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A Guide to CalPERS Amortization Policy

A Guide to CalPERS Amortization Policy


>>David Teykaerts:
And thank you, all, for joining us this morning to discuss this important topic regarding
proposed changes to CalPERS amortization policy. Including our valued stakeholders in this
process is an essential part of our Board’s decisionmaking process as they consider the
best action to take to ensure the longterm sustainability of the fund while also balancing
the cost impacts to employers and ultimately to members. I’m David Teykaerts, Stakeholder
Strategy manager here at CalPERS in Sacramento, and I’m joined today by two of our senior
pension actuaries, Julian Robinson and Kurt Schneider, and our Deputy Chief Actuary Randy
Dziubeck. You can see our lovely pictures there. Little known fact, actuaries are legally required
to wear ties and I am not. Even though there is a oneway call this morning, the actuaries
are literally wearing ties in the room and I’m not. So you can trust my word on that. A few housekeeping notes before we dive into
the material. This is a oneway call. You’ll be able to hear us but we won’t be able to
take live verbal calls or questions or comments from you. However, questions can be answered
into the chat box function. So we have folks here in the room that will be fielding those
questions and then at the end of the call we will be able to crowdsource up the most
common questions and have our actuaries address those. So please don’t hesitate to send us
a question at any time during the presentation. The slides that we will go through today are
available to download as a PDF file. You should see a link to that on your screen right now.
And those are also available for us to share with you after the webinar if you’re interested. The entire webinar is being recorded and we’ll
have that edited and available to all of you within a couple of days and it will also be
on our website. So if any of your colleagues were unable to join us this morning live we’ll
be able to get them that information. Lastly, on the right side of your screen you
will be seeing a link to a survey. We just ask that you wait until the end of the webinar
to take that survey so that you have a chance to see and hear all the information that we
want to share as we walk you through some examples and scenarios so you can make a totally
informed decision. So more information on that survey as we reach the end of the presentation. Alright, enough housekeeping, so let’s ahead
and get into the material. So here’s an outline of what we’ll be discussing today. We’re going
to lay out the current state of funding levels and liabilities in the system we’ll define
amortization, discuss how it plays into pension funding and costs and lay out our current
policy, and then dive into what the changes our actuarial team is bringing forward would
really look like. We’ll provide our rationale for the change and then take a look at some
investment return scenarios and how those possibly impact plans and employer contributions.
And then lastly, we’ll layout the next steps in the process, take some questions and then,
again, ask for your feedback via that survey link that I mentioned earlier. So let’s begin real quick by level-setting
a bit and let’s establish sort of a shared understanding of the funding realities that
all of us as stakeholders in the system are facing right now. So our fund is 68 percent funded right now.
That’s what you’re seeing on the left there in blue. The PERF, the Public Employees Retirement
Fund, that’s the pool of the combined assets of the 3,000-plus employers in the system,
that’s the pool of funds that’s used to pay off pension benefits to members, beneficiaries
and survivors. So right now, the fund is hovering at about $350 billion, give or take a few
billion. It fluctuates every day with market performance. But even with that huge number
with about 1.9 million members of the system, we only have 68 percent of the assets needed
to cover those longterm liabilities, which are those pension benefits promised to our
members, to you, and to your employees. The shaded parts of the circle that you were
seeing there represent that percentage of unfunded ratio. So you can see they are slightly
different between the three sectors that we provide there. You see the public agencies
at 66.2. That’s our cities, counties, special districts, and then school employers are carved
out there at 67.8. We were pleased to see that this last fiscal
year we did return 11.2 percent, which was above our expected rate of return. So that’s
good, and we’ve captured a lot of value from this current bull market that we’re in so
we’re on track for another strong performance. But it is vital that we build our fund back
up so that we do not fall below that 50 percent funding level threshold. That’s a level from
which it would be very difficult to recover for the fund. So in order to sustain the system,
we need to pay that accrued liability down and, again, that’s that shaded like dashed
area of these circles here. So how did we get to this situation? A lot
of you are quite aware of this as CalPERS has done a lot of engagement with our employer
communities over the last few years, but essentially as with any complex scenario there’s not a
single root cause. There are many different contributing factors that have led to the
current funding status: fluctuations in investments, demographic experience, meaning hiring, retirement
rates, things like expectancy changes. Although I do have some good news on that one, folks.
Our most recent study shows that people are no longer living any longer than they were
before. And in fact, men’s life expectancy is predicted to go down a bit. So we’ve got
that good news to look forward to. Economic outcomes. We’re talking about macro factors
such as inflation, which then trickles down to us in the form of changes in salaries and
COLAs. The plans themselves contribute to the funded status and many employers still
feel the impacts of actions and decisions from years or even decades ago rippling across
their valuation reports. And lastly, the funding policy set by the CalPERS Board do have a
major impact as well. Things like smoothing and the amortization policy, the very purpose
of our webinar today, all contributing. So far we’ve been talking very big picture
here. So the funded status of the combined PERF trust, the macro factors contributing
to the unfunded liability, the thousands of public agencies and schools combined, just
huge numbers based on mega trends over many, many decades. So what we want to do now is
kind of narrow our focus to tee up the conversation from our actuaries in a moment and let’s talk
about how this plays out for individual employers. Here’s an extremely simple diagram that shows
the two component parts of each employer’s contribution towards their members pensions.
