The Probability of Fulfilling Pension Promises: Pennsylvania’s Illustration

Commentary

The Probability of Fulfilling Pension Promises: Pennsylvania’s Illustration

A recent study by Erick Elder and Gary Wagner at the Mercatus Center, George Mason University, examines the nexus between investment returns and pension funding levels for Pennsylvania’s two largest public pension plans, Pennsylvania’s Public School Employees’ Retirement System (PSERS) and the State Employees’ Retirement System (SERS). Having assets of more than $75 billion, the two plans are unfunded by as much as $100 billion under market valuation.

The study finds that while the two plans have a 100 percent probability of having sufficient assets to pay benefits without increasing contributions for the next five years, the probability drops after the five-year period. In 15 years from now, PSERS and SERS will have only a 31 percent chance and a 16 percent chance, respectively, of sufficient funding. In 50 years, the probabilities are only 4 percent for PSERS and 1.5 percent for SERS.

Based on financial modeling for the two plans, the study illustrates key ideas applicable to all public pension plans:

– Investment return volatility implies a high chance that even fully funded plans may have insufficient assets to cover their future benefit obligations.
– A proper discount rate should reflect the riskiness of future pension liabilities, not the expected returns of pension assets.
– Overfunding pensions can lead to political pressure for benefit increases.

To read the full study, go here.

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