September 22, 2016

The California Public Employees’ Retirement System’s (CalPERS) Finance and Administration Committee met this week and heard an annual review of the system’s funding levels and risk report that included news of higher contribution rates for contracting employers and the conclusion that the risk that plans will continue to fall to low funding levels remains high.

Counties will recall that in 2015, following internal discussions that included CSAC, among other local government stakeholders and employee representatives, and almost four years of ongoing work by CalPERS to address market volatility issues after the large losses in 2008 and demographic changes in the retiree population, the CalPERS’ Board of Administration adopted its Funding Risk Mitigation Policy to incrementally lower its discount rate (currently 7.5 percent) used in actuarial valuations in years with good investment returns and provide less volatility and more predictability for employers’ contribution rates.

The policy implemented a trigger created to reduce the discount rate by a minimum of .05 percentage points to a maximum of 0.25 points when investment returns outperform the existing discount rate by at least four percentage points. The four percentage point threshold would serve to offset increases to employer contribution rates that would have otherwise increased rates when the discount rate is lowered.

CalPERS’ Chief Actuary, Alan Milligan, told the Finance and Administration Committee that the current funded status of the system has fallen to roughly 68 percent – a five percent drop since June 30, 2015. While contributing factors to this decline include recent economic conditions and the maturation of many of the system’s plans, Milligan made it clear that while a risk mitigation event was not triggered in the 2015-16 fiscal year, a lack of explicit risk targets makes it unclear as to whether the system’s current risk mitigation strategy has lowered risk to acceptable levels.

The Committee staff report states that, “It is increasingly clear that some change to the expected rate of return is going to need to be considered by CalPERS…The Board may wish to take additional actions to address the level of funding risk.”

Market factors (including a 0.6 percent return in the capital market and CalPERS’ passage of its risk mitigation policy) and environmental factors (the ongoing maturation of public plans and a trend toward lower discount rates caused by the expectation that capital markets will continue to produce lower returns) prompted CalPERS’ staff to advise the Committee to consider policies that address the risk resulting from these factors. Such consideration, staff mentioned, could include a lowering of the discount rate to buffer the impact of an expected low market return of only 6.12 percent over the next decade on already financially-stressed public agency employers, many of which received actuarial valuations in July that showed a rate increase of 1.3 percent of payroll for 2017-18.

CSAC will continue to update counties on this issue as it evolves.