City of Palo Alto )CA) Staff Report: Response to Colleagues' Memo on Employee Benefits (2013)

7/29/2019 City of Palo Alto )CA) Staff Report: Response to Colleagues' Memo on Employee Benefits (2013).

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City of Palo Alto (ID # 3275)City Council Staff Report

Report Type: Action Items Meeting Date: 1/22/2013

City of Palo Alto Page 1

Council Priority: City Finances

Summary Title: Staff Response to Colleague's Memo Concerning Pension

Benefits

Title: Response to Colleagues' Memo on Employee Benefits

From: City Manager

Lead Department: Human Resources

Recommendation

Staff recommends that Council receive input and provide guidance, on issues related to the

Citys strategy for reforms and innovations in employee retirement plans and pension. The

Councils direction for this session anticipated the following purposes:

1. Educate the public and employees about CalPERS pensions and how they work

2. Inform the public and employees about the recently enacted pension reform and how it

impacts the City of Palo Alto

3. Enumerate the limitations on the Citys options given our participation in the CalPERS

system and the requirements of state law.

4. Explore additional pension legislation to close remaining loopholes and to give cities

broader decision making power in regards to their pension plans.

Staff recommends, at a minimum, the following action by the Council:

DRAFT MOTION: I move that the staff explore additional pension legislation with our legislators

and other parties (such as the League of California Cities) to close remaining loopholes and to

give cities broader decision making power in regards to their pension plans. (Agenda Item later

this evening on Legislative Matters anticipates this action).

I further move that staff continue to work with our employees and the public to fully


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understand the facts about pensions and the status of the Citys efforts to manage our costs

and provision of benefits while maintaining a talented work force.

Background

Council proposed exploring a sustainable model of pension, health and other benefits in itsColleagues Memo dated June 15, 2012. Beginning with the Council meeting of October 15,

staff created a foundation for this discussion with a review of the components of total

compensation (salary, health benefits, retirement savings/pension, paid time off, etc.) and their

relationship to recruitment and employee engagement. This report, the second in a series of

three reports, seeks to educate the public and City employees about the CalPERS pensions

system, explain the Public Employee Retirement Law (PERL) and the Public Employee Pension

Reform Act (PEPRA) that became effective January 1, 2013, and provide a foundation for policy

discussions and long-term strategies from Council regarding employee pensions. Many of these

issues are subject to collective bargaining with the Citys recognized bargaining units and to

state law.

The primary objective of PEPRA is to ensure that employees share in paying the normal pension

cost, introducing a lower-formula second pension tier, and in this regard Palo Alto has been in

the forefront of implementing cost-cutting pension practices as permissible under existing law.

Before PEPRA, Palo Alto had already implemented second tier CalPERS plans and negotiated

that employees pay their full percentage of pension cost for nearly every employee group. A

review of our standard Bay Area survey cities indicates that only 41% of cities have created

second pension tiers for miscellaneous employees and 50% for public safety. Additionally, 25%

of survey cities continue to provide City-paid employee pension contributions and only one

agency pays some portion of the employee pension contribution for safety employees.

Most of the PEPRA changes apply to new, future employees. PEPRA does not do enough,

however, to address the hurdle that California agencies still face covering the cost of

increasingly expensive employee pensions for current active employees and retirees. Cities

operating under the CalPERS pension system will experience increasing costs and the lack of

flexibility provided to cities will put downward pressure on salaries and health benefits.


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PEPRA does level the playing field for competing for talent for the long-term, with all new

CalPERS agency non-safety employees earning the same 2% at 62 pension benefit formula

across CalPERS agencies statewide. It also caps pensionable earnings, imitating social security.

There the flexibility ends, leaving CalPERS cities like Palo Alto with few alternatives to

traditional defined-benefit pensions short of further legislation. If the City wished to hire

employees with alternate retirement benefits but no defined-benefit CalPERS pension, we

could not legally do so. Attachment A is an analysis of PEPRAs impact to Palo Alto. At Council

request, staff has sought employee feedback about the desirability and the perceived value of

various benefits through two facilitated employee forums. (Attachment B is a summary of the

employee feedback).

Discussion

What is a defined benefit pension? A defined benefit pension is a retirement plan that

guarantees a fixed monthly retirement allowance, calculated according to the plan formula,

when certain prerequisites are met. CalPERS retirement allowances are calculated based on

three factors:

Service Credit - generally, the number of years the employee worked

Benefit Factor - the percentage of Final Compensation an employee is entitled to for

each year of service. For most CalPERS plans, the benefit factor increases with the age

of the employee at retirement


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Final Compensation - either the highest single year or the average of the highest three

consecutive years of the employees compensation

Defined benefit examples. For example, under CalPERS 2%@ 60 formula, which is now in use

for Palo Alto employees hired after July 2010 in non-safety positions, pension is calculated at

age 60 by taking the number of Years of Service x .02 (Benefit Factor) x Final Compensationequal the Annual Retirement Allowance, as shown in the two examples below.

A non-safety employee who retires under that formula at age 60, with 30 years of service and a

final compensation of $70,000 will receive the following annual retirement allowance:

30 Years of Service

X .02 Benefit Factor

X $70,000 Final Compensation

= $42,000 Annual Retirement Allowance

A safety employee, who retires at age 55 under the 3% at 55 formula, with 30 years of service

and a final compensation of $70,000 will receive the following annual retirement allowance:

30 Years of Service

X .03 Benefit Factor

X $70,000 Final Compensation

= $63,000 Annual Retirement Allowance

Both of these examples reflect the second tier pension formulas adopted by the City over the

past few years. The majority of existing employees maintain their tier one formula benefits of

2.7% at 55 for non-safety employees and 3% at 50 for safety employees, which result in a

higher pension benefit. PEPRA made no changes in this regard.

