CalPERS plans to get local government reaction to a proposed new policy that would pay down new pension debt over a shorter period, yielding big savings in the long run but also requiring larger payments in the early years.
Employer rates for current debt or “unfunded liability” would not be changed, Scott Terando, CalPERS chief actuary, told the board last week.
But for new debt from investment losses, the payment period would be shortened from the current 30 years to perhaps 20 years, Terando said, and the higher debt payments from years with investment losses could be offset by lower payments from years with gains.
“We wouldn’t have to reamortize the existing bases,” said Terando. “That’s a nice way to transition from the old policy to the new policy without immediately impacting a lot of employers.”
A decision on the tentative proposal, still in flux, could come in November. A lengthy CalPERS routine review, the first since 2014, is determining if there is a need to alter investment allocations, the earnings forecast, actuarial assumptions, and risk management.
A CalPERS agenda report last week revealed, for many non-actuaries, that the California Actuarial Advisory Panel and some national groups recommend that gains and losses be paid off or amortized over 15 to 20 years.
Current CalPERS policy amortizes gains and losses over 30 years, beginning with a smaller annual payment that gradually increases to the full amount in five years. The phase-in or ramp up “smooths” the jolt on employer budgets. Payments ramp down in the last five years.
Potential savings from paying pension debt faster moved into the spotlight in May. Gov. Brown’s budget contained an extra $6 billion to double the annual CalPERS payment for state workers, saving an estimated $11 billion over two decades if investment earnings stay on track.
CalPERS has been encouraging employers to make extra payments to pay down debt. Recent valuations of pension plans for the 1,581 local governments in CalPERS show the potential savings of paying off debt over 10 and 15 years.
Terando said a number of local governments have asked the California Public Employees Retirement System to reconsider its amortization period to reduce long-term costs.
“They feel the interest cost, by having such a long amortization period and ramp up and ramp down, is actually hurting them, and they come to us to shorten their amortization period,” said Terando. “They would like to see it applied more consistently across the board.”
Some have suggested shortening the period to 15 to 20 years and switching from a percentage of pay to a level dollar amount, he said. CalPERS plans to show employers before November how the “various levers” impact payments, interest and the stability of the fund.
Under the current 30-year amortization, said Terando, the first 18 years of payments make no progress in paying off the loss or increasing pension funding. The payment of the original amount of the loss occurs in the last 12 years.
A 30-year amortization does, however, reduce the “volatility” or big swings up and down in the annual pension rates paid by employers.
“So, you basically have a conflict,” Terando said. “By paying off losses quickly you are going to increase your funding status. You are going to increase your stability of the fund. You are going to get to 100 percent (funding) quicker. Your rates are going to be more variable.”
Many CalPERS employer rates are doubling under a series of four increases. A group of cities made an unsuccessful plea to the CalPERS board last week to analyze cost savings from cost-of-living suspensions and giving current workers smaller pensions for future work.
The CalPERS funding level has not recovered from a huge investment loss in the financial crisis a decade ago. The portfolio plunged from about $260 billion in 2007 to $160 billion in 2009, before climbing to $366 billion last week.
Despite a lengthy bull stock market, which some think is due for a correction, CalPERS only has about 69 percent of the projected assets needed to cover rapidly growing future pension costs.
A new worry for CalPERS is that another big market decline could drop the funding level below 50 percent, a crippling blow in the view of some experts that would make recovery difficult if not impossible.
Board member J.J. Jelincic reminded his colleagues last week of an ill-timed shift last fall from higher-yielding stocks to less risky but lower-yielding bonds, a move to reduce losses and the need for more rate increases.
“We have spent a whole bunch of effort on stabilizing contribution rates,” Jelincic said. “We have walked away from, quite frankly, significant potential earnings for stabilization.”
The failure of CalPERS to recover from low funding, as it has done in the past, has often been attributed to overly optimistic earnings forecasts, a long period of low interest rates, and cutting contributions and raising pensions during a market boom around 2000.
A newer factor was mentioned last week by Julian Robinson, CalPERS senior actuary. He told the board that in the past few years there has been significant discussion throughout the pension industry about what should be an appropriate amortization for public plans.
“I think what’s driving this is the challenges faced throughout the country — the funding status,” said Robinson. “In the past I think the top priority was rate stabilization. Now the priority seems to be fund stability or sustainability and dealing with negative amortization.”
Negative amortization means debt continues to grow. For example, annual contributions may cover the normal cost, the pension earned during a year, but not be large enough to pay the interest on debt from previous years.
In the current 30-year amortization of CalPERS debt from losses, the negative amortization stops in year nine, a spokeswoman said last July. The current CalPERS interest rate is 7 percent, the same as the earnings forecast and discount rate used to offset future costs.
Robinson may have referred, among other things, to a Society of Actuaries nationwide study last June that found 160 public pension systems set an annual contribution target, from 2006 to 2014, that allowed debt to continue to grow.
A study issued in July by the Center for Retirement Research at Boston College found that the aggregate funding level of 170 public pension plans last year was 72 percent, not much different from CalPERS.
“To achieve more meaningful progress, plans need to establish contribution levels that will actually reduce unfunded liabilities,” the Center study concluded.
The 30-year CalPERS amortization was adopted in 2013. CalPERS had used “rolling” amortization for some debt, refinanced each year, and a rare smoothing period that spread gains and losses over 15 years. The first of the four post-crash rate increases did not begin until 2012.
Originally posted at Cal Pensions.
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.