CalPERS warns on pension reforms

CalPERS has raised concerns that California Governor Edmund G. Brown Jr’s plan for a hybrid defined contribution (DC) and defined benefit (DB) public pension system could lead to a more conservative investment strategy and threaten the actuarial soundness of its existing DB scheme.

The $225.2 billion fund released a working paper on Governor Brown’s 12-point plan to reform the state’s underfunded public pension system as part of evidence it recently gave to a state legislature committee.

The plan includes lifting the retirement age to 67 and placing all new public employees into a hybrid system.

Last week Ann Boynton, CalPERS’ benefits program, policy and planning deputy executive officer, and Alan Milligan, the fund’s chief actuary, appeared before California’s Interim Conference Committee on Pensions.

In a working paper on the proposed reforms, CalPERS says that, if the hybrid scheme includes closing off the current DB scheme to new members, it would result in lower investment returns and increase contribution to fund existing pensions.

By stopping the flow of any future new member contributions, a hybrid system would also further worsen the current 75 per cent funded ratio of CalPERS’ current DB scheme.

Sponsored Content

Governor Brown proposes that all new public employees would be required to join a hybrid pension plan that would target a 75 per cent income replacement ratio after 30 to 35 years of service.

The retirement benefits would be provided equally by the DB and DC component and social security. If a member did not access social security their benefit would consist of two-thirds DB and one-third DC components.

“It should be noted that if the design of the Hybrid Plan results in the closing of the current DB plan there would be a significant cost impact to the employer due to the changes in asset allocation and amortization methods,” CalPERS notes in its analysis of the effect of the proposed reform package.

In an issue briefing released earlier in the year, CalPERS says that closing off the current DB scheme would mean that investments would gradually shifted into lower risk, more liquid assets such as fixed income to ensure benefit payments for existing members.

The authors of the briefing paper The Impact of Closing the Defined Benefit Plan at CalPERS says the fund currently has an allocation to fixed income of approximately 16 per cent.

If this fund were closed to new members, all its current active members would have retired in 30 years’ time. The paper notes that a gradual shift to a 60 per cent fixed income allocation over this time period would result in a decrease in investment income of between $150 and $200 billion.

“The actual amount of investment income lost is affected by how quickly the closed DB plan shifts its asset allocation toward a more conservative allocation involving a higher proportion of fixed income, and how much of the assets are invested in fixed income,” the paper says.

CalPERS notes that it is unclear if the 12-point plan, which is yet to be fully detailed, would involve closing off the current DB fund, but it says that it would need “significant legislative action, including statutory and administrative restructuring” to come into being.

Under its current constitution, CalPERS is limited in how it can be involved in any new DB pension fund.

“No assets from the Public Employees’ Retirement Fund may be used to design or implement any other plan, nor may such assets be used to administer any other plan,” CalPERS notes.

In its analysis of each of the 12 points of Governor Brown’s plan, CalPERS provides an analysis of the legal ramifications of the each point, the workload, its potential fiscal effect and the potential pros and cons of the change.

Part of the plan involves enshrining a 50/50 split between annual pension costs for both employees and employers.

CalPERS says it doubts the legality of this proposal to split contributions evenly, as it may impair the vested rights of some members.

Similarly, it is unclear if closing off the current DB scheme to new members would also constitute an impairment of the rights of members of that scheme, given that this decision may lead to a cut in benefits.

There have been several successful constitutional challenges to moves by states to wind back pensions, as they constitute a contract between employees and their employer.

As part of the reform package Governor Brown also proposes changes to CalPERS board to “increase pension board independence and expertise”.

The proposal would see an addition of two independent public board members with financial expertise and replace the current state personnel board representative with a senior representative from the Department of Finance.

CalPERS says the proposed changes had the potential to make the board “unwieldy and inefficient” and “would not impact benefit packages agreed to by employers and employees”.

Leave a Comment

Sort content by

Hong Kong still has it: CIC recognises Hong Kong’s international finance status with subsidiary

The China Investment Corporation has recognised Hong Kong’s international position by establishing a wholly-owned subsidiary, Hong Kong-CIC International (Hong Kong) Co., Limited. mrec4inarticleinline Sponsored Content scnative1 scnative2 scnative3

Credit overweight pushes Texas to top spot, performance pay reinstated

The 108 investment staff of the Teacher Retirement System of Texas (TRS) have had their performance incentive awards reinstated, and will receive $9.7 million between them, after a year which saw the fund outperform its benchmark by 240 basis points making it the best performing public pension fund in the US.mrec4inarticleinline Sponsored Content scnative1 scnative2

New decision making parameters for Alaska’s investments

The $38.5 billion Alaska Permanent Fund Corporation (APFC) has made further enhancements to its unique approach to investment decision making, clarifying procedures relating to risk guidelines in its investment policy. mrec4inarticleinline Sponsored Content scnative1 scnative2 scnative3

Emerging and frontier markets continue darling run

Global equity markets significantly underperformed emerging and frontier markets in 2010, evidenced by MSCI Indices end of  year data, with some emerging markets returning as much as 50 per cent and some frontier markest returning 70 per cent for the year.mrec4inarticleinline Sponsored Content scnative1 scnative2 scnative3

Japan fund reduces domestic bond weighting

The world’s largest investor, the ¥117,643 billion ($1.43 trillion) Government Pension Investment Fund of Japan (GPIF) has reduced its weighting to domestic bonds by more than 1 per cent, moving the money into short term assets.mrec4inarticleinline Sponsored Content scnative1 scnative2 scnative3

Specialised short positions challenge beta behaviour

Long/short funds with specialised short positions have greater beta convexity and present greater liquidity strain in rebalancing, according to new research by Morgan Stanley.mrec4inarticleinline Sponsored Content scnative1 scnative2 scnative3

Previous