Our Fiscal Outlook publication today discusses various near-term budget risks for the state related to pensions and retiree health. (See pages 43-45 of the pdf version of the report.) This note is an addendum to the Fiscal Outlook to reflect some recent developments concerning the California Public Employees' Retirement System (CalPERS).
On November 18, after the Fiscal Outlook was finalized, the CalPERS board approved a proposal to gradually lower the system's 7.5 percent long-term annual earnings assumption ("discount rate") and investment risk profile. The new policy is the plan proposed by CalPERS staff that we mention in the Fiscal Outlook (p. 44 of the pdf version). Specifically, after years when the CalPERS portfolio generates returns that are 4 or more percentage points above the system's discount rate assumption, the plan would gradually ratchet down the discount rate and the risk profile of the CalPERS portfolio. Therefore, in years when the system's investments generate an 11.5 percent or greater return, the discount rate and investment risk would be ratcheted down gradually. As a result, over the next two decades or so, the discount rate will move gradually to around 6.5 percent. This lower discount rate may increase employer and employee costs in some periods. In future decades, however, the lower-risk investment profile could reduce the severity of some investment losses and the contribution spikes that otherwise would result, thereby benefiting public budgets.
A CalPERS committee rejected a proposal from representatives of the Governor's administration for a much faster shift to a 6.5 percent discount rate. That plan would have cost the state more in the near term, but potentially less than the adopted plan decades from now.
By rejecting the faster shift to a 6.5 percent discount rate, the CalPERS action mitigates some of the near-term budget risk for retirement funding we discuss in today's Fiscal Outlook. As we state in the Fiscal Outlook (p. 44 of the pdf version), the plan adopted today by the CalPERS board "would not necessarily increase costs above our assumptions between now and 2019-20" because it changes the system's discount rates so gradually.
Issues discussed in the Outlook related to potential near-term cost pressures for CalSTRS and retiree health prefunding remain, as they are not directly affected by this CalPERS action. As a result of CalSTRS and retiree health prefunding costs, there remains the possibility that overall General Fund retirement expenditures could be $1 billion or more above our main scenario Fiscal Outlook assumptions by 2019-20.