Report Prepared by: Venus Rodriguez, Finance Officer
Title
SUBJECT: Approval of a First Amendment to Services Agreement with Phase II Systems for the Section 115 Post Employment Benefit Trust Administered by Public Agency Retirement Services (PARS) to Fund the City’s Pension Benefits
REPORT IN BRIEF
Requests approval of a First Amendment to Services Agreement with Phase II Systems, doing business as “Public Agency Retirement Services” and “PARS” for administrative services as Trust Administrator for pre-funding pension obligations.
RECOMMENDATION
City Council - Adopt a motion approving the First Amendment to Services Agreement with Phase II Systems, doing business as “Public Agency Retirement Services” and “PARS” for administrative services as Trust Administrator for pre-funding pension obligations and authorizing the City Manager or designee to execute the necessary documents.
Body
ALTERNATIVES
1. Adopt as recommended by staff; or
2. Refer back to staff with specific direction, or
3. Deny
AUTHORITY
City of Merced Charter Section 405
CITY COUNCIL PRIORITIES
On January 7, 2019, the City Council approved Resolution 2019-04 to establish a Post-Employment Benefit Trust to mitigate the increasing pension obligation and unfunded accrued liability.
DISCUSSION
In 2012, the Government Accounting Standards Board (GASB) issued Statement No. 68, Accounting and Financial Reporting for Pensions. GASB 68 requires that governmental employers that sponsor Defined Benefit plans (i.e., CalPERS) must recognize a net pension liability or unfunded accrued liability (UAL) on their balance sheet. This is the difference between the City’s total pension liability, or actuarial accrued liability (AAL) and actual plan assets. GASB 68 became effective for fiscal years starting after June 15, 2014.
In addition, CalPERS has made changes that significantly increased the City’s UAL. On December 21, 2016, the CalPERS Board of Administration lowered the discount rate from 7.50% to 7.00%. CalPERS implemented a five-year ramp-up that began in fiscal year 2018-19 to take into account actuarial gains and losses, as well as changes in actuarial assumptions and methods. The first three of the five years phased in the new discount rate. In December 2017, CalPERS also decided to reduce the amortization period from 30 years to 20 years, with the impact beginning in fiscal year 2020-21. There was another reduction to the discount rate from 7% to 6.8% also in FY 2020-21. Based on the most recent CalPERS Annual Valuation dated June 30, 2024, the City of Merced’s UAL is $124.1 million.
With the understanding that these impacts posed a significant budgetary increase to the City, staff began researching different methods and strategies to present to the Council for consideration in mitigating the financial impact. One option staff considered was to commit additional funds to CalPERS, in excess of its existing annual required contributions, to pay down the UAL. In doing this, CalPERS would continue to manage all assets without an assurance that additional contributions would reduce the City’s UAL.
Another option staff considered was to create a separate trust, or Trust 115, as approved by the IRS in a private letter ruling to “pre-fund” the City’s UAL. This option provides the City with an alternative to making additional contributions to CalPERS. It also allows for greater local control over assets, investment by a professional fund management team selected and monitored by the City, and Council discretion over the use of the funds towards increased contribution amounts in future budget years.
On October 16, 2017, staff presented the City Council with these options to consider. The Council provided direction to staff to proceed in evaluating the potential of a Trust 115 for pension liability and if determined to provide a positive benefit to proceed in issuing a request for proposal (RFP). Staff determined that a Trust 115 would be the City’s best solution and proceeded with issuing an RFP.
On January 7, 2019, the City Council approved the adoption and operation of a Post-employment Benefits Trust Program to be used to pre-fund pension obligations and a three-year agreement with Phase II Systems (PARS) to administer the trust. On June 7, 2021, the City Council approved another agreement for a 5-year term which expires on 6/30/26. Staff is requesting the approval of a First Amendment for an additional 5-year term with PARS to continue the administration role of the Post-Employment Benefit Trust for pension. In the last three years the City has worked well with PARS. They continue to provide expert guidance to the city and are very responsive. PARS is one of two known entities with an IRS private letter ruling which allows tax exemption because it is derived from the exercise of an essential governmental function.
To date, over 200 public agencies have adopted the Pension Rate Stabilization Program (PRSP) through PARS.
Expected benefits offered by the PARS PRSP include:
• Contributions placed in an exclusive benefit trust could address the City’s Net Pension Liability
• Investment flexibility with Section 115 Trust compared to restrictions on general fund investments (Govt. Code 53216)
• Increased risk diversification of plan assets through different asset management
• Oversight and control of fund management selection, monitoring of performance and ability to replace fund management based on performance criteria
• Increased flexibility on use of trust assets (i.e., trust assets can be accessed at any time as long as the assets are used to fund the City’s pension obligations and defray reasonable expenses associated therewith)
• Lower investment management and administrative expenses compared to CalPERS
• Potential for positive rating agency and investor consideration.
In an effort to help public agencies address and manage their GASB 68 liability, PARS has developed the PARS Post-Employment Benefits Trust Program. PARS has assembled leading professionals to provide the City with the necessary services required under one program to pre-fund pension liabilities through an IRS reviewed program. The program has been established as a multiple employer trust so that public agencies regardless of size can join the program to receive the necessary economies of scale to keep administrative fees low and avoid any setup costs. The trust permits the City, under federal and state law, to invest in a more diversified array of investments to maximize investment returns long term.
PARS has partnered with US Bank to serve as trustee and its sub-adviser HighMark Capital Management, Inc., to provide investment management services for the program.
The cost of the services will be determined by the value of the assets under management. The Fee Schedule has not changed from the original agreement in 2018. The only change in the amendment is to extend the term to 6/30/2031.
Since inception the City has invested $7.2 million into the Trust 115 for pension. The balance as of January 31, 2026 is $8.5 million. The City has made $1.3 million net interest earnings.
IMPACT ON CITY RESOURCES
The cost of the services will be determined by the value of the assets under management and are reduced by investments earned.
ATTACHMENTS
1. First Amendment to Services Agreement
2. Agreement for Professional Services