CalPERS is about to implement a new investment policy that will reduce risks and future profitability. But the giant pension fund is being urged by Gov. Jerry Brown’s administration, and some of CalPERS’ own board members, to dial back those risks more quickly.
A schism over the CalPERS plan arose at a meeting Tuesday of the fund’s finance and administration committee. Committee member Bill Slaton, a Brown appointee, urged CalPERS to move more aggressively to reduce the fund’s “discount rate,” a target for investment profits. Other committee members, however, said they prefer the more gradual proposal that’s on the table.
Both sides agree that CalPERS should reduce the discount rate at a time of increasing market volatility. Other public pension funds have been lowering their discount rates in recent years in an effort to cushion themselves against wild swings in the market, and CalPERS argues that its plan will improve its long-term stability.
Hundreds of millions of taxpayer dollars are at stake as CalPERS deliberates its new investment strategy. A lower discount rate translates into a more conservative portfolio. That in turn will require the state and municipal agencies, which are already facing hefty contribution increases, to pump even more money into the California Public Employees’ Retirement System.
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CalPERS’ discount rate is currently 7.5 percent. The fund earned just 2.4 percent in its latest fiscal year, well below the target, although CalPERS said its annual average return has been 11 percent over the past five years.
The risk-reduction mechanism, unveiled a week ago, is unusual if not unique. It would have the pension fund cut the rate every time its most recent annual returns exceed the discount rate by at least 4 percentage points. Under this plan, the discount rate is expected to drop to 6.5 percent in around 25 to 30 years.
Slaton and others, along with a representative of Brown’s Department of Finance, said CalPERS should lower the discount rate more quickly. Slaton said the cuts in the discount rate should begin when annual returns exceed the current rate by 2 percentage points, not 4 points.
The more gradual approach means “we’re putting off the day of reckoning,” said committee member Richard Gillihan, representing the state Department of Human Resources.
Eric Stern, an analyst with the Department of Finance, told the committee that CalPERS should simply approve a plan to reduce the discount rate to 6.5 percent in five years.
The CalPERS staff, however, cautioned against moving too quickly. A strong year of investment returns generally translates into pension-contribution rate relief for state and local agencies. By ratcheting down the discount rate when returns exceed the rate by just 2 points, CalPERS would cancel out the benefits to those agencies, said chief actuary Alan Milligan.
The discount rate is also a sensitive political issue for CalPERS. Moving quickly to lower the fund’s expected returns would mean imposing higher contributions on member agencies, creating political problems for public pensions at a time when some advocates are pushing for dramatic reforms in how much government retirees make. The faster the contributions go up, the more the political pressure builds for change in the pension system. Several members of the CalPERS board, which tends to tilt toward labor interests, said the go-slow approach is better.
“It’s important that we don’t hurt taxpayers or the municipalities,” said board member Theresa Taylor, who represents current state employees. CalPERS has already imposed pension contribution hikes on municipalities and the state amounting to hundreds of millions of dollars a year, in order to recover from the horrific losses of 2008 and to reflect longer life spans among retirees. CalPERS is 75 percent funded, meaning it has 75 cents for every dollar of long-term obligations.
Richard Costigan, chairman of the finance and administration committee, said the panel will consider both the original proposal and Slaton’s alternative. A vote is expected next month but could get put off until December.