CalPERS' Action on Discount Rate was a Prudent, Smart Decision
January 6, 2017
By Marcie Frost
CalPERS, Chief Executive Officer
Last month, the CalPERS Board of Administration took a decisive step to strengthen our fund by cutting what is known as the "discount rate" by a half percentage point over the next three years.
The move generated a lot of attention. Some praised it. Some complained that we didn't make a deeper cut. Others were considerably harsher. They charged that we had hid our 4-year-old policy, one that was very publicly debated in 2013, of implementing any reduction over five years.
Of course, that's just straight-out wrong.
I took over as the Chief Executive Officer of the California Public Employees' Retirement System last October. I believe deeply that all of us, private and public sector workers alike, deserve financial security in our retirement. Let me explain why cutting the discount rate is so important - and let me tell you about our goals and our future and why we won't shy away from tackling the pension challenges ahead.
First, some background: The discount rate is what we assume our $304 billion in investments will return in a typical fiscal year, July 1 to June 30. It's a critical component of pension financial planning, because it’s used in calculating the amount of money those who are part of the CalPERS system contribute.
We lowered the rate because experts inside and outside CalPERS advised us that, the recent stock market surge notwithstanding, the long-term financial outlook had darkened. Achieving a 7.5 percent return – the rate in place since 2012 – was now far less likely than it was just two years ago when we last revisited it. Solid investment returns are the cornerstone of the CalPERS system: They pay for nearly two-thirds of every dollar we pay out in pension benefits.
But cutting the discount rate has real financial impacts for California taxpayers. We're acutely aware of that. The state, local public agencies, and school districts that make up CalPERS will have to contribute more money. So will many public employees, especially those hired after the Public Employees' Pension Reform Act took effect in January 2013. Liabilities too will grow before they level off and begin a downward trend.
"The reduction is a key step to ensuring the long-term sustainability of the fund..."
Those hard realities helped inform the CalPERS Board when it decided to reduce the rate over three years - to 7.375 percent immediately, to 7.25 in July 2018, and, finally, to 7 a year later. To sustain the CalPERS Fund for decades to come and pay the benefits they've promised their employees, our 3,000 employer partners knew the discount rate had to be reduced. But it was abundantly clear from our many conversations with them that they wanted to see the changes phased in. For their own budgeting purposes, they didn't want the rate to be cut dramatically in one fell swoop.
The reduction is a key step to ensuring the long-term sustainability of the fund and keeping in place reasonable retirement benefits that public employers need as they compete in the marketplace for talented workers. Others recognize the benefits of the decision as well. The credit-rating agency Moody's has called it a "credit positive" (PDF) for the State of California and many local governments.
We are a maturing pension fund like many across our nation. More money is going out in pensions than coming in, we have a low funded status, a decline in the number of active workers supporting retirees, and a low-return investing environment. These issues are real, but we are on the right path to full funding - and the Board's action on the discount rate has strengthened our efforts.
We've just started a comprehensive review of our assets and liabilities to make sure we're invested in the right places as we continue to pay the benefits our members have earned. We're working overtime to provide the public agencies and school districts with the clear financial roadmap they need to properly plan their budgets over several years. It will take time, but we have the discipline, confidence and the financial expertise to solve these issues for the next generation of public servants.
The real difficulty about this debate is not simply the data before us. It's the clear understanding that what we do impacts real lives - the lives of our 1.8 million members, the bottom line of the cities, counties, schools, and special districts that are the backbone of California, and, ultimately, the taxpayers of our state.
CalPERS is celebrating its 85th anniversary this year of serving those who serve California. We intend to directly confront what's ahead so that we can provide retirement security for the next 85.