider adopting policies and procedures that require Council action in order to withdraw funds from the trust.  In addition, once a trust is established, the City may change its investment portfolio as well to reduce its risk exposure and mitigate losses.

The benefits of a trust include:

1. Local control over assets, including contributions, disbursements, timing and risk tolerance of investments
2. Investment flexibility and the potential increased return on investment compared to City General Fund
3. Flexibility in determining when and how to use trust assets to mitigate pension. For example, the asset may grow and the City could use the assets to pay off the UAL in the future; the assets may be transferred to the retirement system to help smooth ‘spikes’ in the City’s annual retirement contribution and/or the City may reimburse the General Fund for pension-related expenses for the current or prior year during difficult budgetary times.

On January 8, 2019, City Council adopted a resolution that endorsed the City’s participation in a pension rate stabilization program (i.e. a Section 115 Trust) and authorized staff to issue a Request for Proposals (RFP) to select a third party to manage the Section 115 Trust.  The RFP requested information regarding the firm’s experience in serving local government clients in establishing Section 115 trusts and related investment services; the proposed program team; private letter ruling; trustee and trust administration services, investment requirements and investment performance; fees; references and proposer warranties.  In response to the RFP, the City received two proposals by the deadline: (1) one from the Public Agency Retirement Services (PARS) and (2) one from Keenan Financial Services.

The evaluation process was temporarily placed on hold due to other competing priorities at the time, including the development and adoption of the Fiscal Year 2019-2020 budget and the sales tax renewal measure. However, Council renewed its discussions regarding the establishment of a trust and pension mitigation strategies in January 2020 and subsequently in the spring of 2021, including providing direction to staff to resume efforts related to selecting a trust provider. 

Keenan and Associates proposal includes Keenan and Associates (administrator), Morgan Stanley (investment manager) and the Benefit Trust Company (trustee).  Demonstrated strengths include Keenan’s experience with financial consulting services related to GASB 68 and employee benefits, the reputation of Morgan Stanley as a global investment firm and the partnership with the Benefit Trust Company, which is a leading national provider of trust, custody and fiduciary services.  Keenan also utilizes a Board of Authority, which consists of a representative from each member agency (participation is not mandatory) to review the trust and provide advice regarding the investment outlook for the future.  Keenan charges a flat fee for service.

The Public Agency Retirement Service (PARS) proposal includes PARS (administrator), HighMark (investment manager) and U.S. Bank (trustee).  Demonstrated strengths include PARS experience as a leader in providing Section 115 trust administration services and breadth of clients utilizing the firm’s trust services to prefund pension costs.  PARS team includes U.S. Bank, which is the fifth largest bank in the nation. PARS allows both pension and other post-employment benefits (OPEB) to be funded within the same trust, should the City decide to also utilize a trust for its OPEB liability in the future. PARS charges fees based on the amount of the invested assets.

A summary table of the two proposals is included below for reference.

Table 1: Comparison of Section 115 Trust Services Proposals

City staff (City Administrator and Budget Director) and the City’s municipal financial advisor (NHA Advisors, LLC) conducted interviews with the two firms and contacted other cities for input regarding the trust providers. In particular, staff reviewed the experience of the provider in implementing a trust, the qualifications of the proposed key personnel on the team, the team’s communication and approach to working with clients, reputation and integrity of the trust administrator, investment manager and trustee, the historic return on investment and fees.

It is staff’s determination that the City would be well-served by either firm based upon experience; the size and type of assets managed; the reputation of the investment manager and/or trustee; the responsiveness of the firms as demonstrated through references and the ability of the firms to provide monthly and quarterly reporting.  However, staff recommends PARS as the trust provider as the firm appears to be a better fit for the City’s needs based on such factors as the firm’s experience in establishing pension trusts, the diversity of its portfolios and its customer focus, including its ability to assist the City with developing an investment policy.

Should Council concur with this recommendation, staff will return in August with a resolution authorizing the City’s participation in the PARS Public Agencies Post-Employment Benefit trust and authorizing the City Administrator, as the Plan Administrator, to execute all other necessary documents. Staff will then work with PARS to develop a specific investment policy statement, procedures, and funding strategy for future trust contributions and bring forth the policy for Council approval. In addition, staff will review cash flow projections and make a recommendation regarding the timing of transferring funds from the General Fund to the trust. 

There are no fiscal impacts associated with receiving the report and recommendation. The Fiscal Year 2021-2022 Adopted Budget includes an allocation of $1 million toward pension mitigation strategies, such as funding for a Section 115 Trust.

1.    Council received presentations on the City’s pension liability on April 8, 2018 and December 4, 2018 respectively.

2.    Council adopted Resolution 2019-006 on January 8, 2019 to endorse the participation in a Pension Rate Stabilization Program to pre-fund pension obligations and authorized staff to issue a Request for Proposals for a Section 115 Trust

3.    Council received presentations on the City’s pension liability and potential cost management and alternative payment strategies on January 7, 2020, March 2, 2021, and April 6, 2021 respectively.  Council provided direction regarding setting aside $1 million annually for pension mitigation during its March 2, 2021 meeting.