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Accounting for the rise in unfunded public pension liabilities: faulty counterfactuals and the allure of simple gain/loss summations*

  • ROBERT M. COSTRELL (a1)
Abstract
Abstract

This paper provides a methodological critique of an influential method for assessing the impact on the Unfunded Accrued Liabilities (UAL) of the gap between assumed and actual investment returns over extended periods, and offers a sound replacement. The method in question simply sums over time the components of the annual actuarial gain/loss report. This implicitly assumes that in the counterfactual exercise, the interest on the additional UAL is covered dollar-for-dollar by amortization. But under actual funding formulas amortization usually varies less than interest. This means there are large intertemporal interactions between the gap in investment returns and subsequent shortfalls between contributions and interest. Using the actual funding formula in the counterfactual can lead to much higher estimates of the UAL impact of the gap in investment returns because it does not assume away these interactions. This method can more accurately inform policy-makers, regarding the importance of cutting the assumed rate of return.

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An earlier version of this paper was presented at the Fall Research Conference of the Association for Public Policy and Management, November 12, 2015, Miami, FL. I have received particularly helpful comments from Andrew Biggs, Josh McGee, and Martin West. I would like to acknowledge the early support of StudentsFirst and EdBuild for my work on Connecticut.

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Aubry J-P. and Munnell A. H. (2015) Final report on Connecticut's state employees retirement system and teachers’ retirement system. Center for Retirement Research at Boston College, November 2015.
Biggs A. G. (2015) The state of public pension funding: are government employee plans back on track? American Enterprise Institute, Economic Perspectives, September 2015.
Brown J. and Wilcox D. (2009) Discounting state and local pension liabilities. American Economic Review, 99(2): 538542.
Connecticut State Teachers’ Retirement System, various years, Actuarial Valuation.
Costrell R. M. (2016) The 80 percent pension funding target, high assumed returns, and generational inequity. Contemporary Economic Policy, forthcoming, special issue on aging and pensions.
Dobbs R., Koller T., Lund S., Ramaswamy S., Harris J., Krishnan M. and Kauffman D. (2016) Why Investors May Need to Lower their Sights. McKinsey Global Institute, Brussels, San Francisco, and Shanghai.
Malloy D. (Governor of Connecticut) (2015) Connecticut's Economic and Budgetary Reality, PowerPoint presentation, Hartford, CT, 28 October 2015.
Munnell A. H., Calabrese T., Monk A. and Aubry J-P. (2010) Pension Obligation Bonds: Financial Crisis Exposes Risks, Center for Retirement Research at Boston College, Number 9, January 2010.
Munnell A. H., Aubry J-P. and Cafarelli M. (2015) How Did State/Local Plans Become Underfunded? Center for Retirement Research at Boston College, Number 42, January 2015.
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State of Connecticut (2008) New Issue. $2,276,578,270.55 State of Connecticut, Taxable General Obligation Bonds, 16 April 2008.
State of Connecticut (2014) Annual Information Statement, February 28, 2014, revised 8 December 2014.
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Journal of Pension Economics & Finance
  • ISSN: 1474-7472
  • EISSN: 1475-3022
  • URL: /core/journals/journal-of-pension-economics-and-finance
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