The Denver Post<\/em> is reporting that negotiators are nearing a deal<\/a> on PERA, the generous defined-benefit plan that most state workers have benefited from over the years:<\/p>\n

The major changes to the Public Employees’ Retirement Association include increasing employee and employer contributions by 2 percent and reducing cost-of-living increases for current retirees from 3.5 percent this year, capping them at 2 percent….<\/p>\n

Several issues remain to be resolved, most revolving around age of retirement and years of service needed to get full benefits, but both men said those issues could be resolved by the time lawmakers convene for their 120-day session next week….<\/p><\/blockquote>\n

So let’s assume that accounting for the government worked the same as accounting for a private pension.\u00a0 In fact, in this case, there’s no good reason why it shouldn’t.\u00a0\u00a0 Basically, the plan has assets and obligations, but both of those change over time.\u00a0\u00a0 So the inputs to the model are 1) Actuarial Assessments, and 2) Interest Rate Assessments.<\/p>\n

Actuarial assessments include things like Years of Service, Age of Retirement, Years of Benefits, Salary Increases (due to seniority), Benefit Increases (due to age).\u00a0\u00a0 Interest rate assessments include benefit inflation, health care inflation, discount rate, and return on plan assets.<\/p>\n

The things that can be adjusted generally fall into Actuarial Assessments, and that’s where the article focuses.\u00a0 Retirement age and years of service all fall into this category.\u00a0 What’s critical is the stuff that’s left out.\u00a0 We have no idea what the plan’s assumed rate of inflation, discount rate, rate of benefit inflation or health care inflation are, or what the assumed return on investment is.\u00a0 We don’t know what they’ve assumed them to be in the past.\u00a0 If those numbers are unrealistic, or even aggressive, we’ll likely find ourselves right back in the same place a few years from now.<\/p>\n

Consider a simple scenario, where the plan assumes a constant 8% real return on plan assets.\u00a0 Historically, this might be reasonable.\u00a0 But if the bulk of the return is in the out years, the plan will have depleted its assets before those returns can catch up, and will run out of money.\u00a0 (Cool graphs on this topic here<\/a>.)\u00a0 If you could forecast how returns would change over time, you’d have a more accurate model, but the fact is, as we’ve seen time and again, it’s impossible<\/em> to make those sorts of predicts 5 years out, never mind 25 years out.\u00a0 Which means that the solvency of any<\/em> defined-benefit plan is mostly guesswork.\u00a0 Promises of long-term solvency are simply mirages.<\/p>\n

Maintaining a defined-benefit for incoming and even current employees\u00a0 is not realistic (promises made to those already retired must be honored).\u00a0 The only fair way to move forward is to transition to a defined-contribution plan, which has only assets, and by definitions, no liabilities.\u00a0 Unfortunately, the political will for this move doesn’t seem to exist.<\/p>\n

UPDATE: According to the actuarial projections<\/a> accompanying PERA’s legislative recommendations<\/a>, they are indeed projecting a constant 8.0% return for the next 30 years.\u00a0 This strikes me as aggressive.\u00a0 But they key point to remember is that these returns are never <\/em>constant, and that the shape of that returns curve strongly affects the ending balance.\u00a0 There is simply no way for even the best prognosticators to get that right, and worse, no acknowledgment in the docs that it even matters.
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