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Navigating CalPERS Investment Policies and Strategies

Learn about CalPERS' contribution policies, demographics, recent changes, risk mitigation strategies, and potential cost impacts. Discover options for paying down unfunded liabilities and rate stabilization.

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Navigating CalPERS Investment Policies and Strategies

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  1. How Did We Get Here? • Investment Losses • Enhanced Benefits • CalPERS Contribution Policy • Demographics

  2. Historical Investment Returns

  3. Enhanced Benefits • At CalPERS, enhanced benefits implemented using all (future & prior) service • Typically not negotiated with cost sharing

  4. CalPERS Old Policy • Effective with 2003 valuations: • Slow (15 year) recognition of investment losses into funded status • Rolling 30 year amortization of all (primarily investment) losses • Designed to: • First smooth rates • Second pay off UAL and • Mitigated contribution volatility

  5. Demographics • Around the State • Large retiree liability compared to actives • Declining active population • Common to have 60%-75% of liability for retirees

  6. Recent CalPERS Changes • Contribution Policy • Assumptions • Risk Mitigation Strategy • Discount Rate • Other

  7. Contribution Policy Changes • No asset smoothing • 5-year ramp up • All amortization bases have fixed amortization periods • No rolling amortization

  8. Contribution Policy Changes • June 30, 2013 Valuation (15/16 rates) • Designed to: • First pay off UAL and • Second smooth rates • Uses MVA so only one funded status/ratio • If assumptions are met then: • Contributions go up in the short run but then come down • UAL will be paid off

  9. Assumption Changes • June 30, 2014 Valuation, 2016/17 rates • No changes to economic assumptions • Anticipate future mortality improvement • Other, modest, changes to assumptions

  10. Risk Mitigation Strategy • Move to more conservative investments over time • Only when investment return is better than expected • Lower discount rate in concert with investment allocation changes • Essentially use ≈50% of investment gains to pay for cost increases • Likely reduces discount rate 100 basis points over ≈20 years

  11. Timing

  12. Ultimate Cost Increase Misc.Safety Next 15 Years • Contribution Policy ≈ 7%≈ 9% • Assumptions ≈ 4%≈7% • Total ≈11%≈16% Next 25+ Years • Risk Mitigation ≈ 8%≈12%

  13. Discount Rate • Combination of • Expected Inflation 2.75% • Real Rate of Return (above inflation) 4.75 • Margin for Adverse Deviation 0.00 • Total 7.50% • Based on: • 2010 Capital Market Assumption study (updated in 2014) • 2010 Asset Allocation

  14. Discount Rate • CalPERS Board was told at the end of last year: • 2017 Capital Market Assumption Study real rate of return will likely be 50 basis points lower • Delivered by: • Outside investment advisors • CFO • CIO • Actuarial staff • Based on above, Board reached a compromise deal lowering the discount rate

  15. Discount Rate • Decrease discount rate from 7½% to 7% over next 3 valuations, for public agencies: RateInitialFull • 6/30/16 val. 7.375% 18/19 22/23 • 6/30/17 val.7.25% 19/20 23/24 • 6/30/18 val. 7.00% 20/21 24/25 • Risk mitigation suspended until after 6/30/18

  16. Discount Rate Misc.Safety • Normal Cost 2.0% 3.5% • UAL 5.5 9.5 • Total 7.5% 13.0% • Standard Deviation 1% 2%

  17. Ultimate Cost Increase Misc.Safety Next 10-15 Years • Contribution Policy ≈ 7%≈ 9% • Assumptions ≈ 4%≈7% • Subtotal ≈11%≈16% • Discount Rate ≈ 8%≈13% • Total ≈19%≈29%

  18. Other Changes • Collect payment on UAL as dollar amount for stand alone plans • Beginning with 2017/18 fiscal year • Capital Market Assumptions Study • Beginning summer 2017, finish early 2018 • Likely confirm 7.0% discount rate for current asset allocation

  19. Paying Down Unfunded Liability &Rate Stabilization

  20. Options • Pension Obligation Bonds (POBs) • Borrow from General Fund • Amortization Period • One time payments • Internal Service Fund • Irrevocable Supplemental (§115) Trust

  21. POBs • Usually thought of as interest arbitrage between expected earnings and rate paid on POB • No guaranteed savings • Including paying off CalPERS Side Fund • PEPRA prevents contributions from dropping below normal cost • Savings offset when investment return is good

  22. Borrow from General Fund • Pay GF back like a loan • Payments should come from all funds

  23. Request Shorter Amortization • Higher short term payments • Less interest and lower long term payments • PEPRA prevents contributions from dropping below normal cost • Savings offset when investment return is good

