Thursday, November 4, 2010

What discount rate should the California teacher's fund use?

From my colleague, Craig Newmark:

The Cal teacher's retirement fund is set to vote on whether to reduce their assumed discount rate from 8% to 7.5%.  I've blogged on this a couple of times before (here and here).

Reducing the rate will have the effect of increasing the reported present value of the liability faced by the State of California.  In reality the liability remains unchanged - the fund owes what it owes.  In fact, because this liability is guaranteed - it must be paid - the correct discount rate is probably much nearer the risk free rate of interest which is about 4%.