Loading...
HomeMy WebLinkAboutMINUTES-2007-11-19-20071 CITY COUNCIL ROLL CALL — PRESENT: A Quorum was present. NOT PRESENT AT ROLL CALL: ABSENT: PRESIDING: Alderman Bernstein Alderman Holmes Alderman Moran Alderman Wynne November 19, 2007 Alderman Tisdahl Alderman Rainey Alderman Wollin Aldermen Hansen and Jean -Baptiste Mayor Lorraine H. Morton City Clerk Mary Morris read the call of Mayor Morton for a SPECIAL MEETING of the City Council for the purpose of discussing police and fire pension funding. The meeting started at 6:33 p.m. in the Council Chamber. City Clerk Morris submitted minutes of the September 5, 2007 Special City Council meeting with corrections on pages one, four and five, indicated by boldface type and underlined..Alderman Moran moved approval of the minutes as corrected. Seconded by Alderman Wollin. Motion carried unanimouslv. Alderman Bernstein moved that the agenda be changed and that the Fire Pension Presentation go before the Police Pension Presentation. Seconded by Alderman Tisdahl. Motion carried unanimouslv. EVANSTON FIREFIGHTERS PENSION BOARD PRESENTATION Patrick Dillon, Board of Trustees president since 1985, firefighter for 29 years and an active firefighter is one of three elected trustees; Ronald Brumback, an active firefighter is secretary, and Bob Schwarz, a retired firefighter. Appointed members are Finance Director Matt Grady, who is treasurer, and Fire Chief Alan Berkowsky. Trustees serve three-year terms. Active members are elected by active firefighters and the retired trustee is elected by retired firefighters. The Firefighters Pension Fund, as created by state statute, governs their activities. Their intent is to ensure that the retirement fund for retired firefighters stays solvent. Currently there are 110 active firefighters. Each pays 9.45% of their salary to the pension fund; 76 are retired, 12 disabled and 26 receive survivor pensions (mostly widows) and one quildro. The fund pays out roughly $375,000 in benefits monthly and $4,500,000 annually. Questions from the City Council on how the money is invested came up at its September meeting. Mr. Dillon stated that Mrs. Tomanek's presentation will show how funds are invested. The board has worked with her since 1998. It has been a long process dealing with changes in state laws. Now 45% of the funds can be invested in equity instruments and 55% in fixed income. Mary L. Tomanek, CFP, CIMA, Senior Institutional Consultant, Smith Barney Consulting Group, discussed three areas: historical capital markets information, strategy when the laws changed, current investment strategy and how they are doing. Currently they have 54% invested in domestic fixed income, 42% in domestic equities and 4% in international equities. (At this time Alderman Wynne was present.) In response to Alderman Bernstein, Mrs. Tomanek explained that the style allocation is a blend of equities to achieve the 46% allocation with higher weighting in growth stocks. The current strategy is to generally invest assets in proportion to the Fund's liabilities. They employ an asset allocation that seeks to participate in up markets while outperforming in down markets. Current holdings are mutual funds, separate account (insurance), equity separately managed accounts, active fixed income and inter -governmental investment pools. She showed three-year and five-year fund performance, annual returns and benchmark index. In response to Alderman Wollin, Mrs. Tomanek showed returns from 2001-2006 noting that 2001 and 2002 were flat years. City Manager Julia Carroll added that all the returns are divided by six to get an average return of 5.05%. In response to Mayor Morton, "developed non-U.S. Stocks" are from developed countries such as Spain or France as opposed to emerging market stocks from India or China. The return for last year was 7.35% and outperformed the benchmark. They had to realign the portfolio due to the need to remove investments in Sudan. The year-to-date return is 6.49% (through September). 2 November 19, 2007 Alderman Tisdahl asked how "non-U. S. bonds" are doing with the dollar falling. The strategic return estimates are going forward so Mrs. Tomanek did not have the returns and explained that these are illustrative of estimates of returns. Ms. Carroll said the pension funds cannot invest in non-U.S bonds. Mrs. Tomanek said there could be an opportunity to do non-U.S. bonds in mutual funds. The law permits bonds in equities or mutual funds. Alderman Rainey asked the value of the portfolio. $43 million. Because 55% of the portfolio is in the highest quality instruments, the return should reflect that. Bonds are benefiting even more from the drop in interest rates. Mayor Morton asked Mrs. Tomanek how she is paid. Mrs. Tomanek explained the various fees and offered to give a full breakdown. It is less than 1% of the assets. Ms. Carroll said it is important to have a money manager for the pension funds. Mr. Dillon noted that in 1998 when they started to invest in more equities, trustees recognized the need for professional financial expertise. Before they were buying government securities and the strategy was to buy and hold, which is not their strategy today. What would help the pension funds is for the state legislature to expand the amount they could invest in equities. Alderman Rainey asked when aldermen could ask questions about the memo sent by the manager. How do the pension fund trustees feel about approving bonds or infusing the funds with cash? Mayor Morton wanted the public to know what they are paying for and that firefighters' benefit from all monies put into the pension funds. Mr. Dillon explained that the City's Finance Director has been on this board all along