A study presented by the Brookings Institute suggested that many state and local (Pay-as-you go) pension funds do not need to be fully funded in order to be able to meet required benefit payments. Without the added pressure of making contributions, governments may be better able to allocate money to residents, infrastructure, and education, according to Brookings.
Highlights from the study include:
- The study took on the debate about the appropriate liability discount rate for public plans. Rather than advocating for a lower discount rate that further increases underfunding, Brookings argued that the appropriate discount rate should be tied to public finance. In their view this is because unfunded pension liabilities are another form of government debt. This premise supported the continued use of higher expected asset return assumptions when discounting plan liabilities.
- The authors determined that being underfunded is not inconsistent with paying benefits in perpetuity. Using data from 40 public pension plans, the study included calculations to determine when plans could be expected to exhaust assets. About half of the 40 plans in the study would exhaust assets in 88 or fewer years if a 2.5% discount rate was used. Higher discount rates significantly improve the number of plans that would be sustainable over the next 99 years.
- Many state and local pension plans have started reforms such as benefit reductions, which are projected to ease general underfunding over the next 20 years. The study proposed additional reforms to contributions and asset management as a way to extend sustainability, and suggested these fiscal changes commence now rather than in the future.