On the left on top we have the normal cost which is essentially just a cost for pension
debt that was accumulated that year by the current workforce, which should be enough
to pay for those folks’ pensions. And on the right we have the UAL, the unfunded accrued
liability. Now, generally speaking, the normal cost is not the problem. Not to minimize it,
it’s real money, it’s definitely a big budget line item, but for most employers this is
a manageable cost. I think I can fairly say that for most finance directors it would be
a dream come true if the normal cost was the only thing that they were dealing with when
it comes to paying pension debt. It’s really the piece on the right, the top right, that’s
the main concern, that UAL. The UAL is essentially the accumulated pension debt that wasn’t covered
by contributions in the past. So it continues to roll forward yearafteryear and accumulate
and increase. Let me show you exactly what we’re talking about in plain black and white. So here is a page that I ripped from the most
current Actuarial Valuation Report from a real California city in the CalPERS system.
This is real data. All cities and counties and special districts get a valuation just
like this for their miscellaneous and if they have one for safety plans, so this probably
looks familiar to the finance folks here. Now, in this particular plan, this is a safety
plan, and we see that the normal cost is projected to go up. That’s an increase but that’s probably
manageable at least. Now, called out in the dark blue is the real issue at hand. This
is the payment that’s due for that unfunded accrued liability, the UAL. You see that that
payment there is slated to go from 15 million up to 30 million in six years. Payment today
15, in six years it will be 30. That is significant, to put it mildly. I probably don’t have to
say too much about the details. Obviously that’s a sobering and a huge challenging a
huge challenge for most employers to deal with in terms of budget projections. For the schools folks, I haven’t forgotten
you either. Now, because schools are all in one pool together we don’t break it out and
bill you for dollars for your UAL so it’s not as clearly laid out in your vals, but
it’s shown as a percentage of payroll. Here’s the valuation for the schools pool where we
can see the overall contribution goes from 17.7 to 25.1. That’s a 35 percent increase
end-over-end. Just like with public agencies, the lion’s share of that is really attributable
to that bugaboo, the UAL. So just as we saw that there’s no one single
cause for the unfunded liability that we’re facing, there’s really no one single swift
stroke that will rectify or remedy the UAL situation either. Instead, it’s going to need
to be a lot of small, but intentional adjustments and actions from many different stakeholders
and participants in the system over a long period of time. So, what we’re discussing here today, this
amortization policy, is one such adjustment. Your actuarial team believes that this course
of action will be the best way to position the fund and you, our employer partners, to
halt the ongoing growth of the UAL and ultimately to start to reverse that tide. It is just
one piece but it’s going to be an important piece. So with that, let me turn it over to our Senior
Pension Actuary, Julian Robinson.>>Julian Robinson:
Good morning. This is Julian Robinson from CalPERS Actuarial Office. David’s just established
that there’s an unfunded accrued liability and we don’t require you to pay that amount
all at once. We, in fact, amortize this over future years. What is amortization? Amortization is the
systematic paydown of debt. To talk about an example, which everybody is very familiar
with, let’s consider a mortgage. A mortgage is a loan which is paid down over a period
of time, typically 15 years or 30 years. The bank or the financial institution sets an
interest rate which is fixed or variable, and in most cases level payments are made
over the period of the loan. Let’s consider example number one, a one milliondollar
mortgage. We’re using a 7 percent interest rate because that matches the discount rate
we use in our fund. And we compare a 15-year amortization to a 30-year amortization. On
the right side of the screen you can see the annual payments in the blue line, about $106,000
per year, represent the amount that is paid for a 15-year amortization. The orange line
shows annual payments of about $78,000 per year. Interestingly to note, over the entire
period of paying down this million dollars for a milliondollar mortgage, over 15 years,
only $1.6 million is paid in total compared to the amortization over a 30-year period
where over $2.3 million is paid. So there is significant extra interest paid as you
extend the period of the amortization. On the lefthand side of the slide, we show
how the balance of the mortgage decreases over time. Of course, it starts at $1 million
and ends at zero and you can clearly see that the blue, the 15-year amortization, gets to
zero much more quickly than the 30-year amortization. Let’s consider a second example. We have our
milliondollar original mortgage and then some years later we add a second mortgage of $200,000.
Here, the on the righthand side of the screen you can see the $78,000 approximately which
pays down the first mortgage and now have an additional approximately 15-and-a-half
thousand dollars paid on the second mortgage. And this paydown of the second mortgage in
example 2a is over a 30-year period. In example 2b, we have a very similar situation.
