Colorado PERA’s Defined Benefit Pension Funds are Facing Insolvency

Good afternoon Chairman Neville, thank you for the opportunity to testify this afternoon.

My name is Anthony Randazzo, I am a Senior Fellow the Pension Integrity Project at Reason Foundation, a 501(c)3 nonprofit, think tank. The Pension Integrity Project works with policymakers, labor associations, and other interested stakeholders around the country by offering data-driven analysis and policy concepts designed to improve the overall solvency of public-sector retirement systems.

Over the past several months we have had the opportunity to work with a range of stakeholders here in Colorado to provide technical assistance in understanding the causes and scope of PERA’s sustainability challenges. In that capacity we have developed robust actuarial models of PERA’s Schools and State divisions to perform various solvency and stress tests.

The unfortunate reality is that PERA does face a solvency crisis. In virtually every plausible scenario, the State and Schools divisions will either run out of money in the next few decades or come very close with funded ratios below 10%. Without an increase in the contributions into PERA, there is a very real likelihood that several divisions will run out of funds around 2040.

It is valuable to have a robust debate about where contribution rates should come from — employer or employee, or both — and how such increases might be mitigated with changes to the Annual Increase or prospective benefit design. However, these political and policy debates must start with the underlying premise that the additional dollars are needed.

The primary factor driving unfunded liabilities for PERA is that assumptions about the future have not matched actual experience. In particular, investment returns and withdraw rate assumptions. This has also been the primary reason that SB1 from 2010 has not fully solved the problems facing Colorado PERA — while the changes provided then were a positive change, the entire plan for solvency was based on assumptions that were quickly shown to be unrealistic.

Thus, this committee and the legislature would be wise to ensure that any reform bills adopted address in some way the methods and assumptions used to forecast and ensure plan solvency. To the degree that such changes are not affordable under the status quo budget and revenue structure, at the very least more realistic assumptions and best practice methods should be adopted prospectively.

In addition to our solvency analysis of PERA’s pension funds, we have also analyzed the PERA investment portfolio and its underlying capital market expectations against independent capital market forecasts.

PERA’s investment expectations today are that there is around a 50% chance of earning a 7.25% return. Some of our independent analysis suggests that the probability is probably closer to 30% that PERA will return 7.25% over the next couple of decades. But in either case this is a fairly significant amount of risk.

A very conservative investment outlook would suggest that if Colorado wanted close to a 75% probability of success on the existing portfolio, the assumed return should be closer to 5% to 6% (depending on the capital market expectations).

Ultimately, the risk tolerance of Colorado is a decision the state and its pension board trustees need to make for themselves. However, the given the high degree of risk for the current assumptions it is worth bearing in mind how that might change the future funding of PERA — if the investment returns are just 5.25% (reasonably likely) over the next 20 years instead of 7.25% (at best 50-50 chance), then in less than 25 years the State and Schools division will run out of cash.

The Pension Integrity Project does not take a position any specific piece of legislation, but we do have seven objectives we think all good pension reform legislation should adhere to. We have put together an analysis of SB200 and how it stacks up against these benchmarks and with the Chairman’s permission I will distribute a copy to the committee and would be happy to walk through the details in Q&A should any Senator wish to further discussion.

Thank you again for allowing me to present and I am happy to take any questions you may have.

Note: the distributed analysis available here: PERA_TestimonyTable