2009-07-13_Agenda Packet--Dossier de l'ordre du jourCity of Saint John
Common Council Meeting
Monday, July 13, 2009
Committee of the Whole
1. Call to Order
5:00 P.M. Council Chamber Open to the Public
1.1 Morneau Sobeco Presentation: Financial Advisory Services to Common
Council Re the Employee Pension Plan
City of Saint John
Seance du Conseil communal
Lundi, le 13 Juillet, 2009
Lieu : Salle du conseil communal
Comite plenier
1. Ouverture de la seance
17 h - Salle du conseil communal
1.1 Morneau Sobeco: Regime de retraite des employes des seiArices consultatifs
financiers
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> The information provided in these slides is incomplete without
the discussion that accompanies the presentation
> The figures / costings contained in this presentation are based
on rough estimates only (detailed costing will produce different
results)
> The figures shown in this presentation are meant for illustrative
purposes only in order to help Council make decisions (this, in
turn, may facilitate the need for future enhanced precision)
> In order to allow a third party to better understand how these
rough estimates were calculated, we have included details of
our calculations in the Appendix
2
3
> Limited attendance at Meeting #3 resulted in most decision
making scheduled for that meeting being delayed to today
> Councilors present at Meeting #3 wanted to provide missing
councilors with the opportunity to review Meeting #3 material
in order to provide input on decisions to be made
> Council also requested that more information on Cash versus
Accounting be provided in order to aid their decision as to
which should be Council's focus
> Council confirmed that the City remains committed to the
principle of equal sharing of plan costs with plan members
> Council also decided that the City should be prepared to give
further consideration to the inclusion of retirees in cost sharing
3
4
> Project Review
> Outcomes for Today's Meeting
> Recap of Ana .ysis
> Discussions /Decisions
> CProcess
> Next Steps
4
5
> We are 2.5 months into effort (first meeting April 27) and this
is our 4th meeting (3rd real working session)
> We believe that working with full Council in open sessions has
been successful in creating a transparent process but has
contributed to a slower project pace and increased work effort
> We are concerned that project is in danger of not moving ahead
quickly enough (need to be ready for 31/12/2009 valuation)
> If stakeholder consultation is desired, we need to be ready to
being this process within the next few weeks to finish in time
> What is Council's opinion regarding how effort is going to
date? Are we providing the right information to you? What
parts of the project are going well? Are there things we should
be doing differently?
5
6
> Ensure understanding of Meeting 3 materia s
> Require decisions regarding key issues inc'-uding:
- Definition of critical measure (cash vs accounting)
- Definition of "goalposts" for bearable costs for City
- Desired level of risk sharing among stakeholders and
mechanisms for tracking relative allocation
- Direction regarding desired attributes of go forward
plan design
- Definition of consultative process (who participates,
form of discussions, etc.)
6
7
> City Pension Ran current -y faces significant financia'.
cha : enges (-$150 mi .ion unfunded : iabi ity)
> Wi_ this fix itsel through future investment gains?
-Would require -6.5% real return (above inflation)
compounded every year to be fully funded in 20 years)
- Historical experience of results following past similar
market events tells us that this is highly unlikely (has
happened twice in 9 significant market declines over
past 80 years)
> C-Investment returns a.one wi.. not fix this
7
8
> It has been suggested that the issue is a creation of the actuary and it is not
really that significant
> What if the City could ignore the unfunded liability and simply matched
employee contributions (special approval required)?
- Based on a very simple model assuming:
• current plan cost paid by City match of employee contributions
• current negative cash flows of $8M / year grow by 7.5% annually
• plan experience produces no net gains or losses versus assumptions
- In 10 years time the plan is still over 50% funded; but
- _ _ - - - - - - Pension P is
30 - ~ - ° - - - -
on - - - - _s- - - =-e - - - -
- -
- - - D- W - - - - -
1-a.-
> Conclusion - Can get away with ignoring issue for short term but this will
inevitably lead to disaster for all stakeholders
s
9
> Addressing problem requires "Real Deficit Solution":
- More money in (City):
• Under present legislative requirements, full funding of -$150 M
deficit by City would require contributions of 24% of payroll for 15
years (17% if over 25 years - special approval required)
• Would also require payment of employer share of current benefit
cost (-11% of pay in 2010)
• Total City cost -35% of payroll (28% if special approval granted)
- Under current plan terms, deficit is 100% City's responsibility
- We understand that these cost levels are not feasible for the City
> Conclusions:
- Sharing of deficit funding with members necessary (how to do?)
