CITY OF NEWBERG

PENSION SUBCOMMITTEE

WEDNESDAY, FEBRUARY 15, 2017

5:30 PM MEETING

PUBLIC SAFETY BUILDING TRAINING ROOM (401 EAST THIRD STREET)

I.  CALL MEETING TO ORDER

The meeting was called to order at 5:28 PM.

II.  ROLL CALL

Members Present:  Denise Bacon, Chair  Patrick Johnson      

 Mike Corey  Mayor Bob Andrews

Staff Present:  Matt Zook, Finance Director

 Anna Lee, Human Resources Director

Others Present:  Mary Caballero, Impact Benefits

 Russ Heinzerling, Principal Financial Group

III.  NEW BUSINESS

1.  Market Review

Russ Heinzerling, Principal Financial Group, had worked with the City five years ago. He was a Senior Investment Consultant. Principal Financial was a registered investment advisor for the pension plan and was responsible for asset allocation and investment manager selection. He discussed how the market and stocks were up last year as well as international markets and emerging markets. He then reviewed last year’s rising interest rate performance (anticipating a couple 0.25% increases), political influence, and mild inflation. Real unemployment was still around 10%, however there were a lot of people reentering the workforce. The average wage growth was about 2-3%. Their chief economist predicted 2017 would be a 9% return in the marketplace, but he thought it would be about 6-7%. He moved to page 13 and discussed the asset performance over the last 15 calendar years.

FD Zook asked about the City’s investment portfolio performance against the 15 year average. Mr. Heinzerling explained how it was in the 6-7% range and how they were trying to take the volatility out of the pension plans.

Mr. Heinzerling moved to Tab 1, page 1, and discussed how they created a customized strategy based on the City’s plan. They looked at the City’s assets, liabilities, and benefits to get the appropriate asset allocation with highest possible return with least possible risk. He explained the beginning and ending balances and assets at the end of the year which were $18,302,354. The earnings were $540,758, contributions from the City and employees were $682,730, and the payout of benefits was $789,158. He explained on page 7 it stated there was 50% allocation in fixed income and 50% allocation in equities.

FD Zook discussed the recommendation from Principal to go into Foreign Small Cap and the recommendation to increase from 5% to 10% in Real Estate (prior to July 1, 2016).

Mr. Heinzerling continued to pages 8 and 9 and discussed who was running the funds. There were a wide variety of managers and asset classes. On page 10 it showed that the City’s portfolio return as of December 31 was up 8.36%, the weighted index was down .16, and an excess return of half a percent. During the six month period, the City was up 3.04%. The one year return was behind 55 points due to the managers not being able to beat the index. They had also broken it down by asset class and he explained the asset performance. On the next page he reviewed the performance of each individual investment. He had been asked if they would be comfortable with making a portfolio change by increasing the City’s equity exposure, and the answer was they would be comfortable if the City wanted to go from a 50% fixed income to a 40% fixed income. The equity expectations for the next ten to fifteen years were 6.5%, and the current average with the 50% fixed income was 5.33%. If they decided to put another 10% in equities, they would be comfortable with that, but no more.

Mary Caballero, Impact Benefits, explained that the 6.5% was the assumed rate of return for the plan. The higher the assumed rate of return, the lower the liability and the better it would be funded. The 50/50 portfolio would support a 5.33% return. That would discount the liability by 1% less and the funding would go up exponentially. They were trying to find a medium between the portfolio and the rate of return in the assumptions. A 60/40 portfolio would support a 5.75% to 6% assumed rate of return. If they overshot the assumption and underperformed, the actuary had to catch that difference up over 5-7 years, so it did affect the rates. The 50/50 portfolio was a decision made by a prior management team and it really came down to how comfortable they were with the risk. She was comfortable with the 60/40 and so was Principal. Also, the actuary had already told them that they had to come down from 6.5%. Principal was saying that if they went to 60/40, the assumed rate of return would be at 6%. If they stayed at 50/50, the assumed rate would have to drop to 5.75%.

