What is the discount rate?

The discount rate is the long-term interest rate used to fund future pension benefits. It is one of the key components of the Asset Liability Management (ALM) (PDF) cycle that CalPERS uses to balance assets with future pension obligations. The discount rate is also known as the assumed rate of return because it's what CalPERS expects its investments to earn during the fiscal year.

What did the CalPERS Board do?

On December 21, 2016, the CalPERS Board of Administration voted to lower the discount rate from 7.5 percent to 7 percent over the next three years. This incremental lowering of the discount rate will give employers more time to prepare the changes in employer contribution costs.

The discount rate changes approved by the Board, for the next three fiscal years (FY), are as follows:

For public agency and school employers:

  • FY 2018-19: 7.375%
  • FY 2019-20: 7.25%
  • FY 2020-21: 7.00%

For state employers:

  • FY 2017-18: 7.375%
  • FY 2018-19: 7.25%
  • FY 2019-20: 7.00%

Employers

Employers who contract with CalPERS to administer their pension plans for their employees' will see increases in their total employer contribution. CalPERS contracts with more than 3,000 employers including public agencies, school districts, and the State of California, and we serve more than 1.8 million members.

The new discount rate for the state would go into effect July 1, 2017. The new discount rate for the school districts and public agencies would take effect July 1, 2018. The difference allows schools and public agencies additional time to plan for rate increases.

The costs will vary across plans within public agencies, school districts, and for the State of California since each plan is unique. It depends upon the employer's normal cost, the benefit structure, and the unfunded liability.

Because of a policy that allows the increases to be "ramped up" by the CalPERS Board, the increases will be phased in over seven years. The increase to the contributions for the State of California will begin in FY 2017-18. Increases for schools and public agencies will begin in FY 2018-19.

Employers can use circular letters as a guide to calculate broad estimates and apply the new rates to their current June 30, 2015 actuarial valuations. See the Circular Letter for public agencies (PDF), schools (PDF), and the state (PDF).

The normal cost rate is determined by looking at the annual cost of providing benefits to active employees for the upcoming fiscal year. The normal cost should be viewed as the long term contribution rate.

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 that the assets are different from the liability, the plan or pool will also be assessed an unfunded liability payment. The purpose of the unfunded liability payment is to get the assets and liabilities back to even over time.

The total employer contribution is the sum of the normal cost rate applied to an employer's reported payroll plus the UAL payment. These two components are the required contribution amount that employers pay CalPERS to fund their employees' pension benefits.

For Fiscal Year 2015-16, total employer contributions were as follows:

  • State of California: $5.0 billion
  • School districts: $1.4 billion
  • Public agencies: $4.4 billion

The total combined contributions from the employers equaled $10.8 billion.

A smoothing policy is something an actuary employs to help "smooth out" the volatility of employer rates from year to year. The current amortization and smoothing policy ensures new costs are paid in full over a specific period of time. The costs are also phased in with a five-year ramp up period at the beginning of the schedule and phased out with a five-year ramp down period at the end of the schedule.

The five-year ramp up means the payments in the first four years of the amortization schedule are 20 percent, 40 percent, 60 percent, and 80 percent of the ultimate payment, which begins in year five. The five-year ramp down means that the reverse is true and the payments in the final four years are ramped down by the above percentages.

When the discount rate drops, both the normal cost and the unfunded liability increase. The normal cost changes immediately in year one and continues at the higher rate. The UAL is amortized over 20 years and those payments ramp up over 5 years. So after 20 years the increase in unfunded liability will be fully paid off and the cost will go away, but the increase in normal cost will continue.

There will be a change to the discount rate every year for three years. Each time the discount rate drops, the normal cost will increase and a new UAL ramp will be established. Since all the UAL amortizations are scheduled with a five-year ramp up, it will be seven years until the full impact of the discount rate change is completely phased in.

The overall financial health of the employer's plan is measured by the plan's funded status.

The funded status represents the funded market of the assets minus the discounted value of the future liabilities. Sort of by definition, when the discount rate is reduced, it decreases the funded status because basically all of those future liabilities have less discounting as they go out into the future, is the way to think about it.

Each employer in the CalPERS system has their own specific funded status, which can be found in your actuarial valuation report.  A change in the discount rate will affect each employer a little differently because of the timing of cash flows and the structure of their liabilities.

The June 30, 2016, valuations that set the rates for FY 2018-19 will be available in the summer of 2017. These plans will show the updated projections for each of the specific plans. Employers can access their current actuarial valuations of June 30, 2015.

Members

Members retiring or re-retiring on or after December 22, 2016, are affected. Those who retired before that date are not affected.

For Classic members there are no changes since the contribution rates are set by statute.

For PEPRA members the discount rate change will most likely increase contribution rates over the next three years. Check with your bargaining unit for updates.

Retirement benefit options will be calculated using the ultimate discount rate of 7 percent. This affects service, disability, and industrial disability retirements.

Retirement allowances are reducing approximately $5 per $1,000 of the retirement allowance. For example, a $3,000 retirement allowance will be reduced approximately $15 but will vary depending on the option selected and the ages of the member and beneficiary.

Some service credit purchase selections will be affected, including:

  • Alternate Retirement Program (ARP) Purchase (when funds were not transferred)
  • California National Guard
  • Comprehensive Employment & Training Act (CETA)
  • Fellowship Service
  • Leave of Absence: Educational, Maternity/Paternity, Sabbatical, Service, & Serious Illness
  • Military: Public Agency, State and Schools; active and retired (does NOT include Military Leave of Absence)
  • Peace Corp/AmeriCorps/VISTA

The Service Credit Calculator incorporating the discount rate change will be updated in late spring 2017. No change will be made to payment schedules put into effect prior to December 22, 2016.

The retirement option factors will change for members who re-retire after December 22, 2016.

Contact the CalPERS Customer Contact Center at 888-CalPERS (or 888-225-7377).

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