Whistling Past a Graveyard

What are the odds PERA can earn a 7.25 percent return?

Now for the scary stuff.

In its analysis of Colorado PERA, the Pension Integrity Project at the Reason Foundation examined rate of return forecasts by asset class from three reputable firms. It then looked at the probability of earning PERA’s current estimated  rate of return — 7.25 percent per year — and rates of return higher and lower than that.

Before we get into the numbers, it’s only fair to issue some caveats. The Pension Integrity Project points out that these are estimates, and by their very definition lack precision. Its model looks at specific PERA’s asset allocations and maps them against “forecasts of return by asset class generally. Probability estimates are approximate as they are based on the aggregated return by asset class.”

Nevertheless, this probability analysis gives us a good sense of how hard it would be for PERA to climb out of its deep hole based on returns alone.

OK, here are some numbers.

Based on BNY Mellon 10-year forecasting, the most optimistic of the three, PERA has a 36 percent chance of meeting its rate-of-return goal of 7.25 percent over the next decade. To have even a 50 percent chance of meeting its goal, PERA would have to drop its estimated returns to 6.5 percent. And to hit a more prudent 75 percent probability of meeting its goal, PERA’s assumed rate of return would have to drop to 5 percent.

But wait. It gets worse.

According to JP Morgan, a fund with asset allocations like PERA’s has just a 31 percent chance of hitting a 7.25 percent rate of return ion the next 10-15 years. The rate would have to drop to 6 percent to have better than a 50-50 chance of meeting that target. And even dropping to 5 percent would leave PERA with just under a 75 percent chance of hitting the target.

And here’s the gloomiest Gus scenario.

Research Affiliates’ 10-year forecast is the most pessimistic of the three. PERA-like asset allocations would have just a 20 percent chance of hitting 7.25 percent in the next decade, according to this forecast. Dropping to 5 percent annual returns yields a 57 percent probability of hitting the target.

The message here is clear. PERA in all likelihood is painting an irresponsibly over-optimistic picture of future returns, and it’s hard believe its leadership doesn’t know this. What will it take to get PERA to lay its cards on the table and allow for an honest conversation about the dilemma it faces?

As the old cliché goes, the first step toward resolving a problem is admitting you have one. But if your ship has been hit by a torpedo and all you do is plug nail holes, how effectively are you confronting the problem, and how likely are you to stay afloat?

1 Comment

  • Lisa Bennetts

    19.09.2017 at 08:26 Reply

    Although the board quite often selects the rate of return, it is the plan actuary who is responsible for determining the reasonableness of that rate. Yes, the rate of return is too high, and there is ample information for the actuary to draw a similar conclusion. Why haven’t they?

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