Mr. Heinzerling said they needed a rate of return that they could expect a little fluctuation from, but aggressive enough that it would fund the plan.

There was discussion regarding the amortization of the differences between assumed rate and actual rate which could go both ways for a positive and negative performance. The 6% assumed rate was just an assumption for earning interest.

FD Zook brought up the point that they were basically discussing one of the two pieces of the funding (investments versus contributions). There was a whole separate conversation going on where they could modify the plan and benefits to help reduce the liability.

Mayor Andrews shared that as the assumed interest rate dropped, the model then assumed lower investment income. This shifted more burden to contributions, and since the employee contribution was static, it made the employer contribution rate go up, which created a budgetary impact.

Ms. Caballero recommended going a little more aggressive to essentially keep the City from going from 6.5% to 5.5 ‐5.75% which would increase funding.

Mr. Heinzerling explained that there was a difference between the Principal Financial Advisors and the actuary, who was the one working with the assumed rate of return. He explained that there was grayness around the 5.75%, or whatever the rate was. In the corporate world the actuary might give a higher rate with greater reserves. For government, it would take an increase in taxes.

Human Resources Director Anna Lee asked if this was modeled after the PERS Tier 1 plan.

Mayor Andrews explained it was a plan modeled after itself. The PERS and NERPS plans had morphed in different ways.

Ms. Caballero thought the formula for PERS and NERPS was not too far off. She could understand how employees thought they were similar.

Mayor Andrews asked what was being seen as the standard assumed interest rate for small public pensions.

Ms. Caballero said every company came out with their own capital market assumption and the actuaries were leaning on the investment advisors to tell them. For a 50/50 portfolio, a 6.5% rate of return was overshooting it.

Mr. Heinzerling said if they really wanted a 6.5% assumed rate of return, they would have to have 100% equity. The industry standard for a 60/40 portfolio had gone from 8% to 6% over the last ten years.

Mayor Andrews asked what was the migration from a highly conservative 50/50 to a little riskier 60/40 as they were looking across public pension systems.

Mr. Heinzerling stated it depended on the funding status. They were 60% funded. If they were 80% funded, he would see plans move to be more aggressive because they had more margin for negative performance.

Councilor Johnson said he had attended a PERS meeting where they said 80% was standard.

Mr. Heinzerling clarified that was for private plans, but very few were at 80%. Cities were different because of taxes and stronger limitations in revenue growth.

Ms. Caballero said the real decision point for the City now was if they were ok with more volatility in their funding year over year or did they want to contribute more to the plan as a budget item so the volatility was more evened out.

Mayor Andrews asked what was being proposed now for smoothing effects if they went to a 60/40.

Ms. Caballero said they were using all of the smoothing effects now. Mortality was longer too. Thus there were some changes happening that weren't any fault of the plan.

Mayor Andrews clarified they were exercising today all of the reasonable smoothing.

Ms. Caballero said they had to cut the smoothing from 15 years to 7 years.

Mr. Heinzerling reminded them that they didn’t have to go from 60 to 100% tomorrow. These were 30 years out.

Ms. Caballero said whether or not they made a decision tonight, the handout showed the different portfolio allocations and what they might do as a percentage of payroll contributions. There was not much impact on employer contribution rates.

HRD Lee referred to the back page of the handout and asked if the assumptions recognized the recent change where fewer employees would be entering the system.

Ms. Caballero said for the purposes of this decision, she did not know if that mattered. They did take into account the effect of having no new employees entering the system.

Councilor Corey thought 60/40 was reasonable, however he was concerned about the risk.

Mr. Heinzerling stated from a budget perspective, the 60/40 would not cost them more than the 50/50. However if they had a few bad years, the cost would be significant.

Mayor Andrews said if as an actuary, he assumed a 5.5% return and there was a fixed amount from employees, but they needed a certain amount on an annual basis, then the City paid more.

Ms. Caballero clarified they either paid more every year and knew what it was, or they tried to pay less but it might be more volatile. They were paying a premium for knowing and for the stability.

