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Linking Benefits to Investment Performance in US Public Pension Systems

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  • Robert Novy-Marx
  • Joshua D. Rauh
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    Abstract

    This paper calculates the effect that introducing risk-sharing during either retirement or the working life would have on public sector pension liabilities. We begin by considering the introduction of a variable annuity for the retirement phase, modeled on the Wisconsin Retirement System, in which positive benefit adjustments are granted only if asset returns surpass 5% but benefits cannot fall below their initial levels. This change would reduce unfunded accrued liabilities by around 25%, and would lower the annual contribution increases required to target full funding in 30 years by 11%. If there is no minimum benefit guarantee, the impact of introducing variable annuities is substantially larger: the unfunded liability would fall by over half and required annual contribution increases would fall by 44%. Alternative measures that have similar effects on costs include increasing employee contributions by 10.3% of pay while keeping benefits unchanged; or giving employees a collective DC plan with an employer contribution of 10% of pay for future service. We discuss these results in the context of models of lifecycle portfolio choice, which suggest that employees should generally prefer to take risk earlier in their lives rather than later.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18491.

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    Date of creation: Oct 2012
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    Publication status: published as Robert Novy-Marx, Joshua D. Rauh. "Linking Benefits to Investment Performance in US Public Pension Systems," in Robert Clark and Joshua Rauh, organizers, "Retirement Benefits for State and Local Employees: Designing Pension Plans for the Twenty-First Century" Elsevier, Journal of Public Economics (2014)
    Handle: RePEc:nbr:nberwo:18491

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