Abstract
Given the financial troubles facing state pension plans in recent years, we examine determinants of the ratio of assets to liabilities, or the funded ratio, based on data for 153 pension plans from 2001 to 2014. The focus is on the relationship between both the actual investment return on pension assets and the assumed return used to discount pension liabilities, or the funded ratio. Importantly, only when appropriate empirical techniques are employed to address potential econometric problems do we find that these two factors have the expected relationship with the funded ratio. Surprisingly, we also find the actual and assumed returns are negatively correlated, even though the correlation is quite low. Furthermore, the assumed return is on average higher than the actual return and has a much larger marginal effect on the funded ratio. We therefore show how a relatively high value can be assigned to the assumed return to make a pension plan appear to far healthier than actually is the case.
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Notes
The Pension Benefit Guaranty Corporation, which itself is facing financial difficulties, is a federal agency created by the Employee Retirement Income Security Act of 1974 (ERISA) to protect pension benefits in private-sector defined benefit plans. For more information, go to www.pbgc.gov.
A few states have hybrid plans that combine features of both defined benefit plans and defined contribution plans. For information on such states, see Barth and Jahera (2015).
According to Cebula (2014), quantitative easing has not only reduced cash flows for pensions but also placed them under greater interest rate risk.
Private Pension Plan Bulletin Historical Tables and Graphs, U.S. Department of Labor, 1975–2014.
2014 Survey of Public Pension: State & Local Data, the U.S. Census Bureau.
Financial Accounts of the United States, Federal Reserve Board, March 12, 2015.
Financial Accounts of the United States, Federal Reserve Board, March 12, 2015.
See American Academy of Actuaries (July 2012). In addition, it is stated “A plan’s actuarial funding method should have a built-in mechanism for moving the plan to the target of 100% funding” (p. 2).
The null hypothesis of the Sargan’s and Hansen’s tests is that specified orthogonality conditions of the instrument set are satisfied. If we reject the null hypothesis of the Sagan’s or Hansen’s tests, we should strongly doubt the validity of the estimates.
A fixed effects model may suffer from a finite sample bias (see Nickell 1981) because we include a lagged endogenous variable in the equation. We therefore used a GMM estimator and conducted the standard diagnosis statistics (e.g., second order autocorrelation test AR (2)), which did not indicate any issue on the validity of the instrumentation at the 5% significant level.
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Barth, J.R., Joo, S. & Lee, K.B. Another look at the determinants of the financial condition of state pension plans. J Econ Finan 42, 421–450 (2018). https://doi.org/10.1007/s12197-017-9402-1
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DOI: https://doi.org/10.1007/s12197-017-9402-1