CalPERS presentation: Section 115 trusts can help agencies prefund pension costs, reduce volatility

A CalPERS presenter said Section 115 trusts can give California public agencies “additional options to grow assets and aid in making defined benefits more affordable,” describing the trusts as irrevocably dedicated to pay prospective benefits.

The presenter framed the issue by noting that pensions are long-term employer liabilities that can be expensive and volatile: based on a 20-year average ending June 30, 2024, the presenter said “for every dollar CalPERS pays in pensions, 55¢ comes from investment earnings, 34¢ from employer contributions, and 11¢ from employee contributions.” That funding mix, the presenter said, makes employer contributions and unfunded accrued liabilities (UAL) the primary budgeting challenge for agencies.

CalPERS staff outlined the principal tools agencies using CalPERS have to manage pension costs: a one-time July annual prepayment that applies a 3.4% discount to the UAL portion of annual contributions; a “Fresh Start” amortization reset that shortens repayment schedules (analogized to refinancing a mortgage) and raises near-term payments while lowering long-term interest; and additional discretionary payments (ADPs) that directly reduce UAL principal. The presenter cautioned that ADPs carry liquidity and timing risks and should be sized only from funds an agency will not need for operations.

The presentation described Section 115 trusts — created under Internal Revenue Code Section 115 — as another tool that can be used to prefund both normal cost and UAL, increase investment diversification and allow investment earnings to supplement operating budgets. The presenter said CalPERS’ prefunding program includes a pension trust with about $290,000,000 in assets under management and 101 participating agencies, and that the program offers two investment strategies designed to a 10-year horizon.

CalPERS’ participation fee for the trust was described as an all-inclusive rate of 25 basis points charged only to assets in the trust, with no tiered pricing, no fees for changing strategies and no termination or transfer fees. The presenter described those terms as intended to cover program administration rather than generate profit.

On practical use, the presenter said agencies commonly combine approaches — for example, using ADPs to reduce outstanding UAL principal while contributing to a Section 115 trust to smooth future budget impacts and create a stabilization reserve to subsidize higher pension outlays during stress periods. The presenter also recommended agencies use CalPERS tools such as the pension outlook tool and schedule consultations to review plan-specific valuations and options.

The presentation included implementation cautions: market performance affects the effectiveness of additional payments and trust growth; Section 115 trust contributions are generally irrevocably dedicated to retiree benefits; and some actions (for example, reallocating operating reserves) could reduce agency liquidity. The presenter closed by directing interested agencies to contact CalPERS’ Prefunding Programs team and to follow the program onboarding steps described in the briefing.

CalPERS’ presentation was informational; no formal actions or votes were taken during this session.