The discount rate is used to calculate future investment returns, taking into consideration how the current year’s performance will affect the next year.
The new plan could potentially produce lower returns for the nation’s largest pension investment fund and trigger changes in employer and employee contributions in the future. Under the proposed policy the CalPERS “discount rate” would be lowered from its current rate of 7.5 percent in increments of .05 percent up to a maximum of .25 percent depending on the excess investment return over the established discount rate. Discount rate reductions will then trigger changes in investment asset allocations, reducing likely investment returns and volatility in investment returns and gradual increases in employer and employee rates in the future.
The proposed policy is viewed by CalPERS as a preferable alternative to the current policy in which strong investment years are typically followed by lower performing years. When returns are lower, the cost to participating agencies rises. It is hoped the proposed policy will soften the employer and employee rate swings that result from steep declines in investment returns.
The potential action is detailed in the Sacramento Bee
, “CalPERS aims to lower investment risks,”
Oct. 12, 2015
League Research and Reaction
The League recently conducted a survey of cities to assess cities’ perspectives on CalPERS volatility. The survey found that 77 percent of the 115 responding cities support the CalPERS board taking steps to reduce volatility in its investments by lowering the discount rate and gradually raising employer/employee contribution rates in the next few decades in addition to already programmed increases. However, the League cautioned CalPERS when reporting on the results that the implementation of any additional rate increases to reduce future investment and rate volatility will be even more challenging for those cities in fiscal distress. The League urged the CalPERS board to balance its policy with this reality.
League Executive Director Chris McKenzie stated: “We believe the proposed Funding Risk Mitigation Policy reflects the overwhelming opinion of the respondents to the League survey and still allows the CalPERS Board to consider fiscal distress of local agencies and other factors as they may arise in the future. There is strong support at the local level for keeping the CalPERS system fiscally sustainable, and reducing volatility risk in the investment portfolio is a major ingredient in accomplishing that goal. These additional costs will likely be the subject of future local labor negotiations.”