The only difference here is that the second mortgage is now paid down over a 20-year amortization
period rather than a 30-year amortization period. To summarize these two scenarios,
in the 30year paydown of the second mortgage our total annual payment is approximately
$93,500. In the second example where we amortized over 20 years, the annual payment kicks up
to $96,000, approximately 2.85 let’s call it 3 percent larger. The reason why we’re giving this second example
of a mortgage is to tie it to the amortization policy changes which we are proposing. The
nature of the changes we are proposing and the Board will consider is that any changes
to the policy will be on a prospective basis only. The original milliondollar mortgage,
if you like, is comparable to your current unfunded accrued liability and the amortization
of that. There is no intention to change how the existing amortization bases are handled.
The discussion here today is only focusing on how we’re going to handle future pieces
of the unfunded accrued liability as they emerge over time. And here, the effect in
this kind of simplified example, is this 3percent difference that we’re discussing. The effect
of changing from a 30-year amortization down to a 20-year amortization in this particular
scenario has approximately a 3 percent increase in the cost. Also interestingly to note, on
the far right column, the total payment, there is significant savings of $100,000 if we shorten
the amortization of the second mortgage paydown. We know that mortgages and amortization of
pension liabilities are different. As mentioned before, each year that we have our we perform
our actual valuations, new pieces of gains and losses emerge. And each gain or loss has
an impact on the unfunded accrued liability. So as you see on the table on this page, and
this is observed out of one of our actuarial reports and should be familiar to everybody,
is essentially all the different components of the unfunded accrued liability and it shows
how they’re paid off over time. Each year, bases are added and each year bases drop off
and that’s the nature of the unfunded accrued liability and how it gets amortized. Let’s step back and ask ourselves a bigger
question. What is the purpose of an amortization policy? There’s basically three main aims
every year we want to achieve where we have an amortization policy. First of all, benefit
security. Our aim is to have the funds reach a funding ratio of 100 percent and that’s
the target we are aiming for. And when the fund is at 100 percent we feel that that’s
the most secure position for all the benefits to be paid and the beneficiaries to expect
to receive their benefits. A second aim of an amortization policy is to maintain intergenerational
equity. What I mean by that is ideally, as benefits accrue during the working lifetime
of an employee, the contributions should be paid to match that. Unfortunately, if amortization
periods are too long, payments get pushed out and the next generation is left paying
off debts from previous generations. So one of the significant aims of an amortization
policy is to have the benefits paid over the working lifetime of the people earning the
benefits. And the third aim of an amortization policy is to maintain some kind of stability
in the contribution rates. Nobody likes very volatile rates from yeartoyear. We know as
finance directors, it’s difficult to budget if there’s significant changes in these
things. So one of the aims of an amortization policy is to maintain or achieve stability
to the extent possible. CalPERS current policy. Let’s do a quick review
of where we are right at the moment. On the slide before, you can see across the top of
the table the various sources of where the unfunded liability emerges. There’s gains
and losses from investments and there’s noninvestment gains and losses. The noninvestment
gain and losses refer to the impact of changes in mortality, salary increases, retirement
ages, disability and things like that. We also make assumption changes from time to
time. As you know, we conduct experience studies every four years, we review our actuarial
assumptions to make sure they are our best estimate of what we expect, and we keep reviewing
these on a regular basis. When benefit changes happen, they also, especially if they are
retroactive, that generates additional liabilities which need to be amortized. And of course,
if there’s a golden handshake offered, that generates additional liability, too. Down the lefthand side are the variables which
impact amortization. The first is amortization period is very relevant. For gains and losses
it’s 30 years. For assumption changes and benefit changes its 20 years, and golden handshakes
five years. The discussion, which we are having today,
is mostly focused on this amortization period and the desirability of possibly reducing
this period from 30 years to 20 years or something along those lines. The other two
factors which also impact the amortization are the escalation rate and they ramping up
and ramping down. Let’s go a little bit into each of these factors.
This slide in front of you shows the difference between amortizing over a 20-year period or
a 30-year period. In these scenarios, as you can see on the righthand side of the graph,
the annual payments are increasing — are escalating. The 30year is showing in orange
and the 20-year in blue. On the lefthand side of the screen you can see the balance paydown
over the amortization period. If you look carefully, the orange graph the orange line
actually increases above a million dollars and only starts ticking down beyond 15 years
or so. What this is essentially saying is that using this 30year period we’re not
even paying sufficient interest to start paying down the principal of the million dollars,
and that’s why we have this effect of negative amortization where the outstanding balance
actually increases for a number of years. This is a significant issue. With the 20-year
amortization in this scenario, there’s no negative amortization. And, as you can see
in the graph on the left, and the blue line is moving down throughout the period. A quick discussion on the effect of the escalation
rate. So here in this graph we compare escalating amortization compared to a level dollar amortization.
