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Discussion:
International Perspectives on
Public Retirement Systems
The Future of Public Employee Retirement Systems
May 1st, 2008
Peter Brady*
Investment Company Institute
*The views presented reflect the conclusions of the author and do not necessarily
reflect the views of the Investment Company Institute or its members.
Discussion Inspired
by the Papers
• Moving from pay-as-you-go pensions to
funded pensions
ƒ Nonmarketable government securities
ƒ Investment risk premium
• Funded pensions and demographic shifts
4
Moving from
PAYGO Pensions
to Funded Pensions
Reasons to Shift
to Funded Pensions
• Increase national savings
• Strengthen property rights
• Take advantage of market risk premium
6
PAYGO Plans
• Advantages of PAYGO
ƒ If population in steady state, can fund fully indexed
benefits with constant contribution rate
• Taxes are claim on future productive activity
• Disadvantages of PAYGO
ƒ Demographic shifts may require benefit cuts or
increased contributions
ƒ No new, or possible decreased, national savings
• Capital deepening
7
Are U.S. Government Employee
Pensions Funded or PAYGO?
Percent of assets, end of 2007
Nonmarketable Government Securities
Other Credit Market Instruments
Mutual Funds
100%
2.4%
8.9%
0.7%
59.4%
40%
79.5%
20%
24.4%
0%
4.9%
Source: Federal Reserve Board
12.4%
7.4%
80%
60%
U.S. Treasury Securities
Equity
Other Assets
State & Local Governments
Federal Government
$3.3 Trillion
$1.2 Trillion
8
Is Social Security
Partially Funded?
U.S. Federal Government Budget Surplus and Social Security Surplus, Billions of Dollars, 1980-2007
On-Budget Surplus
Social Security Surplus
Total Surplus
300
Billions of dollars
200
100
0
-100
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07
-200
-300
-400
-500
-600
-700
Year
Source: Congressional Budget Office, The Budget and Economic Outlook Fiscal Years 2008 to 2017, January 2007
9
Moving from PAYGO
to a Funded System
• Accumulated pension benefits still need to be paid
• How will contributions be invested?
ƒ Government bonds
• Marketable
• Nonmarketable
ƒ Private securities
• How will contributions be financed?
ƒ New taxes
ƒ New debt issuance
• Is this margin investing?
ƒ Ad absurdum: Why not finance all government activities?
10
Can Funding Make
Taxpayers Better Off?
• Need to change real behavior
ƒ Shifting assets will not help in aggregate
ƒ Stocks, bonds, and taxes all represent claims on future
productive activity
• Increased national savings could impact aggregate
economy
ƒ Capital deepening
ƒ Easier to pay off future claims
Simple Model of Economy
Assumptions:
Initial Government Debt Level
Initial Market Value of Corporate Equity
1,000,000
1,000,000
Interest Rate on Government Debt
Equity Rate of Return
Equity Issuance
6%
10%
60,000
Government Pension Contribution
Private Household Savings
60,000
60,000
12
Model Results After 20 Years
Invest in
Government Debt
Invest in
Corporate Equity
2,207,135
3,436,500
2,207,135
0
0
3,436,500
Private Household Assets
11,164,000
9,934,635
Government Debt
1,000,000
3,207,135
Equity
10,164,000
6,727,500
Total Government Debt
3,207,135
3,207,135
Total Corporate Equity
10,164,000
10,164,000
Government Pension Assets
Government Debt
Equity
Private Assets versus
Government Debt
• Investment Risk Premium
• Investing in market assets or paying down debt both
could lead to economy-wide capital deepening
• Other rationales for investing in market assets
ƒ Behavioral public finance
ƒ Distributional issues
• Which groups made better off?
• Assignable property rights
14
Funded Pensions and
Demographic Shifts
Funded Plans Not Immune
to Demographic Shocks
• Typical DB pension benefits accrue unevenly
• As long as age composition of workforce
remains stable, contributions as percent of
payroll remain stable
• Even in a fully funded plan, aging of the
workforce increases funding costs as percent of
payroll
16
DB Benefit Accrual
for Individual Employees
PDV of DB benefit accruals with formula 1.5% per year up to 30 years
25
Age at Start of Continuous Employment:
35
45
55
40%
30%
20%
10%
0%
21
23
Source: Author’s Calculation
25
27
29
31
33
35
37
39
41
43
45
47
49
51
53
55
57
59
61
63
65
17
Depends on
Definition of “Funded”
• If changes in workforce can be forecast, can
adjust funding as percent of payroll
• If decline of industry or increased productivity
unexpected, may be hard to forecast aging of
workforce