- Need to determine what level of cost is feasible for City
9
10
> More money in (Active Plan Members):
- What about increasing contributions by active plan members (such as
2% special funding currently in place)?
- Member contributions of 8.5% (10.5% to 05110) are quite high
- Benefits are also relatively generous (2.0% lifetime pension, etc)
- An additional 2% contribution rate by active plan members generates
-$1 million of additional contributions / year (total deficit cost 24%)
- Plan members must receive a minimum benefit equal to the value of
their contributions to plan plus interest limited net value to plan
- Council has confirmed that the pension plan is an important tool for
recruiting and retention; excessive member contribution rate will defeat
this purpose
> Conclusion - relatively little (if any) of the solution will come from higher
contributions to the plan made by active plan members
10
11
> Less Money out of plan
- This means paying less benefits to plan members than the
current plan terms would call for
- Some plan changes that have been proposed in past would create
benefit "cliffs" with significantly different amounts paid to
members who might be in very similar situations
- Other options would see immediate reductions in benefits
currently being paid
- We strongly recommend that any plan changes not follow either
of the above approaches
- Support of all stakeholders will be required in order to succeed
11
12
> Less money out of plan:
- Propose that changes to plan with respect to benefits earned to
date focus on temporarily suspending future increases in benefits
that current plan terms call for (growth in best average earnings
for active members, indexing of pensions for retirees)
- All changes will require legislative approval
• Freezing of best average allowed under PBA
• Suspension of indexing likely more problematic
- Because retirees make up over 50% of plan liabilities, if their
benefits are considered untouchable, balancing plan finances will
be very difficult to achieve (no City money for active members)
12
13
> Less money out of plan:
- Observe that when 2% indexing introduced 1 / 1 /95, inflation over
prior 20 years had been 6.1% (4.6% over prior 40 years); so 2%
indexing was likely expected to provide 30-40% of inflation
- Actual inflation since then has been -2% so actual benefit
provided has been close to 100% inflation protection
- Most significant change in 2006 valuation was reduced inflation
expectation (4.0% 2.5%) 2% indexing is -80% of inflation
- Indexing at 1% rate for benefits pre I/ 1 /93 paid for by plan
surplus after 1/1/97 valuation ($12.1 M)
> Retiree net inflation protection has been better than anticipated
13
14
> Less money out of p '.an (current active members):
-Recognize that current benefit provides very generous
income replacement in retirement (combined with CPP
and OAS net benefit can even exceed working income)
- Potential change in structure for future benefits may
allow reduction in contributions for both members and
City, saving costs while protecting net member value
- Details of redesign should include consultations with
both members and City staff to ensure future plan
design meets needs of all stakeholders
14
15
> Tracking Mechanism for Cost Sharing
- Concept of "Core" and "Target" plan designs
• Core = Minimum guaranteed benefit
• Target = Desired benefit provided subject to plan finances
- For benefits to date:
• Core = Existing benefit $ but no future increases
• Target = Existing benefit $ plus inflation protection
- Treat any shortfall versus Target benefit as a "contribution"
made by members to Plan's finances
- Assume City matches member contributions (cash from active
members plus shortfall versus Target benefit value)
15
16
> Cost sharing example (not actual values for City plan):
- Assume liabilities of $15 OM active and $1 OOM retirees
- Active members contribute $4M
- Assume target indexing of 3% for active and 1.5% for retirees
- If 0% indexing provided member "contributions" =
• 3% * $150M = $4.5M +
• 1.5% * $100M = $1.5M +
• $4.OM cash
- Total employee "contribution" of $10.OM in year
- Suppose City makes cash contributions of $8.OM
