Why public pension funds make riskier investments

This piece from The Economist has some technical bits that those of us who aren’t financial or math whizzes may have a bit of trouble parsing. Still, it’s well worth a read and makes a good point about why federal accounting regulations have created “perverse incentives” for public sector pension funds, like Colorado PERA, to take greater investment risks than their private sector counterparts. Here, as they say in journalism, is the “nut graf (or grafs):”

American public pension funds are allowed (under rules from the Government Accounting Standards Board) to discount their liabilities by the expected return on their assets. The higher the expected return, the higher the discount rate. That means, in turn, that liabilities are lower and the amount of money which the employer has to put aside today is smaller.

Investing in riskier assets is thus an attractive option for a public-sector employer, which can tap only two sources of funding. It can ask its workers to contribute more, but since they are well-unionized that can lead to friction (after all, higher pension contributions amount to a pay cut). Or the employer can take the money from the public purse—either by cutting other services or by raising taxes. Neither option is politically popular.

These perverse incentives created by accounting regs make it clear, the article concludes, that “the rules need to change.” We agree.

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