Biggs and Smetters: Understanding the argument for market valuation of public pension liabilities (AEI Report)

ABSTRACT:

This paper first reviews how public pensions value their liabilities under current GASB rules. Next, it outlines the standard approach to valuing liabilities from an economic point of view and what this market-based approach implies for public-sector pensions and their funding levels. Following that, the authors provide examples designed to better convey the qualitative principles regarding the economic approach to pension liability valuation.

The emphasis here is not on detailed calculations of how fair-market valuation would affect pension funding in states and cities around the country, nor the increased budgetary burden the pensions might impose.Likewise, the emphasis is not on how defined-benefit pensions might be reformed in light of information conveyed via more accurate accounting rules.

Rather, the intent is to provide readers with a better handle on the simple intuition that lies behind the economists’ call for fair-market valuation of public pension liabilities. Those who follow the debate are aware that economists argue for using lower discount rates to value public pension liabilities but often are unaware of why economists believe what they do. This paper aims to better articulate those beliefs.

 

Available for download here.

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