Linking Benefits to Investment Performance in Us Public Pension Systems

45 Pages Posted: 27 Oct 2012 Last revised: 2 Nov 2012

See all articles by Robert Novy-Marx

Robert Novy-Marx

Simon Business School, University of Rochester; National Bureau of Economic Research (NBER)

Joshua D. Rauh

Stanford Graduate School of Business; Hoover Institution; National Bureau of Economic Research (NBER)

Date Written: October 2012

Abstract

This paper calculates the effect that introducing risk-sharing during either retirement or the working life would have on public sector pension liabilities. We begin by considering the introduction of a variable annuity for the retirement phase, modeled on the Wisconsin Retirement System, in which positive benefit adjustments are granted only if asset returns surpass 5% but benefits cannot fall below their initial levels. This change would reduce unfunded accrued liabilities by around 25%, and would lower the annual contribution increases required to target full funding in 30 years by 11%. If there is no minimum benefit guarantee, the impact of introducing variable annuities is substantially larger: the unfunded liability would fall by over half and required annual contribution increases would fall by 44%. Alternative measures that have similar effects on costs include increasing employee contributions by 10.3% of pay while keeping benefits unchanged; or giving employees a collective DC plan with an employer contribution of 10% of pay for future service. We discuss these results in the context of models of lifecycle portfolio choice, which suggest that employees should generally prefer to take risk earlier in their lives rather than later.

Suggested Citation

Novy-Marx, Robert and Rauh, Joshua D., Linking Benefits to Investment Performance in Us Public Pension Systems (October 2012). NBER Working Paper No. w18491, Available at SSRN: https://ssrn.com/abstract=2167594

Robert Novy-Marx (Contact Author)

Simon Business School, University of Rochester ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
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Joshua D. Rauh

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Hoover Institution ( email )

Stanford, CA 94305-6010
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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