Public Pension Crisis and Investment Risk Taking: Underfunding, Fiscal Constraints, Public Accounting, and Policy Implications

Authors

Nancy Mohan, University of Dayton
Ting Zhang, University of DaytonFollow

Publication Date

5-8-2012

Series

Policy Paper No. 2012-013

DOI

10.17848/pol2012-013

Abstract

Public pension funds that cover retirement benefits for almost 20 million active or retired employees have been significantly underfunded. An important, though largely overlooked, issue related to pension underfunding is the excessive investment risk levels assumed by public plans. Our analysis suggests government accounting standards strongly affect public fund investment risk, as higher return assumptions (used to discount pension liabilities) are associated with higher investment risk. Public funds undertake more risk if they are underfunded and have lower investment returns in previous years, consistent with the risk transfer hypothesis. Furthermore, pension funds in states facing fiscal constraints allocate more assets to equity and have higher betas. There also appears to be a herding effect in that a change in CalPERS portfolio beta or equity allocation is mimicked by other pension funds. Solutions to excessive investment risk include use of more realistic discount rates such as a Treasury rate or a municipal bond yield to estimate liabilities and regulations or practices that reduce the ability of a plan to shift an underfunding burden to future generations.

Issue Date

February 1, 2012

Sponsorship

W.E Upjohn Institute Grant No. 11-130

Subject Areas

LABOR MARKET ISSUES; Retirement and pensions