Mr. Heinzerling likened it to budget billing, where they estimated what the bill would be next year and divided that by 12 and the customer paid the same amount per month but then settled up at the end of the year. That was how the pension plan was, but it was for 30 years and there was some guessing as to how much the bills were going to be based on the asset allocation and at the end of the year the funding allocation might need to go up to make up for any shortfall.

Ms. Caballero said they could go 55/45.

Councilor Johnson asked if this would go back to Council for a vote.

Mayor Andrews said yes, it would. He explained that at one time, correctly or incorrectly, these decisions were made by staff. The Council bore the fiduciary responsibility for the management of the pension system. Now the subcommittee was formed to ask questions and ferret it out and say to the rest of the Council that this was what they believed that they should do in order to maintain reasonable stability in the NERPS program.

Ms. Caballero would like to have these meetings semi-annually.

Mr. Heinzerling stated the actuaries would not make a recommendation on the asset allocation. They would just tell them what the assumed interest rate they would use based on their asset allocation. Principal Investment Team’s recommendation was 50/50, but they were willing to go 10% in either direction.

FD Zook explained that he looked at it from a budgetary standpoint and the LRFP. The focus on the rate should be deminimized. What really mattered was the annual cost. The bigger challenge was how much they could afford to pay.

Mayor Andrews commented that they were looking at a 30 year horizon, not just this administration. He didn't think it would hurt to consider moving to a little more aggressive portfolio, but no more than 60/40. Sometimes they had been too conservative. He reminded them that it might change in 12‐15 months.

Mr. Heinzerling commented that the Mayor brought up a good point. Actuaries today were saying based on capital market assumptions they were going to have to lower the interest rate. But if they stayed at 50/50 and the market performed differently, they might come back in 3 years and say 6.5%. If that happened, they could then dial the risk back.

Mayor Andrews said that went along with what Ms. Caballero said about meeting more frequently and looking at this more.

Mr. Heinzerling said if they wanted to move forward, all he needed to make it happen was an email saying they would like to increase their equity allocation by 10%.

Ms. Caballero explained that if the Pension Subcommittee wasn't comfortable making a recommendation today, they could keep it on as an agenda item.

Councilor Johnson would like to sit down with FD Zook to look at the budget and LRFP to see what the trend line was and how much they could afford to pay. He didn't want to lay people off to pay for pensions. But last year they made a decision to hire five people, and that was a budget consideration.

FD Zook shared that the amount of retirement next year was $1.5 million.

HRD Lee asked if during negotiations with the Public Works union, if they decided to go to PERS, then what?

FD Zook said that would only be for future employees. If the new employees went to PERS they would save 10% of their salary.

Councilor Corey said 60/40 was still considered conservative. Generally the stock market was high and that was the unknown.

Mr. Heinzerling offered a perspective on what was high. The average price earnings ratio of stocks in the market today was 17.5, slightly ahead of the 25 year average. If they went back to the tech time, Microsoft was trading at 35 times earnings. He thought that was high. Where they were at today was a little bit overvalued, and the earning reports were solid.

Motion: Corey/Johnson moved to present the 60/40 option to the Council. Motion carried (3 Yes/0 No).

Councilor Johnson still didn't understand the budgetary picture.

Councilor Bacon said that they would still need to get the City Manager’s and Finance Director’s input on the bigger picture and if they had the funding to cover the risk.

Ms Caballero asked when the Council meeting to decide this would take place. Mayor Andrews said it was yet to be determined.

FD Zook said if they did nothing, they would continue to slide. Budgetarily, they controlled their budget. The City had always paid what the actuaries recommended.

Ms. Caballero explained that rate swings might result in $100k to $300k, not $500k in a year.

Mr. Heinzerling reminded them that when the actuary said that this was the required minimum contribution, it meant nothing. If they did just the minimum, they would never move the dial.

Mayor Andrews also mentioned that the funding status of the plan would affect their credit rating. That had a universal impact on everything they did.

2.   Next Meeting

Councilor Bacon said FD Zook would figure out the next meeting date in October.

IV.  ADJOURNMENT

 The meeting adjourned at 7:05 PM.