How Sensitive is Public Pension Funding to Investment Returns?
This brief reinforces the importance of public pension plans adopting sound funding policies. It finds that while it is important to look at investment returns and adjust them as needed, there can be a range of outcomes, even if investment returns are met. Key findings and takeaways include:
- To assess the sensitivity of pension funding to investment returns, the analysis projects funded ratios to 2042 for large public plans using a stochastic model of year-to-year returns and a median real return of 4.45 percent, the average used by plans in 2012.
- The baseline results show that the funded ratio for the 50th-percentile outcome does not reach 100 percent because the analysis presumes that plans will pay only 80 percent of annual required contributions (ARC), the average for the last two years, and amortization approaches produce inadequate contributions.
- Paying 100 percent of the ARC and using more robust funding approaches leads to near full funding by the end of the period.
- The variability of returns poses a risk of funding shortfalls.