and has participated for decades. All performance reports are filed through the City by the Finance Director. Alderman Wollin confirmed that the 45% is the cap on equities. No investments have resulted in any kind of commission coming to Mrs. Tomanek. In response to Mayor Morton, Mrs. Tomanek provided information on data that is provided to the Board of Trustees. Mayor Morton asked her contract arrangement. Mrs. Tomanek stated it is ongoing and could be cancelled at any time. EVANSTON POLICE PENSION FUND PRESENTATION Timothy Schoolmaster, president, noted they are a defined benefit plan in which part of salary is deferred with a promise to pay later - a contractual obligation of employment. It helps attract and retain experienced and highly trained personnel in positions critical to the continuous and reliable delivery of vital public services. The bulk of funding is not shouldered by taxpayers. The plan was created and is governed by state statute (like Fire) and is required of all Illinois municipalities with a population greater than 5,000. It is responsible for paying retirement, death and disability benefits. The plan is not subject to Home Rule, alteration or to Erisa and is controlled and managed by the Board of Trustees and regulated by the Illinois Department of Insurance (IDOI). Five persons serve on the Board of Trustees. Jim Hutton, a police officer for 27 years and trustee for seven years; and Sergeant Jeffrey Jamraz, police officer for 29 years and trustee for four years were elected by active members of the fund. Schoolmaster is retired and was elected by and from beneficiaries of the fund. Two trustees are appointed by the Mayor. Bob Costello, a long-term Evanston resident, was present. He has a long history in the financial markets with leadership positions at ABN-Amro Securities and Capital markets, Robert Baird and Co., and is currently CEO of the Sam Adams Foundation. All serve without compensation. The trustees (and others) are fiduciaries of the fund; exercise discretionary authority/control over the management/disposition of the assets. Fiduciaries are to discharge duties solely in the interests of participants and beneficiaries for the exclusive purpose of: 1) providing benefits, 2) defraying reasonable expenses of fund administration, 3) operating under the prudent person doctrine (care, skill, prudence, diligence of one with similar knowledge, skill and aims), 4) diversifying investments to minimize the risk of large losses, and 5) in accordance with the provisions of the Pension Code Articles governing the fund. The fund may indemnify trustees, consultants, and employees against damage claims, including defense thereof, for negligent or wrongful acts. Breach of fiduciary duty — acts found to be willful misconduct or gross negligence cannot be indemnified. y2 3 November 19, 2007 Board duties and powers are to control and manage exclusively, the pension fund itself, investment income and all money assessed, donated, paid or provided by law for pension purposes and to invest the funds; to order payments and issue certificates for pensions and other benefits; to enforce contributions; to subpoena witnesses — to compel witnesses to attend and testify before it in all matters connected with administration of the pension code; to appoint a clerk; to pay all necessary expenses (e.g. custodial fees, investment manager fees, financial consultants fees, attorneys, court reporters, medical exams, trustee education, actuarial studies, supplies, state compliance fees); to keep records and recover losses. The Board of Trustees belongs to the Illinois Public Pension Fund Association and the National Conference on Public Employee Retirement Systems in Washington, D.C. The board made an arrangement with Northern Illinois University in 1999 to set up a 32-hour trustee certification program to teach about investing, actuarial science, capital markets, etc. All trustees are graduates of that program. Professional staff. financial consultant, David Wall & Associates; attorneys, Ottosen, Britz, Kelly, Cooper & Gilbert Ltd., and Wolf Popper LLP NYC (securities monitoring); actuary, Tepfer Consulting Group, Ltd.; fixed income managers are JP Morgan Chase; Great Lakes Advisors; SKBA Capital Management; Davis Hamilton Jackson & Associates and custodian is MB Financial Bank; Evanston Finance Department, Matthew A. Grady III is treasurer of the fund and is assisted by Kathy Brown in accounting and Rom Chmara, analyst. The current annual payroll is $6,726,506.40 or $560,542.20 per month. There are 158 beneficiaries and 161 active members. 116 receive a service pension, 15 disability, 1 quildro, 25 surviving spouses and 1 dependant child. Pension benefits range from $1,000 to $9,4 7 0 per month to persons ranging from ages 50-94. This is a mature fund — beneficiary to active ratio is nearly one-to-one. Compared to Naperville Police Pension Fund of $73 million — 72% funded with 44 beneficiaries and 189 active members. Tax levy is $3.1 million and payroll is $1.8 million. Evanston's tax levy is $4.7 million and payroll $6.7 million. The age of the fund is significant. Fund investments and returns are governed by the Illinois Pension Code "list." Prior to January 1998 only fixed income investments were permitted except up to 10% in separate accounts of insurance. Since January 1998, the fund could go up to 45% in equities and 55% in bonds. Virtually all other Illinois pension funds invest to the prudent person standard. As of September 30, 2007, the police pension fund had $61.4 million with 2% in cash, 53% in fixed income instruments and 45% in equities. He showed the equity fund investments by weight, style and size. Year-to-date return