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Cost Management Strategies in Focus as Payment Volatility Remains

By Mike Meyer, Vice President, NHA Advisors

This article is a brief excerpt.  The full article can be found here: https://nhaadvisors.com/calpers-beats-target/.  The 4-page PDF can be downloaded from this link.

In July 2024, CalPERS announced preliminary investment returns of 9.3% for the fiscal year ending June 30, 2024.  Despite this most recent year’s returns outpacing the discount rate of 6.8%, the 20-year annualized average return dropped from 7.0% to 6.2% and the 10-year annualized average return from 7.1% to 6.7%.

Pension Bond Issuance Skews Overall Funding Status - the overall funded status for the CalPERS Public Employees’ Retirement Fund (PERF) rose to 75% from 72%.  Notably, this aggregate figure has been slightly elevated by over $4 billion in recent Pension Obligation Bond/UAL Restructuring bond issuances during 2020-2022, with most of those pension bond issuers now experiencing funding ratios above 85-90%. Non-pension bond issuers may see their funding ratios rise to 68-71% on average.

Section 115’s Perform Extremely Well - FY 2023-24 saw strong returns for many of the 115 portfolios – including >10% for many moderate-risk style portfolios (≈50% Equity / 50% Fixed Income) and 13-19% for portfolios with a higher equity ratio (60%-90%).

Potential Impacts for Member Agencies

No Change to Discount Rate - While the outsized returns of 9.3% did technically trigger a Funding Risk Mitigation Event, CalPERS decided to make no changes to the Discount Rate at their Board Meeting on September 17, 2024.

UAL Balance & Payment Impacts – Many public agencies will see a UAL reduction between 5-12%, with pension bond issuers on the higher end of that range given the higher funding ratios and sensitivity to returns.  UAL payment reductions will be slowly ramped in starting in FY 2026-27, with the overall annual payment reduction around 4-8% once they are fully ramped in by FY 2030-31.  However, many agencies are still projected to see an increase of over 30% through the end of the decade, and for many, this is double the amount paid just a few years ago in 2020. 

Pronounced “Trough/Peak” for POB Issuers – as discussed more comprehensively in the full article, many recent pension bond issuers will see a notably different UAL repayment shape than non-pension bond issuers.  Given the serendipitous timing of the FY 2020-21 CalPERS returns (21.3%) around the same time as UAL restructuring bonds were issued, many agencies have been experiencing a large dip (“trough”) in payments after they became close to or above fully funded.  However, the impact of the poor FY 2021-22 returns year (-7.5%) is now beginning to impact these agencies and could lead to a more magnified increase in payments.  Several cost management strategies that leverage the savings from the pension bond, including fresh starts, targeted ADPs and 115 trust

Considerations for Managing Rising Pension Costs - it is highly recommended that agencies re-assess and re-calibrate their pension funding strategies given the evolving nature of the pension challenge. Consistent stakeholder education, annual review of pension funding policies, and continued refinement of cost management strategies are also encouraged.

For more information on potential approaches to manage pension liabilities, please feel free to contact the NHA Advisors team at Pension@NHAadvisors.com or Mike Meyer at Mike@NHAadvisors.com.