Benefit increases with age. The above illustrated examples do not tell the entire story, because

the benefit factor increases with age. The 2% at60 plan, for instance, pays a factor of 1.092

for early retirement at age 50, increasing incrementally to a factor of 2.418 at age 63 or older.

This translates to an annual pension of $50,778 at age 63, up from an annual pension at age 60

of $42,000. At Attachment C are detailed charts showing the available percentage of final

compensation for the CalPERS safety and non-safety plans according to age/benefit fact and

years of service. Note that the reduced benefit formulas and increased retirement age

provisions under PEPRA, explained later in this report, create new defined benefit formulae for


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all miscellaneous (non-safety) and safety employees. Moreover, CalPERS pensions are subject

to inflation adjustments up to 2% each yearbut cannot exceed the national rate of inflation.

How are CalPERS defined benefit pensions funded? Three sources fund CalPERS pensions.

First, employees generally contribute a percentage of their annual pay toward theirpension. Historically, statute sets that amount, and for most commonly-used plans it is

7% or 8% for non-safety employees and 9% for safety. Employers may agree to pay

some or the employees entire portion, and many have done so. A comparison of Bay

Areapension plans shows that 25% of local agencies pay a ll or part of the employees

portion of pension. For fiscal year 2014 the employee contributions will be a combined

7.945% for non-safety employees and 9% for safety employees (not including new

pension tiers). Under PEPRA, employee contribution rules and procedures will be

changing, as described in this report and the attachments.

Second, the entire CalPERS system has investment earnings (or losses) arising from

investment of system assets in stocks, bonds, real estate and other investment vehicles.

This source of funding varies from year to year, sometimes dramatically. Gains are

available to fund pension benefits. Losses must be made up by the agencies providing

additional funding. If investment earnings are not high enough, CalPERS will just pass

the bill onto the city. CalPERS reports total returns varying as shown in the table below.

2012 YTD ending 10.31.12 4.1%

3 year period ending 9/30/12 9.3%



Third, employer contributions provide the balance of needed funds. Employer

contributions may decline when investment returns rise and increase when returns fall

and/or when actuarial assumptions adjust to reflect higher system costs. Every year,

CalPERS transmits an actuarial study to each participating employer stating the

percentage of payroll that the employer must pay to fund benefits for its currentemployees and retirees. Employers must pay the entire employer contribution each

year. In the last 15 years, employer contributions have varied from zero (when

investment earnings were very high) to more than 24.6% of payroll for non-safety

employees and 33.4% of payroll for safety employees in fiscal year 2014. This translates

that, for every $1 in qualified pension salary, the city pays $0.25 and $0.33 respectively.


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What are Palo Altos pension costs?

For fiscal year 2014 CalPERS provided the following pension costs:

CalPERS Required Employer

Contribution

FY 2012-13

June 30, 2010

FY 2013-14

June 30, 2011 Difference

Non-safety 15,800,795$ 16,208,975$ 408,180$ 3%

Safety 7,870,938$ 8,322,938$ 452,000$ 6%

Total 23,671,733$ 24,531,913$ 860,180$ 4%

Funded Status

Total Unfunded Liability (AVA Basis) 153,941,378$ 176,609,601$ 22,668,223$ 15%

Total Unfunded Liability (MVA Basis) 300,666,178$ 256,827,528$ (43,838,650)$ -15%

Non-SafetyFunded Ratio (AVA Basis) 80% 79% -1%

Funded Ration (MVA Basis) 62% 69% 7%

Safety

Funded Ratio (AVA Basis) 83% 81% -2%

Funded Ration (MVA Basis) 65% 72% 7%

* The Actuary Value of Assets (AVA) is used to establish funding requirements and the funded

ratio on this basis represents the progress toward fully funding future benefits for current

participants. The funded ratio based on the Market Value of Assets (MVA) is an indicator of the

short-term solvency of the plan.

End of the Reversal. A long-standing retirement pay practice is ending for Palo Alto

employees because of PEPRA and the Citys policy that employees pay their full share of

pension costs. When a city employee retires, they must designate a 12 month period during his

or her service in CalPERS as their final compensation period. Prior to employees paying the

full employee retirement contribution, an employee retiring was eligible for reversal of

Employer-Paid Member Contributions (EPMC). The City would reverse the applicable 7, 8 or 9

% employer-paid member contribution paid out of a retiring employees wages, by increasing

their salary by the applicable 7, 8 or 9% and the employee would then pay the contributiondirectly to CalPERS.

However this reversal was only applicable if an employee was designating the final 12 month

period preceding the effective date of retirement. Any employee who designated an earlier

period as their highest 12 months would not be eligible for the EPMC or reversal. Since

employees are now paying their full employee retirement contribution, this reversal is no


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longer available.

The Colleagues Memo posed the following questions about public pensions.

I. How should the costs of pensions be shared between employers and employees?

Cost sharing is a critical issue in pension design. There are two primary means of lowering

pension costs for employers: reducing benefit levels and achieving greater cost sharing from

employees. Of the two, only cost sharing has the potential to impact employer costs in the

short and medium term. This is because under current law, pension benefit levels are generally

considered to be vested, which means that employers are prohibited from making significant

reductions for existing employees. Lower pension formulas may be applied only to new hires,

resulting in a longer time horizon for cost-reduction.

By contrast, employers may lawfully seek additional cost sharing from current employees.

