September 19, 2021
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Cotati considers options to address unfunded liabilities

By: Brandon McCapes
May 21, 2021

The City of Cotati is facing about $10.8 million in unfunded pension obligations, according to consultants working with the city.

The Cotati Council received a presentation from consulting groups CalMuni Advisors and Weist Law Firm regarding the nature of Cotati’s unfunded liabilities as well as options to repay California Public Employees Retirement System (CalPERS). Following the presentation, the council directed city staff to continue working with the consultants to further explore several scenarios proposed to resolve the unfunded pension obligations.

According to Dmitry Semenov, of CalMuni Advisors who gave the presentation, unfunded actuarial liability (UAL) is calculated by subtracting the market value of assets from the total accrued liability—in other words, the amount of cash the city has on hand for pension obligations minus its total obligations.

The majority of UAL falls under two employment categories: about $6 million for employees classified as “miscellaneous,” and another $4.5 million for employees classified as “safety,” first or second tier. The remaining $229,000 UAL is categorized as “other.”

Semenov said the City of Cotati, with just over two thirds of its total obligations funded, is on par with other cities of similar size when it comes to funding for pension obligations.

“Everybody is kind of in the same boat. Being about 69 percent funded—that’s very typical, unless someone has taken proactive steps in the past,” Semenov said.

CalPERS obligations should be viewed as debt with a seven-percent interest rate. Payments to CalPERS are subjected to the investment markets, as the state invests the money cities pay it on their behalf. This means that cities participating in CalPERS are exposed to the volatility of the investment markets, and cities assume all investment risk.

When CalPERS investments suffer, the return rate decreases. When that number drops below the seven-percent interest rate, cities suffer a shortfall.

With the Covid-19 pandemic last year, CalPERS investments received a return rate of 4.7 percent, 2.3 percent less than the seven percent required for the City of Cotati to break even through the system. That reduction in return on investments led to $546,000 funding shortfall for Cotati pensions and more in interest payments.

“At a seven-percent interest rate, It is really the city’s most expensive debt,” Semenov said. “The best way to think of it is the payment of the sins of the past. Whether it was payment for your sins or the system’s the city still has to pay it.”

The consultants offered four scenarios for the city to address its pension obligations, two of which were discussed at length. The first scenario would involve directly refunding the totality of outstanding UAL balances by issuing pension obligation bonds.

A second scenario would take a more holistic approach to resolving the city’s unfunded liability.

This scenario would consider using General Fund reserves and surpluses from the next year and a half to pay off the about $4.7 million of the UAL. This money would be reallocated from planned street improvements, and the city would issue tax-exempt debt to refinance those projects. In addition, the city can issue taxable debt to directly refund the remainder of UAL.

Semenov explained that the CalPERS system, which was once overfunded in the 1990s, has been underfunded for decades following state legislation that increased retirement benefits retroactively coupled with the recessions in 2001 and 2008. This year, the City of Cotati suffered an additional shortfall because of a loss in revenue caused by the economic ramifications of the Covid-19 pandemic.

In 2020, CalPERS was 71 percent funded, compared to 128 percent in 1999 prior to the retroactive increase in retirement benefits and 61 percent following the Great Recession of 2008 and 2009.

Vice Mayor Mark Landman acknowledged that though the pension obligation issue is pressing, it would be worse—especially following the pandemic—if the city had not worked to improve its finances over the past decade. Because of the work the city has undertaken, he said, it is in a better position to address CalPERS obligations.

“It’s a very good place to be at and it’s the result of ten years of clawing our way to this point,” Landman said.