• City $2.0 M contribution "owing" grows with interest to next year
16
17
> It is our understanding that the City has used current cash
funding requirements to record the cost of the pension plan to
the City (i.e., defined contribution accounting)
> Accounting expense is the measure used by private sector
(CICA 3461) and various public sector bodies (PS 3250) and is
based on actuarial valuation not unlike funding basis
> If this measure is what Council is most worried about we will
need to address some additional topics in our discussions
> Council requested that we provide more information on Cash
versus Accounting to aid in the decision as to which was more
fundamental for the City to focus on
17
18
> On a cash basis, assuming no changes to the plan / assumptions / etc., and
full amount of deficit is paid by employer, City cost would be -35% of
payroll in 2010 (24% for deficit and 11% current service cost)
> On an accounting basis, again assuming no changes and employer pays full
deficit, City cost would be -54% of payroll in 2010
> These calculations are highly simplified estimates but internally consistent
> Elements of accounting costs are outlined as follows:
- Current Service Cost: -20% of payroll
- Interest on Deficit (6.75% of $150M): -18% of payroll
- Amortization of Deficit of $150M over 11 years (expected average
remaining service lifetime): -25% of payroll
- Employee contributions of 9% of payroll
18
19
> Accounting cost of 54% of payroll is significantly higher than the cash cost
of 35% of payroll
> The main reason for this large difference is that the cash cost amortizes the
deficit in equal payments over a 15 year period of time at an estimated cost
of 24% of payroll
> In contrast, accounting cost front ends more of this by taking into account
both the interest on deficit (18% of payroll) and the eventual payment of the
deficit over a shorter period of time of -11 years (25% of payroll), totaling
43% of payroll not including normal cost
> This results in a difference of 19% of payroll (43% - 24%)
> Continuing use of cash accounting likely advantageous to City at present
> In the long term there may not be any choice due to new accounting
requirements mandating adoption of formal accounting treatment
19
20
> Many government entities use PS3250 defined benefit
accounting as their primary disclosure methodology
> City of Saint John may find a change to PS3250 defined
benefit accounting too onerous to implement at the present
time
> This, in turn, brings us back to our original decision point from
Meeting #3
> DECISION: Is the cash funding requirement (versus defined
benefit accounting costs) the appropriate measure of the cost of
the pension plan that is critical for Council at the present time?
20
21
> In Meeting #3, we suggested that a City may have to
be prepared to support contributions of -20% or more
of payro for severa years
> We suspect that it wi . be very difficu'l to address the
current funding crisis with .ess City funding than this
> Starting with a p: an deficit of -$150M (the December
31, 2008 projected va.ue), amortizing 50% of this
($75M) wou: d require 12% of payro :for 15 years
> Assuming a 50-50 cost sharing of today's benefits,
tota City contributions are approximate .y 23% of pay
21
22
> While we are not suggesting -20% of pay should be the
"Normal" (expected) level of contributions, unfortunately this
may be the "Special" level of contributions that will be
necessary for an extended and indeterminable period of time
given the pension plan's current funding crisis
> Amortization contribution levels were determined using a 15
year period (as per the PBA)
> This 15 year period implies that the City should expect that this
contribution rate will continue for a relatively long time
> This time frame will vary depending on future investment
experience (either favourable or unfavourable)
22
23
> DECISION: What is the "Normal" (desired) level of
contributions that Council believes is appropriate for the City
during "Normal" (non-crisis) times?
> DECISION: What is the "Special" level of contributions
(required due to the large deficit currently in existence) that
Council believes that the City's budget can withstand in
dealing with this funding crisis?
