LOS ANGELES - The California Public Employees' Retirement System's decision to reduce its assumed rate of investment return to 7.0% from 7.5% is good for the credit of the state and its local governments, Moody's Investors Service said Thursday.
The CalPERS board made the decision Dec. 20 amid increasing worry about lower-than-expected investment returns leaving the pension short of the money it projected would be available to pay benefits. A fiscal year-end report issued in July showed a 0.61% return for 2016 compared to a 2.4% return in fiscal 2015, reflecting generally lackluster pension investment performance across the nation. The smaller assumed rate does force local government participants in the pension to make higher contributions, Moody's pointed out, but reduces risk overall.
"The lower discount rate assumption will force government contributions toward long-term liabilities to increase, but will lessen the risk of unanticipated contribution hikes in the future from adverse investment performance," the rating agency said. "Investment risk-taking needed to justify a discount rate above declining return expectations would translate to a heightened chance of investment losses, which could ultimately produce even higher contribution requirements."
Normal costs, which are the present value of current year benefit accruals, will increase by 1% to 5% of payroll for most plans administered under CalPERS due to the discount rate decline, Moody's said. Employees hired after California's Public Employees' Pension Reform Act (PEPRA) took effect in January 2013 will split the normal cost increase with employers, but participating governments must fund the entire normal cost increase for all other employees. In addition to normal cost increases, many participating governments will experience 30% to 40% increases in amortization payment requirements as a result of the change.
Gov. Jerry Brown hailed the decision last month, which was a more aggressive change than a previous "smoothing" voted in by the board. The change will be phased-in over several years to reduce the impact on those affected.