The market recovery after the Great Recession has prompted many to claim that most government pension plans are now back in good shape, and that pension reform is largely no longer necessary. Pension expert Andrew Biggs in this paper shows how the recovery is exaggerated and that pension reform is still imperative.
Despite the recent strong investment returns, less than half of government pension plans (41 percent) paid in full their annual required contributions (ARC) in 2013. The worse thing is that the current ARC is already a very low bar to meet, due to the excessively high discount rates and the long amortization periods adopted by US public pension plans. If those plans used a lower discount rate and a shorter amortization period, in line with the rules governing private plans, the total employer ARC as a percent of payroll would quadruple.
The high discount rate, combined with declining yields on low-risk investments, has also encouraged public plans to take increasing investment risk, leading to higher volatility of pension contributions. This means more difficulty for governments in planning budgets and higher chances of contribution shortfalls.
Using a corporate bond yield to discount pension benefits would drop the average funded ratio for public plans from the official 71 percent to 46 percent in 2013, and would more than double the aggregate unfunded liability to $2.6 trillion.
To read the full paper, go here.