Again, the orange line here on the righthand side of the graph shows how the annual payments
are escalating at 3 percent per year. On the blue line on the other hand, shows a level
dollar paydown of the same million dollar loss. Again, if you look at the lefthand side
of the screen, there is significant negative amortization when we have the escalation.
However, when the escalation is removed and we go down to a level dollar, that negative
amortization is essentially removed. So there is a desirability to perhaps eliminate the
annual escalation rate from our amortization policy. And the last part one of the last drivers
is ramping. We introduced ramping because various gains and losses, especially the asset
gains and losses, tend to be very volatile from yeartoyear. And in the past we used to
smooth these volatile gains and losses in the assets by using an actuarial value of
assets. Nowadays, we don’t use an actual value of assets; we instead directly smooth the
rates by using a ramp up and a ramp down. And you can see the patterns here on the right
hand side of the screen. The orange is the fiveyear ramp up and it takes, as you would
expect, longer to reach the relatively straight period. And because of the delay in reaching
the top of the ramp that causes the ultimate amounts to be higher than the other ramp ups
or no ramp as shown on that graph. On the lefthand side of the screen, you can see how
the paydowns work. Essentially in each of these scenarios there is negative amortization.
But, as you can see, the orange line, there is more negative amortization when you’re
using the fiveyear ramp because the delay in getting up to paying off the principal
is delayed a number of years. I’m now going to turn over this discussion
to my colleague, Kurt Schneider.>>Kurt Schneider:
Good morning. Kurt Schneider, Actuarial Office. When the current policy was implemented in
2013 it was an improvement over the prior policy. Now, we continually review and finetune
our policies to ensure we’re meeting our goals to sustain the fund. Given the current funding reality, our policies
may not adequately address our future goals. Unfunded ratios currently are at a point where
we’re already hearing employers say some of that may have difficulty meeting their
obligations. A significant market downturn in the future will drop the funded ratio and
with the current amortization policy the funded ratio could continue to decline for several
years following a loss. The UAL could become so large the employer will have extreme difficulty
paying it. If a plan sponsor can’t make the required contributions the benefits are at
risk. That’s the reality of CalPERS. And even if the plan sponsor can make the minimum payment,
they’ll be paying down the UAL so many years in the future there will be future taxpayers
paying for services they did not receive. And let’s be honest, it’s not always just
the future taxpayer that bears the burden. If the employer’s budgets are stressed,
they don’t have money for salaries to keep up with inflation, they don’t have money to
fill vacancies, it’s future public sector employees who also bear the burden. Now, the actuarial profession has developed
solutions for these problems but CalPERS is lagging a little behind other California public
retirement systems in implementing these changes. Now, the benefit security issue, the issue
is driven really by the negative amortization and we can actually see this playing out currently
if you look at many of the CalPERS actuarial valuations. For many of you, if you look at
your amortization schedule it will look similar to this one and you will see the UAL projected
over the next few years to increase. And these amortization schedules don’t have any future
losses or future assumptions builtin. This is just how the current bases are being amortized.
The payments are not enough to cover the interest and the UAL is projected to grow. Now with the current policies, this is intended
to correct itself in the future as these payments escalate high enough, but with another future
loss you can actually see this negative amortization continue for many years, perhaps indefinitely.
And we are now projected to achieve full funding during the working life of the active members.
With negative amortization and extremely long amortization periods, the UAL is pushed forward
for future generations to deal with. Now we do have solutions, as I said. The California
Actuarial Advisory Panel and the Conference of Consulting Actuaries recommend the gains
and losses be amortized over a period of 1520 years. The reasoning behind this is that if
you try and do it in less than 15 years you wind up with very large payments initially.
But if you go any longer than 20 years you have issues with negative amortization and
intergenerational equity. Here you see some of the large public sector
plans in California and the policies they’ve adopted. You can see that CalPERS is not the
only one that still uses 30year amortization of gains and losses, but by and large they’ve
shortened that period to between 15-20 years. You see that fiveyear asset smoothing is very
common. CalPERS does not use asset smoothing. We use the fiveyear ramp for investment gains
and losses and we recommend continuing that practice. And that has that same effect on
contribution rates to smooth the contribution rates from the effect of year-to-year volatility
in investment returns. Now, given the current funding realities,
and the professional opinions of both the actuarial staff and the actuarial community
as a whole, there are some ways the current policy can be improved. Now, what we’re saying is the thirtyyear
amortization of gains and losses is pretty long. We recommend shortening that amount.
