Archive for the ‘Funding’ Category

CalPERS faces another decision on employer rates

October 30, 2017

Another CalPERS employer pension rate increase might seem unlikely. Several of the four rate increases adopted during the last five years are still being phased in. But a serious funding shortfall from a huge investment loss a decade ago lingers on.

In a regular four-year review, the CalPERS board is scheduled to receive three or four options next month for adjusting long-term investments in its portfolio valued at $338 billion last week. A change could be approved as soon as December.

Under one of the options a rate increase adopted last December, when the investment earnings forecast used to discount future pension costs was lowered from 7.5 to 7 percent, will remain on track to begin next year, CalPERS officials said last week.

Other undisclosed “candidate portfolios” may have less risky but lower-yielding investments requiring an employer rate increase to fill the gap. A riskier but higher-yielding portfolio option may even allow slightly lowering the scheduled rate increases.

“This December, I think, are the most consequential decisions that the board has had to make in a very long time,” Marcie Frost, CalPERS chief executive officer, told the annual CalPERS Educational Forum in Rancho Mirage last week.

The three-day event with multiple sessions on pension and health plan issues was attended by nearly 800 state, school and local government officials, each paying a $399 fee and their own travel and hotel costs.

In the opening remarks, Frost thanked local government officials for expressing their concern about the rate increases at the CalPERS board and at city council where CalPERS has been making presentations.

“The messages are very consistent. They are very clear that you are under stress,” Frost said.

But while encouraging local government officials to participate in the rate process, Frost and others made it clear that CalPERS also is under stress. The system only has roughly 70 percent of the assets needed to pay future pension costs.

If there is another market crash like the one during the financial crisis a decade ago, the CalPERS funding level could drop below 50 percent, regarded as a red line by experts who say recovery would be very difficult.

“Our primary focus is we want to stabilize the fund,” Frost told the forum. “We want to boost the funding status.”

Another kind of rate increase may be considered next month. Scott Terando, CalPERS chief actuary, is proposing faster payment of new debt or “unfunded liability” from below-target investment earnings.

The payment period would be shortened from the current 30 years to perhaps 20 years. The higher debt payments from years with investment losses could be offset by lower payments from years with gains.

“We are going to be taking a hard look at whether the smoothing and the five-year ramp up and down and the 30-year amortization are in the best interest of employers,” Terando told the forum last week.

The long payment period increases the employers’ total cost. Under current policy, the debt payment is gradually increased or “ramped up” over the first five years, then ramped down during the last five years of the 30-year period.

The rate increase from the 7.5-to-7 percent discount drop will be paid off over 20 years, with a five-year ramp up and down. At the request of local governments, the rate also is being phased in over three years and won’t reach the maximum level until 2024.

The CalPERS board is scheduled to receive an “experience” study next month reviewing important pension factors such as life spans, retirement rates, salaries, inflation, disability, and actuarial assumptions.

A change in those factors could affect employer rates. One of the previous rate increases was for longer expected life spans. The other two increases were for actuarial changes that lowered the discount rate and paid down debt more quickly.

Cutting pension costs by faster payment of debt got new attention this year when the state budget made an extra $6 billion payment to CalPERS for state worker pensions. It’s expected to save the state $11 billion over two decades, if all goes as planned.

In recent years, CalPERS has taken several steps to reduce the impact of another large investment loss. The normal cushion against dropping below the 50 percent funded red line is having a funding level of 80 percent or more.

But the CalPERS funding level has not recovered since dropping from 100 percent in 2007, when the portfolio was worth $260 billion, to 61 percent in 2009 when the portfolio had shrunk to $160 billion.

The funding level was about 68 percent last year. Several CalPERS officials said last week that the low funding level is a major problem. The chief executive, Marcie Frost, tries to keep the focus on working toward a solution.

“Marcie carries this sign around the office, actually, with this little ’68 %’ on it to remind us — she actually does,” Wylie Tollette, CalPERS chief operating investment officer, said as he shared the stage with Frost at the opening of the forum.

CalPERS adopted a “risk mitigation” plan in 2015 to reduce investment losses. When earnings are at least 4 percent over the forecast, half of the excess would be used to lower the discount rate 0.05 to .25 percent, allowing a slow shift to less risky investments.

Last February CalPERS lowered the trigger for the tiny reductions in the discount rate. Earnings need to be at least 2 percent above the target, not 4 percent. The policy was delayed until 2020, when the three-year phase in of the 7 percent discount rate is done.

The decision in December to drop the discount rate to 7 percent was driven by a the revised view of experts that CalPERS would earn 6.2 percent during the next decade, not 7.1 percent, before rebounding to 7.83 percent in the following two decade.

In September of last year, the CalPERS board, in a closed session not revealed until later, shifted the investment portfolio to less risky but lower-yielding investments (see chart).

By last February, the CalPERS board was told, the portfolio shift had cost CalPERS $900 million in gains as the stock market began a post-election surge, which has continued as the S&P 500 and Nasdaq Composite closed at record highs last week.

CalPERS has engaged specialists and is working on a cost-efficient options hedging strategy that could provide some protection in a deep market downturn, Ron Lagnado, CalPERS investment director, told one of the forum sessions last week.

“The analogy is an insurance policy,” he said.

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 30 Oct 17


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