CalPERS Explains Impact to Employer Contributions Due to Reduction in the Assumed Rate of Return

Category: Blog Posts
Date: Jan 23, 2017 12:32 PM
CalPERS Explains Impact to Employer Contributions Due to Reduction in the Assumed Rate of Return

On January 19, 2017, CalPERS provided greater clarity on how contracting agency employers, and even some members, will see contribution rate increases due to a decision to reduce the assumed rate of return.  On December 20, 2016, we reported that the Board of Administration was poised to, and in fact did, reduce the assumed rate of return following a recommendation by the Finance and Administration Committee that the current assumed rate of 7.5% was unrealistic in today’s economy.

The assumed rate of return, also called a discount rate, is the percentage of expected returns on investments made by CalPERS.  Generally, the higher expected return, the lower employer contributions will likely be. The problem arises, though, that if CalPERS’ investments do not meet the expected return rate, this creates risk and greater unfunded liabilities because the employer contribution rates were based on that expected return.

On December 21, 2016, the CalPERS Board voted to adopt a reduction in the assumed rate of return over a three-year period.  According to CalPERS’ recent Circular Letter, for contracting agencies, the discount rate will fall from 7.5% to 7.375% for fiscal year 2018/2019, then to 7.25% for fiscal year 2019/2020, and finally to 7% for 2020/2021. 

The result is two-fold:  an increase in the normal cost of pension benefits and an increase in the unfunded accrued liability (UAL).  This not only means an increase in employer contributions, but for those employees who are “new members” under the Public Employees’ Pension Reform Act of 2013 (PEPRA), they too will see an increase in member contribution rates as these members are required by law to pay 50% of the normal cost of their retirement benefits.

Public agency employers can expect the following relative increases in their normal cost contribution:

2018/2019       0.25% - 0.75% increase for miscellaneous plans; 0.5% - 1.25% for safety plans

2019/2020       .5% - 1.5% increase for miscellaneous plans; 1.0% – 2.5% for safety plans

2020/2021       1.0% - 3.0% increase for miscellaneous plans; 2.0% - 5.0% for safety plans

In addition, employers will see gradual increases in their UAL payment, with a five-year ramp up for each reduction in the assumed rate of return.  As such, employers can generally see an approximate increase in their UAL payment for both miscellaneous and safety plans as follows:

2018/2019       2% - 3% increase in the UAL payment

2019/2020       4% - 6%

2020/2021       10% - 15%

2021/2022       15% - 20%

2022/2023       20% - 25%

2023/2024       25% - 30%

2024/2025       30% - 40%

For example, assume an employer’s current UAL payment is $800,000 for fiscal year 2017/2018.  In 2018/2019, the employer could generally expect a payment of $816,000 up to $824,000. 

These numbers are current global estimates projected by CalPERS, but employers should refer to their annual valuation reports this summer which will provide specific projections for your plans.

These increases no doubt bring significant strain on employers, some of whom are still grappling with losses occasioned by the Great Recession.  Employers should be cognizant that further increases are always possible in future years if actuarial assumptions are again updated, as they were in the last few years. 

Some possible strategies for employers to address these hikes include:

  • Maintain and publish comprehensive multi-year projections on pension costs prepared by independent actuaries who can provide direct recommendations and strategies to the governing board.  These reports should be transparent and thoroughly presented and discussed in open board/council meetings or workshops to educate stakeholders, employees and the public.
  • As part of long-term budgeting, maintaining and increasing restricted reserve funds for paying down unfunded liabilities.
  • Subject to meet and confer with employee labor organizations, stabilize larger on-schedule salary increases and increases in other pensionable compensation, and in the alternative, offer increases in non-pensionable benefits, such as health care contributions or contributions to a defined contribution retirement plan, subject to IRS and PEPRA limits.
  • Subject to agreement with employee labor organizations, consider cost-sharing employer contribution rates by CalPERS contract amendment and/or MOU.  This again can be negotiated in exchange for other benefits.

Employers are also encouraged to collaborate with labor negotiators and actuaries for creative strategies in addressing pension rate increases.

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