Wednesday, March 7, 2012

CalPERS should not lower its assumed rate of return

Bloomberg is reporting today that the chief actuary for CalPERS, Alan Milligan, has advised the retirement system's board to lower the fund's assumed rate of return on its investments from 7.75 percent to 7.50 percent. Doing so will cause local governments in California affiliated with PERS to pay substantially higher rates to fund the pensions for their employees and retirees whose pensions are currently underfunded.
Feb. 14 (Bloomberg) -- California Public Employees’ Retirement System, the largest U.S. public pension, should consider changing its assumed rate of investment return, its actuary said. Trimming the forecast may add to taxpayer costs.

“It could have a very significant impact on employer contribution rates,” actuary Alan Milligan told the Calpers governing board in Sacramento today. He said he would make more specific recommendations to the panel in March.

Milligan made this same request a year ago:
Calpers last year rejected his proposal to reduce the presumed rate of return to 7.5 percent. Board members at the time expressed concern that the lower figure would burden local governments when they were already facing financial strains.

Mr. Milligan's timing strikes me as quite odd. CalPERS has been riding the wave of increasing stock values since the market bottomed out. Its portfolio has performed the last two fiscal years.
In the fiscal year ended June 30, Calpers earned 20.7 percent, its best result in 14 years, led by stocks and private equity.

The numbers on the PERS website say the fund earned a 20.9 percent (not 20.7 percent) return in the fiscal year ending June 30, 2011. And as you can see in the chart below, the average annual return on investment over the 20 year period ending June 30, 2011 is 8.41 percent. In fact, beginning with the 1991-92 fiscal year, CalPERS has never ended a fiscal year since then in which its average annual rate of return did not exceed its assumed rate of return of 7.75 percent.

Unless Mr. Milligan has a strong argument in favor of the proposition that market rates of returns over the next 5, 10 and 20 years will fail to achieve what have been normal market returns over the last 20, 30, 50 and 100 years, I think the CalPERS board would be mistaken to listen to their actuary's advice. Given the recent strength in stocks, it's hard to understand why Milligan would suggest what he is suggesting today.

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