This won't come as a shock to anyone following funding problems in public sector pensions, where unfunded liabilities have reached some $3 trillion when calculated using a reasonable rate of investment return, but a new paper by several academic economists concludes that government employee pension funds have used an increasingly risky investment strategy that is not only dicier than that used by private pension funds, but also riskier than the investment approaches of public pension funds in other countries.
The paper attributes the investment strategy of our state and local pensions to the fact "that they can decide their strategic asset allocations and liability discount rates largely without much regulatory interference, due to wide latitudes allowed in the currently applicable Government Accounting Standards Board (GASB) guidelines."
The authors of the new paper point out there are several things wrong with this pursuit of ever riskier investments. The first is that it has occurred during a period in which most funds have "matured," that is, the ratio of retired members who must be paid benefits has increased relative to the total population of the funds. That generally calls for decreasing risk because of the need to send money out the door every month.
The second problem is that our pensions have increased their degree of risk at a time of declining interest rates, when other funds do the opposite: as rates declined others have lowered their projections for future investment returns thanks to the necessity of investing a certain amount of assets in less-risky, interest-bearing fixed-income products. As the authors conclude:
The authors of the new paper point out there are several things wrong with this pursuit of ever riskier investments. The first is that it has occurred during a period in which most funds have "matured," that is, the ratio of retired members who must be paid benefits has increased relative to the total population of the funds. That generally calls for decreasing risk because of the need to send money out the door every month.
The second problem is that our pensions have increased their degree of risk at a time of declining interest rates, when other funds do the opposite: as rates declined others have lowered their projections for future investment returns thanks to the necessity of investing a certain amount of assets in less-risky, interest-bearing fixed-income products. As the authors conclude:
In summary, our results suggest that over the last 20 years U.S. public funds uniquely increased their allocation to riskier investment strategies in order to maintain high discount rates and present lower liabilities, especially if their proportion of retired members increased more. These decisions by the boards of U.S. public DB pension funds have large economic effects and could have potentially severe future consequences.
Join the conversation