Changes in cost sharing generally are subject to collective bargaining and may be subject toother limitations, as described in part below. The new PEPRA legislation fails to increase cost

sharing options for the City, since we have already achieved employee pick up of the employee

pension costs. Years down the road, the City may have more options but these are restricted

over the next five years.

Because Palo Alto provides pensions through the CalPERS system, the City must comply with

the cost-sharing procedures and limitations in the Public Employees Retirement Law (PERL), as

amended by the Public Employee Pension Reform Act (PEPRA), which took effective January

1, 2013. Under the PERL, the employee contribution amount is fixed by statute and ranges

from 5% to 9% of earnings. Pension formulas and cost-sharing for Palo Alto employees are

shown below:


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Pension Formulas and Employee Contributions by Employee Unit

Non-Safety (Miscellaneous)

SEIU Mgmt

(Unrepresented)

Utilities Mgrs

Formula 2.7%@55 2%@60 2.7%@55 2%@60 2.7%@55 2%@60

Eff Date 2007 2010 2007 2010 2007 2010

Current EE

Contribution

Amount

8% 7% 8% 7% 2%* 2%*

*Currently negotiating increased EE pension contribution

Safety

POA Police Mgrs Assoc IAFF Fire Fire Chiefs' Assoc

Formula 3%@50 3%@55 3%@50 3%@55 3%@50 3%@55 3%@50 3%@55

Eff Date 2002 2012 2002 2012 2001 2012 2001 2012

Current EE

Contribution

Amount

9% 9% 0%* 0%* 9% 9% 9% 9%**

*Will be negotiating increased EE pension contribution this fiscal year

**Employee contribution for 4 members of Fire Chiefs Association will reset to 5.1% in March 2013based on concession agreement in MOA.

The question of who actually pays the employee contribution has historically been subject to

negotiation, as employee pension contributions falls within the scope of representation under

the Meyers Milias Brown Act (MMBA). However, for new employees, PEPRA establishes


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mandatory formulae and cost sharing of pension benefits, leaving little negotiating discretion

over the legislatively mandated changes. Non-Safety employees hired on or after Jan. 1, 2013

will receive the new 2% at 62 pension formula; new public safety employees as of Jan. 1, 2013

will receive the new formula (2.7% @ 57) that is closest to the formula provided to safety

members in the same retirement classification offered by the City on Dec. 31, 2012).

PEPRA provides as of Jan. 1, 2013, that the new employee contribution rate will be at least 50%

of the total normal cost for the pension plan. This DOES NOT mean 50% of the pension

contribution costs and in fact is far less than that cost. An employer may not pay any part of

new members employee contribution. If the terms of a contract between an employer and its

employees in effect on Jan. 1, 2013, would be impaired by the equal sharing of normal cost for

new employees, the equal sharing of normal cost will not apply until the contact contract

expires, is renewed, amended or otherwise extended. Local agencies throughout the state are

seeking to understand CalPERS instruction regarding how it will implement cost-sharing for

employees hired on or after January 1, 2013. CalPERS has issued guidance in the form of a

Circular Letters, such as attached in Attachment D.

PEPRA also addresses cost-sharing for existing employees, in two ways. First, after January 1,

2018, PEPRA authorizes employers to bargain for current employees to pay 50% of the normal

cost so long as the employee contribution does not exceed 8% for Miscellaneous and 12% for

Police & Fire. This language and its implementation are not entirely clear. In Palo Alto, most

employees already pay their full statutory PERS contribution of 7%, 8% or 9%. PEPRA appears to

authorize Palo Alto to negotiate, after January 1, 2018, additional increments up to the PEPRA

cap of 8% for Miscellaneous and 12% for Safety employees. At this point, with limited guidancefrom CalPERS, it appears that this provision will apply to Tier 2 non-safety employees (who

currently pay 7%) and safety employees (who currently pay 9%). Second, PEPRA authorizes

employers and employees to agree to share the employer contribution, but prohibits

employers from imposing cost-sharing of the employer share in the absence of an agreement

with labor.

In sum, Palo Alto and its employees have already achieved substantial cost sharing through

employees agreement to pay their full PERS contribution. Going forward after 2018, the

Council has authority to consider seeking additional cost sharing, through negotiations where

appropriate, with respect to employees paying50% of the normal cost, capped at 8% for

Miscellaneous and 12% for Safety. In addition, at any time when contracts are open, the

Council may consider seeking additional cost sharing of the employer contribution through

collective bargaining process.

Finally, Council should be aware that there is active litigation over the question of whether


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there is a constitutional limit to the extent of costs that can be shifted to employees without

impairing vested pension rights, and if so, what is that limit. San Jose voters enacted changes

to that citys pension system that shifted substantial costs onto current employees who wish to

retain current benefit levels. San Jose unions have challenged that cost shift on the theory that

it violates members constitutional vested contract rights. The matter is in litigation in theSuperior Court.

II. Should the City establish a hybrid plan combining defined benefits, defined contributions,

and social security?

PEPRA has answered this question in the negative and precludes such options. The question of

whether the City should establish a hybrid plan combining defined benefits, defined

contributions and social security is moot short of new State legislation. Retirement planning

has long held that a three-fold approach yields the most predictable results for the retiree by

spreading risk. The three foundational pillars of retirement have been social security, employer

pension and personal savings. A defined benefit plan is one where the employee, uponretirement, is entitled to a fixed periodic payment. The asset pool - available to pay benefits -

may be funded by employer or employee contributions, or a combination of both. But the

employer typically bears the entire investment risk and must cover any underfunding as the

result of a shortfall that may occur from the plans investments. Conversely, defined

contribution plans are a type of retirement plan in which the amount of the employees annual

contribution is specified. Individual accounts are set up for participants and benefits are based

on the amounts credited to these accounts (through employee contributions and, if applicable,

employer contributions) plus any investment earnings on the money in the account. Only

contributions to the account are guaranteed, not the future benefits.

