By Ed Mendel
Monday, January 6, 2013

To cover the cost of retirees living longer, the CalPERS board next month is expected to approve the third rate hike in the last two years, phasing in the increase to soften the blow on state and local governments.

The new rate hike would not begin until fiscal 2016-17 to allow employers time to plan after receiving rate projections next year. When fully phased in by 2020-21, the new rate hike and the previous two would raise rates roughly 50 percent above current levels.

In the first rate increase in March 2012, CalPERS lowered its investment earnings forecast from 7.75 to 7.5 percent, but critics say that’s still too optimistic. In a second rate increase last April, CalPERS adopted new actuarial methods that pay off debt sooner.

Now to reflect new longevity estimates (two more years for males and 1½ years for females) CalPERS plans a third rate hike. Employers have been told a longevity rate hike is likely, but the jump may be larger than some expected.

As CalPERS reviews economic and demographic assumptions, usually done every four years, the board has leaned toward a new investment allocation that, if adopted next month, is unlikely to change the earnings forecast and trigger yet another rate hike.

A staff report to the board last month said a rate increase resulting from changes in the other assumptions, mainly longevity, will have a “significant impact” on employers at a time when their budgets are strained.

“Concern has been raised that the contribution increases may be too much for employers to bear,” said the report from Alan Milligan, California Public Employees Retirement System chief actuary, and David Lamoureux, deputy chief actuary.

There is no easy way out. Delaying action on the longevity change could lead to a “qualified” actuarial valuation reflected on the financial statements of CalPERS and state and local governments. Delaying a rate increase boosts the long-term cost.

Following current CalPERS policy, staff recommends a five-year phase in of the rate hike to pay off the new longevity debt over 20 years. For each $1 million in debt or “unfunded liability” the interest payment is said to be $1.2 million.

Two alternatives given to the board phase in the rate hike over seven years and pay off the debt over 30 years. With a 30-year payment period, for each $1 million in debt the interest payment nearly doubles, jumping to $2.2 million.

For the pension fund, the longevity rate hike would drop the funding level, now 74 percent, four points to 70 percent, and liabilities, now $329 billion, would increase $22.6 billion. (The unfunded liability, not covered by projected assets, is $57 billion).

For employers, the staff report has a chart showing estimates of the rate increases in the first and fifth year when, under current policy, the longevity rate hike is phased in over five years and the debt paid off over 20 years.

If the new longevity estimates are combined with a previous six-year projection of CalPERS rates for the state and schools (annual actuarial valuation, p. 61), it’s possible to get a rough look at what the total employer rate might be in 2020.

The employer rate for most “miscellaneous” state workers, now 21 percent of pay, could be around 32 percent in six years. Employees currently contribute 8 percent of pay, which only increases if agreed to in labor contract bargaining.

The employer rate for the California Highway Patrol, now 35 percent of pay, could be around 55 percent in six years. The employer rate for non-teaching school workers (the largest CalPERS group), now 11 percent of pay, could reach 20 percent.

In the giant CalPERS system, there is a wide variation among the 1,581 local governments with more than 2,000 plans. For example, the estimated year-five longevity rate increase for a common miscellaneous plan is a range, 2.4 to 4.8 percent of pay.

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