on investments is 6.45%. In 2006 the returns were 9.04%. The three-year return is 8.28% and five-year return is 8.04%. The 12-year return is 7.01 %. Fixed income is 55% of the portfolio. Bonds returned 3.5% for the past five years. Last week a 10-year Treasury Bond was 4.15%. He went through the benchmarks for fixed income investments. Mr. Schoolmaster noted that equities are 45% of the portfolio and that during the last 10 years, according to the S&P 500, earnings were 6.5% and bonds for the last five years were 3.5%. Historical returns on stocks have been about 9% and bonds 4%.With the 45%- 55% split, a 12-13% equity return is needed to achieve 7% total fund return. Manager quality is monitored constantly. Impediments to better returns are the state law 1) expansion of the equity cap to at least 60% or complete removal of the cap 2) the ability to invest in investment grade corporate bonds, ADRs and 3) legislative meddling —social legislation (e.g. Sudan Divestiture Act) and lack of capital. Funding the fund. Contributions plus investment income equals benefits and expenses. Gabriel, Roeder, Smith said that the fund needs $139 million to pay benefits. The fund has $61.4 million. That means an additional $77 million is needed. Expenses for 2007 are $149,227, $135,613 in 2006and $151,362 in 2005. Active police officers contribute 9.91% of salary to the fund. The City's tax levy contributes to the fund and there is money from other sources. Investment earnings are dependant on the interest rate's assumed rate of return. The City's prior actuary, Windsor, said 7.54/0, GRS says 7.25% and IDOI says 7%. If funded properly and timely, the bulk of the benefits are paid by investment income. How we got where we are now: 1) failure to make contributions, 2) funding law changed in 1993 and actuarial smoke and mirrors. He noted that in the 1960s and 1970s unions came in and officers got increased salaries. During the 1980s and 1990s the City's budget policy on pension contributions was what was politically expedient. Two actuarial reports N3 4 November 19, 2007 were submitted, one by IDOI and the other by the City's actuary. Both were ignored. Typically the tax levy was 50% of the IDOI amount. There were conflicts of interest with appointed members of the board who were high-ranking city officials that forgot who their fiduciary duty was to. Recent IDOI figures are broken down two ways. Normal cost is $1,709,471 (what is owed) and the amortization amount is $3,135,934. $10 million of skipped contributions at 7.5% more than doubles in 10 years to $20,610,316. Taxpayers are on the hook for $10 million, plus $10.6 million in interest. No amount of reasonably expected investment income will make up for the failure to contribute. The total levy needed is $4,845,405. In 1972 he figured the unfunded accrued liability at $4 million. In 1986 it was $15.6 million according to the Mercer, Meidinger, Hansen study by the City (funds needed to reach 50% funding). In 1987, according to IDOI, it was $22 million. In 2006 it was $54 million according to Windsor (City's actuary) and in 2007, $77.5 million according to GRS. Mr. Schoolmaster stated the 1993 funding law change went from level dollar to a percentage of payroll. In fact, the mortgage was refinanced and the payment period extended another 13 years from 2020 to 2033. (It was a 40-year payment period from 1980 and was changed in 1993.) There was not one word about this change in the Illinois Municipal League (IML) publication that was given to Council members. The funding law change was structured as a back -loaded balloon mortgage, promising 6-8 years of lower payments, then precipitously rising payments thereafter. In 2001-2002 the stock market went way down. IDOI and numerous independent actuaries warned that even if all of the assumptions came true, and required contributions were made, a debt of $10 million in 1993 would increase to $35 million in 2007, an increase of 350%. This bill, done by IML, was not a help to taxpayers. There were actuarial smoke and mirrors for a couple of years, a lack of credentials and a failure to correctly state benefits, unsupported assumptions and a disconnect between report delivery and numbers. Mr. Schoolmaster quoted statements to the police pension board over the years. "I don't care what the law requires — we're not going to pay it, and if you force us to pay, I know where I'm going to get the money."(Referring to layoff or lack of raises.) "You don't need the money now."(Only correct if somebody did not understand the pension law.) "The increase in unfunded liabilities for public safety pensions is mainly due to benefit increases and poor overall pension performance." "We have consistently paid (into the funds) the amount actuarially mandated by the state."(That has not been true going back to 1970.) The Gabriel, Roeder, Smith & Company report was compared with IDOI numbers and examined carefully by the board's consulting actuary. He quoted Mr. Tepfer's response: "My applause to the City of Evanston for finally reaching a proper conclusion concerning the funding condition of the Police Pension Fund. I have reviewed the GRS report and find it quite acceptable and appropriate. The data matches the IDOI annual statement and the assumptions are reasonable and appropriate. GRS is a well respected actuarial firm and is certainly familiar with the provisions of the downstate system." Mr. Schoolmaster stated that they disagree with some of the report, such as the 7.25% interest return, which is optimistic, and a couple of other things. Where do we go now? The Pension Fund Board of Trustees will continue to pay benefits and prudently manage the fund. City Council's job