In the last two decades, the traditional three-fold approach almost entirely disappeared from

the private sector, as corporate defined-benefit pension plans were being phased out in favor

of defined-contribution programs, such as 401(k) employee savings accounts. A 2010 survey by

Towers Watson, the global consulting firm, found that only 17% of Fortune 100 companies still

offer a defined-benefit plan, down from 67% in 1998. Those that offer direct-contribution

plans, such as 401(k)'s, total 58%, up from 10%. There is more emergent data and studies that

challenge the effectiveness of 401(k) plans for providing adequately towards retirement.

Despite the decline, 36% of the country's small and medium companies still offer pensions, and

there is a slight trend towards combining defined benefit pension benefits with 401(k) plans

among companies, according to Towers Watson. That study, as written up in HR Magazine, isdetailed in the attached Attachment E.

Currently, Palo Alto uses two of the three traditional retirement planning vehicles: a pension

plan and optional voluntary employee savings. Palo Altos pension plan is described in detail

elsewhere in this report. The City supports employees savings by sponsoring a defined


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contribution 457 plan, although the City does not contribute any funds. Employees may defer a

portion of gross compensation each year, up to an annual dollar limit, which is $17,500 for

2013. The 457 plan offers a "Catch-Up" provision for employees over age 50, which allows

employees to contribute an additional annual amount of $5,500. Currently 55% of employees

actively participate in the 457 plan.

Establishing a hybrid pension/social security plan would either necessitate that the City commit

to change to the one CalPERS plan that combines social security with a lower-level CalPERS

pension, or exit CalPERS. This is because the CalPERS system only provides for one social

security plan (that may or may not still be open to new entrants).

CalPERS has an option to combine social security with a lower pension formula called a Section

218 agreement. This option would only be available for non-sworn future new hires and any

current employees who vote in agreement to join Social Security. For safety employees, all

members of their bargaining group would have to vote and approve the change. If the Citywere to pursue the CalPERS Social Security plan, staff will need to investigate how would the

plan work in conjunction with PEPRA.

The alternative scenario for adopting a hybrid pension/social security plan is for the City to

leave CalPERS altogether. In that case, the City must pay a sum to CalPERS that will secure the

pensions already in the system. CalPERS has informed the Administrative Services Department

(ASD) that the Citys cost to exit CalPERS is estimated to be between $600,000,000 and $1

billion.

III. What is the appropriate and sustainable vesting for pension rights?

The question of what is the appropriate vesting schedule for pension rights is the subject of

much scholarly debate and developing legal case law. A vested benefit is one that has

matured into an irrevocable contractual right. It cannot be taken away or otherwise impaired

without the members consent, except in extremely limited circumstances. According to

CalPERS, California law establishes that public employee retirement benefits are a form of

deferred compensation and part of the employment contract. At the time when the employee

provides service to his public employer, he earns rights to the deferred compensation. To be

eligible for any service retirement (as opposed to disability or industrial disability retirement)active employees must be at least 50 years of age and have at least five years of credited

service. Frequently the term vested indicates that the employee earned the minimum

number of credited service years and that a pension will be due to the employee upon reaching

50 years old. A members initial allowance is subject to annual cost-of-living adjustments

(COLAs) that account for changes in the applicable cost of living index each year.


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IV. Are retroactive pension increases justifiable and, if not, how can they be prohibited?

Retroactive pension increases are prohibited under PEPRA.

PEPRA now prohibits retroactive pension increases. The new law prohibits public employers

from granting retroactive pension benefit enhancements that would apply to service performedprior to the date of the enhancement. In addition, if a change in a members classification or

employment results in a benefit enhancement, such enhancement applies only to service

performed on or after the operative date of the change. This provision applies to both classic

and new members. Note that annual cost-of-living adjustments are excluded from this

prohibition. This is an important and long overdue change.

V. Should the city offer employees a choice of significantly reduced pension packages in

exchange for more desirable near term compensation and employment terms?

The City is currently restricted to offering pension packages offered by CalPERS. The CalPERSsystem, the largest public pension system in the U.S., offers a set group of packages, none of

which is a significantly reduced package. It would not be possible for the City to offer anything

else unless the City exits CalPERS altogether.

VI. How should the timing of negotiations and the Citys position in negotiations relate to

The Long Range Financial Forecast?

The Citys Long Range Forecast provides the basis for the funding resources and service cost to

run the City, and it provides the information needed to attain cost savings that may be

necessary to make up funding shortfalls. Each union negotiation features a financial overviewto share the fiscal forecast with employees. Therefore it is advantageous to update the long

range forecast before the next round of negotiations, which will begin the Summer 2013. The

coming union bargaining schedule is set forth below:

January 2013 UMPAPA

January 2013 SEIU Hourly

March 2013 Begin discussions with PMA (pension cost sharing issue)

June 2013 Deadline PMA

Begin SEIU

December 2013 Deadline SEIU (contract expires)

Begin PMA, POA, Fire


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June, 2014 Deadline POA, PMA, Fire (contracts expire)

Resource Impact

At this time funding isnt required. However, if a study is necessary, staff will come back toCouncil for such a request.

