Tag Archives: Rockefeller Institute

Pension funding practices and investment risk

A recent paper by Donald J. Boyd and Yimeng Yin of The Nelson A. Rockefeller Institute of Government at SUNY  investigates how public pension funding practices contribute to big funding gaps and the need for sudden contribution increases. This is a situation public sector plans find themselves in due to three reasons 1) muddling the valuation of debt-like pension liabilities with the plan’s investment strategy (i.e. using discount rates basked on risky asset portfolios to measure pension liabilities) 2) amortization methods and 3) asset smoothing.

To find out the impact of these assumptions the authors build a stochastic simulation model for public sector plans that allows them to look at how different funding policies affect plan funding. They find that the funding polices and practices of most plans reduce the volatility of contributions and increase the risk of severe underfunding. And “even if investment return assumptions (7.5 percent annually) are met every single year and employers make the full actuarially determined contributions” they would only reach 85 percent funding after 30 years.

Now consider that it’s unlikely that plans will meet the 7.5 percent annual return each year. If investment returns vary – as they do –  the same plan faces a one-in-six chance of falling below 40 percent funding.

The authors have an interesting chart from a recent presentation highlighting what happens when returns vary each year. In reality, a plan with a portfolio made up of a mix of stocks and bonds is likely to achieve greater than 7.5 percent return in some years and less than 7.5 percent returns in other years). Current plan assumptions project steady and gradually increasing funding ratios and completely flat contribution levels. But in reality, it is all over the map: a roller coaster for funding levels levels and the potential for a huge ramp up in contributions.

Source: Boyd and Yin, 2016 "Standards and Metrics for Public Retirement Systems" The Nelson A. Rockefeller Institute at SUNY

source: Boyd and Yin, 2016, “Standards and Metrics for Public Retirement Systems” The Nelson A. Rockefeller Institute at SUNY

New York: Stimulus Bellwether

With its fiscal year beginning in April, New York is the first state to pass its budget, serving as a early indication of how stimulus funds are being employed.

About $144 billion of the total stimulus was to be used by states to plug shortfalls and defray the need for tax increases. New York took the most it could get: $7.2 billion and according to David Schaffer of the Rockefeller Institute writing at Stateline.org, the state will raise taxes by $7 billion, “while sticking with spending patterns that could pose enormous fiscal problems when the stimulus runs out.”

With its fortunes closely tied to the financial sector, how New York fares in the coming months,  Schaeffer notes, provides a bellwether for stimulus effectiveness,  not only for how the state manages its fiscal house, but for the federal bet that pump-priming is the antidote to recession.

The scenario suggested by the Rockefeller Institute is not positive.  Some states will still be running huge deficits and openly discussing the need for a second federal bailout.