23
24
> From meeting #3, it appears that the primary tool for sharing
increased costs of plan with members will be "less money out"
- Need to design approach that is easily adaptable from year to
year without substantial special intervention
- Must not create benefit "cliffs" to preserve equity among groups
of plan members (avoid "have" / "have not" groups) or incenting
actions that would create experience losses for plan (i.e., an
unusually high number of early retirements)
- Must be transparent and fair allocation among plan members and
maintain 50-50 sharing with City
24
25
> DECISIONS:
- Is Council comfortable with the basic concepts of a Target and a
Core plan design?
- Does Council endorse the concept of members' making
additional "contributions" to amortize any unfunded liability the
plan has by receiving benefits less than the Target level (i.e.
temporarily suspending indexing of benefits) and crediting the
value of this in the calculation of 50-50 cost sharing?
- Is there agreement on the Target versus Core concept?
- How does this discussion get moved forward for presentation at
Meeting #5?
25
26
BALANCING MECHANISM (Brief summary from Meeting #3)
> The Accumulated Net City Contributions Owed keeps track of
any variation from 50-50 cost sharing
> When a positive balance, plan members have contributed more
than the City to the plan and greater than matching funding
from the City is due to restore the balance
> When a negative balance, the City has contributed more than
plan members and can make less than matching contributions
> DECISION: Does Council endorse this type of concept to
track and balance the 50-50 cost sharing?
26
27
> We now need to provide some direction so the project
can move forward to broader stakeho_der invo'-vement
> Fo__owing Decision Points wi__ provide key guidance
for ongoing work and, whi .e we wi . move forward on
the basis that these decisions are fshou d not
be assumed comp ete y unchangeab e shou d future
circumstances warrant reconsideration.
27
28
> Cash vs. Accounting: Is the cash funding requirement (versus defined
benefit accounting costs) the appropriate measure of the cost of the pension
plan that is critical for Council at the present time?
> "Normal" City Contribution Level: What is the "Normal" (desired) level
of contributions that Council believes is appropriate for the City during
"Normal" (non-crisis) times?
> "Special" City Contribution Level: What is the "Special" level of
contributions (required due to the large deficit currently in existence) that
Council believes that the City's budget can withstand in dealing with this
funding crisis?
> Target Plan versus Core Plan: Is Council comfortable with the basic
concepts of a Target and a Core plan design? Note that this is a
fundamental plan design change
2s
29
> Target Plan versus Core Plan: Does Council endorse the
concept of members' making additional "contributions" to
amortize any unfunded liability the plan has by receiving
benefits less than the Target level (i.e. temporarily suspending
indexing of benefits) and crediting the value of this in the
calculation of 50-50 cost sharing?
> Balancing Mechanism: Does Council endorse the Balancing
Mechanism concept as illustrated to track and balance the 50-
50 cost sharing?
> Indexing of Pensions: Is a temporary suspension of indexing
a potential avenue for consideration? Could alternative options
be considered (i.e. 30% of CPI)?
29
30
> Have estimated impact of proposed suspension of indexing on plan
finances using 2006 actuarial basis (see later comments)
> If future indexing not guaranteed, plan is almost fully funded - in
table below City contribution driven by matching of employee
contributions)
Funded
EE % of
EE
ER % of
Position
pay
benefits
pay
Current Plan
(150)
9%
0
35%
Target Plan
(138)
6%
0
28%
Core Plan
(20)
6%
14%
20%*
Core Plan +
(127)
8%
10%
24%
indexing at 2%
31
> City indicated that the plan is not to be part of the bargaining
process or union members
> Since both active and retired members will be greatly affected,
especially if indexing is temporarily suspended, feedback must
be sought
> Union representatives will also need to be part of the process
> If decisions reached on preceding issues, may now choose to
begin consultative process
> DECISION:
- Who are the appropriate groups?
- How should they be included?
- Who runs the consultative process and how will it work?
31
32
> Assuming that consultative process begins, Council needs to
turn attention towards longer term structures
> Direction under consideration (50-50 cost sharing with benefits
varying based on funded position) differs significantly from
current terms (City responsible for 100% of deficits)
- Do current governance structures meet needs under new terms?
- What are the appropriate roles of City Council and the Board of
Trustees under this new design?
