Other Resources | School + State Finance Project

Stress Test Analysis on Public Pensions (The Pew Charitable Trusts)

Written by Pew Charitable Trusts | May 1, 2018 11:02:00 PM

This paper, produced by The Pew Charitable Trusts for the Harvard Kennedy School Mossavar-Rahmani Center for Business and Government, summarizes the results of a stress test simulation analysis on the largest government pension plans in 10 states under different economic scenarios and assumptions for policymaker behavior.

Below are the findings from the stress test analysis:

  • States with both low funded levels and low contribution rates face the real prospect of pension system insolvency — the complete depletion of pension plan assets — under downside economic scenarios. The pension systems in New Jersey and Kentucky have the greatest exposure to system insolvency in our study.
  • States with low funded levels that have already increased contributions are unlikely to face insolvency, but may struggle to improve funding levels and reduce costs if target investment returns are not met. The risk of permanent high costs is most acute in Pennsylvania and Connecticut.
  • States with funding policies that are not designed to respond to market downturns are also at risk of fiscal distress. Colorado faces the greatest level of uncertainty due to an inflexible pension funding policy that does not automatically adjusted to offset lower than-expected investment returns. Ohio also follows a fixed rate funding policy, but recent increases in contributions and cuts to benefits have mitigated the immediate risk of insolvency for the state’s pension plans.
  • In certain cases, states’ actuarial funding policies are not fit for managing costs in an affordable and sustainable manner in the face of market volatility. This finding is informed by stochastic simulation analysis of two states that follow actuarial funding policies, but have very different results — Virginia and South Carolina.
  • Current reporting on public pensions is not adequate to assess these risks.

Citation
Mennis, G., Banta, S., & Draine, D. (2018). Assessing the Risk of Fiscal Distress for Public Pensions: State Stress Test Analysis. Cambridge, MA: Harvard University, John F. Kennedy School of Government, Mossavar-Rahmani Center for Business and Government. Retrieved from https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/files/AWP_92_final.pdf.