Blog entry Jack Ehnes

CalSTRS Defined Benefit Program Continues Progress Toward Long-Term Funding Goal
Changes to actuarial assumptions likely to increase State of California and CalSTRS “2% at 62” member contribution rates beginning July 1, 2017

As trusted fiduciaries of California educators’ pensions, on an annual basis, the Teachers’ Retirement Board assesses CalSTRS’ long-term funding status in a detailed actuarial valuation report. In order to support the accuracy of these financial projections, the board periodically reviews actuarial assumptions to ensure the data reflects the system’s recent actuarial experience.

As part of this process, on February 1, the board adopted various demographic and economic assumptions which take into account members’ increasing life expectancies and current economic and market trends. These assumptions will now be used to calculate the actuarial valuation report for the board’s consideration in early April 2017.

The bottom line is that the board’s actions taken on February 1 represent positive opportunities for CalSTRS to further strengthen the fund as we flex to meet current and projected market conditions and the increased lifespans of our dedicated members.

Because of the complicated nature of this topic, I want to provide more background on the careful and measured approach resulting in the board’s adoption of the comprehensive set of new assumptions. I will also share with you why these datasets are critical for CalSTRS’ long-term planning purposes, and how it applies to our more than 914,000 members.

The actuarial experience study is a highly-technical report which has powerful impacts on CalSTRS funding and cost projections. The analysis is conducted every four to five years by an independent third-party actuarial consulting firm, and verified by a separate external actuarial firm. This year’s study encompasses five years of data (July 2010 through June 2015) and represents an overview of the demographic and economic assumptions used to forecast CalSTRS liabilities and assets. 

Three of the key takeaways from the experience study and the board’s recent actions are as follows:

  • The study’s findings indicate that early career members are living an average of two to three years longer than members retiring today. This is important because actuarial experts use projected life expectancy data when calculating costs to the system over a long-term horizon, typically 30 years. This also factors into the system’s overall funding ratio, as well as our projected investment returns and how funds are allocated to pay member benefits. Essentially, if members live longer after retirement, more assets are required to pay for the additional years of benefits they will receive.
  • In order to maintain a realistic view of investment markets, as well as future long-term performance projections, the board reduced the assumed rate of return, also known as the discount rate, to be phased-in over a two-year period. The return assumption was reduced from 7.50 to 7.25 percent for the June 30, 2016 actuarial valuation, to be presented at the April 2017 board meeting. Next year, the return assumption will decrease to 7.00 percent for the June 30, 2017 actuarial valuation, which will be presented at the April/May 2018 board meeting.
  • And, finally, with the updated actuarial assumptions in place, the experience study validated that CalSTRS continues to make progress toward the long-term funding plan enacted in the July 2014 Assembly Bill 1469 legislation.

The investment return assumption receives a lot of debate and discussion in the media. Given the 24/7 news cycle, there is always a variety of conjecture as to what’s happening across the global markets. Some of it is based on sound research, and some just wild guesses on market direction. CalSTRS does not invest the trust fund based on short-term strategies and day trading themes. Rather, our investments staff conduct extensive research and solicit opinions from industry experts with a long-term outlook/perspective – meaning 30 years, which is how the Legislature also looks at funding the system. At times, it can be challenging not to react to short-term up-and-down spikes in the capital markets, but responsibly investing a pension plan with a $196.4 billion portfolio (as of 12/31/16) necessitates looking far past those emotionally-infused periods.

In the past, actuarial decisions made by the board have generated minimal attention due to the fact that contribution rates were fixed by law, and there were no immediate financial implications on the fund or on our members. However, two pieces of recent legislation have changed this. The Public Employees’ Pension Reform Act of 2012 (PEPRA) and the 2014 CalSTRS funding plan both require contribution rate adjustments relative to the cost of the benefits and the necessity of paying off the long-term unfunded liabilities of the system. An unfunded liability occurs when the projected assets of the system are less than the projected costs of the benefits.

Now that the assumptions outlined in the experience study have been adopted by the board, the data will be used to prepare the actuarial valuation for the period ending June 30, 2016. This report, scheduled to be presented at the April 2017 board meeting, provides a snapshot in time of CalSTRS overall financial status and monitors the continued progress toward funding plan goal.

When the board discusses the upcoming valuation, they will discuss potential modest contribution rate increases for the State of California and the CalSTRS “2% at 62” members (first hired on or after January 1, 2013). At this time, there are no additional impacts on employers or the CalSTRS “2% at 60” members, regardless of the actuarial assumptions of the upcoming valuation discussion.

It is important to recognize that the Teachers’ Retirement Board considers and weighs budgetary impacts of any potential contribution rate increases prior to making a decision. However, the board is also exercising their responsibility in accordance with State law in setting the contributions required to continue progress toward the long-term funding plan.

Additionally, both pieces of legislation enacted in 2012 and 2014 further illustrate the shared responsibility of funding the CalSTRS Defined Benefit Program, which involves fair and gradual contribution rate increases for the State of California, over 1,700 employers and CalSTRS’ active member population.

I think it is important to recognize that, although any future changes to contribution rates as a result of the adoption of the new assumptions appear to be relatively modest as a percentage of payroll, the impact on educators’ take home pay and the state budget is real. Nonetheless, adopting assumptions that best match the actual experience of the CalSTRS plan is an important, necessary step in pursuit of the system’s strategic plan goal of ensuring a financially sound retirement system. Delaying action would only serve to defer the costs in the short-term while increasing costs over the long-term.

For more information on any potential contribution rate changes which will be dependent on the board’s discussion of the actuarial valuation in April, refer to CalSTRS experience study press release as well as an estimated contribution rate table for each group.

In summary, the updated demographic and economic assumptions that are now in place more closely match CalSTRS recent actuarial experience and provide an updated perspective of the continued progress toward the system’s long-term funding goals. Additionally, the board’s prudent actions to adopt a more dynamic mortality methodology, phased-in changes in the investments assumed rate of return, and decreased economic-related assumptions, further reinforce the depth of their fiduciary responsibility to meet the financial needs of CalSTRS more than 914,000 members and their beneficiaries well into the future.

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