A plan by California’s largest pension fund to shorten its amortization period is credit positive for the state government and participating local governments, though it could mean untenable budget strain for some, Moody’s Investors Service said.
The new policy adopted by the California Public Employees’ Retirement System on Feb. 14 that shortens the amortization period to 20 from 30 years will force a more rapid pay down of unfunded pension liabilities.
The policy “will require earlier and potentially difficult budget adjustments,” but if the government’s pension debt is “unaffordable under the new requirements, it is also likely unaffordable to an even greater extent under a lengthier schedule with interest penalties and greater risk that further losses pile on to already deferred costs,” wrote Moody’s analysts Thomas Aaron and Timothy Blake in a report Friday.
CalPERS’ current contribution rules backload required payments, raising the risk that payments will crowd out government services in the absence of commensurate revenue growth, while the new rules will reduce the extent to which deferred pension costs render government budgets structurally imbalanced, Aaron and Blake wrote.
For example, analysts said, if a CalPERS plan expected $30 million of investment earnings in a given year, but the plan only earned $20 million, the sponsoring government must amortize the resulting $10 million “actuarial loss.” Under the old system, the government would have to repay the $10 million with 30 backloaded payments, accumulating to $28 million. Under the new policy, the government would make just 20 payments, accumulating to $20 million.
CalPERS’ new amortization policy will first apply to contributions set by June 2019 actuarial valuations, meaning the fiscal year beginning July 1, 2020 for school districts and the state, and July 1, 2021 for other local governments.
If significant actuarial losses materialize in fiscal 2019 or later, the new funding mandate will add to the pension cost challenge already facing California governments, analysts wrote. The new policy will only apply to prospective actuarial gains and losses, meaning that the currently backloaded schedules applied to already accumulated unfunded liabilities will remain in place.
“Based on numerous actuarial valuations for California cities that we rate, CalPERS is projecting annual contribution requirements to roughly double from fiscal year 2017 to fiscal year 2025 (in nominal dollars), assuming the pension system is able to meet its assumed 7% annual investment return,” analysts wrote.
The contribution hikes are required to make up for losses in prior years and to address various moves by the pension system to reduce risk. CalPERs lowered its assumed rate of return to 7% from 7.5% in December 2016 phased over three years.