Working Session

MAYOR COUNCIL WORK SESSION
Thursday, July 20, 2006 – 5:00 p.m.
Council Chambers

Members Present: Bob Brooks, Eliot Glassheim, Doug Christensen, Art Bakken, Curt Kreun.

Members Absent: Mayor Brown, Hal Gershman, Mike McNamara.

Others Present: John Schmisek, John Packett, Al Grasser, Mike Flermoen, Roxanne Fiala, RaeAnn Burger, Daryl Hovland, John Herz, Todd Feland, Saroj Jerath, Charles Durrenburger, Derik Zimmel, Maureen Storstad, Joe Martin (Brady Martz & Assoc.), Mark Hall (Alerus Financial). Via Phone: Eric Roling (Deloitte &Touche) and Don Carlson (Dorsey & Whitney).

Glassheim called the meeting to order at 5:05 p.m. and announced that it was being taped, both video and audio.

Matter of Defined Benefit Pension Plan.

Schmisek introduced Eric Roling of Deloitte & Touche, who serves as the City’s actuary for the Defined Benefit Plan, and Don Carlson of Dorsey & Whitney, who serves as the consulting attorney to the City in regards to Pension related matters.

Roling began the discussion by reviewing the history of the plan and the assumptions used in the plan. Roling explained that the Defined Benefit Plan is for employees hired prior to January 1, 1996 and provides a benefit at retirement payable for life based on the years of service, compensation (highest 7-year average), and that participants elect at date of hire a retirement age of either 55, 62, or 65. He continued that for a retiree with a 30-year career, the benefit would be approximately 55-63% of pre-retirement earnings and that no cost of living adjustment is made on an annual basis to that benefit. He explained that retirees contribute between 3.7 and 7.4% of compensation each year, determined by the retirement age that they select. Roling stated that employees that were hired after January 1, 1996 are in a separate Defined Contribution Plan.

Roling stated that the plan assumptions are: 8.25% investment return, 3% annual salary increase, RP-2000 Mortality Table with generational mortality using Scale AA, with police and firefighters under the blue collar table and all other employees in the combined-collar mortality table. The retirement assumption is based on a graded rate based on the actual retirement experience of the City. The final assumption is the expense load, which is last year’s actual expenses rounded to the nearest $10,000, which for 2006 is $380,000.

Roling continued that the present value of accrued benefits represent benefits earned as of January 1, 2006 and are $49,039,971 in the current actuarial report. He added that the market value of assets at that time was $37,656,927, which leaves an unfunded accrued benefit of $11,383,044. Roling stated that the actual liability could be significantly higher if an actual plan termination, because annuities would be to cover the liability. Christensen inquired what the rate would be if we did terminate. Roling responded that 4-6% is the current average.

Roling reviewed the process that is used to develop the recommended contribution. He stated that all the projected costs are based on the current population in the plan, which is approximately 250 and that in about 10 years the anticipated population is anticipated to be approximately 150. Christensen inquired whether active participants means those now working. Roling responded that it was. Roling stated that the first graphic shows the projected contributions through 2016 based on the City making annual contributions under the 5-year smoothing method. He continued that the next graphic shows how the recommended contributions would change if no employer contributions were made for 5 years, and then normal contributions were resumed and noted that this changes the annual contribution to about $3.7 million for 2010. Roling continued that the next graphic shows the change in the funded ratio for the plan based on continued employer contributions at the recommended level and under the scenario where employer contributions are withheld for 5 years and then resumed.

Don Carlson, Dorsey & Whitney, Consulting Attorney for the City, discussed the legal concerns with funding level in the plan. He stated that he had reviewed legal requirements, including those under federal law, ERISA (which does not apply to municipal plans), IRS code (under which this plan is qualified as a 401a), ND Century Code and City ordinances and can find no language which mandate a particular level of funding for our municipal plan. He did find a requirement that the employee contributions must be remitted to the trust, which is specified in IRS code. He continued that in reviewing the Plan Document, it only implies that the city will consult with an actuary on the funding of the plan, but makes no specific reference to a particular funding level. Carlson stated that this is separate from any requirements for funding that are outlined in the Government Accounting Standards and any impact that not funding it for a period of time could have on the credit rating agency. He added that there has been a lot of press recently about City, County, and State plans with problems similar to ours, but he does not see a mandated federal funding levels coming into play in the near future, but it may be foreseeable that at the State level there would be some legislation introduced to cover these plans.

Christensen inquired whether there is any requirement to keep the plan in existence. Carlson responded that there is not. Christensen inquired whether the City has the ability to make changes to the plan that would lessen the liability. Carlson stated that the City can make prospective changes to the plan, but can not make any changes to lessen liability that already has accrued. Roling stated that the City could eliminate or cut the liability by ____________________________________________________________________________ Christensen stated that it would be helpful to get a synopsis of this for future reference.

Brooks stated that there is more than just these legal obligations and need to keep other things in mind. Christensen responded that the City must pay in what’s earned to date and that there is no question about that. Brooks continued that we are not addressing the moral and other responsibilities that the City may have in regards to the employees in this plan.

