How a Pension Discount Rate Deceives the Public


Over on Tiverton Fact Check, I’ve used Tiverton’s police pension as an example to show how the high assumptions for investment returns work to give taxpayers a false sense of security:

The problem is that 7.5% is a very high return to hit every year.  According to the latest actuarial report, Tiverton’s pension fund lost$332,601 last year, which is about -3.4%.  In other words, because we needed a 7.5% increase, we were 10.9% short.  Tiverton should havestarted this year with another $1,065,971 or so in the bank.

Investment professionals will tell you not to panic, because we have to expect the market to go up and down, and what’s important is the average over years and decades.  One bad year is not the end of the world, and during the three years prior to this loss, Tiverton beat its 7.5% every year.

Two things make this picture too bright.  The first is that 0% isn’t the break-even number in this calculation — 7.5% is — which means every loss is huge and every gain is smaller than it seems. The second is that coming up short one year means there’s less in the bank to invest the next year, so the gain the next year has to be even bigger.