The San Diego City Employees’ Retirement System (SDCERS) Board of Administration today voted to reduce the System’s discount rate to 7.25%, affirming a recommendation by the system’s actuary Cheiron. The Board of Administration approved the new discount rate at its meeting by a vote of 8-4.
This is the third time the rate has been changed since 2008, when it was changed from 8.0% to 7.75%, the first change in decades. In 2011, the discount rate was further reduced from 7.75% to 7.5%.
The discount rate, or the rate at which a system discounts future liabilities of member benefits to determine their actuarial present value, is set by the SDCERS Board of Administration with input from the system actuary. Rate adjustments are prompted by several key factors, including historical plan experience, expectations for the future, the Board of Administration’s risk preference as well as industry trends.
“If the two major market downturns of the last decade have taught us anything, it’s that pension plans need to manage risk,” stated Cheiron CEO and principal consulting actuary Gene Kalwarski. “Trustees for any plan should decide how much risk, if any, they are willing and can afford to take. Based on that risk appetite, the appropriate funding and investment strategies will emerge. SDCERS has adjusted the rate based on their risk appetite and appropriate funding strategies for the long term health of the System.”
Following market trends over the past decade, lowering the discount rate has become more common among municipal pension systems across the country and within California. According to a 2012 survey by the National Association of State Retirement Administrators (NASRA), many plans have reduced their investment return assumption since 2009. The median assumption is 7.8%; however, the number of plans assuming 7.5% or lower has increased significantly, according to NASRA.
“This was a carefully considered decision for the Board of Administration to make, as we understand the impact it will have on our members and on our plan sponsors,” stated Board President Ed Kitrosser. “The adjustment is a prudent, fiscally conservative risk-reduction measure, designed to protect the long-term health of the System and safeguard system assets that pay vested benefits of our members. Pension plans have long-term commitments, and our Board of Administration has a fiduciary obligation to ensure the System is equipped to meet those commitments.”
The Board also took action on wage inflation assumptions, reducing the rate to 3.3% from 3.75% and confirming the salary wage inflation for the City of San Diego will be 0% through FY 2018. This confirmation is based upon negotiated wage agreements between the City and its bargaining units.
The agreements, finalized in May 2013, were multi-year agreements that freeze pensionable pay levels. The impact to the City’s ARC from these agreements was estimated to be approximately $1 billion over the next 30 years in the analysis published by the Office of the Independent Budget Analyst in 2012. The pensionable pay freeze through FY 2018 will be included in the June 30, 2013 valuation, as will a revised pensionable wage increase assumption for FY 2019 and beyond of 3.3%.
The lower discount rate will increase the City’s ARC payment, Unfunded Actuarial Liability (UAL) and member contribution rates. However, the multi-year wage agreements and the Board’s action to lower the wage inflation assumption will more than offset the lowering of the discount rate. The precise impact of the discount rate and wage inflation rate assumption changes will be unknown until the release of the June 30, 2013 valuation in January 2014. Preliminary estimates by SDCERS’ actuary indicate the impact to be approximately a $12 million decrease to the City of San Diego’s ARC in FY 2015, an increase of $0.6 million to the San Diego Unified Port District’s FY 2015 ARC and an increase of $0.1 million to the San Diego County Regional Airport Authority’s FY 2015 ARC.
SDCERS administers defined benefit plans for the City of San Diego, the San Diego Unified Port District, and the San Diego County Regional Airport Authority and provides service retirement, disability retirement, death and survivor benefits to more than 20,450 members. As of September 30, 2013, SDCERS had approximately $6.3 billion in net investments.