Year of Publication

2011

College

Martin School of Public Policy and Administration

Executive Summary

Defined benefit retirement plans for state employees have come under fire, both financially and politically, following recent market volatility and subsequent losses in pension investments. Asset losses matched with liabilities that are set years in advance translate to pressures on state policymakers and plan administrators to either find ways to improve the finances of these pension systems or transition to defined contribution plans that put the financial risk on individual employees rather than the state government. Because most states are legally and contractually obligated to pay retiree benefits regardless of the pension system’s financial condition — even to the point of paying benefits out of their general funds — this looming threat could be borne not just by public service retirees, but by those who receive the benefits of public schools, social services, and other important public programs.

Defined benefit plans gain funding from three sources: employee contributions, employer (state government) contributions, and earnings on investments. While the first is largely unchangeable for current workers, the latter two come under constant scrutiny. This research seeks to investigate the role these two funding sources have played in various state pension plans’ financial conditions.

Using data from the U.S. Census Bureau, the National Association of State Retirement Administrators, and the Center for Retirement Research at Boston College for Fiscal Years 2001-2008, this report evaluated three aspects of plan funding: 1) employer contributions relative to actuarial recommendations, 2) investment returns, and 3) asset allocation decisions. This was done by both simple time-trend analysis and regression analysis.

This research suggests that while there is little connection between broad asset class allocation and pension plan investment returns, and little connection between investment returns and the overall financial condition of individual pension systems, two factors may play a role in pension plan finances.

First, there is a small but distinct difference in asset allocation decisions between states that had financially sound pension systems for state retirees at the end of Fiscal Year 2008, and those that did not. Better-funded plans tended to place a larger share of their investments in cash and stocks, and a smaller amount in bonds and alternative investments. Second, states that regularly contributed the full amount recommended by plan actuaries were more likely to have financially sound pension systems.

Although these results are not conclusive, they suggest that further research in this area may prove instructive to policymakers.

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