And we’re considering it going to level dollar payments. We believe the escalation
rate in the payments — built into the payments from the beginning wind up being a very big
burden later on just to maintain the existing bases and not leave room in anyone’s budget
to handle any new bases that show up. We�re talking about changing the ramp up in the
amortization schedule. We believe it’s appropriate for investment gains and losses but don’t
see a need for it in any other bases. And eliminating the ramp down doesn’t serve any
function as far as asset smoothing. And most importantly, as Julian mentioned, we’re
proposing changes to be applied prospectively to future bases. We’re not proposing there
any changes in the way you amortize the current UAL. Now, what effect is this going to have? By
shortening the amortization bases, it means faster amortization losses, but also faster
amortization of gains. So we say this means it’s expected to increase the contribution
volatility. So whenever there is a gain or loss that very first payment is going to be
larger with a shorter amortization period. But it works both ways. Remember, a loss means
will increase it a little bit more and amortize the loss faster but a gain means we’ll decrease
the contribution faster and amortize the gain faster. So the total payments over the amortization
period would be less. There’s less interest. And this will improve intergenerational equity.
Obviously if you shorten it enough you can assure you are paying for at least the bulk
of the UAL over the average working life of your current employees. And fund sustainability is improved. We’d
be reducing the probability that the fund would drop below 50 percent and this is
tied to the increased contribution volatility, bigger fluctuations. You can think of this
as a shift, trying to cross a street and get to an island. And an investment loss pushes
the ship off course and we need to correct course and steer back. So what we’re saying
is at this point we’re in a situation where we want to be able to steer back a little
bit quicker, that’s all. And that will increase the chance that we hit our target. We’re proposing going to a level dollar
amortization. And we think this is important because of the burden presented by building
in these exponentially increasing costs into every single amortization base. And it does
the same thing. It means a little bit higher cost upfront when you first establish a base.
If it’s a gain, it means a little quicker drop in the contribution rate, so more fluctuation
from yeartoyear but the total payments would be reduced over the period. And this improves
intergenerational equity again because for the same reason. We’re just simply adjusting
quicker to the reality. Now, we keep saying this increases contribution volatility, but
remember we are proposing any funding policies that are any more aggressive than what’s been
adopted and in practice in California for several years now. And we’re proposing changes
to the ramp. So the ramp up is appropriate we believe for asset gains and losses. It
replaces having asset smoothing. Now, for asset smoothing, the reason we believe
it’s appropriate for asset smoothing is that the asset returns fluctuate quite a bit from
yeartoyear. You can have a large loss one or even two years but you would expect for
a market recovery to pay for part of that loss. You don’t need to immediately start
funding it. And the same thing when you have large gains, you don’t want to drop the contribution
rate too quickly because there could be some market correction or some slowdown in the
economy that will take away some of those gains. But for things like assumption changes,
if an assumption change increases the UAL we do not expect the next year to have another
assumption change that then decreases it. Right? The assumption change is going to have
to be paid for. The sooner you pay for it, the less it’s going to cost. Other than
that, this has the same effect as the other ones. We’re going to improve the fund sustainability
and correct course a little bit quicker by not having those ramps when we don’t need
them. So how exactly in terms of numbers is this
change going to affect you? The alternatives that we suggest are going to help ensure that
we meet our goals and protect the fund. It’s going to improve benefit security by limiting
negative amortization and paying down the UAL faster and protecting the funded ratio
and it’s going to protect intergenerational equity by not passing on the debt to future
generations. And as I mentioned, we also maintain adequate contribution stability and we are
not proposing anything that other systems aren’t already doing. So what we did to try and show you the impact
of this is we took a typical public agency plan, we looked at their valuation, we looked
at their amortization schedule, and we said what’s going to happen in the future. So in
this first one we assumed — in that blue box up there you can see that we assumed over
these three years returns of 7.25, seven, seven. That’s exactly equal to the assumed
rate of return. And in all future years we’re also assuming that the fund earns 7 percent,
the assumed rate of return. So we’re going to put these new policies
in place. So for these projections we assume that these go in place in 2019. And what we
have here, the dotted black line is the projection comes from the projection that this employer
has already seen. This is the projection that was in the 2016 actuarial evaluation. Then
what we did was we said well, those were we done in the spring of 2017 and in the year
2016’17 the fund earned 11.2 percent. It was a gain. They’re better off than they
were in the projections. So then we plotted the green line and took into account that
gain and amortized that gain. And then said what happens if we change our policy in 2019.
Well, in this scenario where we’re earning the assumed rate of return nothing happens.
There’s no new bases to amortize and the new policy has no effect. Remember the new policy
wouldn’t affect any existing bases. In order to see the impact of this policy, we’re
going to have to assume some future gains and losses so we have something to amortize
over this new policy. Now, everybody is worried about what happens
if we have losses. What’s that going to do to us? So we took and we put in a pretty bad
scenario. We have 3 percent returns for these three-year periods. So 3 percent doesn’t
sound too terrible for one year. That’s happened before. But a 3 percent average over three
years is actually pretty bad. And furthermore, after this we’re assuming a 7 percent
return so usually when you have a market downturn you eventually have a recovery that gets you
some of it back but we didn’t want to do that. We want to really show a very bad scenario
so we can distinguish between these different policies. And you can see the green line now
is above the old projection in order to amortize these losses. And we said okay, let’s take
a new policy. Let’s say these last two losses are amortized using 25-year level dollar amortization.
