LACERA's retirement fund relies on three sources of funding: investment earnings, employer contributions, and employee contributions (except noncontributory Plan E).
LACERA is legally obligated to monitor the fund and make strategic adjustments to the Assumed Rate of Investment Return (interest rate) and contribution rates, as needed, to strengthen the fund and fulfill our legal duty to pay the promised benefits.
The County Employees Retirement Law of 1937 (CERL) and the Public Employees’ Pension Reform Act of 2013 (PEPRA), the laws governing LACERA, provide the rules for the establishment and adjustment of these rates.
Investment Earnings and Assumed Rate of Return
Historically, investment earnings have accounted for about 70 percent of the money necessary to pay the promised benefits. The Assumed Rate of Investment Return is the minimum rate of earnings the retirement fund must average over 30 years in order to provide the funds needed to pay the promised benefits. It is also referred to as the interest rate in recognition of the interest earned (or assumed will be earned) on fund investments; the interest LACERA applies semiannually to member contributions; and the interest LACERA charges on purchase contracts.
How the Interest Rate Is Determined
According to Section 31453 of CERL, not less than every three years a system valuation must be conducted under the supervision of an actuary (see below for more about what actuaries do). A system valuation is an examination of the pension plan to determine whether contributions are being accumulated at a rate sufficient to provide the funds needed to pay the benefits promised by law.
The valuation covers the mortality, service, and compensation experience of members and beneficiaries and evaluates the assets and liabilities of the retirement fund. The actuary then recommends any necessary interest rate changes to the Board of Investments (BOI) for approval. Rate changes approved by the BOI must be presented to the Board of Supervisors for approval at least 45 days prior to the beginning of the next fiscal year, July 1.
In 2009, the BOI adopted a Retirement Benefit Funding Policy requiring the plan actuary to conduct annual valuations of plan liabilities and assets to measure the pension plan's funding progress and to make strategic recommendations. Such recommendations may include proposals for changes to the interest rate and/or employee and employer contribution rates.
Employer and Member Contribution Rates
In accordance with California retirement law, employer and member contribution rates are adjusted regularly based on actuarial methods and assumptions that project the system’s ability to pay for future benefits.
A decrease in the investment return assumption signifies an expectation of lower investment earnings by the fund. When the investment return assumption is lowered, typically the employer and member contributions are increased so the retirement system will continue to receive adequate funding. When the investment return assumption is increased, employer and member contributions are lowered, as the retirement system is expecting to receive more funding from investment earnings and therefore requires less funding from contributions.
Rate adjustments are based on recommended actuarial methods and assumptions (determined in triennial investigation of experience studies) and annual pension fund valuations. (See LACERA’s Financial Reporting page for current and previous years’ studies and valuations.)
Employer rates are updated every year and include the annual cost of benefits not covered by employee contributions; half of the cost-of-living benefits; and contributions to cover the unfunded liability, which is the difference between the pension liability accrued (for existing and future retirees) and the retirement system's assets.
Member contribution rates for legacy plans (General Plans A, B, C, D, and Safety A and B) depend on entry age and are adjusted every three years; member rates for PEPRA plans (General G and Safety C) are flat rates for all ages and are adjusted annually.
PEPRA Plan Contribution Rates and 50/50 Cost-Sharing
PEPRA, which took effect January 1, 2013, requires 50/50 cost-sharing between the employee and the employer. In accordance with this law, LACERA members who enter membership after 2013 are enrolled in new plans—General Plan G or Safety Plan C—that are structured for 50/50 cost-sharing.
The cost referred to under 50/50 cost sharing is the retirement system’s Normal Cost, which is the cost to pay for the pension benefits earned in the current year. In determining 50/50 cost-sharing, the actuaries determine the total amount of contributions needed in a year to fund the benefits accrued in that year.
That cost is split evenly between employer and employee. Contribution rates in 50/50 cost-sharing plans are based on a flat rate; members of each respective plan pay the same contribution rate, regardless of their entry ages. Rate negotiations between the employer and employee groups are not permitted under PEPRA.
What Actuaries Do
An actuary is a statistician who calculates the probability of the occurrence of an event such as death or disability. Actuaries who work with administrators of defined benefit plans like LACERA study the actual experience of the pension plan to create assumptions (known as actuarial assumptions) regarding each member’s future salary increases, age at retirement, and life expectancy. They also apply those assumptions to assess the level of pension contributions required to help ensure pension plans are maintained on a sound financial basis.
Actuaries formulate economic and demographic assumptions that forecast the probability of future events that affect the outcome and duration of pension benefits. Based on these assumptions, actuaries project the expected cash flow required to fund future benefit payments.
Demographic assumptions deal with factors affecting when benefits will become payable and the amount of those benefits. This type of assumption includes projections on the likelihood of a member’s termination of employment, retirement, disability, or death at each age.
Economic assumptions deal with factors affecting how assets grow and how salaries increase. Such factors include inflation, investment returns, plan expenses, and salary schedules. Actuaries use economic assumptions to determine the present value of future liabilities (promised benefits) and salary increases.
When changes in some or all of the actuarial assumptions occur, actuaries recommend adjustments to interest and contribution rates accordingly.