August 30, 2024
Circular Letter: 200-040-24
Topic: Actuarial

To: All School Employers

Purpose

The purpose of this Circular Letter (CL) is to provide updated projections of the employer contribution rates that reflect the 9.3% CalPERS preliminary investment return for fiscal year (FY) 2023-24 (without reduction for administrative expenses). This CL also projects contribution rates under different investment returns in future years known as a “scenario test”.

Employer Contribution

The school employer contribution rate for FY 2024-25 is 27.05% of payroll and is projected to increase in FY 2025-26 to approximately 27.4%. The actual school employer contribution rate will not be known until audited assets and demographic changes as of June 30, 2024, are measured as part of the next actuarial valuation. The actual FY 2025-26 school employer contribution rate will be presented to the CalPERS Board of Administration in April 2025 and will differ from the estimate shown here.

Projected Future Contribution Rates

The table below shows the required and projected employer contribution rates for the current FY and the next five FYs. Projected results reflect an investment gain for FY 2023-24 based on preliminary investment return information released by the CalPERS Investment Office. Further, projected rates reflect the anticipated decrease in normal cost due to new hires entering the Public Employees' Pension Reform Act (PEPRA) benefit tier.

It is assumed that all actuarial assumptions will be realized and that no further changes to assumptions, contributions, benefits, or funding will occur during the projection period. Projections, by their nature, are not a guarantee of future results. Future contribution requirements may differ, perhaps significantly, from those shown below. The actual long-term cost of the plan will depend on the actual benefits and expenses paid and the actual investment experience of the fund.

Under the CalPERS amortization policy, changes in the Unfunded Accrued Liability (UAL) due to investment gains or losses (actual return relative to assumed return for the year) are amortized using a five-year ramp up. This method attempts to mitigate employer cost volatility from year to year by phasing in the impact of investment experience over a five-year period. As a result of this methodology, dramatic changes in the required employer contributions in any one year are less likely. However, required contributions can change gradually and significantly over the next five years. In years when there is poor investment return, the relatively small amortization payments during the ramp-up period could result in a funded ratio that is projected to decrease initially while the contribution impact of the investment loss is phased in. For more information, see the CalPERS Actuarial Amortization Policy (PDF).

Future Investment Return Scenarios

To illustrate the sensitivity of contribution rates to investment return, analysis was performed to estimate the effects of various hypothetical future investment returns on required employer contributions. Projected results reflect an investment gain for FY 2023-24 based on preliminary investment return information released by the CalPERS Investment Office. The projected normal cost rates reflect that rates are anticipated to decline over time as new employees are hired into the PEPRA benefit tier. The projections also assume that all other actuarial assumptions will be realized and that no further changes in assumptions, contributions, benefits, or funding will occur. The projection does not reflect any potential future change to the discount rate stemming from the CalPERS Funding Risk Mitigation Policy. Under this policy, as amended in April 2024, a board review of the asset allocation and discount rate is triggered after a year when investment return outperforms the assumed rate by a specified margin; any change in discount rate is at the board’s discretion.

The first table shows projected contribution requirements if the fund were to earn either 3.0% or 10.8% annually starting in FY 2024-25. These alternative investment returns reflect the 5th and 95th percentile returns of the fund’s portfolio over a 20-year period based on stochastic analysis using capital market assumptions from the Asset Liability Management process completed in 2021.

Required contributions outside of this range are also possible. In particular, whereas it is unlikely that investment returns will average less than 3.0% or more than 10.8% over a 20-year period, the likelihood of a single investment return less than 3.0% or more than 10.8% in any given year is much greater. The following analysis illustrates the effect of an extreme, single year investment return.

The portfolio has an expected volatility (or standard deviation) of 12.0% per year. Accordingly, in a given year there is a 16% probability that the annual return will be −5.2% or less and a 2.5% probability that the annual return will be −17.2% or less. These returns represent one and two standard deviations below the expected return of 6.8%.

The following table shows the effect of a one or two standard deviation investment loss in FY 2024-25 on the FY 2026-27 required contribution. Note that a single-year investment gain or loss impacts the contribution rates for each of the next five years, not just one, due to the five-year ramp in the amortization policy. However, the contribution rates beyond the first year are also impacted by investment returns beyond the first year. Historically, significant downturns in the market are often followed by higher-than-average returns. Such investment gains would offset the impact of these single year negative returns in years beyond FY 2026-27.

Without investment gains (returns higher than 6.8%) in FY 2024-25 or later, projected contributions rates would continue to rise over the next three years due to the continued phase-in of the impact of the illustrated investment gains and losses prior.

Questions

If you have questions, call our CalPERS Customer Contact Center at 888 CalPERS (or 888-225-7377888-225-7377).

 

Scott Terando, Chief Actuary
Actuarial Office