is to figure out where to get the money. He does not envy this job, which they inherited from prior municipal governments and the IML. Council has been painted into a corner but can get out. The pension board wants to work with Council and has confidence in Council's willingness to make hard choices. In response to Mayor Morton, Mr. Schoolmaster stated he is not paid to operate the Police Pension Fund. Patrick Dillon is not paid either; he noted that most of the conditions described by Mr. Schoolmaster also apply to the Firefighters Pension Board. Mayor Morton asked how the pension for police is determined. It is based upon salary and years of service. Salary is based upon rank and/or the labor contract. Chief Kaminski was at the department for more than 30 years and was maxed out at 30 years. The fund appreciated the extra money he put in from which he received no benefit. Pension benefits can be based upon the last years of salary or an average of all years worked if someone is promoted. The firefighters' pension is based upon the last month of service. Mayor Morton asked if that is fair to the City. That is state statute. Mayor Morton noted that every time a raise is given to police or fire personnel, there is a corresponding increase in the pension contribution. Mr. Schoolmaster pointed out there is an assumption in the tax levy that there will be an j ZA 5 November 19, 2007 increase of 5% in salary. Benefits from both pensions are controlled locally. Mayor Morton asked Mr. Schoolmaster to stop by her office and discuss state statutes. Ms. Carroll passed out copies of the IDOI valuations she referenced in her November 16 memo. Alderman Rainey said it was difficult to get these materials and not be able to think about it. If this keeps up through the budget season, they will make decisions without enough study. Ms. Carroll was not asking for a decision that evening. Her memo had a recommendation. The intent of the meetings is to educate Council. Ms. Carroll reviewed the analysis activity to date. Alderman Rainey asked the role of Scott Balice Strategies. Ms. Carroll stated they are the City's financial advisor, a role held previously by John Peterson. They were hired through the RFP process to advise on any kind of bond issue or financing for the City. Their role in the pension bond study is to give the City information on costs, what would be covered by the bonds versus normal ongoing contributions, how the investments could be structured and typical financial consulting expertise that staff does not have. They are accustomed to working with the capital markets, the City of Chicago and hundreds of issuers. They help to formulate recommendations and options. It is of no interest to them what the City does other than to get the best fiscal advice. Phoebe Selden, Scott Balice Strategies, LLC, outlined three scenarios. 1) 65% funding goal -pension obligation bonds can be structured to achieve savings in every year versus the pay/go cash funding. Under current assumptions and with a 65% funding goal in 2008, approximately $52 million in assets would need to be deposited. If the actuarial rate of return is achieved, this would lead to a total present value savings of about $8.8 million. This scenario would put Evanston at the state-wide average for funded ratio, but is most likely to lead to a downgrade of the City's credit rating. 2) 75% funding goal -under current assumptions and with a 75% funding goal in 2008, approximately $78 million of assets would need to be deposited. If the actuarial rate of return is achieved, this would lead to total present value savings of about $13.6 million. This funding percentage would put Evanston at a similar level to other Aaa rated issuers in Illinois. (Fire 77.4% and Police 74.6%) 3) 90% funding goal -under current assumptions and with a 90% funding goal in 2008, approximately $116 million of assets would need to be deposited. If the actuarial rate of return is achieved, this would lead to present value savings of approximately $20.5 million. Ms. Selden explained that the savings have been structured so that once the program gets going there is the same amount of savings every year. Different units of government will push savings up -front or move them to the back. Part of the reason Evanston has an A credit rating is because the City has had a conservative approach to finances over time. With the 90% funding goal, once they get going, there is a $1.6 million savings annually. For the 75% funding goal they have a little more than $1 million a year and with the 65% funding goal they have about $700,000 in savings. She then addressed a handout with a yellow column that showed costs with no pension obligation bonds (cash funding only, which is the actuary's forecast). This is the required funding under Illinois law. Ms. Carroll noted the resetting of the amortization period really becomes clear here. The numbers increase over time, pensions are going up with more cost being put on the back end rather than the front end. She noted that in the columns under 65%, 75% and 90% funding scenarios, they have the on -going contributions plus debt service for total cost and estimated savings. Green columns show savings. Ms. Selden noted the difference in total dollars. Under the ,65% funding level there would be an estimated $17.4 million in total savings. Under the 75% column there would be an estimated total savings of $26.6 million and under the 90% level, an estimated total savings of $40.3 million. Ms. Selden explained that the actuary takes into consideration all factors to determine actuarial liability. The actuarially required contribution (ARC) will change a little each year. Ms. Carroll noted the