CalPERS Funding Risk Mitigation Policy Frequently Asked Questions

The primary purpose of the policy is to reduce risk in our investment portfolio, the Public Employees’ Retirement Fund (PERF). Reducing risk also lessens the likelihood of future volatility in employer contribution rates, since a portfolio with less risk is less likely to experience the same downside losses as a riskier portfolio during future market drawdowns. This is accomplished by taking some of the excess returns during very good investment years and applying it toward reducing risk in the portfolio. The remaining excess returns are allocated towards reducing future employer contribution costs.

The policy is triggered when investment returns for a given fiscal year exceed the current target rate of return by 2 or more percentage points. For example, with a discount rate of 6.8%, the policy is triggered when the fiscal year returns are 8.8% or higher.

When the policy is triggered, the discount rate for the PERF is automatically lowered by an amount in proportion with the excess returns. The higher the excess returns, the more the discount rate drops.

For example:

• The fiscal year investment returns were 19.8% (exceeding the discount rate of 6.8% by 13 percentage points)
• Because the policy is triggered, the discount rate would be reduced by 0.2% (or 20 basis points) to 6.6%

The maximum amount the discount rate can be reduced in any one year in this manner is 0.25% (25 basis points).

*1 basis point equals 0.01 percentage point

No. The policy only triggers in years where the investment returns exceed the discount rate by at least 2 percentage points.

For all future years. The discount rate reduction would be in effect until either the board makes the decision to change it, or another risk-mitigation event is triggered in a later year.

The policy reduces future risk in the investment portfolio, which in turn increases the long-term sustainability of CalPERS. When the discount rate is reduced, our investment team adjusts the asset allocations within the portfolio. Typically, this means replacing some riskier assets with lower-risk assets. This function isn’t automatic nor immediate, and requires consideration of market timing, asset prices, and overall investment strategy.

There are two primary impacts to employers:

1. Stabilization of future contribution rates. Volatile investment returns are the primary cause of significant employer contribution rate volatility. Since the policy lessens the likelihood of volatile returns, it provides more certainty to employers for budgeting their long-term contributions.
2. Less relief for projected contribution rates than if the policy was not in effect. The policy calls for some of the excess returns earned in very good investment years to be used to reduce investment risk. That means employers won’t reap the immediate benefit of those exceed returns in their projected contribution rates. For a given risk mitigation event, it’s estimated that employer rates will decrease by about half of what they would have with no risk mitigation event. Approximately half of the excess return will be used for rate relief and half of the excess return will be used to lower the discount rate.

It’s important to note that employers will still benefit from the good investment performance that year, so there is direct relief in future rates. The other benefits are widely shared by helping CalPERS long-term.

Employers only contribute “more” in the sense of “more than if the policy did not exist.” When we compare future contributions to what was expected with a 6.8% return, employers will see relief in the form of lower projected contributions.

There is a one-year lag for contribution rate changes for state and school plans and a two-year lag for public agencies.

For example:

• The policy was triggered based on excess returns for fiscal year (FY) 2020-21 and the discount rate was reduced to 6.8% from 7%
• The employer contribution rate changes went into effect in:
  • FY 2022-23 for state and school plans
  • FY 2023-24 for public agencies

No, the rate change wouldn’t be phased in. However, if there are additional changes to the discount rate through the Asset Liability Management (ALM) process, the effect of those changes may be phased in over time. The CalPERS Board would need to approve such a phased-in approach.

In general, when the discount rate is lowered, liabilities increase as does the UAL. The UAL is determined by looking at the market value of assets of the plan or pool and comparing it with the accrued liability of that plan or pool. To the extent the assets are different from the liability, the plan or pool will also be assessed an unfunded liability payment. In other words, existing plan assets are assumed to grow at a slightly slower rate under the lower discount rate – often leading to a higher UAL.

Yes.

Yes. CalPERS is currently in its regular four-year Asset Liability Management (ALM) cycle review that could result in a recommendation to lower the discount rate.

Yes. The Pension Outlook tool is a free, publicly available tool developed by us to model “if/then” scenarios for pension plans. Users can generate different types of results by adjusting the discount rate and investment returns to see a variety of future scenarios.

Learn more about how to use Pension Outlook and log-in.

For detailed and specific information on plan impacts, contact your assigned actuary.

There is no direct impact to Classic members’ required contribution rates. Rates won’t change.

There is no direct impact to CalPERS retirees. Pension amounts won’t change.

It’s likely at least some Public Employees’ Pension Reform Act (PEPRA) employees/employee groups will experience an increase in the PEPRA member contribution rate in any year that the policy is triggered. Over time, it’s expected that all PEPRA members will see member rate increases.

The required member contribution rate for public agency PEPRA members is based on the total “normal cost” for the benefit structure applicable to the member. The total normal cost is an actuarily determined percentage of pay that can be thought of as the expected annual cost of funding a member’s benefit from date of hire to their date of retirement. A decrease in the discount rate results in an increase to the normal cost percentage.

Under PEPRA requirements, if the total normal cost changes by more than 1% from the “base” total normal cost (the total normal cost at the time of the last change to the member rate), the member contribution rate must be reset to 50% of the new total normal cost. Different PEPRA member groups are currently closer or further away from their 1% threshold.

For example:

• One group may already have a normal cost that is only two-tenths of 1% from hitting the 1% increase from the “base” normal cost
• In that case, it does not take much of an additional increase to push that group’s total normal cost over the 1#% threshold

Another group may be a full 1% away from the threshold, so that a bigger increase is needed to cross it.

The decrease in the discount rate due to a risk mitigation event has the potential to push total normal costs over the 1% thresholds for multiple member groups. We haven’t performed any analysis at this time that would indicate which groups would see an increase to the PEPRA member contribution rate.

Any employee contribution rate changes wouldn’t take effect immediately. Instead, they would go into effect on the same timeline as employer rates, as discussed above.