Linking Benefits to Investment Performance in US Public Pension Systems

Robert Novy-Marx, Joshua D. Rauh

NBER Working Paper No. 18491
Issued in October 2012
NBER Program(s):   AG   AP   PE

This paper calculates the effect that introducing risk-sharing during either retirement or the working life would have on public sector pension liabilities. We begin by considering the introduction of a variable annuity for the retirement phase, modeled on the Wisconsin Retirement System, in which positive benefit adjustments are granted only if asset returns surpass 5% but benefits cannot fall below their initial levels. This change would reduce unfunded accrued liabilities by around 25%, and would lower the annual contribution increases required to target full funding in 30 years by 11%. If there is no minimum benefit guarantee, the impact of introducing variable annuities is substantially larger: the unfunded liability would fall by over half and required annual contribution increases would fall by 44%. Alternative measures that have similar effects on costs include increasing employee contributions by 10.3% of pay while keeping benefits unchanged; or giving employees a collective DC plan with an employer contribution of 10% of pay for future service. We discuss these results in the context of models of lifecycle portfolio choice, which suggest that employees should generally prefer to take risk earlier in their lives rather than later.

download in pdf format
   (219 K)

email paper

The NBER Bulletin on Aging and Health provides summaries of publications like this.  You can sign up to receive the NBER Bulletin on Aging and Health by email.

This paper is available as PDF (219 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w18491

Published: Linking Benefits to Investment Performance in US Public Pension Systems, Robert Novy-Marx, Joshua D. Rauh. in Retirement Benefits for State and Local Employees: Designing Pension Plans for the Twenty-First Century, Clark, Rauh, and Duggan. 2014

Users who downloaded this paper also downloaded these:
Novy-Marx and Rauh w18489 The Revenue Demands of Public Employee Pension Promises
Clark, Morrill, and Vanderweide w18488 Defined Benefit Pension Plan Distribution Decisions by Public Sector Employees
Brown, Clark, and Rauh w16792 The Economics of State and Local Public Pensions
Rauh and Novy-Marx w16453 Policy Options for State Pension Systems and Their Impact on Plan Liabilities
Munnell, Aubry, and Quinby w16442 Public Pension Funding in Practice
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us