The orange line is a little higher than the green line. And if we said what if we go even
shorter. Let’s go 20 years, we get the blue line. That’s slightly higher than the orange
line. And when you try to do 15-year level dollar, now you get another jump up. Now, these lines kind of blur together. In
order to see what’s going on here and really analyze it, we’re going to zoom in a little
bit to scale, set the scale from 35 to 45 percent, and you can see the green line is just above
40, the 25-year level dollar bumps it up another percent. I’m looking at the year 2024, that
peak in the contribution rate that everybody would be looking at. It is 1 percent higher
with 25-year level dollar, a little higher with 20-year level dollar, and then another
percent higher at the 15-year level dollar. That’s the difference. Now, remember this
increase for the green line goes on for 30 years whereas for the other lines it doesn’t
go on that long, but we are only showing you the next 10 years because that’s all anyone
cares about. So this is what we’re talking about when
we say it increases the contribution volatility. In order to correct course and fund these
losses, we need a bigger increase in this very bad scenario. But remember, it works
both ways. You don’t always have very bad scenarios. Sometimes, just as often, we would
expect to have a very good scenario. So we did just the same in the other direction.
Let’s say these three years are 11, 11, 11, about 4 percent above the assumed rate
of return instead of 4 percent below. And then there is no return or recession following
to bring our lines all back together again. Let’s spread them out and see what happens.
And the green line, the current policy, the contribution rate would go down because you
have those gains funding the plan. So if you did it at 25-year level dollars it would go
down even more. Right? We’re making a bigger correction, in this case downward in contributions.
Twenty, slightly different. Fairly hard to tell between 25 and 20. And then 15-year you
get a little bump down again. And again, we need to zoom in in order to see what’s going
on here. When we set the scale from 25 to 35 percent and you see the same thing in
the opposite direction. Let’s look again at 2024 because that’s what we’re looking at
before. That’s when we’re near the top of these ramps for all these losses. You’re
at 31 percent under the current policy, 1 percent lower for a 25-year level dollar,
and a half a percent for a 20-year level dollar and another half a percent for 15-year level
dollar, 2.5 percent between them, and that’s the same thing in the opposite direction. So just to review, let’s throw all these graphs,
all these scenarios on the same graph to see what we’re talking about. So remember, those
lines that are bunched up at the top, that’s what you get with a bad scenario, very bad
scenario with different policies, those lines bunched up at the bottom, that’s what you
get if you get a very good scenario and no correction. And that green line in the middle
is where you would be with the assumed rate of return, it’s also about where you would
be if future gains and losses cancelled themselves out, which they don’t in the examples we
showed. And what this graph is designed to show you is that it is the investment return
has the largest change in the contribution requirements. Okay, if returns are worse than
expected, contributions are going to go up. If returns are better than expected, they
can go down. That was true yesterday, that’s still true today. These changes in the policy
is a much smaller impact on the contribution rate and it’s more of a fine tuning to make
sure we get steered on course a little bit better than before. Now, the alternatives we suggest help ensure
that we meet our goals and we’ll continue to meet our goals far into the future to protect
the fund. Benefit security will be improved if we eliminate negative amortization and
pay down the UAL faster. And intergenerational equity will be improved because we will not
pass on so much debt to future generations and contribution stability will be maintained.
We’re not proposing anything that other systems aren’t already doing. Now with that, I’m going to turn it back to
David to close this out.>>David Teykaerts:
Thank you very much, Kurt. Appreciate that. And thank you to Julian also for your insights
into this proposed policy. So what you’ve heard here today, we’re proposing to make
changes that could address negative amortization; it will positively address the UAL, enhance
benefit security, and address intergenerational equity. And this is all really being put forward
on a perspective, that is a going-forward basis. So please keep that in mind. I have just a few brief comments about the
next steps in the process and then we’ll take some of your questions. So at the end of the webinar we hope you’ll
take just a few minutes and fill out that survey. The link is right there on the right
side of your webinar screen. If for any reasons there’s issues clicking through that please
go ahead and send us an email. I’ll pull that up on the screen shortly. If you’re
watching this as a recording and you don’t see a link, again, just reach out to CalPERS
and we can get that to you. Please complete the survey by January 24th and we will be
able to analyze those results and get those to our Board for consideration as they take
a look at this policy again in February. The scheduled date for that is February 13th
here in Sacramento at our Finance and Admin Committee meeting. We’d love to hear from
you in public comments on that as well. Okay, so now let me turn to our Deputy Chief
Actuary Randy Dziubeck, who’s been faithfully manning the laptop in the room and has been
taking some of your questions and he’ll pull out a few of those and we will go through
some answers for you. Randy.>>Randy Dziubeck:
Thanks, David. And thanks to Julian and Kurt for a great presentation. I have been monitoring
the questions and we have several good questions that I’m going to turn over to our speakers.
