Increased costs for employee retirement plans for the next fiscal year could be a little less jarring after the pension management board decided on June 17 to phase increases in over a three-year period.

“There is a correlation between investment success and employer contribution rates,” explains Edward Fong, a manager in the office of public affairs at California Public Employees’ Retirement System (CalPERS).

“If investments perform well, then rates go down. If investments don’t perform well, then rates have to go up,” Fong says.

How drastic the increase would be each year was up for discussion at a CalPERS Board of Administration meeting on Wednesday.

Rate-setting for cities and counties always lags two years behind investment performance. That means that in the fiscal year starting July 1, 2009, rates are based on returns ending June 30, 2007, which was a good year with 19.1 percent gains. Returns of 7.5 percent are considered average rates of return.

“Therefore rates for public agencies will stay flat or even go down a fraction of a percent for the 2009/2010 fiscal year,” predicts Fong.

The market problems started in the fiscal year ending June 30, 2008 with almost 5 percent losses. Even that could end up a wash for the 2010 rate setting, because of Rate Smoothing Methodology enacted in 2005 to spread gains and losses over 15 year periods.

Rate Smoothing put some of the record returns from four good years into a reserve that can be used during the bad years.

“Rate Smoothing was enacted based on feedback from cities and counties which said it was difficult to handle dramatic ups and downs in rates,” Fong says.

The fiscal year ending on June 30, 2009 could result in losses too large for current smoothing methodologies to cushion. Estimates are that CalPERS will record upwards of 20 percent losses. That could mean rate increases of 2 percent to 5 percent in July, 2011.

Cities and Counties already facing budget shortfalls due to shrinking sales and property tax revenues along with state “borrowing” could find that jolt too difficult to swallow.

For most local governments, an average of 13 percent of payroll goes to retirement benefits. Contributions for miscellaneous or office workers are usually lower than for Safety or fire and police plans.

A jump of 5 percent could move the contribution to 18 percent of payroll, making layoffs even more likely in many jurisdictions.

That is why CalPERS expanded the rate smoothing algorithm to amortize investment losses – and gains if applicable – over three years using a “fixed and declining” 30-year amortization period.

“That way cities and counties don’t get one big hit,” says Fong.

Instead, a city might see its contribution go to 14 percent of payroll in 2011, and if the market recovers stay there or go up by two percent more in each of the following two years depending on the market.

Local governments can still pay the full amount or more if they wish.

If, as most analysts predict, the market recovers in 2010 and the fund once again realizes average returns, Fong says the long-term impact will be negligible.

“The rate-setting modification isloates an extraordinary one-year event, spreads the need to pay additional contributions over a fixed 30-year period,” explained CalPERS Board President Rob Feckner in a statement after the hearing. “It also allows local employers to pay a little less during the next three years than they otherwise would, while ensuring that the funded status of the CalPERS plan is not compromised.”

Non-teacher school employers were granted the same option, but a decision on state employees was deferred until September.

JT Long can be reached at