The “New Normal” In Public Pension Investment Returns
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Policy Brief

The “New Normal” In Public Pension Investment Returns

The primary culprit of growing pension debt has been the across-the-board investment underperformance of pension assets relative to plans’ own return targets.

Executive Summary

Despite a decade-long bull market—and even before the arrival of the COVID-19 pandemic-related market turmoil of March 2020—many “defined benefit” (DB) pension plans covering U.S. state and local government employees have continued grappling with growing unfunded liabilities. And the primary culprit of growing pension debt, according to analyses by the Pension Integrity Project at Reason Foundation, has been the across-the-board investment underperformance of pension assets relative to plans’ own return targets.

This unwelcome emergence of the “new normal” lower-yield investment environment is characterized by low dividend yields, ultra-low interest rates, subdued economic growth, subpar inflation, and increased market volatility/risk. Furthermore, most financial advisors now portend muted, compared to the past 30 years, investment returns for institutional investors over the next 10–to-15 years.

But, despite the mounting evidence and informed projections of the “new normal” lower-yield environment, many public pension plans postpone adjusting their investment risk policies and long-term rate of return (and discount rate) targets to the new realities.

The implications of inaction could be severe. If, for example, pension trustees are wrong on the expected investment returns (and on the discount rate), then they will continue gradually adding more unfunded pension liabilities (i.e. pension debt) and weaken their cash flow, which is crucial for managing annual benefit payouts. Furthermore, leading economists agree that when state and local governments discount their pension liabilities at high rates, they understate the contributions needed to pre-fund promised pension benefits. And putting off pension payments further degrades cash flow and leads to long-term fiscal disaster.

Each state and local government pension plan is unique with its own set of problems, and budget trade-offs are a large part of the public finance equation. And yet, faced with such headwinds, policymakers and pension trustees must acknowledge the evidence supporting the changing investment reality and the “new normal” for pension plans. Doing so sooner rather than later, by taking proactive steps, will position these state and local public pension systems to better secure promised pensions, and weather any economic, capital market, or other fiscal storms along the way.


Over 16 million state and local government employees across the U.S. participate in “defined benefit” (DB) pension plans that rely primarily on regular contributions (both from employers and employees) and asset returns in order to pre-fund promised pension benefits for teachers, law enforcement officers, judges, and other public service workers. As much as 63 percent of overall pension revenue between 1989 and 2018 came from investments alone, according to the National Association of State Retirement Administrators (NASRA).

It is, however, now clear that over the past decade the capital markets have drastically changed; sustainable double-digit yields are long gone. Public pensions lost a significant portion of their assets in the aftermath of the dot-com crash in the early 2000s (when most public pensions were 100 percent funded), and then again during the 2007–08 financial crisis.

This chain of asset losses, followed by muted returns, plunged many jurisdictions into a spiral of unfunded pension liability accruals and debt payments. With pension liabilities growing faster than assets, costs of underfunding are claiming a disproportionate amount of tax revenues, escalating funding concerns for elected leaders. According to an analysis by Fitch Ratings, from 2001 to 2017 public pension liabilities and assets grew at compound annual rates of 5.2 percent and 3.4 percent, respectively.

At press time, it is premature to offer more than informed speculation on the potential impacts of the recent market turmoil—with the S&P 500 Index dropping by 30 percent by mid–March of 2020 below its records just a month ago—brought about by the global response to the COVID-19 pandemic. However, it is safe to say that because most U.S. public pension funds had still not yet fully recovered from the Great Recession by 2020—despite a decade-long bull market—they will hardly withstand another such crisis without suffering a major blow to their asset levels and long-term solvency prospects.

Similarly, most leading financial advisors project subdued capital market returns in the next 10-to-15 years. As The Group of Thirty Steering Committee and Working Group on Pensions recently pointed out: “[t]he ongoing fluctuations in asset prices and the likely ‘new normal’ future of low real asset returns for a protracted period of time create major uncertainties for individuals, policymakers, and pension fund professionals.” But despite the mounting evidence of changed capital market realities and a likely need to curb investment expectations amid this “new normal” in the global capital markets, many U.S. public pension administrators (or in some cases, policymakers) continue to maintain assumed investment returns in the 7 percent-to–8 percent range.

Defenders of maintaining unrealistic asset return assumptions tend to make a few common arguments:

  • Public plans’ average returns over the last three decades have actually exceeded the assumed returns.
  • Public plan return assumptions take the long-term view, so short-term volatility should be of no serious concern.
  • Investment risk decreases over time, so the long-term view justifies the high assumed returns.

In the following sections, we will explore these and other arguments in the context of the “new normal” lower-yield environment and its implications for the future of public pension finance and unfunded pension liabilities across U.S. jurisdictions.

Full Policy Brief: The “New Normal” In Public Pension Investment Returns


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