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

Why integrated reporting makes sense: Robert Eccles

Robert Eccles has been trying to change the nature of corporate reporting for more than 20 years. He has been an advocate for supplementing financials with information on non-financial factors that are leading indicators of financial results – such as product development, customer satisfaction and the development of intangible assets. The premise is those companies

Opportunities in Europe

Investors and academics agree that political developments in Greece are important because they may shape how financial markets will respond to future political situations in the Eurozone. But according to Olivier Rousseau, the executive director of the FFR, the French pension reserve fund, there is more hype outside of the Eurozone on the implications of

More evidence big is better in pension funds

A pension fund that has 10 times more assets under management has on average 7.67 basis points lower annual investment costs according to a working paper from authors at De Nederlansche Bank, that explores the relationship between pension fund size and investment costs. Written by Dirk Broeders, Arco van Oord and David Rijsbergen the paper

European investment plan requires public private collaboration

The two largest institutional investors in the Netherlands, PGGM and APG, have responded to the European Commission’s investment plan, urging the commission to call on institutional investors to collaborate on the investment proposal. However they also warn that institutional investors are not just a “subsidising entity” and the Juncker Plan is best executed as a

Why Andrew Ang joined Blackrock

Andrew Ang believes factor investing is a more efficient way to organise a portfolio as it allows liquid and illiquid strategies to be managed across the portfolio. It also has the added benefit of honing managers on value creation. He’s been working with a handful of investors while Professor of Finance at Columbia University on

The power of engagement

It is called the “CalPERS’ Effect” but it could easily be called the asset owner effect, or the institutional investor effect, or the power of engagement effect. Wilshire, which is a consultant to the $300 billion Californian fund CalPERS, has provided an update on its study measuring the effect of engagement on a targeted list of companies called the Focus List.

Previous