@EdWorkingPaper{ai22-674,
title = "An Economic Reformulation of Public Pension Funding Policy",
author = "Robert M. Costrell, Josh B. McGee",
institution = "Annenberg Institute at Brown University",
number = "674",
year = "2022",
month = "November",
URL = "http://www.edworkingpapers.com/ai22-674",
abstract = {Current public pension funding policy has arguably failed on both theoretical and empirical grounds. The traditional actuarial approach elides the risk-return tradeoff at the heart of finance economics and has resulted in steadily rising contribution rates, instead of a sustainable steady state. We propose an economic reformulation of funding policy based on steady-state analysis of the fundamental equations of motion for pension asset and liability growth, incorporating both an expected return on risky assets and a low-risk discount rate for liabilities. Our steady-state result simultaneously conveys the benefit of risky investment and the cost of the associated risk. We integrate our analysis into a simple social welfare function to re-examine the basis for pre-funding and elucidate the net benefits of using risky assets to defray contributions. We also formally derive a family of transition policies for convergence to the expected steady state. We illustrate how the parameters of our proposed policy can be adjusted to manage the tradeoff between long-run contribution rate risk and short-term responsiveness. We believe our analysis provides the basis for reformulating contribution policy in a way that better supports sustainability and coherently conveys the tradeoffs consistent with finance economics.},
}