If you haven’t submitted a question, please feel free to do so. First question: Can you explain why employers
pay interest on their own UAL?>>Julian Robinson:
Yes, the answer is like any other debt, perhaps going back to our mortgage example, interest
is paid. And also the amount that’s underfunded needs to be — interest has to be earned on
that to replace the lost interest that we would have expected had those assets been
there in the trust earning its own investment earnings.>>Randy Dziubeck:
Okay. What else do we have… let’s say that an agency has sufficient funds and can make
a contribution to PERS to cover 100�percent of its UAL today. Would you recommend they
do so? Is there some optimum/prudent funding level other than 100 percent?>>Kurt Schneider:
Hi, this is Kurt Schneider. It all depends on the financial resources of that agency
and where that extra money is coming from. We have seen some agencies fund the plan completely
by taking on other debt, which is really taking money out of one pocket and putting it in
another and not really paying down their debt. If they actually have reserves that are set
aside for future needs and they want to put that in the fund, that could be a very good
thing to do. Remember, once you put the money in the fund it’s invested in the equities
market and other financial instruments and is at risk so you accept more investment risk
by doing that. That’s up to the agency.>>Julian Robinson:
Yeah, and if I could add something to that, Kurt, too, whenever I discuss this with my
agencies I always cautioned them that once the plan becomes 100 percent funded, back
in the good ol’ days there were things such as a contribution holiday. PEPRA law changed
that and under the law at the moment, an agency always has to make its normal cost contribution.
So therefore, if an agency puts itself into a situation where they’re more than 100 percent
funded, they’re not really going to benefit from being more than 100 percent funded.
So I always caution them to aim for perhaps somewhere in the range of 95 percent or
so to be a very safe place to be and not lose out on the situation where you’re going
over being over 100 percent funded and not being able to benefit from that surplus.>>Randy Dziubeck:
Those are great answers. I’ll just add because I hear this a lot, and you as listeners may
read or hear this that 80 percent is a fine funded ratio for a retirement system. And
sometimes it’s discussed as if that is a great target. So once you hit the 80 you are all
set, don’t worry. We don’t believe that to be the case. We think we should all be targeting
100 percent. How we get there is something we all work on. But if you read something
that says 80 percent is a great funded status and you’re all set at that point, I would
say we don’t believe that to be the case. Okay, let’s see what else we have. We have
a lot of great questions. Okay, the inevitable recession will likely result in layoffs and
a lower payroll overall. Won’t that compound the effect of level payments and faster amortization?
This could negate the local impact of layoffs and perhaps increase layoffs to achieve desired
savings. This would likely happen at the same time that pension fund earnings will reduce.
How do we address this? That is a tough question. [Chuckling]>>Kurt Schneider:
That’s a problem with many different solutions are going to help solve that problem. But
remember one of the things that we would like to do is go to level dollar amortization.
And one of the reasons we’re doing that is because the current escalation rate, the
level percent of pay escalation rate makes that problem you describe even worse because
the amortization payments even with no losses built into them have these increases that
are supposed to remain level as long as your payroll increases at that same rate. But if
your payroll doesn’t increase or your payroll drops you have a huge increase in the contribution
rate and level dollar amortization payments are one way to help that situation.>>Randy Dziubeck:
So I think to clarify what I think Kurt is saying is we want to make sure there’s no
misunderstanding that if your payroll goes down your UAL payment goes down. That is not
the case. We set the payment as a dollar amount whether your payroll goes up or down is irrelevant
to what the UAL payments are. So we just want to make sure that’s clear. Okay, here is a question regarding schools.
Are school districts required to pay down the unfunded liability? If so, how do we set
that up?>>Julian Robinson:
The school pool determines a total contribution rate for all the participants in the pool.
There is no option for school employer at this point to make any additional contributions
to pay off a portion of the unfunded accrued liability. On the other hand, many public
agencies bear independent and have their own individual unfunded accrued liability maintained
and many of our agencies in fact, do make additional voluntary contributions. At this
point, all school employers pay the same rate towards the normal cost and the amortization
of the unfunded accrued liability.>>Randy Dziubeck:
Great, Julian. Thanks. Okay, next question: These proposed changes
are on top of the discount rate change. Are there also other discount rate changes being
considered? What does the total impact of that look like for all of these changes?>>Kurt Schneider:
Well, at the December Board meeting, the Board finalized its decision for the discount rate
and we expect that decision to hold until — that was the end of our four-year ALM cycle
where all the asset classes were reviewed and the asset allocation was reviewed. The
Board decided on an asset allocation and that decision is done. And right now there is no
plan to change the discount rate. It will continue to be reviewed and the next ALM cycle
is starting and it will come back to the Board in four years.>>Julian Robinson:
Just want to add to that, we do have our risk mitigation policy and depending on if any
of those thresholds are triggered in the risk mitigation policy, that could lead to a further
adjustment in the discount rate. But other than that, there is nothing scheduled to impact
the discount rate.>>Randy Dziubeck:
Great. And we are continuing to get lots of great questions so I want to thank the listeners
for that. Okay, next question: If approved, when would
these changes go into effect?>>Kurt Schneider:
That is part of the approval process. The Board will decide what the changes are and
when they’re going to be implemented.>>Randy Dziubeck:
Yeah, I think realistically where we are in the year, it would be difficult to implement
changes for the 6/30/17 valuations. That’s not to say that it won’t happen but that’s
probably less likely. But whether it would be in 2018 or 2019, that would be up to the
Board. Okay, let’s see… perhaps a little outside
of the amortization policy but we’ll toss it out and may be the guys have some thoughts.
