CalPERS Board Adopts New Contribution Rates

The California Public Employees’ Retirement System (CalPERS) has approved new pension contribution rates for fiscal year 2017-18, including raising the employer contribution rate to 15.531% from 13.888%, and boosting the member contribution rate to 6.5% from 6%.

“While we recognize that rates will rise due to the change in the discount rate, pension reform helps reduce the risk to the fund and provides vital cost savings for our employers over the long-term,” said Richard Costigan, chair of CalPERS’ finance and administration committee.

The CalPERS board of administration said its decision was spurred by the lowering of the assumed rate of return to 7.375% from 7.5%, a 3.7% increase in member salaries, and last year’s disappointing investment return. The investment return for the fiscal year ending June 30, 2016 was 0.6%, well below the assumed return. CalPERS said “the impact of this investment loss is being recognized for the first time, and will be phased in over five years in accordance with the board policy.”

Combined, the state and school employer’s pension costs for FY 2017-18 are just under $8 billion. The state’s contribution towards pensions will increase by $521 million from $5.4 billion to $5.9 billion from the previous fiscal year. Meanwhile, the schools pool contributions will rise by $342 million to $2 billion from nearly $1.7 billion.

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“We recognize the increases are a concern to many of our employers,” said Rob Feckner, president of the CalPERS Board of Administration, “but today’s decision reflects the reality that we are in a low-return economic climate that is expected to continue for the next five to 10 years.”

CalPERS said that school districts will not see the impact of the discount rate change until fiscal year 2018-19 to allow more time to prepare for the rise in the contribution costs.

The California state pension plan is approximately 65.1% funded, while the schools plan is approximately 71.9% funded as of June 30, 2016. The total CalPERS Fund is estimated to be 65% funded to date. CalPERS is the largest defined-benefit public pension in the U.S., and its total fund market value is approximately $316 billion.

Tags: CalPERS, contribution rate, school districts

The decision by Verizon Communications to borrow $3.4 billion to make a discretionary pension contribution was driven by tax considerations and concern over rising Pension Benefit Guaranty Corporation (PBGC) premiums, according to Bob Collie of Russell Investments.

According to Verizon CFO Matt Ellis, the $3.4 billion discretionary pension contribution the company is making has a “net present value positive (NPV),” but the math behind that statement is driven by tax considerations and a sharp increase in PBGC premiums.

In a 2015 paper, Russell consultant Jim Gannon noted that when PBGC premiums were increased, it created a situation where “the variable rate component of these premiums is now a very significant cost for sponsors with underfunded pension plans.

“However, the same legislation makes it easier for an underfunded plan to be maintained, by giving greater flexibility to sponsors in determining their contribution schedules (i.e., reducing the required minimum contributions),” Gannon wrote.

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While pension funds have traditionally borrowed money to fund their plans, they essentially substituted one form of debt with another (borrowing to either fund the plan or else to repay a borrower). But the Verizon action was made different, according to Collie.

In an April 2017 note, Collie wrote that Verizon’s Ellis said in a quarterly conference call that “the discretionary pension contributions are net present value positive on an asset tax basis given the reduction in our variable rate PBGC premiums and the expected net return on planned assets.”

This “borrow to fund” strategy is driven by tax considerations, Collie said, since the “tax affects the NPV calculation because pension contributions are tax deductible, whereas only the interest on corporate debt is tax deductible (while principal repayments are not.) Tax effects therefore generally have tended to favor a borrow-to-fund strategy.” Collie also noted that the increase in PBGC variable rate premium is equivalent to a tax on pension shortfalls, so this is another factor that tends to favor borrow-to-fund.

In a related matter, earlier this month, Richard McEvoy, a Mercer partner, said pension funds are at a “tipping point” in deciding to make contributions or close their pension funds altogether. In a paper, “DB Pensions and the Emergence of the Big Bang Theory,” McEvoy said pension plans are making contributions because a plan has to be fully funded before it is closed in accordance with PBGC standards. Among the reasons more plans are making larger contributions is due to the four-fold increase in the pre-participant and variable-rate (“deficit tax”) participant PBGC premiums. Another feature driving the push towards making pension contributions is that funds receive a corporate tax deduction due to pre-funding.

Tags: Bob Collie, Matt Ellis, PBGC, Russell Investments, Verizon