Finance and Administration Committee

Agenda Item 7c
September 14, 2021

Item Name: Review of PERF Actuarial Assumptions
Program: Actuarial Office
Item Type: Information
Executive Summary
In accordance with the CalPERS Board of Administration’s Actuarial Assumptions Policy, theActuarial Office (ACTO) has completed its statutorily mandated investigation (experience study)of the actuarial assumptions. The assumptions reviewed include both the economic
assumptions and the demographic assumptions. This agenda item contains the preliminary
recommendation for new actuarial assumptions as well as a draft copy of the experience study
report. The final recommendation for the adoption of new actuarial assumptions by the board iscurrently scheduled to occur in November 2021.
One primary economic assumption, the rate of return on investments, cannot be determineduntil the board selects an asset allocation. Depending on the asset allocation selected, costs forthe pension plan could be materially different. Aside from the rate of return on investment, allother recommended assumptions are not expected to have a material impact on contribution
rates for most plans; contribution rates would vary positively or negatively by a minor amount.
However, cost increases are expected for a few groups including the California Highway Patrol.
If adopted, these proposed assumptions would become effective with the June 30, 2021
actuarial valuations. Contribution rates for the state and schools plans would be impacted in the2022-23 fiscal year. Public agencies would be impacted in the 2023-24 fiscal year.
See Attachment 1 for a copy of the draft experience study report.
Strategic Plan
This item is presented as part of the regular ongoing workload of the Actuarial Office andsupports the fund sustainability goal of the CalPERS 2017-2022 Strategic Plan.

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Finance and Administration Committee
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BackgroundAn experience study is a summarization of actual experience over a defined period and, alongwith future expectations, is used in setting actuarial assumptions. Experience studies which
include reviews of both economic and demographic assumptions are required every four years
under the Board’s Actuarial Assumptions Policy and Government Code §20133. The previous
experience study was completed in 2017. Note that actuarial standards of practice require theactuary to evaluate whether assumptions are reasonable for every valuation, so some change inassumptions could be recommended in the intervening years between mandated experiencestudies.
Not all demographic assumptions have the same relative impact on the results of the actuarial
valuations (and hence on employer contribution rates). In almost all cases, retirement benefits
make up most of the liabilities of a retirement system such as CalPERS. Accordingly,
assumptions that affect retirement benefits will have more of an impact than assumptions that
only affect death, disability, or termination benefits. Since retirement rates, salary increases andpost-retirement mortality all affect the valuation of retirement benefits, these assumptions
generally have a much greater impact on contribution rates than do other demographic
assumptions.
Economic assumptions affect all benefits as well as the expected return on plan assets and tend
to have a significant impact on contribution rates.
Analysis
COVID-19 Impacts
The current pandemic has had an impact on the operation of public retirement systems acrossthe nation and the world. Based on the timing of this study, the member data used for ouranalysis, which runs through June 30, 2019, does not include impacts of COVID-19. Preliminary
analysis of system experience since the beginning of the pandemic has shown demographic
experience (e.g., retirements, deaths, etc.) did differ from the current actuarial assumptions insome areas. These differences will be more precisely quantified in actuarial valuations dated
June 30, 2021 and beyond. At this time, we do not believe that the demographic impacts of
COVID-19 will have a material impact on system experience going forward. Therefore, theexperience analyzed through June 30, 2019 in this study is the primary driver of recommended
assumptions to be used for future valuations.
Review of Economic Assumptions
Actuaries use certain economic assumptions to set a contribution schedule of employee andemployer contributions designed to accumulate with interest to an amount sufficient to provide
for all benefits expected to be paid to members and their beneficiaries. The economic
assumptions used to determine liabilities and set contribution rates are price inflation, wage
inflation, payroll growth and the discount rate assumption.

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Finance and Administration Committee
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The summary of the result of the review of economic assumptions is as follows:•Price Inflation Assumption: Currently, the Board has approved an annual priceinflation assumption of 2.50%. Since the 2012 study, price inflation has consistently
been under 2% per year. Going forward, market indicators today point to an expectationthat future price inflation may be in the range of 2% to 2.50% per year. We recommendthat the inflation assumption be decreased from 2.50% to 2.25% per year. This would
place the assumption closer to the levels expected in the financial markets and predictedby economic models.

•

Wage Inflation Assumption: Currently, the real wage inflation assumption is 0.25%.
Historical data shows that national increases in total compensation have generally
outpaced price inflation by between 0.50% to 1%. Even though this difference may besomewhat smaller in the public sector, we recommend increasing our assumed real
wage inflation assumption to 0.5%. This results in a total wage inflation of 2.75%.

