The changes the California Public Employees Retirement System (CalPERS) made this week are prudent steps that will improve the system's funded ratio and the predictability of payments for employers over the long term. However, they will also add to already rising budgetary pressure for the state and participating local governments.
CalPERS modified its actuarial smoothing and amortization methods with the goal of improving long-term pension sustainability and reducing annual contribution volatility. We expect increased budget pressures to be greatest for participating governments that face high pension contributions relative to their budgets or that have limited flexibility to offset rising contribution requirements.
We consider carrying costs for debt service, pensions, and other post-employment benefits to be high when they total more than 25% of general government operating expenditures. Of the 40 California cities Fitch rates, seven are at or above that threshold. Although the CalPERS changes are expected to increase pension contribution levels by up to 50% over a five-year ramp up period, contribution rates have already been on an upward trajectory.
CalPERS' new methods will increase pension contribution rates for all participating governments beginning in fiscal year 2016. This gives governments at least some time to plan for the increased payments. The changes will replace the current asset smoothing method with direct smoothing of contribution rate changes over a five-year period, with a fixed 30-year term for amortizing differences between actual and assumed returns. CalPERS expects the revisions to help it achieve full funding within 30 years — most CalPERS plans are now funded between 65% and 80%.
CalPERS provides pension and retirement benefits for the state of California and hundreds of California local government units. Like public pension plans across the nation, CalPERS' funded ratio has fallen sharply in the wake of the recent financial crisis. The planned changes will raise budget pressures for participating governments throughout the state, but place CalPERS on a clearer path towards fiscal sustainability.