Ridgeline offers a unique and in-depth knowledge of the California Public Employees' Retirement System (CalPERS) pension plan management practices. Our goal is to make the complicated topic of public pensions and unfunded liabilities easy to understand.
Our pension liability optimization process starts with a comprehensive assessment that looks into the agency’s CalPERS obligations. We look at how the CalPERS’ actuarial policies impact pension plan funded levels, unfunded accrued liabilities (UAL), and associated costs. We also cover different strategies available to optimize pension liabilities, beginning the discussion that leads to understanding your specific priorities for pension cost management.
The initial pension liability assessment lays the foundation for putting together and implementing a set of agency-specific pension liability management strategies. These strategies incorporate the review of revenue adequacy, the ability to make targeted additional discretionary contributions, and the implementation of various financing tools, including pension obligation bonds.
We take a holistic approach to designing the pension liability management plan, taking into consideration the overall context of each agency’s financial, operational, and political variables. Prudent reserve policies, workforce management, capital improvements funding, new debt issuance, and refunding of outstanding obligations all have a role to play.
The UAL is your agency’s most expensive and least understood debt, and we can help you address it more efficiently. At the end of our work process, not only will you have identified strategies to address your past issues, but we will also work with you to design a comprehensive pension liability management plan that will allow you to avoid costly mistakes in the future and build up a cushion to navigate future UAL costs.
There really is not a one-time fix for pension liability increases as long as you have employees, retirees, and beneficiaries with pension benefits. Ridgeline is available to provide ongoing support in analyzing the annual actuarial valuation reports sent to you by CalPERS and in implementing pension liability management policies.
Each agency has to pay minimum required contributions to CalPERS. These contributions consist of two components – the Normal Cost and the Unfunded Accrued Liability (UAL) payments:
• The Normal Cost is the annual cost of pension benefits earned by active employees during the fiscal year. The Normal Cost is shared by the agency and its employees and calculated as a percentage of salaries. The Normal Cost payments are made monthly and fluctuate with payroll.
• The UAL Payments are the repayment of previously accrued unfunded pension liabilities (see below), amortized over two to three decades. Each agency has an option to make monthly or annual UAL payments. Making the annual payment prior to July 31 is more beneficial, since it comes with a 3.5% discount comparing to the monthly payments. While the actuarial report shows the UAL payments as a percentage of payroll, it is billed as a fixed dollar amount. Even if an agency no longer has any employees, but has pension plan beneficiaries eligible for benefits, it still has to make the UAL payments.
Your agency is not alone in facing a large and growing pension liability – many other municipalities are facing the same problem. Here are some of the reasons for the UAL increases.
• Inadequate investment performance. Each year that the investment returns fall short of the formula expectations (the discount rate), the UAL grows. However, if investment performance is better than the formula expectations, the UAL is reduced.
• Assumption changes. Actuarial assumption changes by CalPERS have a direct impact on the UAL. Such changes include life expectancy, salary increases, retirement age, etc. It is very unusual to see an assumption change that results in a decrease of the UAL.
• Discount rate reduction. The discount rate is the minimum average rate of investment return that CalPERS must earn in order for the pension plan to be sufficiently funded to meet the future retirement benefits, holding all other assumptions unchanged. When the discount rate is reduced, which has been the trend for the last two decades, it results in future expected investment earnings to be lower, and that shortfall requires for an increase to pension contributions by the agencies and their employees. CalPERS has been gradually decreasing the discount rate from 8.75% in 1995 down to 6.8% in 2021. There are also further automatic discount rate reduction provisions built into CalPERS' policies. Every time the discount rate is reduced, the agencies have to make up the future investment income expectation reduction through higher contributions.
While the Normal Cost can only be managed by your agency’s labor practices, there are multiple strategies to optimize the UAL costs. In our experience, most public agencies can find strategies that improve their pension payments situation – whether through lowering their overall interest costs or through modifying the annual payment requirements (and sometimes both). We have identified ten (10) such strategies. While not all strategies are the right fit for you, some likely are. As a part of our work, we do a comprehensive pension liability assessment to evaluate what strategies represent the best fit for your agency. In addition to addressing your existing UAL and the associated costs, we believe it is important for you to implement policies and practices that will help you minimize future UAL increases.