table paints clearly how much Council can save in property tax levies. The reason Ms. Carroll supports funding at the 90% level, is that it results in the most tax levy savings over those 26 years. Ms. Selden stated that all assumptions assume that the City will make the actuarially assumed rate of return of 7.25% and won't suffer a catastrophic loss �5 6 November 19, 2007 Alderman Holmes clarified that they would not have savings until 2009. Alderman Bernstein asked why there were no savings in the first two years. Ms. Carroll explained the first year is the current year. In 2007 the actuarially required contribution is $12.1 million, which they will levy for and use some cash. If they adopt pension obligation bonds, the first year they will have a tax levy related to debt service is 2008. Alderman Rainey asked given the state of the U.S. economy, if Ms. Selden had any hesitation about recommending a bond issue at 90% funding. Ms. Selden responded it is critical that the investment side be managed. It would be disastrous to issue pension bonds and have some kind of loss on the equity side. She is greatly concerned about the U.S. economy. It is important to have an agreement that manages the risk for either a significant period or the entire period. It would be good for the City to lock in the whole thing. Alderman Rainey asked who will manage this investment if Council goes forward with it. Will the City go out and select some firm to manage this? Ms. Selden said here is where Council has an important policy decision. Under Illinois law, this contribution is made to the pension funds and their fiduciary responsibility is to manage this asset. Alderman Rainey noted the City Manager's memo says there has been discussion with the pension funds that the cash is not to be given to them but Council would determine where the assets would be. Ms. Selden said they could give cash or the asset to the pension funds. The second choice is to set up a trust fund that would be part of the City and under the Finance Director or City Manager to manage. Trust structures are more challenging to set up. One issue is that it is less likely that pension funds' actuary can count the asset as a reduction of the UAL. They can go to the Department of Insurance about that. Ms. Selden stated they have gone to the banks and invited them to come forward with ideas to manage risk for a 30-year term. Alderman Bernstein said, according to the law, the pension funds are responsible for managing funds. However, on page three of the manager's memo: "The reason we do not recommend giving the pension funds cash is that their records of returns over the past several years has not always kept up." What is put into the pension funds? Ms. Selden stated they had found four investment structures. Alderman Bernstein asked is there not a legal obligation for the pension funds to control the fiduciary nature of this investment. Ms. Selden says once the funds are contributed, it is the pension funds obligation to control them. Ms. Selden said the City can contribute two ways. One is to give the entire proceeds when they issue the pension obligation bonds and the second option is for the City to hold the funds in a trust. The trust would fund the actuarially required contribution every year. Ms. Carroll reported in her memo, discussions about taking the bond proceeds and the City purchasing a structured investment then depositing the asset into the pension fund, which is another option. Ms. Selden noted the pension funds would have to come together and determine if this is the way that their fiduciary, duty makes sense and manage their own risk. They envision that one of these products will be agreeable to all and the pension funds will agree to receive it. Alderman Tisdahl had never seen a market she would like to be part of less than now. The pension funds have written a letter that they will put 45% into equities. She would not want to tie anyone to that right now. However, she agreed that over time stocks are the best things you can buy. She was very nervous about putting this much money in now and the idea that they are going to tie a money manager's hands and say 45% has to be in equities concerned her. Ms. Selden stated that is a requirement from the actuary. To get comfortable with the 7.25%, the actuary wanted to have assurance that the funds would be at the state mandated level. The products they are looking at are on the debt side of the equation. Instead of being in the 34% range, the fixed income side, this would be a guaranteed 7.25% or 7.50%. They are fixed income instruments and not equities. Ms. Carroll explained one reason they wanted the pension boards to keep their equity position as high as it is, is because over the long term they know that equities produce better returns. They are looking at this over a 26-year period. For the asset allocation to make the 7.25% return, there must be exposure to equities. She recalled that the fire fund did not get up to the 45% asset allocation until this year. Had they done it in 1998, they may have been able to produce a higher return. It is really about trying to get the best return for the pension funds so taxpayers pay less. Alderman Rainey recalled a major objection voiced from a representative of a pension fund about what can and cannot be done with pension funds and asked for clarification. Ms. Carroll thought the issue was about whether the Department of FA 7 November 19, 2007 Insurance would accept assets outside of the pension fund. Mr. Tepfer (Police Pension Fund actuary) said IDOI would not accept assets outside of a fund and even if they did, the actuary probably would not recognize that. There is a professional