Munnell, Aubry & Hurwitz: How Sensitive is Public Pension Funding to Investment Returns?

ABSTRACT:

A recent Issue in Brief projected that, under the most likely scenario, the aggregate funded ratio for state and local pension plans will increase from 73 percent in 2012 to 81 percent in 2016.1 The “optimistic” and “pessimistic” scenarios assume higher or lower, but also constant, rates of return. While this type of deterministic analysis is useful, an analysis that takes into account the variability of investment returns from year to year provides a more complete picture of the risks of serious underfunding. Hence, this brief builds on the previous analysis by extending the projections of pension funding through 2042, using stochastically generated investment returns to quantify the probability that specific outcomes will occur. This exercise, for illustrative purposes, centers around the average real return adopted by plans themselves.

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