Attachments:

Attachment A - PERPRA Effect on CalPers Pension Benefits (PDF) Attachment B - Summary of Employee Feedback (PDF) Attachment C - Percentage of Final Comp Charts (PDF) Attachment D - Circular Letters (PDF) Attachment E - HR Magazine Article (PDF)


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1

Attachment A

CalPERS PENSION BENEFITS:

STATE LAW, PENSION REFORM & IMPACTS ON PALO ALTO

State Law Mandates for Local Agencies Offering CalPERS

Pensions

Palo Alto Benefits

Pension

Formulas and

Retirement

Age

State Law as of 12/31/2012

CalPERS offers employers a menu of pre-defined basic and

enhanced benefit formulas for Miscellaneous (Non-Safety) and

Safety (Police & Fire). In general, employers contract with

CalPERS for one of the formulas after bargaining with employee

organizations. The benefit factor is a percentage of pay to which

members are entitled for each year of service. It is determined at

the members age at retirement and one of the following

retirement formulas that the employer has contracted for.

Misc: 2% at 55, 2% at 60. 2.5% at 55, 2.7% at 55, 3% at 60

Safety: 2% at 50. 2% at 55, 2.5% at 55, 3% at 50, 3% at 55

In 1999, the California Legislature amended the pension law to

allow the state to offer enhanced pension formulas: 3% at age 50for Safety and 2.7% at age 55 for Miscellaneous. Subsequently,

the Legislature authorized cities and other local government

agencies to adopt the same enhanced benefit formulas.

The California Courts have held that a pension formula generally

vests at the time it is promised, which means the promise is

binding and cannot be reduced during the employees service or

retirement, subject to certain limited exceptions. For this reason,

reduced formulas are applied only to newly hired employees.

Palo Alto Pension Benefits as of 12/31/2012

Palo Alto last moved to enhance benefit formulas in 2002 for

Police and Fire and in January 2007 for Miscellaneous

employees. Beginning in July 2010, the City has been

negotiating lower more sustainable benefits for newly hired

employees. Currently, Palo Altos pension formulas are:

Miscellaneous (Non-Safety) Employees

Tier 1, hired before July 16, 2010: 2.7% at 55 Tier 2, hired on or after July 17, 2010: 2% at 60

Police & Fire

Tier 1 Fire, hired before June 8, 2012: 3% at 50 Tier 1 Police, hired before December 2012

(estimated): 3% at 50 Tier 2 Fire, hired on or after June 8, 2012: 3% at 55

Tier 2 Police, estimated to change in December 2012:

3% at 55


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4


Pensions

Palo Alto Benefits

Base

Retirement

Allowance on

Regular Pay


State law defines compensation as that which is payment for the

member's services performed during normal working hours or

for time during which the member is excused from work becauseof holidays, sick, disability, and other leaves, vacation (taken, not

cashed out). State law also defines special compensation.

Special compensation is outside of base pay but still included in

pensionable earnings. Examples are bilingual pay or fire

inspector certification pay.


Memoranda of Agreement may contain provisions forspecial compensation for employees to receive payment for

special skills, knowledge, abilities, work assignment,workdays or hours, or other work conditions as permissible

under PERL.

PEPRA

For employees hired on or after January 1, 2013, pension must

be calculated on normal monthly rate of pay. Excludes some

payments such as vacation, sick leave, overtime and other

special pay categories. In December, 2012, CalPERS issued an

interim regulation stating that many categories of payments that

were previously pensionable as special compensation will still

be considered pensionable compensation under PEPRA. PaloAlto is seeking clarification from CalPERS.

PEPRAs Impact on Palo Alto

Will be subject to further consultation with CalPERS.


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5


Pensions

Palo Alto Benefits

Cap on

Pensionable

Compensation


CalPERS limits safety pensions at either 80% or 90% of final

compensation. Miscellaneous employees are not subject to these

limits, although generally are covered by lower formulas and in

most cases are unlikely to reach 80% or 90% of finalcompensation.

Otherwise, CalPERS pensions apply to all compensation up to the

federal limit in Internal Revenue Code section 401(a)(17),

currently $250,000.


The limits in state and federal law apply to Palo Alto

retirees.

PEPRA

For employees hired on or after January 1, 2013, PEPRA caps the

amount of compensation that can be used to calculate a

retirement benefit at:

$ $113,700for employers participating in social security $136,440for employers not participating in social security.

The cap is adjusted annually based on the Consumer Price Index

for All Urban Consumers or otherwise by the Legislature.

Employers are barred from adopting any supplementary definedbenefit plan. Employers may contribute to a defined contribution

plan, subject to certain limitations.


Palo Alto does not participate in social security. New

employees hired on or after Jan. 1, 2013, except those with

prior CalPERS or reciprocal service, will be subject to

$136,440 cap on pensionable income.

At this time, Palo Alto does not have a program in place to

make deferred compensation contributions on behalf of all

employees. However, employees can make voluntarycontributions to deferred compensation plans made

available.


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6

State Law Mandates for Local Agencies Offering CalPERS Pensions Palo Alto Benefits

Cost Sharing:

Employee

Contributions

to Pension

Costs

State Law of 12/31/2012

CalPERS establishes a fixed mandatory employee contribution:

Misc. Basic Plans (Tier 2) 7% Misc. Enhanced Plans (Tier 1) 8% Safety All Plans 9%

Employers may agree to pick up part or all of the employeecontribution.

In addition to the employee contribution, which does not change

from year to year, CalPERS determines annually an amount that the

employer must pay to fund the benefits owed to retirees and

current employees. CalPERS actuaries determine the employer

contribution by adding the employee contributions to the systems

investment returns and subtracting those sums from the total

amount required to fund the system.