standard that the actuary has to abide by. Even if in a trust outside, it cannot be recognized as an asset of a pension fund. The money has to go somewhere. Ms. Carroll said what they are talking about is putting an asset into the fund that would be owned by the pension fund. Mr. Tepfer said that as long as the asset is a legitimate investment (under the statute) that could be done but would restrict the fund because it would have an asset that is only yielding 6%. Ms. Carroll said 7.25%. Alderman Wollin heard Mr. Schoolmaster say he did not want a cap on equities. Mr. Schoolmaster clarified that he wanted the ability to have no cap. Ms. Carroll supported that position to get better returns. Mr. Dillon noted the large funds have larger exposure. Kevin Hoecker, Scott Balice Strategies, LLC, reported that they went out to a number of banks and found next generation investments. The goals were: locked in arbitrage as little risk as possible, long-term, fixed-rate year after year and the ability to link these investments to equities or debt. The new investment products are structured to guarantee principal with indexed returns. Key features include guaranteed principal over the life of agreement; principal guaranteed when held to maturity by U.S. Treasuries or other sources and collateral held by a third party. Investment returns can be linked to one or more debt or equity -based indices; products can be designed to suit the City's risk/reward profile and agreements are structured to count as debt for the purpose of calculating the 45/55 equity/debt allocation ratio. UBS, an investment bank, came with a product and could give a 20-year asset on the debt side that will guarantee 7.5% rate of return. It is backed by an actively managed portfolio that is rated Aaa. The principal is protected with this product. Mr. Hoecker spoke of the risk of losing investment funds in the first five years and how crucial it is to secure the success in these years. This is a principal protected 20-year term 7.5% interest so it achieves that goal. In the 2151 year it would be converted into cash or assets that the pension fund could invest. It pays quarterly. The next product was proposed by Loop Capital with the backing of Deutsch Bank, a local firm partnering with one of the world's largest firms. They have a floating rate product. The rate can be capped at 10% and floored at a hypothetical 0%. They are giving up some of the upside and giving up any negative return. It qualifies as a fixed income investment and can be structured to earn a fixed amount for a period of time. A 30-year term investment — for the first five years they earn 7.75%. After that it is a floating rate instrument that is based on the relationship between the tax-exempt and taxable market, how they perform, the volatility factor and the initial coupon. They look at the main portion of the formula, which has the multiplier on the coupon. He looked at data going back 20 years, they earn 7.75% for five years, then he calculated a return of 7.61 %. He noted the floating rate could be 10% one year and 0% the next. With a pension bond, the first years mean more to its success than the final years. The first five to ten years are important. Alderman Wynne asked why it was critical to have the best success in the first years. Mr. Hoecker said it is related to the compounding of interest. Mr. Hoecker explained the fixed rate structured note proposed by Citi and Bank of America. He stated that it was a nice way to principal protect otherwise volatile investments. The principal is protected and funds are invested in a variety of funds, indexes, securities, etc. The participation rate is a percentage of the total return earned over time. The participation rate is a result of the investment being principal protected. At maturity, the issuer receives back the invested amount plus a payment equal to the price appreciation times a participation rate. Reverse exchangeable notes with Bank of America are the final product. It has no principal protection; provides a fixed rate of return for a fixed period and can be tied to an index. He tied it to pricing on SPX as of November 15 and could earn on a five year return of 8.24%, 7.8% for seven years and 7.44% for 10 years. The return is inherent in the fixed rate paid by the bank. Alderman Rainey asked if these rates were dependent upon investing 65%, 75% or 90% of funds. No. Mr. Hoecker added that all fees are included in the rates that were quoted. After conferring with advisors, Mr. Schoolmaster stated he did not believe the pension funds can own these instruments. Mr. Tepfer said the City can own them. Mr. Costello said this is a structured note from a corporation and not a legal 8 November 19, 2007 investment for a pension. Mr. Tepfer said it cannot be put into a pension fund because of state statutes. They cannot have an instrument that cannot be sold. Mr. Hoecker stated that there is a secondary market for all these instruments and some are collateralized by U.S. government securities or issued by agencies of the U.S. government. They are not all corporate bonds. He also said the funds would need to analyze the entire investment contract before concluding their applicability. Ms. Carroll stated they would talk to the IDOI. The point of this is to get something back that would cover the bogey of the actuarial rate of return and the only way is to borrow for less and invest for more. It has been done in numerous places. They would never recommend bonds unless they had an investment structure that would work; have to mitigate the risk and are exploring ways to do that. Alderman Rainey noted a statement in the manager's memo said that once the asset