The Role of Economic, Fiscal, and Financial Shocks in the Evolution of Public Sector Pension Funding

Abstract

Abstract:Many studies have documented the pervasive underfunding of public sector pension plans in the United States in recent years. The deterioration of the funded status of public pension plans coincided with severe fiscal crises that state and local governments experienced in the 2000s. This development has led to a suspicion that state and local governments have decreased employer pension contributions as a backdoor means of running fiscal deficits. In this paper, the authors investigate the extent to which this phenomenon has occurred.They estimate panel data regressions using the Boston College Center for Retirement Research's Public Plans Database, which provides data for 2001 through 2010. The authors find that contrary to popular belief, plan sponsors do not reduce their contributions in response to negative fiscal or economic shocks. In contrast, plan sponsors' contributions to their pension plans increase in response to growth in their unfunded liabilities.The authors document that the public pension underfunding crisis during the 2000s developed largely as a consequence of portfolio returns that fell short of expectations. Public pension plans' assets portfolios have a relatively high share of equities and other risky assets, leaving the plans' funded status vulnerable to asset price fluctuations. Although plan sponsors increased their contributions in response to the growth of unfunded liabilities, they did not do so by enough to fully counteract the effect of the subpar portfolio returns. This finding holds across the spectrum of plans ranked in terms of funded status in 2010.

The Governance of Public Pensions: An Institutional Framework

“…If it is the latter, researchers will inaccurately assert that financial stress shifts resources away from pension contributions in situations when, in fact, the contribution actually increases, but just not by as much as the required contribution. The first interpretation is common among pension researchers, but preliminary research shows support for the latter (Triest & Zhao, 2013).…”

“…If it is the latter, researchers will inaccurately assert that financial stress shifts resources away from pension contributions in situations when, in fact, the contribution actually increases, but just not by as much as the required contribution. The first interpretation is common among pension researchers, but preliminary research shows support for the latter (Triest & Zhao, 2013). Table 1 illustrates three groups of explanatory variables that are used to measure the effect of political economies on the financial performance of public pensions: (a) political preferences, (b) fiscal stressors and constraints, and (c) administrative professionalism.…”

Fiscal condition, institutional constraints, and public pension contribution: are pension contribution shortfalls fiscal illusion?

“…From the budget management standpoint, accumulative pension payment shortfalls are somewhat analogous to the debt that accumulates from operating deficits. Pension benefits are a form of deferred employee compensation, failure to set aside enough funding to cover the pension benefits those employees earned for that year is equivalent to not fully paying the labor cost component of the operating budget with current‐year revenues (Triest & Zhao, 2013; Rauh, 2017). Peng (2004) showed that pension contributions were used as a countercyclical budgetary tool as policymakers lower pension contributions below required levels when faced with budget deficits.…”

“…Previous studies have evaluated the funding soundness of pension systems by examining pension funding levels, however, this study focuses on the percentage of ADEC paid as a proxy for a government's budgetary decision to meet its pension obligation (St.Clair, 2013; Triest & Zhao, 2013). Since pension funding measures are largely affected by investment earnings, which account for 60%–70% of pension assets (National Association of State Retirement Administrators [NASRA], 2020; Urban Institute, 2017), fiscal conditions and fiscal constraints are more visibly and precisely measured through state pension contributions.…”

Actuarial Inputs and the Valuation Of Public Pension Liabilities and Contribution Requirements: A Simulation Approach

“…A third limitation of the existing research is that it assumes a constant, simultaneous relationship between discount rates and the financial condition of public pensions. All of the studies that regress the financial condition of public pensions on discount rates specify a linear relationship (Mitchell and Hsin ; Mitchell and Smith ; Rich and Zhang ; Triest and Zhao ). Other researchers assume a linear relationship in the way that they attempt to standardize financial conditions across multiple pension systems that have different discount rates and salary growth rates.…”