Funds collected from employees and employers fund two types of

liabilities:

the normal cost of pension benefits, which is the amountthat must be set aside this year to pay for the pension

obligations earned by active employees this year,incorporating CalPERS rate of return and employee

demographic assumptions, and

any unfunded liabilities, which are funding gaps generatedby shortfalls in the projected rate of return on investment,

changes in employee demographic assumptions (such as

employees living longer), etc.


Palo Alto began picking up the employee contribution in

1981 for Fire and Police and in 1983 for Miscellaneous

employees. In 2007, the City began to bargain for

employees to resume paying the employee contribution for

Miscellaneous employees.Currently:

SEIU, IAFF, Battalion Chiefs, POA andManagers/Professionals pay full employee

contribution of 7%, 8% or 9%, depending on the

employees benefit formula.

PMA pays 0%. UMPAPA pays 2%.

In addition to the employee contribution, as of June 30,

2011, CalPERS actuaries calculated Palo Altos pension

liabilities as follows (expressed as a percent of payroll):

Miscellaneous

Normal cost 10.360% Unfunded liabilities 14.240% Total = 24.600%

Safety

Normal cost 18.658% Unfunded liabilities 14.786% Total = 33.444%


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PEPRA

The cost-sharing provisions of PEPRA are complex and not clearly

drafted. CalPERS is working to clarify the implementation of the

new law. Clean-up legislation, implementing regulations or

litigation may be required in order to clarify the meaning of several

of the provisions.

New employees sharing the normal cost. PEPRA states that

employees hired on or after Jan. 1, 2013, must pay at least 50% of

the normal cost of their pension or the current contribution rate of

similarly situated employees, whichever is greater. CalPERS has

informed Palo Alto that new Miscellaneous members will pay 6.25%

and new Safety members will pay 11.25%.

Current employees sharing the normal cost. After Jan. 1, 2018,

PEPRA authorizes employers to bargain for current employees to

pay 50% of the normal cost so long as the employee contribution

does not exceed 8% for Misc and 12% for Police & Fire.

The employer contribution. PEPRA also authorizes employers and

employees to agree to share the employer contribution, but

prohibits employers from imposing cost-sharing of the employer

share in the absence of an agreement with labor.


Palo Alto is at or close to the goal set in PEPRA for employee

cost sharing. Except for Police Managers and UMPAPA, all

Palo Alto employees already pay their full employee PERS

contribution (7%, 8% or 9%).

After 2018, PEPRA allows employers to negotiate an

additional increment, not to exceed 8% for Miscellaneous

and 12% for Safety, as labor contracts are open.

Under PEPRA, the City could seek to negotiate additional

employee contributions towards the employer portion. Any

such negotiations would require agreement and would not

be subject to impasse procedures.


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8

OTHER PENSION REFORM CHANGES

Restrictions on

Hiring Retirees

PEPRA requires new retirees to sit out for at least 180 days before returning to work as a retiree. The local agencys governing

body may make exceptions for critically needed positions. The 180-day rule does not apply to police or fire retirees.

Forfeit Pension

on Felony

Conviction

PEPRA requires a pension be forfeited upon a felony conviction related to the performance of official duties. It appears that

this requirement only applies to pension benefits earned after the date of the felony. PEPRA states the rule applies to both

new and current employees, although CalPERS has stated it believes the rule may violate the vested rights of currentemployees.

Eliminate

Airtime

CalPERS allows employees to purchase service credit for years in excess of those actually worked, known as air time.

Effective January 1, 2013, PEPRA bans the practice of allowing the purchase of air time. PEPRA applies the ban to both new

and current employees. CalPERS has stated that it believes the application of this rule to current employees may violate

vested rights.

Prohibit

Retroactive

Benefit Increases

Historically, CalPERS has required benefit increases to apply to all service earned by current employees, including service

already earned in prior years. Effective January 1, 2013, PEPRA requires that any enhancements to formulas or benefits must

occur prospectively and not retrospectively.

Prohibit Pension

Holidays

CalPERS calculates the annual contribution for all employers. Participating employers must pay the full amount of the annual

required contribution as determined by CalPERS. In some past years, when high returns on investments led to funded status

well over 100%, CalPERS granted employers a pension holiday, meaning employers were not required to contribute to

CalPERS for that year. Effective January 1, 2013, PEPRA prohibits pension holidays, except if (a) the plan is more than 120%

funded; (b) excess earnings could result in disqualification of tax deferred status; and (c) the CalPERS board finds that

additional contributions would conflict with its fiduciary duty.

Other changes PEPRA makes other changes, including requiring local elected members first elected after January 1, 2013, to receive pensions

based on the highest average compensation earned as an elected member; instructing CalPERS to develop regulations to

adjust costs between employers where excessive compensation is paid by a successor agency; increasing Disability

Retirements for certain public safety employees; and requiring equal health benefits vesting rules for non-represented and

represented employee groups.


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ATTACHMENT B

Summary of Employee Feedback

Benefits/Pension 12/12/12

Health/Pension

Forum

1/10/13

Health/Pension

Forum

Total

Health Care Plan City Pays 100%

10 90 190


67 3 70


0 0 0


3 0 3

Health Care Waiver -$284

8 2 10

Dental Plan Current 39 15 54Dental Plan CityPays Less

2 2 4

Vision 5 3 8Short Term Disability 8 29 37Long Term Disability 2 2 4EAP 0 1 1

457 Matching 30 0 30Tuition/TechnologyReimbursement

0 24 24

Increase inEmployees PensionContribution

0 1 1

Retiree Medical 227 252 479Retiree Medical - CityPay 50%

0 0 0

PERS SurvivorBenefit

14 3 17

Retirement HealthSavings Account 2 0 2


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M sc. Group


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M sc. Group


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(Misc. Group)


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(Misc. Group)


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(Misc. Group)


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(Misc. Group)


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(Misc. Group)


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(Misc. Group)


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Sa ety Group


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(Safety Group)


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(Safety Group)


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(Safety Group)


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Sa ety Group


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(Safety Group)


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Attac ement D


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1

AttachmentEAre Defined Benefits Plans Dead?

