One of the main points of contention about PERA has been the expected rate of return. \u00a0Up to 2001, PERA used an expected rate of return of 8.75%, but lowered that to 8.5% from 2002-08, and again to 8% in 2009, where it now stands.<\/p>\n

So how has PERA done since 2001, when it stood at a 100% funding level? \u00a0The chart below shows the annual return over those 11 years for which they’ve reported, plus an estimated return based on a similar portfolio from CalPERS, the California pension plan. \u00a0CalPERS has a .99 correlation with PERA, which is about as close to metaphysical certainty as anything human gets. \u00a0In 2012, CalPERS reported a 13.26% return, which would project a 13.9% return from PERA, so just for grins, I’ve plugged that into the 2012 spot.<\/p>\n

The red line is the running CAGR from 2001, or Cumulative Average Growth Rate for 2001 through the current year.<\/p>\n

<\/p>\n

As you can see, over time the red line becomes less volatile, as more years are factored into the average.<\/p>\n

The green and purple lines are where it gets interesting. \u00a0Those lines are the return that PERA would have to see over the remainder of the 30-year window from 2001-2030, in order to meet the 8.75% and 8% targets. \u00a0So, for instance, after 2007, in order to have a CAGR of 8.75% from 2001-2030, PERA would have to have returns of 9.3% from 2008-2030.<\/p>\n

Note that using the 8% return from 2001 basically gives hindsight credit to PERA, since in 2001 they were projecting 8.75%, not 8%. \u00a0Let’s blow up that part:<\/p>\n

<\/p>\n

As you can see, PERA started out with poor 2001 and 2002 returns, which put it in an immediate hole. \u00a0Even good returns from 2003-2007 only got the required returns down to 9.3% and 8.3%, respectively. \u00a0Then 2008 happened. \u00a0By now, we’re 12 years into that 30-year window, and even a good year like 2012 will only push the required return down a little bit, about 0.3%. \u00a0For instance, it would take 7 years of 15% returns to get the required return for the 8.75% line down to below 8.75%, in effect, to catch up to the 8.75% projection, and it would take 5 more years to catch up to the 8% projection. \u00a0It’s highly unlikely that even 5 years will pass without a normal, cyclical recession, and attendant lower returns.<\/p>\n

The average return is 6.28%, the CAGR is lower, just over 5%. \u00a0In fact, any set of returns with an average of 8%, but which are not actually 8% each year, will compound to less than 8%, making it that much harder to make up ground. \u00a0Bear that in mind when someone talks about how easy it is to make up for a couple of bad years.<\/p>\n

All of this argues for using a Monte Carlo simulation to determine solvency, rather than a simple rate of return. \u00a0Such a model is a little more expensive to run, but will give a far more accurate picture of the health, or lack thereof, of any defined benefit plan.
\n