•Payroll Growth Assumption: The payroll growth assumption is used as the payment
escalation rate when amortizing unfunded liability (of open plans) established before
June 30, 2019 in accordance with the current Board policy. The current assumption isthat the aggregated payroll of open plans will grow at a rate of 2.75% per year. Since webelieve payroll will grow in the future at a rate roughly equal to wage inflation, werecommend keeping this assumption at 2.75%.

•Discount Rate Assumption: The primary economic assumption is the discount rateassumption. This is the sum of assumed price inflation and the expected long-term real
rate of return. The current discount rate assumption is 7%. As part of the Asset Liability
Management process, the board will consider various candidate investment portfolios
presented by the CalPERS team. The board is expected to select the new portfolio
during the November board meeting. This decision will then determine the discount rate.

Review of Demographic Assumptions
In addition to the economic assumptions, several demographic assumptions are used to set thecontribution schedule of employee and employer contributions. These demographic
assumptions include mortality rates, retirement rates, disability rates (both work and non-workrelated), and rates of salary increases due to seniority and promotion.
After performing the review of demographic assumptions, we recommend several changes tothese assumptions. We believe the new assumptions will result in an improvement for predicting
long-term future experience over the current assumptions.
Life expectancies in the developed world are improving and this is consistent with the data inthe experience study. ACTO believes that proper funding of the system requires the continued
inclusion of mortality improvements in the mortality assumption. This is consistent with bestpractices and changing actuarial standards.

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Finance and Administration Committee
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The summary of the result of the review of demographic assumptions is as follows:• Mortality: A significant change to the methodology used for projecting future mortality is
being recommended in this study. However, the implementation of these changes is notexpected to have a significant impact on valuation results. The current approach
estimates mortality improvements for 15 years in the future and reflects thoseimprovements in the current mortality rates. A more precise approach is to allow theestimated annual improvements in mortality to impact mortality rates one year at a time in
the future. This is referred to as generational mortality improvements. In addition toimplementing this change, the study recommends that mortality rates be adjusted for theassumption that members with higher retirement benefits have lower mortality rates thanthose with smaller benefits. Therefore, a set of benefit weighted mortality rates wascreated in order to reflect this observation.
•Retirement Probabilities: Some groups experienced lower numbers of retirements

than expected including State Miscellaneous, Schools Pool and Public Agency
Miscellaneous plans. Other groups such as CHP, State Peace Officers and Firefightersand certain public agency safety groups experienced more retirements than expected.
•Salary scale: Higher than expected salary increases were observed within certain

groups including CHP, State POFF, State Miscellaneous, State Safety, and the Schools
Pool. Other groups experienced slightly lower than expected increases including State
Industrial and Public Agency County Peace Officers.

•Disability Retirement: Our analysis indicated that in general there have been fewer

disability retirements for State Miscellaneous Female, State Industrial, State Safety,
Schools and public agency members than expected based on the current assumptions.
We are recommending slightly reduced non-industrial disability retirement rates for thesegroups. For all other groups, actual experience was generally close to expected.
•Other assumptions: Mixed results for other assumptions that have minimal overall
impact on cost. These are described in detail in the experience study report.

See Attachment 1 for the draft Experience Study report detailing the development of all actuarial
assumptions.
External Review of Experience Study
As in the prior experience study, an external actuarial audit is underway. The final audit reportwill be presented in November.
Impact on Employer Contribution Rates
The estimated impact of the recommended assumption changes on the total employer
contribution rate and the total normal cost are listed in Attachment 2.

Agenda Item 7c
Finance and Administration Committee
Page 4 of 5Budget and Fiscal ImpactsThe experience study and review of assumptions was prepared internally and will be reviewed
externally. Funding was already identified within existing budgetary resources.
Benefits and Risks
Actuarial assumptions determine the expected costs of the plan. The actual long-term costs ofthe plan will be revealed as the plan’s experience is realized. Assumptions that align with future
expectations are necessary if costs are to remain stable. Assumptions that are overly optimistic
produce artificially low current costs but lead to significantly higher future costs. The opposite istrue for assumptions that are overly pessimistic.
By adopting the proposed assumptions, CalPERS ensures that the resulting contribution
requirements reflect, to the extent possible, the true cost of the plan under the actuarial
methodology and policies adopted by the Board.
Attachments
Attachment 1 – Draft Experience Study Report
Attachment 2 – Impact on Contribution Rates
Attachment 3 – Review of PERF Actuarial Assumptions PowerPoint Presentation

Randall Dziubek
Deputy Chief Actuary, Valuation Services

Scott Terando
Chief Actuary

Agenda Item 7c
Finance and Administration Committee
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