CalPERS board gives green light to cut assumed rate of return to 7%

By Randy Diamond - Pensions & Investments
December 21, 2016 2:12 pm | Updated 2:18 pm

The full CalPERS board approved Wednesday a plan to reduce the pension fund's rate of return to 7% from the current 7.5% over a three-year period.

The action follows the recommendation of CalPERS' finance and administration committee Tuesday night.

California Gov. Edmund G. “Jerry” Brown Jr., who in the past has criticized the $303.6 billion California Public Employees' Retirement System, Sacramento, for having unrealistic investment return assumptions, issued a statement in support of the action.

“Today's action by the CalPERS board is more reflective of the financial returns they can expect in the future,” Mr. Brown said. “This will make for a more sustainable system.”

The reduction in the rate of return is not as big as was discussed last month. Chief Investment Officer Theodore Eliopoulos said at last month's finance and administration committee meeting that given diminished investment return assumptions over the next decade, 6% was a more realistic return for the coming 10 years.

Andrew Junkin, president of Wilshire Consulting, which serves as CalPERS' general consultant, said at the November meeting that Wilshire was predicting an annual return of 6.21% for the next decade, down from its estimates of 7.1% a year earlier.

The change comes as representatives of California cities, towns, school districts and other governmental units that contribute to the nation's largest defined benefit plan argue that they could not afford the contributions necessary with a lower return rate.

California state Controller Betty Yee, a member of the finance and administration committee, said at Tuesday's meeting that she can predict the headlines Wednesday. “There will be headlines tomorrow about how we were not aggressive enough,” Ms. Yee said of the 7% rate of return, adding that the reduction will be noted around the world.

But Ms. Yee said the rate reduction will help stabilize the pension fund and added that CalPERS' falling funding ratio is a symbol of the changing world economy.

CalPERS' current funding ratio is 68%. Two years of poor results — a 0.6% return for the fiscal year ended June 30 and a 2.4% return in fiscal 2015 — have contributed to a more negative view of what CalPERS can earn over the next decade.

Mr. Eliopoulos, in explaining how the investment staff came up with the 7% rate of return, said it was based on a longer-term 30-year forecast that shows better investment returns, not a 10-year horizon.

Mr. Junkin said at the November meeting that CalPERS might not survive past 10 years if the rate of return was not lowered but never specified how much the return should be reduced.

Under the three-year reduction, phased in to soften the blow on employers, the rate of return for the pension fund would be lowered to 7.375% for the fiscal year starting July 1, 2017; 7.25% for the following fiscal year; and 7% for the year after that.

CalPERS is far from the only public pension plan lowering its return assumption. Statistics from the National Association of State Retirement Administrators show that 43 of 137 public plans have lowered their return assumption since June 30, 2014. But NASRA statistics show only nine plans out of 127 are below 7% and none has gone below 6.5%.