BCCRR: Public Investment Plans Make Riskier Investments Than Private Plans

Public sector investment plans invest more in riskier assets than private plans, even when controlling for a number of different factors. This is according to a research brief released by Boston College’s Center for Retirement Research (BCCRR).

The basis of the research began with a long-held assumption about the investment activity of pension plans at the state and local levels.

“State and local pension plans use their assumed investment return – 7.4 percent, on average, in 2017 – to value liabilities and calculate required contributions,” the research brief reads. “Prior studies have suggested that this practice results in overly risky portfolios as plan sponsors seek higher returns to reduce their reported liabilities and required contributions.”

Additionally, CRR researchers identify this use of an assumed return by these plans as a separate but related issue that has the potential to lead to a sense of unfounded optimism for expected returns to a portfolio.

Because of these perspectives, the research brief aimed to examine whether or not using the assumed return to value liabilities and set contributions leads to riskier investment activity, and to discover whether the assumed returns on public plans are overly optimistic.

The brief finds that public plans do indeed have a riskier portfolio compared with private plans, which do not use the assumed return in the same way.

“A regression analysis suggests that much of the difference in allocation is related to unobservable differences between the two sectors, including the public sector’s use of the assumed return,” the brief notes in its conclusion.

The research also finds that assumed returns of public sector plans are on a more optimistic end of the assumptions typically made by investment experts.

“This situation is worth monitoring closely because optimistic return expectations could yield required contributions that are ultimately inadequate to meet benefit obligations and, thus, threaten the financial stability of public plans,” the brief notes.

Find the full brief and notes relating its substantiations at BCCRR.

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