Simulation Models Illuminate Risks Faced by Public Pension Plans

Commentary

Simulation Models Illuminate Risks Faced by Public Pension Plans

Last year, the Rockefeller Institute of Government released a paper showing how underfunding risks are significantly increased through funding practices commonly employed by public pension plans, such as high discount rates and long open amortization periods. Rockefeller’s Donald Boyd and Yimeng Yin are now back with a new report to consider how investment risks interact with the funding status and contribution rates.

Similar to last year’s paper, this paper is based on a stochastic model that simulates a range of outcomes based on a number of varying parameters (actuarial rules, average investment return, return standard deviation, etc.). Unlike deterministic models that produce specific results that are wholly determined by the initial parameters, stochastic models allow for random variations in generating the results, which in this case enables us to examine the distributions of funded ratios and contribution rates.

The report helps answer two important questions:

  1. How investment risks translate to volatility in funded ratios and contribution rates, and
  2. How specific assumed return rates and investment practices are related to this process of investment risk and volatility.

Read more here.

Truong Bui is a policy analyst at Reason Foundation, where he works on the Pension Integrity Project.