Bakken requested more background on how the plan funding got to this and also on the 8.25% and how it’s supported on being a valid assumption. Roling stated that as of January 1, 2000 the plan was 102% funded and that the current underfunding is a result of the market changes that have occurred in recent years. He continued that there has been a minor effect on the unfunded by the assumption changes that have been implemented in recent years. He commented that nationwide there are a large number of public and private plans that have all been affected the same as the City’s plan due to the market conditions and that going forward the market can also have a positive influence on the plan. In regards to the 8.25% validity, Roling explained that a recent annual survey done of Fortune 500 companies with defined benefit plans the average assumption is 8.39% and 68% used an assumption between 8.25-9%. He continued that our assumptions are consistent with those of similar plans. Christensen commented that our plan does not seem to have ever met the 8.25% assumption that we have. Roling responded that not many plans have met their assumption over the last 5 years, but that the assumption that is in place for the plan is a long-term assumption and that you would probably see equity earned in the plan of at least that amount if you looked at a longer period.

Christensen inquired whether we would be more underfunded if we lowered the rate of return assumption to something like 6% and less underfunded if we raised it to 9%. Roling stated that was correct. Brooks commented that maybe we should look at adjusting the 8.25% if people are not comfortable with that and also possibly the 3% salary assumption. Roling stated that with in the last 2-3 years had done a study of the salary increase based on actual city history of salary increases and made change to 3% based on that study. He continued that there is another factor to keep in mind in regard to this assumption, there are no new participants in the plan and the older participants will tend to have smaller salary increases each year as they near the top of their range for their position.

Roling directed the Council back to page 9 of the presentation. He continued that the plan is going to see increasing costs should the recommended contributions not be made each year, as the missed principle, plus lost earnings on that principle will need to be contributed at a future date. Roling pointed out that there are also some liquidity concerns that need to be kept in mind. He added that as the number of retirees increase, the cash needs will increase, which will be offset by retirees that pass away, which decreases the cash needs. He continued that in later years the plan will need to begin holding some cash so that they are able to cash flow the payments to retirees. Christensen commented that our current City contribution is $2.3 million, but we pay out $2.6 million and not going to see 8.25% on all assets, because already a shortfall. Roling added that there are also employee contributions that go into the plan of approcimately $600,000 per year. Christensen continued that we have $35 million worth of assets not and getting 4% on them, will actually need to get at least 9.5% for rest of time to make up the difference. Roling commented that the payments out are about $200,000 – 300,000 each month and are made by Aetna. Carlson commented that some of the annual earnings may also be appreciation in stock and not actual cash earnings. Christensen stated that it would be helpful to see a spreadsheet of projected payouts for the plan. Roling stated that by 2016 plan is projected to be at $6 million per year. Schmisek asked the Roling put together a detail of that figure. Roling continued that the payouts as a percent of assets will continue to increase until the plan zeros out at a time in the future when the last participant dies.

Kreun commented that in regards to the 8.25%, if some don’t have confidence in the number could show us what other options would be reasonable and the effect on the plan if change it. Roling stated that this is in the range appropriate for our plan, but as stated before, if we want to increase the assumption would decrease the liability and if we lower the assumption it will increase the assumption. Christensen stated that he would be curious to see how would change if didn’t include any future payroll raises, if we gave them what they had today and that’s it. Roling stated the only way to do that is to freeze the plan and not allow any future service and salary contribution into the plan in order to not increase the liability. Christensen stated that he is looking for a way to keep the problem from compounding.

Brooks commented that the Council will continue to receive more information on this and that we will continue to have people retiring in the plan and we have the Pension and Insurance Committee that provides regular reports to the Council and will monitor this.

Roling stated that the plan is in no different a position than it was 10 years ago when the major changes were made and that those changes did bring the plan back to a fully funded status, but due to market have fallen in funding percent again and not at a critical point at this time.

Schmisek added that any changes that are made hit the older employees that are near retirement the hardest, because their retirement is based on their last years of employment salaryand if we make major changes in the plan it may not be possible for them to get anywhere near a normal retirement from the plan. Roling concurred and said that is a consideration to keep in mind, as most in this plan are too near their retirement to be able to get well enough established in a new plan to make up what they would be losing in the old plan before they get to their retirement age.

Roling continued that not making regular recommended contributions into the plan can also lead to negative publicity as have seen with some other nationwide plans. In addition, the funding ratio can effect the credit rating of the City for items such as bond issues. Glassheim inquired what happens if the City has not paid all in by the time everyone is required. Roling stated that the City will still continue to make contributions in until the plan is fully funded.

Schmisek stated that he had been handed a question from the audience and read “ How do we compare in funding ratio to other cities and corporations?” Roling stated that we are in about the same place as others, and while we may be smaller than some plans, we are about the same percent of budget as they are.

Christensen commented that many city plans now seem same position as social security. Roling stated that there is one distinction and that is that federal plan has always been funded through generations and that we normally fund over the working career of the participant and that our main influence has been the asset losses that have caused the unfunded liability. Christensen stated that another way to handle would be if have a 7 mill liability and only have $3 million to pay in could just sell a bond and cover the rest.

The group consensus was to refer this to Pension and Insurance Committee for any follow-up work.

Meeting adjourned 6:15 p.m.

Respectfully submitted,
Sherie Lundmark
Admin Spec Sr