You Gotta love this one! CIO magazine is reporting that a “legislative representative to the League of California Cities urged the CalPERS Investment Committee Monday to think “out of the box” in finding a way to exceed its 7% investment return projections, saying that cities won’t be able to pay their monthly contributions to the pension plan if returns are that low.” No problem! I’m sure that they will be able to find a magic potion that will all of a sudden create new and exciting investment opportunities for this fund and all market participants!
Dane Hutchings cited a CalPERS September 2017 report, which showed that 180 of the 449 cities and towns that participate in CalPERS had an individual funding ratio of between 60% and 70% (on an actuarial basis). Hutchings also warned that a significant number of those communities could fall between the 50% and 60% funded when new CalPERS data come out in August.
CalPERS is in the midst of a three-year plan to lower yearly expected investments to 7% from 7.5% because of diminished (more realistic?) return expectations. As returns expectations drop, CalPERS’s unfunded liability increases (under GASB accounting), therefore it must increase contributions from employers whose employees are in the pension plan, meaning the state, cities, towns, special districts, and school systems that makeup CalPERS must pay more.
How about valuing public pension liabilities using a more realistic discount rate and separating that rate (for contribution purposes) from the return on asset (ROA) assumption? DB plans used to be managed against their liabilities and not the ROA. Trying to enhance a return will guarantee more volatility, but not necessarily an equivalent pick-up in return.
If plan sponsors began using a mark-to-market evaluation of their liabilities they would understand that the present value of those liabilities changes along with movement in interest rates. A DB plan does not need to achieve its ROA objective in a rising rate environment given that the present value of the plan’s liabilities is falling. A 4-5% return would look heroic in a market environment, such as that! Have they conducted an asset exhaustion test to calculate the actual ROA needed to keep the plan solvent? Let’s apply some real solutions to this problem and not HOPE for unrealistic returns.