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

Innovation to align investors with the social good

The CFA Institute’s president John Rogers, believes there is evidence of innovation in investment products that meet the needs of asset owners in a more sustainable, longer-term way, and points to the work of professors and advisors to the CFA , Andrew Lo of MIT and Robert Shiller of Yale.   One of the main

Adding value through risk allocations

2013 was a great year to add value by using risk to assign asset allocation, according to chief investment officer of Windham Capital, Lucas Turton, whose fund added 300 basis points above benchmark last year by dynamically allocating according to risk.   Windham Capital Management’s style is to focus on measuring and understanding risk to

Alternatives increase as investors manage to outcomes

Investor allocations to alternatives will increase over the next three years as the focus on outcome-oriented investments heightens, according to respondents in the annual conexust1f.flywheelstaging.com /Casey Quirk Global Fiduciary CIO sentiment survey. The second annual survey, which included respondents from 56 asset owners with combined assets of $3 trillion, showed an accelerating trend to moving

Organisational change: asset owners 2.0

A key ingredient for success in any organisation is strong leadership. It is common in the corporate world for the chief executive to change every five to 10 years as the organisation evolves. Are the same principles true for large institutional investors?     Roger Urwin, global head of investment content at Towers Watson, who

The rise of the foreign trustee

Which developed world pension fund will become the first to have a Chinese national sit on its board? The debate on board diversity has focused on gender, race and age, but in future it could extend to having representatives of the countries your fund would most like to invest in. As funds travel along the

Economic growth outlook positive but integrity needs work

The outlook for economic growth this year is markedly positive, compared to last year, but capital market integrity is not improving, according to the opinions of more than 6,000 CFA Institute members. The CFA Institute global markets sentiment survey, measures the views of its members on market integrity and economic issues. This year’s survey, which

Previous