Society of Human Resources Managements HR Magazine, Vol. 57 No. 7

Reports of the demise of the defined benefit pension plan may be exaggerated.

By Joanne Sammer

Defined benefit pension plans have had a string of bad luck. Since their peak

in the mid-1980s, they have been on the decline as more employers close or

freeze their plans each year. Is there a chance for a comeback?

In the 1990s, the robust stock market kept defined benefit plans well-funded,

without the need for hefty contributions from the organizations sponsoring

them. When things were going well, "these plans were out of sight, out of

mind," says Bart Pushaw, a principal and consulting actuary with MillimanInc. in Dallas. "Finance people did not need to pay much attention until

suddenly pension plans became the squeaky wheel."

Then the dot-com bust and the accompanying stock market decline causedplan assets to take a hit. That was followed by years of low interest rates,

which increased plan funding obligations.

At the same time, the federal government tightenedpension plan funding

requirements and established new accounting rules for calculating plan assets

and liabilities. The net result: Plan sponsors have less leeway when it comes to smoothing out the ups and downs in a plan's funded status. This increased

volatility. If there is anything corporate leaders hate, it is unpredictable

expenses. So, more sponsors opted to freeze or close their plans altogether.

Funding requirements and accounting rules aside, the decline in defined

benefit plans is basically about who should shoulder the risks associated with

ensuring that employees have enough assets to retire. With the rise of 401(k)


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plans, employers clearly prefer the risk to be employees'. Has this shift gone

too far?

Risks and Worries

When 401(k) plans gained popularity during the 1990s and began replacingdefined benefit plans, the soaring stock market helped to ease the transition. It

is ironic that the stock market meltdown in 2008 and 2009 and the GreatRecession may have done more to educate employees about the value of

defined benefit plans than any effort by employers. Employees also got a full

appreciation of the investment risks associated with self-directed 401(k) plans,and they did not like it.

Employers have responded by improving 401(k) plan designs with automatic

enrollment, target-date funds and professional investment advice forparticipants. However, the risk of these investments and of creating a stream

of retirement income to last a lifetime still resides with individual employees.

As a result,more workers are concerned about their retirement security,

especially young employees. In fact, 55 percent of employees are willing totrade some of their pay for a guaranteed retirement. That is a significant

increase from 46 percent in 2009, according to a July 2011 survey of 9,218

full-time U.S. employees at nongovernmental organizations with 1,000 or

more employees conducted by Towers Watson.

Employees younger than age 40 who are now participating in a traditional

defined benefit pension plan are particularly concerned. Among this group,

the number willing to pay for a guaranteed retirement benefit increased from39 percent in 2009 to 66 percent in 2011.

This attitude is being driven by concerns that employers will continue to pull

back on the retirement benefits they provide. Indeed, 44 percentof the respondents were concerned about reductions in their retirement

benefits over the next two years. Among employees under age 40 who

participate in a defined benefit pension plan, this worry was particularly

widespread, with 63 percent concerned about benefit cuts.

Defined Benefit vs. Cash Balance Plans

Because they provide a guaranteed monthly benefit from retirement for thelifetime of the participant and, potentially, a surviving spouse, defined

benefit pension plans require a large pool of assets, with associated

investment risks, to cover the long-term liabilities.

A key criticism of these plans is that they no longer fit today's workforce.

To accumulate a significant monthly benefit, participants must work for a


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single company for many years. Moreover, some defined benefit plansbackload benefit accruals to the years just before retirement and base

benefits on average pay during the final five years before retirement.

Recognizing this lack of fit with today's workforce, some employers have

implemented cash balance plans. These defined benefit plans incorporate thebest elements of 401(k) plans, including transparency achieved by

expressing benefits as an account balance and portability that allows

participants to roll over those benefits when they leave the company.

However, as with traditional defined benefit plans, the financial risk of cashbalance plans resides with the plan sponsor and not the employee.

Participants receive credits per year of service and credits based on aspecific interest rate chosen by the plan, usually a government bond rate.

Pay Attention

Since employers offer benefits to meet employee needs and to attract andretain talent, this survey data is something that employers should keep in

mind. The data suggest that "workers are increasingly focused on things that

are less available in the employment market," says Alan Glickstein, seniorretirement consultant with Towers Watson in Dallas. "Plan sponsors would be

wise to pay attention to this data because ultimately there will be growing

competition for talent, particularly as Baby Boomers retire."

As employers look for ways to differentiate themselves in the war for talent, a

defined benefit plan may be more of a selling point than corporate leaders

realize. Twenty years ago, having a defined benefit pension plan was notmuch of a differentiator because so many other companies offered them. Now,

an employer that offers some sort of guaranteed retirement benefit could

really stand out from the competition.

Houston-based CenterPoint Energy, an energy distributor with about 8,800employees, sponsors a cash balance plan with an annual company contribution

equal to 5 percent of an employee's salary and a 401(k) plan with a dollar-for-

dollar match on employee contributions up to 6 percent of pay.