- Who is responsible for measuring and monitoring risk (see
following discussions re Actuarial Basis, Investment Strategy
and Funding /Benefit Policy)?
- How will this transition be managed?
32
33
> Actuarial valuations do not determine what a plan's actual
costs are, they simply serve as a yardstick to measure if the
plan is on track to prudently provide for promised benefits to
plan members when they retire
> Most recent valuation incorporated changes to valuation basis
to more accurately reflect current realities (i.e. lower inflation)
> One of most critical assumptions is real rate of investment
return after fees of 4.15% (2007 Investment Policy Goal was
3.85% after fees, which would actually be more consistent with
assuming a 3.40% real rate of investment return after fees)
> The plan has utilized an aggressive (but not inappropriate)
valuation basis, producing relatively modest levels of current
costs and accrued liabilities relative to benefits promised
33
34
> Given the size of the pension plan compared to payroll and the
resulting risks, we suggest that City consider building a margin
of conservatism into the valuations to help mitigate the impact
of volatility of returns
> This could involve both asset strategies as well as increased
conservatism in assumptions
> Conservatism in assumptions would help the City and plan
members reduce the risk of future adverse situations further
diminishing the health of the plan
> IMPORTANT: Future economic downturns will most likely
occur - both the liability and asset side of the balance sheet
need to be prepared for this
34
35
> Whi .e acceptab e at ast va uation, it is'.ike'.y that the
current actuaria . basis wi .require further
strengthening at upcoming va .uation
> Conservative assumptions shown as "possib:.e"
present a more conservative position of the p '.an and
offer more opportunity for experience gains to arise
than the current assumptions
> Gains he'.p bring funding'eve's up to Target in a more
consistent manner (more "good news" from year-to-
year)
35
36
> The following represents a possible set of assumptions that
reflect more conservative rates based on the nature of the Core
Plan and the use of future experience gains to reinstate benefit
levels to Target (this change would increase current plan
liabilities by -18% or $75M)
Assumptions used for approximation
Current
Discount Rate
I nflation
Salary
Real Return
6.75%
2.50%
3.00%
4.15%
Possible
5.50%
2.00%
2.50%
3.43%
36
37
> Asset & Investment Strategy is a critically important decision
that is a primary determinant of a plan's risk profile
> Investment Policy needs to reflect tolerance of funding parties
> In past 3 years the allocation to fixed income assets has been
reduced from 45% of the portfolio to 25% and three new asset
classes have been introduced (10% Real Estate, 10% Hedge
Funds and 5% Private Debt)
> Would be prudent to confirm that this strategy is consistent
with revised plan terms and approach by detailed modeling
analysis through Asset Liability Study
37
38
> Benefit and Funding Po icy wou .d out .ine funding
and benefit'.eve-.s that wou d depend on the financia'.
