FAQs - Discount Rate for Terminated Agencies
- What is the Terminated Agency Pool?
- What is the “discount rate”?
- Why was the “discount rate” on the terminated pool lowered?
- Why is the discount rate for the active CalPERS fund 7.5 percent?
- How will the lower discount rate in the terminated pool affect employers that terminate their pension plans?
- Does the change in the investment strategy and discount rate mean CalPERS is nervous about the condition of the market, or is making a shift in policy?
The “terminated agency pool” is composed of employers that have chosen to leave or have been terminated by CalPERS, but agreed to allow CalPERS to administer their funds. The terminated agency pool no longer receives contributions from employers or their employees (members); however, existing funds remain with CalPERS for investment, and payment to beneficiaries.
The discount rate is generally the same as the expected rate of return on investments, and is used to calculate the present value of expected plan payments.
CalPERS chief responsibility is to protect our members. In other words, CalPERS always invests in a way to make sure members will receive benefits they are due upon retirement.
In August 2011, the CalPERS Board adopted a more conservative investment strategy for the assets of the terminated agency pool. The discount rate for the terminated pool is now below 4 percent due to an investment strategy that is shorter term, more conservative, and designed to protect the principal by investing the majority of pool assets in U.S. Treasury based securities. The U.S Treasury market is now yielding below 4 percent long term and near 0 percent very short term.
Currently, the terminated pool is funded at 240 percent, meaning there is very little risk to future beneficiary payments. If one large agency chooses to terminate its contract, it could bring the funding level closer to 100 percent, which would place member benefits at risk. Because there are no employer or member contributions in the terminated agency pool fund, member benefits could be reduced in the event of another investment market decline like the one experienced in 2008-09. By investing terminated funds more conservatively, benefits are protected.
The discount rate is always based on the expected rate of return on investments. The active fund has a source of income beyond interest, and is invested for the longer term in a more aggressive and diversified portfolio with a greater rate of return. The greater discount rate is appropriate for an active fund because of the longer investment horizon and higher expected return. With an active retirement fund, there are new members every day who may not retire for many years to come. In a terminated fund, no new members means at some point, there will be no more beneficiaries.
This strategy is similar in concept to what most individuals normally do with their personal retirement savings. Most individuals invest their retirement savings in a more aggressive fashion earlier in their career and slowly move to a more conservative allocation as they near retirement.
The discount rate for the active fund is 7.5 percent. Over the last 20 years, CalPERS has realized a net return on investments that exceeded the 7.5 percent discount rate. Also over the last 20 years, about 64 cents of every dollar paid in pensions has come from investment earnings, with employers paying 21 cents and members 15 cents.
How will the lower discount rate in the terminated pool affect employers that terminate their pension plans?
In the future, if an employer terminates its plan but continues with CalPERS as the plan administrator, the employer is likely to be required to deposit more assets into the pool to fund the terminated liabilities. The new investment strategy for the terminated pool will result in terminated liabilities that will fluctuate with interest rates. Interest rates in the US are currently at an all-time low. If rates start increasing again, the expected rate of return on the terminate pool is also expected to increase, which would in turn lower the cost of termination.
Does the change in the investment strategy and discount rate mean CalPERS is nervous about the condition of the market, or is making a shift in policy?
No. CalPERS has a duty to act in the best interest of its members. By changing the way the assets of the terminated pool are invested, CalPERS is protecting these member benefits. The lower discount rate is not a reaction to the market or current debates surrounding public pensions, it is merely the result of a change in investment policy for the terminated pool. CalPERS continues to back our 7.5 percent discount rate for the Public Employees’ Retirement Fund as the best discount rate that balances growth and stability in that fund.