Sweat the Small Stuff: Strategic Selection of Pension Policies Used to Defer Required Contributions

Abstract

The administrators of state‐sponsored defined benefit public pension plans have considerable discretion to determine the accounting and actuarial parameters used to calculate the normal cost contributions and amortization payments that, together, comprise the sponsoring state's annual required contribution amount. Using longitudinal data from the Public Pension Database and a fixed effects approach, we find evidence that suggests plan administrators decisions about cost and amortization methods are influenced by the normal cost and amortization payments, respectively. When these costs increase, administrators tend to use less prudent methods that defer, or keep low, the pension contributions required from the state while, simultaneously, and perversely, improving the appearance of the plan's funded status and the state's funding discipline. (JEL H75)

Public-sector pension plans and the discount rate assumption: The role of political incentives

“…Eaton and Nofsinger (2004) examine the choice of actuarial assumptions and find that fiscally constrained states are more likely to increase their expected rate of return to discount future liabilities and to increase the period over which their liabilities are amortized. Finally, Diebold, McDonald, and Reitano (2018) note that with an increase in the generosity of a pension, administrators tend to adopt less prudent methods that defer the pension contributions required. This paper contributes to both of these strands in the literature by simultaneously analyzing the role of incentives and the fiscal health of a plan in the choice of actuarial assumptions.…”