CalPERS Announces 9.3% Investment Return for FY2024. What does that mean for your agency?

On July 15, 2024, the California Public Employees’ Retirement System (CalPERS) announced a preliminary 9.3% investment return for FY2024. This is a much welcomed relief after two years of investment underperformance.

As a reminder, in FY2022, CalPERS lost 7.5%, a heavy blow to the funded status of California's public pensions. While the pension fund did better in FY 2023, the return still fell slightly short of the 6.8% target (also known as the discount rate) that is required to maintain the funded level and avoid further unfunded accrued liability (UAL) increases.

The 9.3% investment return for FY 2024 marks the first time in three years that CalPERS was finally able to exceed their discount rate. It translates into 2.5% of excess earnings over the 6.8% discount rate. This helps lower UAL balances and UAL payment amounts for California public employers. The official calculations will become available once the FY2024 actuarial reports are published in summer of 2025.

The 30-year history of the CalPERS investment return is shown in the graph below.

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With the FY 2024 investment return exceeding the 6.8% target, the California’s public pension system slightly increased its funded level from 72% to 75%.

The investment performance was driven by healthy gains in the public stock (17.5% gain), private debt (17% gain), and private equity (10.9% gain) portfolios, while real assets posted a 7.1% loss and fixed income earned a modest 3.7% return. It should be noted that the private equity, real assets, and private debt return calculations usually lag by a quarter and still could be adjusted.

To quantify what the 9.3% investment return means for your agency, it is important to understand the math of pension plan funding within the CalPERS system.

For the pension system to stay on track and avoid significant UAL increases, CalPERS needs to average 6.8% in annual investment returns. This target is called the discount rate, or the minimum average rate of return that CalPERS needs to achieve in perpetuity so that its member agencies could meet their retirement obligations to employees, retirees, and other beneficiaries. Every time that CalPERS misses the return target, additional UAL is created. However, when investment returns exceed the target, the UAL is reduced.

To estimate the FY2024 excess return impact on your UAL, you can to multiply the market value of assets within your pension plan by the 2.5% excess earnings. That will be the approximate amount by which the UAL will be reduced. For each $1 million in pension plan assets, roughly $25,000 of existing UAL will be removed from each agency’s account.

The lower UAL will first be reflected in the 2024 actuarial reports, which CalPERS will publish in July/August of 2025.

The FY2024 performance will result in higher funded status of pension plans, lower UAL balances, and lower future UAL payments, as the effect of the excess earnings will be spread over the next two decades. There should be no change to the Normal Cost contribution rates due to the investment performance.

The impacts of the FY2024 investment performance are illustrated below:

If CalPERS continues to follow its current amortization practices, the FY2024 UAL reduction will be phased in over a 20-year period starting with FY2027, with a five-year credit ramp-up. The 2027 UAL credit will be 20% of the full annual credit amount, the 2028 credit will be 40% of the full annual credit amount, the 2029 credit will be 60% of the full annual credit amount, and the 2030 credit will be 80% of the full annual credit amount. Only in 2031 will the credit be fully phased in and continue at that level for 15 more years.

The years with excess returns should be allowed to work in your favor. Unlike UAL increases, which result in negative amortization, unamortized UAL credits create additional investment income for your agency's pension account. Thus, you probably don't want to take them off the ramp-up to maximize their benefit.

Recently CalPERS elected to pause automatic discount rate reductions in years with excess investment returns. Instead, the Board of Administration is now required to review whether the discount rate should be reduced in the future. It remains to be seen if a reduction will be implemented, but the 5-, 10-, and 20-year average returns are all below the 6.8% return target.

Besides the investment-related UAL changes, CalPERS also performs an annual reconciliation to ensure that actual plan experience matches with the actuarial assumptions. This reconciliation will result in additional UAL changes for FY2024, but we will find out about them only in July/August of 2025.

Ridgeline Municipal Strategies, LLC can help you evaluate the impacts of the FY2024 investment performance on your pension costs and implement appropriate pension cost optimization and mitigation strategies.

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