Company leaders maintain dual retirement plans for two reasons: "We

appreciate the need to have both a defined benefit and a defined contributionplan in order to maintain a stable, high-quality workforce and to stay

competitive in our industry," says Ira Winsten, the company's director of

compensation and benefits. Winsten notes that prospective employees tend tobe "pleasantly surprised that we have both a defined benefit and a defined

contribution plan."

A survey of 424 mid-size and large employers with defined benefit plans


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found that36 percent offer the plans to new employees;

68 percent of those employers said they remain committed to offering the

plans to new hires over the next two to three years. The top reasons forproviding a defined benefit plan to new hires? Seventy-one percent said they

want to attract and retain new employees, and 50 percent do it to maintainemployee morale, according to the Towers Watson survey report, Pensions in

Transition: Retirement Plan Changes and Employer Motivations, which was

released in May.

Ongoing Decline

The story of traditional defined benefit pension plans is one of slow butsteady decline. According to data from the U.S. Pension Benefit Guaranty

Corp., defined benefit pension plans peaked in number at more than 112,000

in 1985. That number of plans had declined to more than 47,000 in 1996.

The most recent numbers show 25,607 plans operating in 2011 and covering

about 33.39 million participants.

Other surveys tell a similar story. Just 22 percent of the companies

represented in the Society for Human Resource Management's 2011Employee Benefits research report offered a defined benefit plan to all

employees, while 12 percent had a plan that is closed and 8 percent offered a

cash balance plan.Finally, data from Mercer reveals a significant change in active plans in just

five years and what happens to many of those formerly active plans. In

2006, 54 percent of the Fortune 200 companies had active defined benefit

pension plans. By 2011, that number declined to just

35 percent. The remainder had no plan at all (27 percent), a plan frozen forall employees (19 percent), a plan frozen for just new employees (15

percent) and a plan frozen for just some employees (4 percent). Inevitably,many of the plans frozen only for new employees are likely to freeze

completely.

Coming Back?

Is it possible that defined benefit plans could come full circle? Yes, it is

possible but by no means certain. The problems associated with traditional

defined benefit pension plansincluding lack of portability, onerousregulatory requirements and fluctuating funding commitmentshave not

changed.

"Defined benefit pension plans were designed to provide retirement benefitsfor employees, but they also served as a long-term incentive," says Randi

Miller, HR and benefits analyst with Allied Container Systems Inc., a Walnut

Creek, Calif.-based company with about 100 employees that designs and


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installs modular buildings. But today, "it is becoming much more common tosee people working for a company for only two or three years, then moving

on."

Given defined benefit plans' lack of portability, expecting companies to

unfreeze existing plans or establish new ones could be a nonstarter. "I do notsee defined benefit plans as viable in today's industry," Miller says.

Miller is not alone. "I don't see a comeback in the cards for traditional defined

benefit plans, given the current business and regulatory environment,"

Winsten says. "It is difficult to see who would champion that type of benefitin the future because it does not fit the mold of today's employment

experience in which you can expect to work for several employers during your

career."

"Employers are convinced that the risks of maintaining a defined benefit plan

are not sustainable," agrees Jim McHale, a principal withPricewaterhouseCoopers LLP in New York City.

New Designs

If any sort of defined benefit plan is to take hold, it will require new thinking

and plan designs. "Right now, we are stuck between two models for

retirement plansone that puts all the risk on the employer and the other thatplaces all of the risk on the individual employee," says Richard Shea, a partner

with law firm Covington & Burling in Washington, D.C. "To build a

sustainable retirement plan, you need to have some risk sharing" among both

the employer and its employees.

"Defined contribution approaches have gone too far to one side and left riskswith the workers that they are unlikely to be able to manage on their own,"

McHale says. "A solution somewhere in the middle is going to be much

healthier for the system."

At a recent standing-room-only conference called Re-Imagining Pensions:

Using Innovative Pension Plan Design to Reduce Risk and Increase

Retirement Income, sponsored by the Pension Rights Center, The Urban

Institute and Covington & Burling, participants discussed how defined

benefit plans could once again play an important part in the retirementlandscape.

"There is recognition that we may see a different type of pension plan thatcombines some of the best features of defined benefit plans, such as employer

contributions, pooled and professional investments, and annuities, with the

best parts of 401(k) plans, including employee contributions and portability,"said Karen Ferguson, director of the Pension Rights Center in Washington,


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D.C.

Newplan designs represent potential solutions for employers that want to

offer a more secure retirement benefit without the costs and regulatory

complexity of traditional defined benefit pension plans. However, it is

important for employers to keep in mind that these designs may requireregulatory clarification.

Government action or inaction could be a major roadblock for any kind of

pension plan renaissance. "The federal government has to encourage

innovation and get out of the way," Glickstein says. "While there is a need toprotect the interests of workers and plan sponsors, it cannot be overly slow

and cumbersome in writing rules that inhibit where plan sponsors and

employees want to go."

Still, the conversation about a new approach to retirement plan design has

started. If plans that offer some sort of guaranteed retirement benefit are tomake a comeback, Pushaw predicts that it will be small or mid-size companies

that lead the way.

"Executives and entrepreneurs in these companies are more likely to have an

open mind about these plans and are less burdened by the political risk of

changing direction than their peers in large companies," he says. "There is alot of risk for an executive who tries to reanimate defined benefit plans when

many companies considered these plans happily dead and buried for the last

five or ten years."

The author is a New Jersey-based business and financial writer.

Documents

City of Palo Alto )CA) Staff Report: Response to Colleagues' Memo on Employee Benefits (2013)