A Not-So-Rosy Update on CalPERS’ Funded StatusCategories: California Developments
The Alert – Public Agency Coalition by Amy Brown, November 15, 2016
Annual Check Up on Funding & Risk
As one of his last actions before departing for a life of leisure (aka retirement), former Chief Actuary Alan Milligan presented the annual review of risk and funding levels to the CalPERS Board. As we mentioned last year, anyone who says that CalPERS presents an overly optimistic picture of the fund has obviously never read this annual report. It never fails to make us break out in a light sweat, and we don’t like to think of ourselves as Polly-annaish. So, with that warning, take a deep breath and join us for a harsh dose of reality…
Based on the FY 2015/16 investment return of 0.6 percent, far short of the expected rate of 7.5 percent, CalPERS’ overall funded status dropped to about 68 percent. Milligan says the average public agency plan is in better shape than the State plans, but overall, risk remains high.
Along with the decline in the funded status, employer contributions will eventually increase in the future to make up for another year of lower than expected returns. Milligan’s report warns that higher employer contribution rates impose significant financial stress for some employers, which may increase the risk that employers will default and be unable to make regular contributions.
The average employer contribution rate for public agency safety employees (per the June 30, 2015 valuation) is 40.5 percent of payroll. The State CHP has the highest contribution rate of all plans at 48.7 percent of payroll. The maturation of plans and the financial stress of some employers remains a concern, Milligan says. Benefits are only secure if an employer stands behind its promised benefits.
The report says that increased collections activities and an increasing number of requests for information on plan termination procedures indicate at least some plans are under significant strain. That’s exacerbated by the fact that the actual cost of termination is based on the market rate of return on Treasuries on the date of termination; the higher cost of termination increases the risk to members of an employer not paying benefit costs.
Employer contributions will continue to increase in the near term and there is an increased risk of high employer contributions. Over the next 30 years, for example, there is a 31 percent chance that employer contributions for public agency miscellaneous employees will exceed 35 percent of payroll; a 50 percent probability that contributions for public agency safety employees will exceed 60 percent of payroll; and a 72 percent probably that State contributions for its CHP employees will exceed 60 percent of payroll.
In conjunction with that, the probability of the plan reaching a low funded status has worsened since last year’s report because of another year of poor investment returns. There is now a 100 percent probability the CHP plan, for example, will fall below 60 percent funded over the next 30 years and a 43 percent probability that it will fall below 50 percent funded. Dropping below 50 percent funded has historically been recognized as posing a significant threat to a plan’s ability to recover.
The report also states that plan changes will continue to influence risk going forward. Risks will continue to increase as a result of the continuing maturity of plans – particularly referring to the ratio of active employees to retirees. With less actives per retiree, the plan’s ability to recover from setbacks declines. In addition, the trend toward lower expected returns and potentially lower discount rates will also negatively affect the plans’ risk.
The report acknowledges a positive impact and reduced risk for some employer plans where the employer has taken charge of addressing funded status. Since GASB 68 went into effect, an increasing number of employers are making additional contributions to improve their plans’ funded status. For example, the report cites the City of Irvine’s adoption of a policy in 2013 to make additional payments of $5 million annually over the next 10 years. Although the City reserved flexibility to modify those amounts based on the financial position and needs of the City, thus far it has met its commitment.
The report also says the increasing number of JPAs is resulting in a greater number of employers with a less stable revenue base or of a less permanent nature than has traditionally been the case at CalPERS. And the growth of charter schools could lead to an erosion of membership in the schools pool as well as the revenue base supporting that pool. For example, 1.8 percent of students were enrolled in a charter school in 1999/2000 compared to 8.3 percent of students in 2013/14.
While in the past Milligan has given the Board wiggle room where he feels like action could be put off, that leniency wasn’t provided in this year’s report. The Executive Summary of the annual report clearly warns, “Recent economic conditions have increased the risk associated with achieving a 7.5 percent rate of return, at least over the medium term — the next 10 years or so. It is increasingly clear that some change to the expected rate of return should be considered by CalPERS.” And the report emphasizes this point again: “Overall, this report shows that risks remain high. In the absence of explicit risk targets and tolerances, it is not clear whether the risk mitigations in place currently have brought risks to the levels that the Board considers acceptable. The Board may wish to take additional actions to address the level of funding risk.”