So with all the discussion about PERA, one key aspect of pension accounting hasn’t yet been mentioned: the discount rate.  Now before you go all accounting-comatose on me, understand how important this is.  Because with all the talk of how underfunded PERA is, it’s actually even more underfunded than you think.

Basically, if you have an obligation to meet, the discount rate is the rate you use to see how much money you need to have now in order to meet that obligation.  So if you’re going to have to make good on a $100,000 obligation 10 years from now, and you use a 4.5% discount rate, you need to have about $65,000 now.  If you use an 8% discount rate, you only need about $46,000.

Of course, the discount rate isn’t arbitrary.  It represents a concept.  The discount rate is the required rate of return, the return that an investor in that project requires, given the level of risk that he’s taking on.

The problem here, and how this relates to PERA (and many, many other public pensions), is that PERA is using the wrong discount rate.  Instead of using the 4.5% discount rate, they’re using the 8% discount rate, which makes them look even less underfunded than they are.

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