Financial Economics Principles Applied to Public Pension Plans
By Edward Bartholomew (Independent), Jeremy Gold (Jeremy Gold Pensions), David G. Pitts (Independent) & Larry Pollack (Independent)
Working from basic principles of economics, financial economics, and public finance, we develop implications for the financial management of public pension plans. We address the measurement of plan liabilities and cost, funding, investment of plan assets, financial reporting, benefit design and risk sharing. Our analysis seeks to maximize efficiency and preserve intergenerational equity. We conclude that full funding based on default-free discount rates is efficient and fair across generations. Investing so as to hedge accrued liabilities facilitates the maintenance of full funding across time, minimizes risk-adjusted costs, and avoids potentially costly and/or futile risk taking. Hedging is more effective when plan design incorporates market principles and avoids off- market equivalences and options. Plan design that deviates from market measurements may be justified if it adds more value to the employer-employee relationship than it might otherwise destroy. Risk-sharing plans that incorporate individual preferences are found to be superior to risk- sharing plan designs that treat all cohort members in unison.
Source: SSRN
