SFERS Board Cuts Rate of Return to 7.4%

The minuscule cut reduced the expected rate of return from 7.5%, the highest return projections of any pension plan in California.

The board of the $24.5 billion San Francisco Employees’ Retirement System (SFERS) has approved a small reduction to its expected rate of return to 7.4% from 7.5%, retaining the system’s status as having the most optimistic return projections of any public pension plan in California.

The return assumption comes as the pension system’s general investment consultant, NEPC, forecasts that the plan’s investment returns will see a lower 6.9% annualized investment return over the next five to seven years. On a 30-year basis, NEPC is more optimistic, predicting an annualized return of 8%.

A video stream of the board’s meeting on Nov. 14 and agenda material shows that the system’s actuary, Cheiron, recommended the system’s board take one of three options on the rate of return assumption: cutting it to 7%, 7.25%, or 7.4%.

A Cheiron analysis shows that the median return expectations of all California public pension plans over the next three decades was 7.2%, with four plans below 7%. The lowest plan had a 6.75% rate of return. Cheiron said while the San Francisco system has the highest projected rate of return in California, 7.5% was in line with the median national US average of 7.5%.

The largest US pension plans, the $361.1 billion California Public Employees’ Retirement System (CalPERS) and the $320 billion California State Teachers’ Retirement System (CalSTRS), each have dropped their assumed rate of return to 7% from 7.5%.

Cheiron projects that the action taken by SFERS, cutting the rate of return by one-tenth of 1%, reduces the pension system funding level to 86% from 87% and increases the unfunded liability to $3.6 billion from $3.3 billion.

If the plan had cut its rate of return to 7.25%, the unfunded liability would have increased to $4.1 billion, an 85% funding level, and if it went down to 7%, the unfunded liability would have gone up to $4.9 billion, or an 82% funding level.

“Those are ugly numbers,” the system’s Executive Director Jay Huish told the board.

Huish said the mayor’s office had authorized him in meetings to tell the board that the city was comfortable with the reduction in the rate of return to 7.4%. Huish said he had briefed city officials on the rate of reduction cuts being considered. While the retirement system operates independently from the city, three of the seven members are appointed by the mayor, and a fourth member is appointed by the president of the board of supervisors.

Pension plan costs have a huge impact on the city of San Francisco.

Under the plan cutting the rate of return to 7.4%, the city’s cost per employee for pension benefits varies in different years over the next decade but is as much as 25% of salary per employee in 2021 to a low of 19.2% in 2024, shows a Cheiron analysis.

Each percentage point drop has an even greater impact. For example, if the rate of return had been cut to 7.25%, the city’s cost per employee over the next decade would have risen to a high of 26.1% in 2021 to a low of 21% in 2024, the Cheiron forecast shows.

If NEPC is right, and the pension system does not achieve its short-term return expectations, the system’s funding ratio would fall and SFERS might be forced to raise the contribution rate even higher. The Cheiron analysis does not examine the shortfall impacts on the pension plan’s unfunded liability if the annualized short-term rate of return falls below 7.4%

Cheiron data shows the pension plan has been unable to meet its return assumptions over the last 20 years. The actuarial firm said the annualized return for the pension system was 7.1% over that period compared to an expected assumed rate of return of 8.25%. Using a shorter five-year period, however, Cheiron noted that SFERS achieved on average a 9.4% return, higher than the expected rate of return. The pension plan has had a 7.5% expected rate of return since 2014, when it lowered the rate of return from 7.58%.

SFERS board member Joseph Driscoll, a fire captain, told the board that he favored the 7.4% rate of return before the unanimous vote approving it. He said public pension system critics, who have argued that a lower rate of return as practiced by corporate pension plans (often in the area of a 5% rate of return) were not realistic and that reduction would lead to a 40% to 45% contribution rate per employee for the city.

“We’re not going down that road,” Driscoll said, noting that “a realistic rate that is achievable is 7.4%.”

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