CalPERS Announces 5.8% Investment Return for FY2023. What does that mean for your agency?

CalPERS Announces 5.8% Investment Return for FY2023. What does that mean for your agency?

July 19, 2023

On July 19, 2023, the California Public Employees’ Retirement System (CalPERS) announced a preliminary 5.8% investment return for FY2023. While the pension fund did not post a loss, as they did in prior year, the return fell short of the 6.8% target (also known as the discount rate) that is required to maintain the funded level and avoid further unfunded accrued liability (UAL) increases. As a result, the agencies that are serviced by CalPERS will see higher UAL balances and UAL payment amounts once the FY2023 actuarial reports are published in summer of 2024.

The 30-year history of the CalPERS investment return is shown in the graph below.

CalPERS' Investment Return History (1993-2023)

The FY2023 return followed a devastating FY2022, when CalPERS lost a near record 7.5%. While significant market corrections are expected to be followed by recoveries, FY2023 did not bring any meaningful relief.

With the investment return falling slightly short of the 6.8% target, the California’s public pension system managed to maintain its 72% funded level.

The investment performance was driven by healthy gains in the public stock portfolio (14.1% gain) and a reasonable return in the private debt asset class (6.5% gain), while private equity and real estate lost money (-2.3% and -3.1%, respectively) and fixed income just sat there (0.0% return). It should be noted that the private equity, real estate, and private debt return calculations usually lag by a quarter and still could be adjusted.

To quantify what the 5.8% investment return means for your agency, it is important to understand the math of pension plan funding within the CalPERS system.

In order for the pension system to stay on track and avoid significant UAL increases, CalPERS needs to average 6.8% in annual investment returns. This target is called the discount rate, or the minimum average rate of return that CalPERS needs to achieve in perpetuity so that its member agencies could meet their retirement obligations to employees, retirees, and other beneficiaries. Every time that CalPERS misses the return target, additional UAL is created.

A funding shortfall happens and new UAL is created every time the investment return for a fiscal year drops below 6.8%. Thus, the FY2023 funding shortfall was 1.0% (6.8% discount rate minus 5.8% investment loss).

To approximate the FY2023 loss impact on your UAL, you need to multiply the market value of assets within your pension plan by 1%. That will be the approximate UAL amount that will be added to your pension plan for the year. For each $1 million in pension plan assets, roughly $10,000 in new UAL will be added to each agency’s account.

The new UAL will first be reflected in the 2023 actuarial reports, which CalPERS will publish in July/August of 2024.

If CalPERS continues to follow its current amortization practices, the FY2023 UAL will be amortized over a 20-year period starting with FY2026, with a five-year payment ramp-up. The 2026 UAL payment will be 20% of the full payment amount, the 2027 payment will be 40% of the full payment amount, the 2028 payment will be 60% of the full payment amount, and the 2029 payment will be 80% of the full payment amount. Only in 2030 will the payments be fully phased in and continue at that level for 15 more years.

Even though the cash flow impacts of the FY2023 investment return will not be felt for awhile, the total cost impacts have already begun accruing and are adding to the pain from the FY2022 devastating UAL increase. CalPERS starts charging its member agencies interest on the UAL as soon as it is incurred. The interest rate is the same as the discount rate, 6.8%.

On July 1, 2023, the new UAL started working against you. The situation is made worse by the negative amortization practice of CalPERS. Even though the interest starts accruing immediately, no payments are required until FY2026. Each year the accrued interest gets added to the UAL balance, and the following year you will be charged interest on top of that interest as well. Because of the payment delay and the ramp-up, each agency is put into a negative amortization situation that will end up costing additional money for two decades. This makes getting to the fully funded pension plan level that much harder.

The FY2023 performance will result in lower funded status of pension plans, higher UAL balances, and higher future UAL payments, as the effect of the loss will be spread over the next two decades. There should be no change to the Normal Cost contribution rates due to the investment performance.

The impacts of the FY2023 investment performance are illustrated below:

CalPERS FY2023 Investment Return Impacts Summary

Each agency’s response to the UAL increase should be developed and evaluated in the overall context of your specific situation, taking into consideration your reserves, revenues, cash flows, capital improvements program, outstanding debt obligations, etc. The higher future UAL payments need to be reflected in the fees and rates that you are charging.

At the very least, you may want to take the following steps:

  • Make additional discretionary contributions in the amount of 1% of the new UAL in FYs 2023 and 2024 and instruct CalPERS to apply them against the 2023 UAL actuarial base.
  • Ask your CalPERS actuary to put the 2023 UAL actuarial base on a flat – rather than ramp-up – repayment schedule.

Ridgeline Municipal Strategies, LLC can help you evaluate the impacts of the FY2023 investment performance on your pension costs and implement appropriate pension cost optimization and mitigation strategies. You can contact us at 916-250-1590 or