is placed with the funds, the City would require that they not liquidate the asset before maturity. That sounds like it is off the table. It concerned her that Hoecker doesn't know Illinois pension laws. It would seem that financial advisors advising on pension funds would be familiar with the law. Mr. Hoecker said that he is familiar with the law, but was not able to give a legal opinion. Ms. Carroll stated that they need to get confirmation to do what they need to do with the investment side to manage the risk. They did not want to go forward unless Council was willing to pursue this and thought this could be worked out. She thought if the pension funds could not own the assets, the City could own them. The only difference would be that the actuary would not recognize the asset as being in the fund. She thought they were interested in trying to save the taxpayers money. That is the ultimate responsibility. Phoebe Selden, of Scott Balice, knows the pension laws. Alderman Bernstein suggested going to the IDOI, is asking for something that is not allowed currently. He asked how much has been spent to date without knowing whether it is an acceptable method of getting funds into that account. He did not understand, if they accept one of these products without a dividend, how will they get the funds into the pension funds? For whatever reason, the courts have upheld the contributions to the pensions as being legal. For whatever reason, the actuarial numbers were different and the City has under funded the pension funds. How can, if the pension funds cannot accept these kinds of investments, they get the funds into their investment? Council is trying to fund the pensions to where the funds and Council are comfortable. The variables in a market that probably will go into a recession for a few years concerned him. As he understood, pension fund caps are 45% and 55%. Theoretically, the City could put 100% in equities. He asked why these products weren't vetted before going through this exercise. Ms. Selden responded that they have been trying to show the progress and results of their work; have come on this enormous journey and have seen four products that can be tweaked. They are talking about managing risk and about whether the funds are in the pension funds hands or the City's hands. Alderman Bernstein did not want to talk about managing the risk until Scott Balice had validated that they could do this. That they had not done that he thought was inexcusable. Was it not true that they would have to go to the IDOI and ask for modification of the statute to do this? Why have they wasted their time and what has the City paid to date? Ms. Carroll stated Scott Balice has been paid nothing. Alderman Bernstein asked if they are paid for investments. No. Mr. Grady explained that Scott Balice is not paid anything for this initiative. They are only paid if a deal is consummated. That means if the City enters into a bond transaction, they would be paid. Alderman Bernstein noted Scott Balice has a vested interest in the City entering into a bond transaction. Ms. Carroll said they don't get paid, but they are not recommending this because Scott Balice will be paid or not. They feel this is the most efficient way to fund $140 million. Alderman Bernstein pointed out that the manager has elicited a company that only gets paid if the City buys bonds. Ms. Carroll stated there are fees if they give the City advice and Mr. Grady stated there are certain set fees. They also advised on the bond refund. Alderman Bernstein thought that Scott Balice is not totally unbiased. They are not consultants. They have a reason to tell Council that pension bonds are the best way to go. Ms. Carroll thought they were trying to show what the obligation is if they go with a pay-as-you-go situation. That is $530 million over a 26-year period. If they can fund this obligation through pension obligation bonds, they can save taxpayers up to $40 million. Ms. Carroll's interest is in getting the lowest cost to fund this. Some examples given that evening did just that. They are spending time trying to look at the best way to solve this problem, which gotten out of hand. Every financial adviser she has worked with over 20 years has had an arrangement that they advise, do research and don't get paid unless bonds are issued. Alderman qv 9 November 19, 2007 Bernstein noted she is going in with a certain presumption that bonds are the way to go. What he needed to hear is that there is no alternative other than pay as you go or bonding. Alderman Bernstein has not found the nexus for getting from the City to the pension funds. Ms. Carroll explained that if they cannot take the assets and place them in the pension funds because the IDOI believes structured assets won't work, the City has the option to create a trust, take the money, invest it in the same kind of products and make an annual contribution to the pension funds so they can meet their obligations. The reason that has not been pursued is the belief that there will be a higher administrative cost. That is still in option. Other agencies throughout the country have done this; created an independent trust to manage the assets created by issuance of pension obligation bonds that contribute to the funds. Ms. Carroll said they are exploring different options and it is important to do due diligence. They have asked Scott Balice to talk to Bank of America and others so they can understand what is the risk -- don't want to do anything that will increase their risk. At the same time, they are trying to figure out how to fund the pensions, so they are walking a fine line. There are other options. They have not explored the trust avenue because