The Widening Gap
The Great Recession's Impact on State Pension and Retiree Health Care Costs
Estimating States' Pension Gap
States make assumptions about investment rates of return when they calculate how much money to set aside to pay for their employees’ pension benefits.
The most common assumption made by states is that a plan’s investments will generate a return of 8 percent. But, some experts argue that an 8 percent return is overly optimistic and takes on too much risk, increasing the chance that the states’ pension plans will be underfunded. Most states have exceeded an 8 percent return over time, but the return has been much lower in recent years.
For example, from 1984 to 2009, the median investment return for public pension plans was 9.3 percent. But from 2000 to 2009 the median return was only 3.9 percent.
The stakes of this debate are high because when a state lowers its investment return assumptions, its liability jumps and the annual contributions required to pay for the states’ pension promises increase dramatically. That takes money away from other state programs and initiatives.
While there is no consensus about the appropriate return rate, we can illustrate the impact of different return rates. Pew presents four different assumptions in the table below:
Using the state's own rate of return assumptions for each of the state’s pension plans.
|8% rate of return:|
Less than half the plans use a different rate of return assumption than 8 percent. We re-estimate liabilities for all plans using an 8 percent assumption to facilitate comparisons.
|5.22% rate of return:|
Defined-benefit pension plans in the private sector use the interest rate for a high-end corporate bond, 5.22 percent as of March 2011.
|4.38% rate of return:|
Some experts suggest using a riskless rate—such as a rate based on a 30-year treasury bond, 4.38 percent as of mid-March 2011.
View tables that show the impact of each rate of return on the next five pages.