Some local government employees in California likely will have to pay more toward their pensions as an indirect result of CalPERS’ good year on investment returns.
The California Public Employees’ Retirement System reported a 21.3% preliminary return on its investments for the fiscal year that ended in June. The big return — triple a 7% target — improves the retirement system’s long-term outlook and shields local governments from new debt payments.
But the earnings triggered a 2015 policy that forces CalPERS to impose additional fiscal prudence on itself, with consequences for local governments and employees.
The retirement system adopted the policy, known as risk mitigation, as it worked to pull itself out of a funding hole after the Great Recession. The policy forces the system to use short-term gains to protect against future downturns by reducing its annual earnings target and shifting money to safer investments.
Since the policy requires CalPERS to assume it will earn less on investments, dropping the projected rate to 6.8% from 7%, the system has to turn elsewhere for money to cover the retirement benefits of its two million members. So the system charges public employers more.
And under the Public Employees’ Pension Reform Act, local government workers hired after 2013 have to pitch in when pension costs go up, so many of them will pay more too.
“This (policy) does generally mean a higher cost to employers and employees, but there’s a balance here,” said Ted Toppin, chairman of Californians for Retirement Security, a group representing public employee unions and retirees. “The risk mitigation policy exists to cut that risk in future years, to pocket your high returns and then seek to rebalance your portfolio in a way that doesn’t expose you to such significant drops that we saw in the Great Recession.”
The contribution-splitting works differently under the law for state and local employees. Local employees pay the increases directly, while the state folds increased costs into contract negotiations with state employee unions.
SOME EMPLOYEES PAY A HALF-PERCENT MORE
Employees’ contributions go up only after a threshold is met. The threshold is a 1% increase in required contributions measured as a percentage of employee pay.
For example, CalPERS might have told a city several years ago that pension benefits for a group of employees would cost 13% of the employees’ pay. The employees would have had to contribute 6.5%. If the total required contribution grew to 13.5%, the employees wouldn’t pay more, but once it reached 14%, the employees would have to start paying 7%. Then they wouldn’t pay any new increases until the required contribution grew to 15%.
CalPERS expects that the average local government employee affected by the risk mitigation policy will have to contribute another half-percent of their pay toward their pension, according to a Q&A sheet shared with employers.
Affected school employees will have to pay more starting in July 2022, while other local government employees will start paying more in July 2023, according to the Q&A. State agencies will start paying higher contribution rates next year, and could ask state employee unions to agree to higher contributions.
Retirees won’t face any price increases, nor will public employees hired before Jan. 1, 2013, according to the Q&A.
CALPERS LONG-TERM DEBT
CalPERS sends employers a separate bill each year to help cover the system’s long-term debts. Those bills won’t increase as a result of the risk mitigation policy, CalPERS CEO Marcie Frost told the board last week.
At the end of June, the system had about 82% of the assets it needs to cover its long-term debts, according to a CalPERS news release. That’s up from about 71% a year earlier.
CalPERS collects the debt payments from employers under a plan to return the system to 100% funded in the 2040s. Employees don’t make payments toward the debt.
CalPERS, with a recent total value of $472 billion, administers pensions for about 2,900 public agencies around the state, including cities, counties, special districts and schools, along with the state. The retirement system has acknowledged in recent years the growing burden local governments face in making their pension payments.
When the retirement system’s investment gains fall short of its annual return target, the debt payments increase. By reducing the target to 6.8% from 7%, CalPERS expects to reduce volatility of the debt payments for employers.
Long-running changes in investment markets, including the extremely low returns on traditionally safe investments such as bonds, are making it harder for the system to reach investment return targets, CalPERS leaders have said.
Separate from the risk mitigation policy, the CalPERS board reviews its portfolio every four years and may make adjustments to the return target, also known as a discount rate, through that process. The board is going through that process this year, and may or may not decide to further reduce the target from 6.8%.