By now, CalPERS employers are beginning to feel the impact of rate increases adopted by the Board of Administration over the last couple of years and employer rates will continue to climb over the next several years.  These rate increases, and the Public Employees’ Pension Reform Act of 2013 (PEPRA), will have an even more significant impact on employers participating in risk pools.

There are three different types of rate increases CalPERS employers should keep in mind.  First, CalPERS reduced the “discount rate” from 7.75% to 7.5%.  The “discount rate” is an actuarial assumption of the average projected market return on investments.  Generally, the higher the discount rate the lower the employer contribution rate.  By lowering the average expected return on investments, employers will have a phased-in increase in their contribution rates by an approximate 1% to 2% for miscellaneous plans and 2% to 3% for safety plans beginning in the 2013-2014 fiscal year.

Second, CalPERS reduced the “smoothing”  and amortization policies to address the ever climbing unfunded liabilities, among other things.  Typically, the gains and losses in market investments are spread over the course of 15 years with experience gains and losses paid for over a rolling 30-year period.  This helped to keep employer rates from drastically changing year-to-year.  However, CalPERS announced that gains and losses will be amortized over a fixed 30-year period with increases or decreases in the rate spread directly over a 5-year period.  This means employers will see an additional rate increase anywhere from 1.1% to 4.2% per year over a five-year period beginning in fiscal year 2015-2016.

Third, CalPERS adopted new actuarial assumptions concerning certain demographic events and changes to asset allocations.  For example, experience data reflected that retirees are living longer than previously assumed.  Therefore, changes were made to assume a longer life span, meaning employers must contribute more to accommodate the projected longer life span of employees.  Employer contribution rates will begin to increase further beginning in fiscal year 2016-2017 with the cost spread over 20 years, increases phased in over the first five years and ramped down over the last five years.  Increased contribution rates are projected to be anywhere between .4% to 3.3% in the first year depending on the benefit formula(s) involved.

With the enactment of the PEPRA, employees hired on or after January 1, 2013 who qualify as “new members” under PEPRA, will have a benefit formula of 2% at 62, for miscellaneous, and one of three possible benefit formulas for safety, the most common being 2.7% at 55.  These changes are likely to decrease employer contribution rates, but only over the long term.  However, these new retirement formulas have an inordinate and possibly negative impact on employers participating in risk pools.

Generally, employers with less than 100 employees are required to be part of a risk pool with other small employers.  A single employer plan with only a few employees can suffer a huge rate increase due to an unexpected demographic change, such as a number of disability retirements.  Smaller employers who join together in a risk pool allows for spreading the risk and containing volatility in employer contribution rates.

However, there was a trend among employers in the few years prior to PEPRA to introduce lower benefit formulas for new hires while retaining higher benefit formulas for previous hires. In addition, PEPRA now mandates a lower benefit formula for “new members.”  Combined, this  may have an unfortunate consequence for risk pool employers.  Essentially, there may be a decrease in the number of new hires and ultimately a decrease in the number of active members which would lead to an increase in the ratio of retired members to active members. Gains and losses of the entire pool are allocated based on payroll. When a risk pool experiences a slower payroll growth than previously assumed, it can lead to less funding of unfunded liabilities.

In order to address this problem, CalPERS recently announced new actuarial polices to contain rate increases for these small employers.  The policies include combining 12 risk pools into two, one for miscellaneous plans and one for safety plans and changing the manner of how employer’s unfunded liability is determined and collected and what portion of employer contributions will be used first to reduce unfunded liabilities.  This will avoid increases in employer contributions to fund risk pools.  Individual employers with a higher ratio of active employees to current retirees may see modest contribution increases.  Those employers with less retirees may see decreases in contribution rates.

The many changes made by CalPERS will have long term effects for employers.  Employers should keep this in mind when entering into multi-year collective bargaining agreements.  Employers should work closely with their actuaries, labor negotiators, attorneys and administrators to handle the long and short term impacts of these changes.