Pension Fund Asset Allocation and Liability Discount Rates: Camouflage and Reckless Risk Taking by U.S. Public Plans?

Abstract:     
Using an international pension fund database, we compare the asset allocations, liability discount rates, and performance across six groups: public and private pension funds in three regions (United States, Canada, and Europe). U.S. public funds face distinct regulations that link the liability discount rate to their expected return on assets rather than to the riskiness of their promised pension benefits. Accordingly, they behave differently from all other pension funds. In the past two decades, U.S. public pension funds uniquely increased allocations to riskier investments to maintain high discount rates (especially as more members retired), thereby camouflaging the degree of underfunding. This increased risk-taking is associated with an annual underperformance of more than 60 basis points and seems to be driven by the conflict of interest between current and future stakeholders, and could result in significant costs to future workers and taxpayers.

Number of Pages in PDF File: 49

Keywords: pension funds, public policy, defined benefit, risk-taking, asset-liability management, asset allocation, liability discount rates, retirement, mature, regulation

JEL Classification: G11, G18, G23, H55

working papers series