CalPERS: a plan for reigning in risk.

• Author: Eason, Cheryl
• Position: BEST PRACTICES - California Public Employees' Retirement System

The California Public Employees' Retirement System won one of GFOA's Awards for Excellence in Government Finance Award in 2016 for its Path to Sound and Sustainable Pension Funding initiative.

It's safe to say that over the past 10 years the financial markets have brought volatility and uncertainty to the economy With economists and financial experts projecting that the economy will head into a cycle of lower returns over the next five to 10 years, the need to examine pension funding is greater than ever before.

Added risks also point to the changing demographics of pension funds and the looming reality that baby boomers are retiring at a rate of 10,000 a day, according to a 2012 Social Security report. Governance and regulatory challenges further increase the level of complexity. Defined benefit pension plans are a significant financial commitment and risk, both now and in the future, so plan sponsors must take action to mitigate pension funding risk.

Risk mitigation is of great importance for the California Public Employees' Retirement System (CalPERS), which is the largest public pension fund in the United States, with $300 billion in assets. The system developed a funding risk-mitigation policy that will lower the discount rate (a factor that attempts to account for the present value of future payments) in years of good investment returns and provides greater predictability and less volatility in contribution rates for employers.

A PERIOD OF CHANGE

The financial crisis of 2008 had a devastating effect on the funding status and market value of many pension funds, affecting the ability of state and local government employers to meet their financial obligations. CalPERS was no exception. Before 2008, CalPERS' pension plan was fully funded at 101 percent of the assets, meaning that after investment returns, there were sufficient assets to make all the anticipated payments to the plan's retirees and beneficiaries. Following the financial crisis, the CalPERS Board of Administration identified the need for risk-mitigation strategies that would support gains at the pension-funding level and to minimize the effects of factors that contribute to significant fluctuations in pension-funding ratios.

Another variable to consider is that life expectancy continues to increase. Projections by the U.S. Census Bureau place the number of Americans aged 65 and older at 88.5 million by 2050, more than double the projection that was made in 2010. Baby boomers, who began crossing into this category in 2011, are largely responsible for this increase. Additionally, as more baby boomers retire and the workforce matures, there are fewer active workers supporting each retiree.

This "maturing" of the fund--a trend most other pension funds also face--means that a decade ago the ratio of active employees to retirees was more than 2 to 1; today, it's 1.3 to 1. This trend is expected to continue for decades, when the ratio of active employees to retirees is expected to be less than one.

In 2016, CalPERS paid $20.5...