of the concern about recognition of the actuary. That has been done many times. The City would know on its balance sheet that they had this asset funding the pensions. They could also give the pension boards cash. There are many factors to look at. Alderman Moran felt good about what was presented. All have a major concern about what they were told in the beginning of this process — how far behind Evanston is. He saw a two -pronged problem to solve. One is they need to meet their pension obligations. They have an obligation to the taxpayers to approach that in the most intelligent and sophisticated way they can. Rather than blindly going forward investing, can they do better and employ financial strategies. Yes, they are complex but these are not science experiments, and they need to study those examples. They need to figure out how they can come up with a sophisticated strategy that allows them to meet their pension obligations and, simultaneously, assure taxpayers they are doing their best to minimize costs. When they started talking about this, all he was told was that Council had to find 1140 million and to get to work on it. Now he has a document that begins to lay out strategies. If these prove out, he felt better than he did three months ago. They have to discover if they prove out. The notion of going to the Department of Insurance for an opinion is done frequently. He has optimism that they are going toward strategies that will allow them to be true to their dual obligations and do it in a safe, efficient and economic manner. He welcomed this information and urged Council to pursue these and move forward. Alderman Wynne said Council has a series of decisions to make and each of those decisions raise questions. There are issues with a trust. What happens when the actuary does not recognize these funds? What is the negative aspect of that? Is it possible to do that? How is the City's Aaa rating affected? They need to find out if any of these products can be transferred to the pension boards. Some may go off the table and others remain. What kind of structured asset is acceptable? They should go to the Department of Insurance to find out if this qualifies. The second tier of questions concerns looking at all the products. She wanted to know the negative and positive aspects of each so they have a much better understanding of choosing one or the other. Much more information would be better. Alderman Rainey said all of that needs to be done in light of the market and the risks and benefits understood. She would like to know about comparable communities that have structured one of these products for pensions. If in Illinois, there must be some ruling from IDOI and if not in Illinois, could they provide some communities as examples'? Mayor Morton thought there would be little history with whatever they come up with. Ms. Carroll stated that pension obligation bonds are not new. The investments are new in what the market is bringing. The reason they are is to provide an option for people to get the return needed in the early years. That is why they looked at instruments that could tie up the money for five years or longer. She understood the concerns raised and wanted to get on the table that the most efficient way is through bonds. This won't be done overnight. More work is needed. If risk can be managed on the investment side, there will be considerable savings to the taxpayers. Alderman Wollin thought California has done pension obligation bonds in many cities. Alderman Bernstein thought they could use TIF funds to fund a portion and read a portion of the September 5 minutes. Ms. Selden said the City has GO bonds to fund various TIF projects. TIFs contribute their revenue to pay the debt service. When she was at Moody's, TIF debt was not viewed the same as GO debt, even though both are funded by �f 9 10 November 19, 2007 different elements of the property tax. She and Ms. Carroll had just found out in discussions with Moody's that they consider both to be part of the GO debt burden. So they are backing off of that strategy as a way to reduce the GO debt. They still think there are ways to switch into a fixed-rate mode and may make sense to get out of variable -rate mode. Alderman Bernstein got the impression at the September 5 meeting that they could tap into TIF funds to pay part of the pension obligation. Ms. Selden was focusing on currently issued GO bonds that were issued for TIF purposes. A garage in a TIF district can be funded through GO bonds. Many municipalities use TIF funded bonds to fund a project. Ms. Carroll said that Ms. Selden was thinking that if the rating agencies would consider refinancing into TIF supported bonds, rather than GO bonds, that would lower their over all debt ratio. They found that the rating agencies no longer look at it that way. They continue to look at market opportunities because if they can go from variable to fixed and get a lower rate and have a net value present savings, which they should do, because that is in the City's long-term interest. Alderman Rainey asked if the rating agencies changed their minds going forward. The City has no TIF debt right now. Ms. Selden was disappointed that Moody's counts the TIFs as part of the GO debt. That is a newer policy. Ms. Carroll appreciated Council's time spent on this and said they are trying to educate on the options and work out the investment risk. There being no further business to come before the Council, Mayor Morton asked for a motion to adjourn and the Council so moved at 9:43 p.m. Mary P. Morris, City Clerk A videotape recording of this meeting has been made part of the permanent record and is available in the City Clerk's office. 1 E