Consultants, Defined Benefit, Governance, Institutional Investors, Pension Funds

San Diego Targets Full Funding; Joins Other Cal. Funds in Boosting PayDowns

With a goal of hitting a 100% funding, the San Diego City Employees’ Retirement System (SDCERS) has adopted a new unfunded actuarial liability (UAL) contribution floor amortization for the City of San Diego and the Port of San Diego pension plans. This new UAL contribution floor amortization method complements the existing 15-year amortization period for actuarial experience gains and losses.

The SDCERS Board also changed the system’s amortization period for assumption changes from a 30-year period to 20 years. SDCERS is currently 71% funded, with an unfunded liability of $2.97 billion, while the San Diego Port fund is 74% funded, with an unfunded liability of $150 million. SDCERS has $8 billion in assets under management.

The 20-period brings SDCERS’ unfunded liability amortization schedule for assumption changes in line with the California Public Retirement System (CalPERS) and other pension funds in the state. Some pension fund actuaries said the practice is widespread in that state.

“The move from a 30-year to 20-year period for assumption changes was based on best practices guidance from SDCERS’ actuary, Cheiron, and is consistent with recommendations made by the Conference of Consulting Actuaries, the California Actuarial Advisory Panel, the Governance Finance Officers Association and the Society of Actuaries,” an SDCER official said. IA asked Cheiron to comment on the SDCERS decision to move from a 30 to 20-year period, but the consultant declined to comment.

CalPERS made a similar move last year. In February 2018, the CalPERS Board voted to enact a 20-year amortization policy. In a recent interview with IA, Betty Yee, CalPERS’ controller, noted that “we are able to reduce the amortization period for public employers to pay off their unfunded liabilities from 30 years to 20 years and deal with our pension obligations, so that we can have our local public agencies not sitting on such huge liabilities for long periods of time.” (IA, 11/28/2018).

According to a CalPERS spokesperson, the change “is scheduled to take effect with the June 30, 2019 valuation for prospective years. Existing debt will continue to be amortized over 30 years; however, local employers have the option to pay it down faster.”

The spokesperson added that “Several organizations including the California Actuarial Advisory Panel, the Government Finance Officers Association, and the Society of Actuaries Blue Ribbon Panel recommend amortizing pension debt over 20 years to avoid negative amortization.” Emily Swenson Brock, director of the federal liason center at the Society of Actuaries Blue Ribbon Panel, noted that 20 years “is a more conservative estimate which mitigates the risk of negative amortization.” The other two organizations could not be reached by press time.

California Ahead of the Curve?

In a staff memorandum that SDCERS sent to its board and shared with IA, it stated: “At the recent Board retreat the Board’s consulting actuary, Cheiron, provided a chart showing most California plans amortize assumption and methodology changes over 20 years with only 4 plans using 30 years.”

IA contacted Cheiron to ask if this was a trend taking place nationwide. According to Bill Hallmark, consulting actuary, Cheiron, “in terms of amortizing periods, there has been growing concern in the actuary community about what we call negative amortization, or schedules that don’t pay the interest on the unfunded liability. If they didn’t make full payment at the end of the year they would owe more than at the start of the year.”

Hallmark added that “a lot of systems have been set up that way because it results in stable contribution rates, but that doesn’t pay off the unfunded liability. This concern has been building for a long time and has led systems that had long amortization periods like 30 years to reduce those so that from the beginning they would be paying down their underfunded liability.”

So are the California funds ahead of the rest of the country in terms of reducing amortization periods?  “I do think California systems, in general, were ahead of the national trend; most funds in California have reduced their amortization periods in the last decade,” Hallmark said. “A lot of systems have addressed it across the country and some have not, but overall there is a trend,” he noted.

According to the SDCERS staff memorandum: “In practical terms, the reduction of the assumption and methodology amortization period to 20 years would be to implement a widely recognized actuarial funding best practice and balance the Funding Objectives of increasing the plan’s benefit security and addressing intergenerational equity while being mindful of facilitating stable, predictable, and sustainable plan contributions.” It also stated that “The shorter periods safeguard against insufficient interest payment in the early years causing the amount of debt to increase.”

100% Funded by 2037?

The SDCERS senior official also noted that, “Based on the System’s June 30, 2018 actuarial reports, we anticipate the employer’s UAL contribution will significantly decrease in future years for the City and the Port.  By setting a minimum UAL payment, both the City and the Port will improve plan funding during the minimum floor payment period, which should help the pension fund reach 100% funding by 2037.  The minimum UAL payments may lower the plan’s long-term employer cost and improve the benefit security for the retirees by achieving 100% funding 11 years earlier than previously expected.”

Under the new UAL payment guidelines, the minimum UAL pension payment, or “floor,” must be paid each year, even if the required annual payment is less than the floor. The annual UAL floor payment for the City is now set at $275.5 million and the annual UAL payment for the Port is set at $13.3 million, according to the official. These amounts were calculated based on the June 30, 2018 actuarial valuations, which set the payment amount for the fiscal 2020 payment to the retirement system.

The official clarified, however, that “if the investment market should have another recession, the UAL minimum payment method does not preclude the employer from making the required UAL contributions due to actuarial experience investment losses. The UAL minimum payment method is effective when the plan is meeting or exceeding its 6.5% investment return expectation.”

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