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Policy options for state pension systems and their impact on plan liabilities*

Published online by Cambridge University Press:  12 April 2011

ROBERT NOVY-MARX
Affiliation:
Simon Graduate School of Business, University of Rochester, 305 Schlegel Hall, Rochester, NY 14627, and NBER (e-mail: robert.novy-marx@simon.rochester.edu)
JOSHUA D. RAUH
Affiliation:
Kellogg School of Management, Northwestern University, 2001 Sheirdan Road Evanston, IL 60208, and NBER (e-mail: joshua-rauh@kellogg.northwestern.edu)

Abstract

We calculate the present value of state pension liabilities under existing policies and separately under policy changes that would affect pension payouts. If promised payments are viewed as default free, then it is appropriate to use discount rates given by the Treasury yield curve. If plans are frozen at June 2009 levels, then the present value of liabilities would be $4.4 trillion. Under the typical actuarial method of recognizing future service and wage increases, this figure rises to $5.2 trillion. Compared to $1.8 trillion in pension fund assets, the baseline level of unfunded liabilities is therefore around $3 trillion. A 1 percentage point reduction in cost-of-living adjustments (COLAs) would lower total liabilities by 9–11%; implementing actuarially fair early retirement would reduce them by 2–5%; and increasing the retirement age by 1 year would reduce them by 2–4%. Dramatic policy changes, such as the elimination of COLAs or the implementation of Social Security retirement age parameters, would leave liabilities around $1.5 trillion more than plan assets. This suggests that taxpayers will bear the lion's share of the costs associated with the legacy liabilities of state DB pension plans.

Type
Articles
Copyright
Copyright © Cambridge University Press 2011

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