Proposing a Funding Rate for US State Pension Plans

60 Pages Posted: 2 Feb 2023 Last revised: 13 Apr 2023

See all articles by Robinson Reyes-Peña

Robinson Reyes-Peña

Florida International University

Krishnan Dandapani

Florida International University (FIU) - Department of Finance

Edward R. Lawrence

Florida International University (FIU) - Department of Finance

Date Written: December 16, 2022

Abstract

US state pension plans generally use overstated discount rates based on historical performance, creating the appearance of healthy funding at the cost of future underfunding. Conversely, adopting a US Treasury discount rate, or another alternative suggested by previous literature, would cause overstated funding gaps and contribution increases, mainly due to statutory reserve regulation. For funding purposes, we identify a lower limit to the discount rate, defined as the Value-at-Risk return of the portfolio with the lowest risk assessment. Adopting this limit curtails intervaluation losses for 94% of funds, while entailing the lowest increase in contributions vi-à-vis any other alternative.

Keywords: State pension funds, funding shortfall, long-term discount rate, global minimum variance portfolio, investment risk, zero interest rate, discount rate, pension plans

JEL Classification: G11, G23, H55, H75, H79, J26

Suggested Citation

Reyes-Peña, Robinson and Dandapani, Krishnan and Lawrence, Edward R., Proposing a Funding Rate for US State Pension Plans (December 16, 2022). Available at SSRN: https://ssrn.com/abstract=4345143 or http://dx.doi.org/10.2139/ssrn.4345143

Robinson Reyes-Peña (Contact Author)

Florida International University ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

Krishnan Dandapani

Florida International University (FIU) - Department of Finance ( email )

Edward R. Lawrence

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

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