strength of the P: an
> Benefit and Funding Po icy wou .d out.ine what
contributions /benefit changes may be required
depending on whether the Ran is in ba'ance or not
and how these shou .d be imp'.emented
> Depending on the terms of the new arrangement,
drafting of a Benefit and Funding Po .icy may not be
up to Counci'- a'-one (50-50 sharing with members)
38
39
> Begin CProcess with stakeho_ders to
secure their input and support for direction
> Assess p'-an governance structures and a__ocation of
responsibi .ities against requirements of new p an
design
> Perform detai'.ed financia'. ana .ysis to more accurate_y
measure impact of proposed strategies and how far
they go to accomp_ish desired outcomes
39
40
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> ASSUMED ACTIVE MEMBERSHIP FOR ALL
COSTINGS:
Assumed Membership Data
Age 45
2009 Salary $587000
FAE3 Now $557000
Years of Service 16
42
43
> ASSUMPTIONS USED FOR CURRENT BASIS:
Assumptions used for approximation
Discount Rate
6.75%
Inflation
2.50%
Salary
3.00%
Retirement
58
Overall 1.6/2=
1.8%
Position: $400m
Liab (48%
Active), $250m Assets
Cost Methods:
Current Plan: Projected
Unit Credit (Service Prorate)
Target Plan: Projected Unit Credit
(Benefit Prorate)
Core Plan: Unit Credit
Frozen Plan: Projected
Unit Credit
(Benefit Prorate)
43
44
> Changes made to Current Assumptions to reflect
Possib_e Assumptions:
Assumptions used for approximation
Current
Discount Rate
of ation
Sa ary
Rea Return
6.75%
2.50%
3.00%
4.15%
Possib e
5.50%
2.00%
2.50%
3.43%
44
45
> FOR PURPOSES OF THIS PRESENTATION, WE
ASSUMED THE FOLLOWING CORE PROVISIONS:
- Pre-2010 Service: Freeze best three year average earnings as at
December 31, 2009 (no indexing)
- All Service: Suspend indexing of pensions
- Post- 2009 Service: Change pension formula from 2% to 1.6% /
2%
- Post-2009 Service: Change from best three year average
earnings to career average earnings (no indexing)
- Post-2009 Service: Change unreduced retirement from 85 points
to age 65
45
46
> FOR PURPOSES OF THIS PRESENTATION, WE
ASSUMED THE FOLLOWING TARGET PROVISIONS:
- Pre-2010 Service: Target indexation of frozen best three year
average earnings as at December 31, 2009 using CPI
- All Service: Target indexation of pension
- Post- 2009 Service: Change pension formula from 2% to 1.6% /
2%
-Post-2009 Service: Change from best three year average
earnings to career average earnings (target indexing using CPI)
- Post-2009 Service: Change unreduced retirement from 85 points
to age 65
46
47
FUNDING POSITION / COSTS: INDEXING AS AFFORDABLE
Current
Ret AL
$
208
Active AL
$
192
Total AL
$
400
Assets
$
(250)
Deficit
$
150
NC
20%
Amort
24%
Total
44%
E'ee
-9%
Net
35%
Target
Core
$
208
$
177
$
180
$
93
$
388
$
270
$
(250)
$
(250)
$
138
$
20
12%
6%
22%
3%
34%
9%
-6%
-6%
28%
3%
47
48
FUNDING POSITION / COSTS: INDEXING AT 2% GUARANTEED
Current
Target
Core
Ret AL
$
208
$
208
$
208
Active AL
$
192
$
180
$
169
Total AL
$
400
$
388
$
377
Assets
$
(250)
$
(250)
$
(250)
Deficit
$
150
$
138
$
127
NC
20%
12%
6%
Amort
24%
22%
20%
Total
44%
34%
26%
E'ee
-9%
-6%
-6%
Net
35%
28%
20%
48
49
FUNDING POSITION / COSTS - INDEXING AS AFFORDABLE
Current
Possible
Assumptions
Assumptions
Tarqet
Core
Ret AL
$
208
$
233
$
233
$
196
Active AL
$
192
$
244
$
229
$
140
Total AL
$
400
$
477
$
462
$
336
Assets
$
(250)
$
(250)
$
(250)
$
(250)
Deficit
$
150
$
227
$
212
$
86
NC
20%
26%
15%
9%
Amort
24%
35%
33%
13%
Total
44%
61%
48%
22%
E' ee
-9%
-9%
-8%
-8%
Net
35%
52%
40%
14%
49
50
FUNDING POSITION / COSTS - INDEXING AT 2% GUARANTEED
Current
Possible
Assumptions
Assumptions
Tarqet
Core
Ret AL
$
208
$
233
$
233
$
233
Active AL
$
192
$
244
$
229
$
229
Total AL
$
400
$
477
$
462
$
462
Assets
$
(250)
$
(250)
$
(250)
$
(250)
Deficit
$
150
$
227
$
212
$
212
NC
20%
26%
15%
9%
Amort
24%
35%
33%
33%
Total
44%
61%
48%
42%
E' ee
-9%
-9%
-8%
-8%
Net
35%
52%
40%
34%
50
51