On March 14, 2012, the Board of Administration of the California Public Employees’ Retirement System (“CalPERS”) approved lowering the “discount rate” or “rate of investment return” from 7.75% to 7.5% in its assumptions when it determines employer contribution rates. This means that employers who contract with CalPERS for pension benefits will see their employer contribution rates increase. For school employers, contributions will likely increase by 1.2% to 1.6% for miscellaneous plans and 2.2% to 2.4% for safety plans beginning fiscal year 2012-2013. For public non-school agencies, contributions will likely increase by 1% to 2% for miscellaneous plans and 2% to 3% for safety plans beginning fiscal year 2013-2014.
In addition, the new discount rate will apply to all service credit purchases and estimate requests postmarked, delivered or faxed on or after March 15, 2012. Costs will also increase between 5% to 13% depending on the individual circumstances of the CalPERS member. Retirement applications that have a retirement date of March 15, 2012 or later will be calculated with the new discount rate. CalPERS members who choose an optional benefit at retirement, such as an optional settlement benefit or leaving a portion of the benefit to a beneficiary at death, may have an approximate 2% increase in cost for the benefit.
At the CalPERS Board meeting on March 14, 2012, Board members requested that staff examine phasing-in the increase on employer contribution rates over a two-year period. However, it is unclear at this time whether such a phase-in will occur.
Employers may be wondering how this lowered discount rate occurred and why now. CalPERS considered lowering the discount rate last year, but opted not to do so at that time. This set CalPERS apart from other public pension systems, such as the California State Teachers Retirement System (“STRS”), which chose to lower their discount rate earlier. However, CalPERS’ decision in 2011 was also contingent upon a reassessment this year.
This reassessment of the discount rate was conducted by the Pension & Health Benefits Committee of CalPERS which retained the services of an independent auditor to perform an analysis of the factors that underlie the discount rate assumption. In performing this assessment, actuaries recommended: (1) that the price inflation assumption (the progressive increase in the general level of prices measured by annual increases in the Consumer Price Index) should be lowered from the current 3% to 2.75% because historically, there has been a steady decline in price inflation; and (2) that a margin for adverse deviation (a “cushion” against poor investment return rates) should be 28 basis points (.28%) to maintain the margin that has historically been maintained. This recommendation resulted in a recommended discount rate of 7.25%.
However, given the major impact a 7.25% discount rate would have on the State and other CalPERS employers, the CalPERS Board voted to lower the discount rate to only 7.5%. The median investment return net of administrative expenses is currently 7.53%. This means that the margin for adverse deviation or that “cushion” against poor investment returns for any given year is only 3 basis points (.03%), as opposed to the 28 basis points (.28%) that was recommended by the Pension & Health Benefits Committee.
What does this mean for CalPERS contracting agencies going forward? Nothing immediate. Rate increases resulting from this change will begin in fiscal year 2013-2014 for contracting agencies, and 2012-2013 for State agencies and school employers. CalPERS employers should keep in mind the following:
- If employers are currently in negotiations over multi-year collective bargaining agreements, employers have to be cognizant that their contribution rates will increase and the exact amount of that increase is not entirely clear at this time. However, the estimates CalPERS provided should provide a basis for negotiation with employee associations.
- There were no changes made to the wage inflation assumption, but it will be reviewed in two years. There is a likelihood the assumption will be modified which may contribute to further increased contribution rates for employers at that time.
- CalPERS chose to only lower the rate to 7.5%, rather than 7.25% as recommended by the actuaries. This means there is less of a cushion to soften the blow if there is a rather poor investment return in any given year. Should we see several years of poor investment returns, this may cause a further reduction to the discount rate and higher contribution rates for employers.
- The lowered discount rate will impact member calculations for things such as a purchase of service credit or optional benefits at retirement. This may result in employees delaying retirement.
- The impact on the State as a whole may add fuel to Governor Brown’s pension reform initiatives.
Employers are urged to work closely with their actuaries, labor negotiators, attorneys and administrators to deal with the long and short term impact of the increased discount rate.