  24. One Time Payments • Council/Board resolution to use a portion of one time money to reduce unfunded liability, e. g. • 1/3 to one time projects • 1/3 to replenish reserves and • 1/3 to pay down unfunded liability

  25. Internal Service Fund • Could be used for rate stabilization • Restricted investments: • Likely low (0.5%-1.0%) investment returns • Short term/high quality • Designed for preservation of principal • Assets could be used by Board/Council for other purposes • Does not reduce GASB 68 Net Pension Liability

  26. Irrevocable Suppl. Trust • IRC §115 • Normally used for rate stabilization • May not reduce GASB 68 Net Pension Liability • Investments significantly less restricted: • Designed for long term returns • Likely much higher (4%-6%) investment returns than agency investment funds

  27. Irrevocable Suppl. Trust • Can only be used to : • Reimburse for pension contributions • Make payments directly to pension system • Assets could not be used for other purposes • PARS, PFM & Keenan • > 50 agencies

  28. Irrevocable Suppl. Trust • Can mitigate: • Investment volatility • Impact of plan becoming over funded • Requires modest seed contribution to trust (≈10% of annual dollar contribution)

  29. Irrevocable Supplemental Trust Contribution Rate Projections

  30. Supplemental Trust Balance Projections

  31. GASBS 73/74 Overview

  32. GASBS 73 • Unfunded single employer plans • Plans that provide pension benefits • Not funded, or funds not in Trust • Often small plans (limited number of people) or old plans • Applies to those that have employees in CalPERS subject to IRC §415.

  33. GASBS 73 • Effective FY Beginning > 6/15/16 • Everyone will recognize pension liability • Does not affect contributions (or require funding) • Discount rate will be 20 year Aa municipal bond rate • Change in net pension liability => pension expense • Additional note disclosures and RSI

  34. CalPERS • Benefits > IRC §415 limit ($215,000/yr in 2017) • Retirees and non-retirees with large projected benefits • No liability valued by CalPERS for • Funding or • GASBS 68 • Materiality?

  35. GASBS 74 – OPEB Plans • Replaces GASBS 43 Effective FY Beg. > 6/15/16 • Similar to GASBS 67 • Reporting for OPEB funded plans • In the plan’s financial statements • Stand-alone • Fiduciary fund in employer’s financial statements • Does not affect/require contributions

  36. GASBS 74 – OPEB Plans • Unclear whether agencies sponsoring funded plans, including those funding with CERBT, PARS, etc., will have to report GASBS 74 • CalPERS is reporting CERBT under GASBS 74 • Likely depends on who has fiduciary responsibility for investments (new GASBS 84)

  37. OPEB and GASBS 75

  38. GASBS 75 • Employer OPEB Accounting • Effective FY Beginning > 6/15/17 • Replaces GASBS 45 • Similar to GASBS 68 • Everyone will recognize net OPEB liability • Change in net OPEB liability => OPEB expense • Additional note disclosures and RSI • Does not affect contributions (or require funding)

  39. Why Pre-fund OPEB? • Taxpayer generational equity • Benefits should be paid for over employee’s service • More manageable cost pattern • Pay-as-you-go typically increases rapidly over time • For financial reporting: higher discount rate & lower net OPEB liability • Demonstrates to stakeholders you are addressing OPEB • Trust investments should produce higher investment returns over time

  40. OPEB - Plan Funding Bartel Associates Database

  41. GASBS 75 – “Crossover test” • Will determine discount rate • If plan assets are projected to cover benefit payments, discount rate = expected rate of return on assets • Provided assets invested so as to generate that return • Contribution policy of full ARC, with reasonable amortization period should be OK • Look to last 5 years of actual contributions

  42. Discount Rate • Expect many more OPEB plans with a crossover than for pension plans • Municipal Bond Rate • Rate is volatile • Net OPEB liability will be volatile • GASBS 75 does not specify which bond curve to use • http://www.bartel-associates.com/resources/select-gasb-67-68-discount-rate-indices

  43. Discount Rate 4.63% 4.29% 3.80% 20 Year AA Municipal Bond Rates 2.85% 3.78%

  44. GASBS 75 • Work with your actuary to: • Select measurement date • Choose valuation dates • Select implementation timing • Select 20 Year AA Municipal Bond Rate Index

  45. CalPERS & OPEB Issues California State Association of County Auditors John E. Bartel President April 12, 2017

  46. Agenda How did we get here?1 Recent CalPERS changes 6 Paying Down Unfunded Liability and 19Rate Stabilization GASBS 73 & 74 31 GASBS 75 37

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