The California Public Employees’ Retirement System (CalPERS) adopted a funding risk mitigation policy it says will incrementally lower the discount rate in years of good investment returns, help pay down the pension fund’s unfunded liability, and provide greater predictability and less volatility in contribution rates for employers.
The policy adopted by the CalPERS Board of Administration will establish a mechanism to reduce the discount rate—or assumed rate of return—by a minimum of 0.05 percentage points to a maximum of 0.25 percentage points in years when investment returns outperform the existing discount rate, currently 7.5%, by at least four percentage points. The four percentage point threshold would work to offset increases to employer contribution rates that would otherwise increase when the discount rate is lowered, and help pay down CalPERS’ unfunded liability, the system notes.
CalPERS staff modeling anticipates the policy will result in a lowering of the expected portfolio volatility to 8% in about 21 years, improve funding levels gradually over time, and cut risk in the system by lowering the volatility of investment returns. While rates are expected to increase for CalPERS employers in the future, the policy is designed to minimize any increases above projected rates.
“Our goal is to be fully funded with an acceptable level of risk,” says Anne Stausboll, CalPERS chief executive officer. “This policy is a balanced approach that recognizes the fiscal constraints on California’s local agencies and represents a milestone for CalPERS.”NEXT: Responding to a maturing workforce
CalPERS investment returns are reported as of June 30 at the end of each fiscal year. In years when the returns exceed the discount rate by 4%, the policy will trigger a discount rate adjustment. CalPERS’ asset allocation will be adjusted to account for the new discount rate and will take effect on October 1 of the fiscal year immediately following.
Member contribution calculations will also reflect the new discount rate effective October 1 of the fiscal year immediately following the good returns, and the changes will be included in employer contribution rates outlined in actuarial valuations as of June 30 for that fiscal year. Resulting contribution rate changes for employers would go into effect one year after the following fiscal year for state and schools, and two years after for California public agencies.
CalPERS says the action is in large part a response to the maturing of the workforce. The ratio of active workers to retirees was more than 2 to 1 just a decade ago, the ratio is now 1.6 workers to every retiree, and that downward trend is likely to continue until 20 years from now when the ratio of actives to retirees is expected to be less than one. Last fiscal year, CalPERS saw a 13% increase in state retirements over the previous year, and for the first time in the pension fund's history, CalPERS is paying out more in retirement benefits than taking in contributions. CalPERS paid $18 billion in pension benefits in the 2014-15 fiscal year, compared to $13 billion in contributions.
The adoption of the risk policy concludes an 18-month examination of risk in the system by the CalPERS Board. The Board looked at several strategies to achieve risk mitigation, based on recommendations from CalPERS staff, external pension and investment consultants, and input from employer and employee stakeholder groups. The policy adopted gained a majority of support from all involved.NEXT: California governor “disappointed” with new policy
Rob Feckner, president of the CalPERS Board, mentioned the 18-month analysis and consideration of several strategies when responding to Governor Edmund G. Brown, Jr.’s statement regarding the system's new risk mitigation policy.
Brown said, “I am deeply disappointed that the CalPERS Board reversed course and adopted an irresponsible plan that will only keep the system dependent on unrealistic investment returns. This approach will expose the fund to an unacceptable level of risk in the coming years.”
However, Feckner said, "We respectfully disagree with Governor Jerry Brown's statement that the funding risk mitigation policy adopted this week by the CalPERS Board is 'irresponsible.' We took a bold leadership step to reduce risk and volatility in the Pension Fund to help ensure the long-term sustainability of the system and protect the public employees who serve and have served our great state.
"The policy is … consistent with the state's goals of helping to pay down debt and we would hope that the Governor would have agreed it is a step in the right direction. A more rapid reduction of our discount rate would have caused financial strain on many of California's local municipalities who are still recovering from the financial crisis. … We believe this action demonstrates our continued leadership in the pension industry."