Pension Cost Optimization Strategies

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.

Pension Liability Assessment

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.

UAL Optimization Strategies

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.

Ongoing Pension Liability Management

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.

CalPERS Unfunded Pension Liabilities: Frequently Asked Questions

Where can I learn more about my agency’s CalPERS’ pension plans?
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The main source of information on the California public agencies’ pension plans are the annual actuarial reports published by CalPERS. These reports are available through the agency’s MyCalPERS portal. The reports are updated once a year, usually around July / August, and incorporate information through the end of the prior fiscal year. In other words, a report published in July of 2021 includes information and valuation data through June 30, 2020. These reports include information on the agency’s past and future pension payments, accrued pension liabilities, market value of assets, and unfunded accrued liabilities and their amortization schedules, etc.
What payments do I have to make to CalPERS?
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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.

What is UAL?
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The Unfunded Accrued Liability (UAL) is the difference between the accrued pension liability (the amount of money that an agency needs to have in its pension plan at a certain date to be able to meet its future pension obligations) and the market value of assets (the amount of money the agency actually has in its pension plan as of that date) within a pension plan. In other words, it is the shortfall between what an agency should have and what it actually has in its pension plan.
How is my UAL calculated?
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The UAL changes every year due to CalPERS’ investment performance, actual pension plan experiences, and any changes to the pension formula assumptions. The UAL consist of multiple layers (called “bases”), each with its own repayment schedule. The bases can be either positive (increasing the UAL balance) or negative (decreasing the UAL balance). Different types of bases have different amortization rules and can require payments for up to 30 years. When a new base is added, it can have a negative amortization period for the first several years, when the required payments are not sufficient to cover the interest cost on the base (see below), which leads to the base balance increasing from year to year.
Why is my UAL so high?
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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 7% in 2019 and is currently looking into lowering it even further. Every time the discount rate is reduced, the agencies have to make up the future investment income expectation reduction through higher contributions.

Does it cost my agency anything to have an outstanding UAL?
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The UAL resembles any other debt obligation. CalPERS requires its member agencies to pay interest on the outstanding UAL balance at the discount rate, which is currently 7%. When new bases are added to the UAL, the interest payments required on the added UAL balance exceed the amount of the UAL increase itself. At 7% interest rate, the UAL is usually an agency’s most expensive debt.
Will my pension costs go up?
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Most agencies see their pension costs increasing every year, particularly the UAL payments component. A typical CalPERS member agency saw its Classic plan UAL payments increase approximately 1.5x (150%) to 2.0x (200%) from 2017 to 2021 fiscal year. As of the 2019 valuation report date, the UAL payments were typically scheduled to continue to increase through 2032 and are estimated to more than double from the 2021 level. In other words, for every $100,000 in UAL payments in 2017, a typical agency paid approximately $150,000 to $200,000 in 2021, and will be paying approximately $400,000 in 2032, a four-fold increase. However, each agency’s situation is slightly different and needs to be carefully analyzed. These increasing payments include not just the repayment of the UAL, but also the interest costs, which are often very close to the amount of the UAL itself.
What can I do to manage my agency’s future pension costs and how can Ridgeline Municipal Strategies help me?
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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.

The pension topic can be complicated and intimidating to discuss. As common in the world of finance, things that we do not have a good grasp on usually end up costing us more than necessary. The goal of Ridgeline’s Pension Cost Optimization program is to make pensions simpler to understand and to find ways to make them less costly.
Step 1
Initial Pension Liability Assessment
Step 1
Debt Needs Assessment and Financing Program Development
Step 1
Debt Needs Assessment and Financing Program Development
Step 2
Overview of Pension Optimization Options
Step 3
Selection of Appropriate PensionLiability Management Strategies
Step 1
Debt Needs Assessment and Financing Program Development
Step 1
Debt Needs Assessment and Financing Program Development
Step 4
Development of Comprehensive Pension Liability Management Plan
Step 5
Implementation of Selected PensionLiability Management Strategies
Step 1
Debt Needs Assessment and Financing Program Development
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Debt Needs Assessment and Financing Program Development
Step 6
Ongoing Monitoring ofPension Liabilities