A Value-Based Approach to the Redesign of US State Pension Plans

Abstract

This paper explores the financial sustainability of a typical U.S. state defined benefit pension fund under the continuation of current policies and under alternative policies, such as changes in contribution, indexation and investment allocation policies. We explore the "classic" asset-liability management (ALM) results, which indicate that a policy of conditional indexation may substantially improve the financial position of the fund. We also investigate the value-based ALM results, which provide a market-based evaluation of the net benefit changes to the various stakeholders of changes in the fund's policies. All cohorts of participants derive a substantial net benefit from the current pension contract, implying that tax payers have to make substantial contributions. The aforementioned adjustment measures can be instrumental in alleviating the burden on the tax payer, although this will happen at the cost of a reduction in the value of the contract to the fund participants.