In a few years CalPERS retirees are expected to outnumber active workers, a national trend among public pension funds that makes them more vulnerable to big employer rate increases.
A mature pension fund for a growing number of retirees becomes much larger than the payroll. So if the pension fund has investment losses, an employer rate increase to help fill the hole takes a bigger bite from the payroll.
The growing number of retirees, partly due to aging baby boomers, is one reason a staff report last week argues that CalPERS has too much “risk” and should consider a number of options during a board workshop early next year.
Among the options listed are a more conservative investment allocation, a lower earnings forecast, an employer choice of asset allocations with different risk and expected returns, and workers sharing the risk through contributions, benefit design or cost sharing.
The staff report, the third of its kind in recent years, was praised by several board members for proposing in good economic times that CalPERS increase its preparation for bad times.
CalPERS employers and employees are contributing more money. Investments have had two strong years. Reform legislation will cut future costs. And a funding level that fell to 60 percent during the recession is back up to 77 percent.
Now the odds are better that the funding level won’t drop below what for some is a fuzzy red line — 50 percent of the projected assets needed to pay promised pensions.
At roughly that level, some think getting to 100 percent funding may become difficult if not impossible. Employer contribution rates would have to be raised to an impractical level, crowding out funding for other programs, and investments would have to yield unlikely returns.
Despite the improved odds, the staff report said the probability of the funding level dropping below the 50 percent red line during the next three decades is still about 30 percent, varying among plans.
“The probability of reaching any of the three low-funded status thresholds shown has been reduced,” said the report. “However, the probability of this occurring is still higher than staff is comfortable with.”
Still fresh in the CalPERS memory is a huge investment loss. The CalPERS investment portfolio valued at $260 billion in the fall of 2007 plunged to a low of about $160 billion in March 2009, before climbing back to $297.5 billion last week.
Even full funding is risky, Alan Milligan, the CalPERS chief actuary, told the board last week. CalPERS was 100 percent funded on June 30, 2007, he said, and two years later on June 30, 2009, CalPERS was only 60 percent funded.
“Being 100 percent funded isn’t necessarily the target,” Milligan said. “Being 100 percent funded at an acceptable level of risk should be the target.”
Adding to the CalPERS risk is the drop in the ratio of active workers to retirees from 2 to 1.5 in the last 10 years, increasing the size of the payroll bite if employer rates are raised after a big investment loss.
“So now we only have about one and a half active members’ payrolls to spread the risk associated with each retiree’s benefits instead of the two-to-one ratio of a decade ago,” said the staff report.
“An additional concern is that these ratios are also expected to continue dropping over the next decades until they reach a floor somewhere between 0.6 and 0.8 depending on the plan.”
Some steps that lower risk have already been taken, possibly limiting options available now. Through bargaining and pension reform legislation, most employees are paying more toward their pensions, usually several percentage points.
Employers are getting a much larger rate increase through a lower CalPERS annual earnings forecast dropped from 7.75 to 7.5 percent two years ago, a new actuarial method last year, and longer life expectancy adopted this year.
“For many plans, the contribution rates have never been as high as they are now,” said the staff report. The more than 3,000 state and local government agencies in the giant retirement system have more than 2,000 retirement plans.
More than 100 miscellaneous plans have CalPERS contribution rates of more than 30 percent of pay. More than 150 safety plans (police and firefighter) have rates of more than 40 percent of pay.
In addition, said the staff report, at the high end of employer contributions 70 plans currently have rates above 50 percent of pay. Eight of them are miscellaneous plans and 62 are safety plans.
A chart with a simplified line shown the board last week (see below) projects rates for a typical miscellaneous plan increasing 5 percent of pay during the next five years, before leveling off for seven years and then steadily dropping for two decades.
“Ultimately, members and employers are in this together,” the staff report emphasized in boldface type.
The risk for employees is that if employers are unable to pay pension costs and terminate their CalPERS plans, the current low funding of the plans would result in deep pension cuts.
“Part of your job is to be Dr. Doom, and you do it well,” CalPERS board member J.J. Jelincic told Milligan, who presented the staff report also signed by the chief investment and financial officers.
Jelincic said the report should recognize the “trade-offs and balances” of the risky stock-based investment portfolio that can yield higher returns, lowering employer rates. He said a near zero-risk bond portfolio would have low returns that “kill the employer.”
Board member George Diehr, praising the objectivity of the “excellent” report, said Milligan is not Dr. Doom. He said the employee risk-sharing option should be in the “realm of actions,” even though it’s beyond board power and would require legislation.
Board member Priya Mathur, who also disagreed that the report is negative, said she supports “having a conversation” about how CalPERS can, without a spike in contributions, lower the risk of the pension fund.
“I think that is probably going to have some element of reducing the target rate of return, the discount rate, over time when it’s not so painful to do so,” she said.
Board member Bill Slaton, chairman of the finance committee that received the report, said the attendance of several board members who are not members of the committee shows the importance of the risk issue.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com. Posted 24 Nov 14