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The Causes and Consequences of the Rising Costs of Public Employee Pensions

Jan 2014
Working Paper
By  Joshua Rauh
This paper posits a political economy explanation for why the public sector has remained on the deferred compensation defined benefit (DB) model of pension provision while the private sector has transitioned to defined contribution (DC) plans. Budgeting for deferred compensation in the public sector is generally done on the basis of targeting the mean of a distribution of outcomes of investments in the pension fund’s risky assets. The budget is viewed as balanced under the assumption that the mean is attained. I document that the loading on the stock market of public pension fund assets has increased very dramatically over the past several decades. The mean outcome on which the budget is based therefore is increasingly less reflective of the wide distribution of outcomes that might obtain, and the “expected return” is often an outcome that is substantially less likely than 50% to be realized. Using CalPERS and CalSTRS as examples, I show that the growth in unfunded liabilities since 2000 has been due to a combination of benefit increases, insufficient funding, and poor investment returns. Pension contributions across many US cities have increased substantially since 2000, although nationally benefit payments are exceeding contributions by increasingly wider margins. Cities that are contributing more are reducing some public safety coverage, particularly fire forces.