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

CalPERS: a new framework of economy

CalPERS has adopted 10 preliminary investment principles following a board offsite in July, but a number of topics, including the role of active management, are still under debate ahead of the September board meeting that is the deadline for the principles’ adoption. The $266-billion Californian fund began the process for establishing investment principles in January

Social networks in the investment web

Reels of financial data and analysis coupled with the occasional piece of market gossip or personal hunch are the time-honoured tools investors rely on in building an active portfolio. More recently, an element of sustainability or corporate governance analysis has tried to muscle into the process. Soon there will be another revolutionary option complementing financial

Eijffinger’s decade of financial repression

Financial repression will define the economic landscape for at least another decade, according to professor of financial economics at Tilburg University, Sylvester Eijffinger, which has serious implications for institutional investors. Eijffinger, who also is also a visiting professor at Harvard, sits on the monetary experts panel of the European Union and is an adviser to

Is reviving Europe a suspended apparition?

Getting Europe’s swelling institutional capital to support long-term projects that could benefit its uninspired economies was an idea that sent heads nodding around the continent as it suffered the brunt of the financial crisis. Get pension, insurance and foundation money into where it is most needed with the attraction of reliable long-term cash flows and

Let’s talk about underfunding

Even using the assets of the pension plan was not enough of a leg-up to save the city of Detroit from bankruptcy. As the last words in the song Put your hands up for Detroit by Fedde Le Grand say, it is system shutdown. The fiscal demise of this city may be a lesson for

Johnson urges pension simplicity

There is a David-and-Goliath feeling to the battle Michael Johnson, a research fellow at the London-based think tank the Centre for Policy Studies, is waging against the pension industry. His research, which lays out the case for radically simplifying all aspects of the United Kingdom’s pension sector, has earned him a reputation as a maverick.

Previous