* and how does that compare with private sector rules? How Are Required Employer Contributions Determined for California Public Sector Pension Plans?* Jay Peters September 18, 2017 * and how does that compare with private sector rules?

Federal Law: ERISA (1974) Standards for U.S. retirement plans: participation, vesting, benefit accrual grievance, appeals procedures minimum funding compensation and benefit limits lots more Governments exempt from minimum funding standards, et. al.

Leads to Key Difference Public Sector Private Sector Governing body sets funding policies used to determine contributions ERISA, regulations determine required contribution Very little discretion Lots of discretion

Funding Policies Measure liability, assets Assumptions to project amount, timing of future payments Annual rate to discount those future payments to current dollars How much of this liability counts as “accrued” and as “normal cost”? How should asset value reflect recent “unexpected” investment results? Translate into employer contributions Period over which to fund gap between assets and accrued liability Contribution pattern during period

Rate Used for Discounting Public Sector Private Sector annual long-term investment return rate that governing body expects fund to earn regardless of plan’s investments, average historical yield on high- quality corporate bonds now 7.0% - 7.6% in CA now ̴ 6%, headed to ̴ 5% by 2021 recent downward trend no role for expectations

Impact Per 1% Drop in Discount Rate employer normal cost: roughly 40% - 50% increase for a “classic” non- safety group somewhat less for PEPRA, safety unfunded accrued liability increases accrued liability ̴13% pre-change: accrued liability = $100, assets = $75; unfunded = $25 52% increase: from $25 to $38 [= $113 ̶ $75] discount rate 7.x% 6.x% total normal cost rate 20% 25% +25% ̶ member rate 10% ̶ = employer rate 15% +50%

Typical CA Public Sector Funding the Gap Typical CA Public Sector Private Sector period 20 or 30 years, depending on source 7 years payment pattern increase 3% - 4% / year level $ phase-in / phase-out reduced payments, first & last 4 years none lag until payments begin one or two years Illustration: City X’s CalPERS plan incurs a $32.4 million experience loss in 2015-16. Additional City X contributions are to amortize this loss over 30 years, starting 7/1/18.

Amortization Payments and Unamortized Balance

Poorly Funded Plans Private Sector By law, if < 60% funded per mandated discount rate, no further pensions may be earned Overrides CBAs Public Sector Pensions earned regardless of funded position Many CA plans have-been / will-be < 60% if measured using private sector discount rates

Upshot If ERISA funding rules suddenly applied to public sector: in the near-term, required pension contributions by CA governments would be several times larger but eventually they would be smaller than if current policies continue.

Comparing Pension Value Typical Private Sector (circa 2000) vs Comparing Pension Value Typical Private Sector (circa 2000) vs. CalPERS Non-Safety employee retires at age 55 after 25 years of service, $75,000 pay in final year