As pension debt continues to grow, more and more governments are turning to one-time fixes and chasing improbable investment returns in an effort to close the gap between plans’ assets and the retirement promises made to workers. These irresponsible funding policies are threatening the security of workers’ hard-earned retirement benefits and have left taxpayers on the hook to make up the difference if the investment strategy fails.
This is particularly concerning given the fact that cities’ and states’ retirement promises are larger than ever before, and pension liabilities have increased from 10 percent to 30 percent of gross domestic product since 1977. Moreover, pension debt is rising much faster than government revenue. Thus, it could be much harder for communities to raise the additional funds needed to cover rising pension costs in the future.
The bottom line is that the stakes are high for both public servants and taxpayers. Governments have taken on significantly more investment risk since the early 1990s, and public pension plans are expecting markets to yield returns that are almost three times larger relative to the risk-free rate of return—meaning that governments are betting on returns they are unlikely to achieve.
In an attempt to earn these high returns, governments have doubled their investments in risky, illiquid, and difficult-to-value assets such as real estate, hedge funds, and private equity. But these bets have yet to pay off. Even though plans earned positive returns during the favorable bull market from 2009 to 2015, that revenue alone was not enough to erase years of underfunding and solve governments’ pension problems. Instead, pension debt actually increased as the market bounced back because many governments continued to make insufficient contributions to the pension systems.