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Linking benefits to investment performance in US public pension systems

Authors
  • Novy-Marx, Robert
  • Rauh, Joshua D.1, 2
  • 1 University of Rochester and NBER
  • 2 Stanford University and NBER
Type
Published Article
Journal
Journal of Public Economics
Publisher
Elsevier BV
Publication Date
Jan 01, 2014
Accepted Date
Jan 14, 2014
Identifiers
DOI: 10.1016/j.jpubeco.2014.01.007
Source
Elsevier
Keywords
License
Unknown

Abstract

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 in which positive benefit adjustments are granted each year only if asset returns surpass 5%. This change would reduce unfunded accrued liabilities by over half, and would lower the annual contribution increases required to target full funding in 30years 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. If there is a minimum guarantee that benefits cannot fall below their initial levels, the impact of introducing variable annuities is substantially smaller. We discuss these results in the context of models of lifecycle portfolio choice, and analyze the conditions under which lifecycle agents might receive utility gains from the implementation of variable annuities.

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