What are your thoughts on the use of Section 115 trusts?>>Kurt Schneider:
If anybody doesn’t know, a Section 115 trust is a trust where an employer sets aside money
for things like retirement outside of CalPERS. A lot of agencies use them. Sometimes they’re
referred to as contribution stability reserves or something where they can put money into
those reserves, set it aside for retirement when they have money, and when they’re short
of money they can use money in the fund to make CalPERS contributions. I think there
are one tool agencies have. It all depends on what their revenue sources are and what
their risks are. It means that the agency has control over the asset allocations so
they can invest those assets how they want and typically they would invest them in less
risky assets than what PERS is invested in. So if they wanted to set aside extra money
and make sure they don’t lose it, that’s sometimes why they use it. Now, it’s also
something that a school employer could use because like we said there is no way for a
school employer to make additional contributions to CalPERS to pay down the UAL. They could,
in theory, use a Section 115 trust to help reduce their future contributions to CalPERS.>>Julian Robinson:
Yeah, and I would just add to that, when establishing a 115 trust, depending on the size of the
assets under management, it would be very unlikely that you would be able to achieve
the same investment management cost that CalPERS has because of our enormous economies of scale
here. Our cost of managing money is relatively or very low. If you engage in a 115 Section
115 trust, it’s very likely that the cost of managing money would be significantly higher
than what is implicit in CalPERS management of the money.>>Randy Dziubeck:
Okay, great. Next question and I’ve heard this from agencies in the past as well so
I think it’s a great question. In the fall of 2015 we paid down our unfunded balance
as calculated in the fall of 2015. Our latest valuation report still has us paying a UAL
on top of increased employer cost in the next few years. What gives?>>Kurt Schneider:
Well, there’s a couple of things. So, another reason, back to the original question, about
paying off the UAL. Well, paying off 100 percent of the UAL doesn’t guarantee you’re never
going to have a UAL again. Right? Every year you measure liabilities, we compare them to
the assets and we recalculate the UAL and any difference turns out to be a new layers
or layers. So a couple of things happened since 2015. Right? The 15, 16 asset
return was less than expected. It was .6 percent that year instead of 7.5 percent, which
it was expected to be. So that alone is going to increase the unfunded liability and create
another amortization layer. And also in 2016 we lowered the discount rate one-eighth of
a point which created an assumption change layer. So if even if you’re 100 percent
paid off, if you are exactly 100 percent paid off before then, chances are whatever
other demographic gains and losses you had, you still wound up with a UAL the following
year.>>Randy Dziubeck:
Great, thanks, Kurt. Next question: Did you consider requiring
a shorter amortization period for the current unfunded bases?>>Julian Robinson:
We considered this and I guess it is a possibility. However, the already existing onerous increases
in contributions as we saw righty at the beginning of the presentation, I think it was felt that
imposing some change on the current amortization schedule would be something which would be
deemed unreasonable. As mentioned before, many agencies have stepped up and made additional
voluntary contributions and of course, we encourage that. But to impose something as
policy across the board is considered something which would be somewhat unbearable.>>Randy Dziubeck:
Yeah, Julian makes a great point that I want to make sure our listeners understand. What
we’re doing with the amortization policy is setting the minimum required contribution
that we, as actuaries, and the Board feel are necessary to provide the necessary stability
to the fund. Employers have had the ability and will always have the ability to contribute
anything more than that minimum contribution. So if you are fortunate enough to have some
extra funds and want to work on those existing bases and pay them off faster, please call
your actuary. We have done that for a lot of our agencies and I think they’ve been very
pleased with the outcome. So call your actuary and make that happen.>>David Teykaerts:
Great, thanks, Randy. And thank you to Julian and Kurt for your information and expertise
as well. Really appreciate it. So we’ve come to the end of the hour here.
We hope that this has been a useful webinar for you. We’ve shared a lot of information.
We do hope that you will take just a few moments to complete that survey. It’s going to be
really valuable for our Board to know stakeholder sentiment on this as we consider the options
and present to the Board in February. Okay, with that, thank you again and everybody
have a great day.

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