As of the third quarter of 2012, state and local government retirement systems held assets of approximately $3 trillion. These assets are invested to defray the cost of benefits within an acceptable level of risk. The investment return on these assets matters because over time, investment earnings account for a majority of public pension fund revenues. A shortfall in expected investment earnings must be made up by higher contributions or reduced benefits.
Funding a pension benefit requires the use of projections, known as actuarial assumptions, about future events. Actuarial assumptions fall into one of two broad categories: demographic and economic. Demographic assumptions are those pertaining to a pension plan’s membership, such as changes in the number of working and retired plan participants; when participants will retire, and how long they’ll live after they retire. Economic assumptions pertain to such factors as the rate of wage growth and the investment return on the fund’s assets.
As with other actuarial assumptions, projecting public pension fund investment returns requires a focus on the long-term. This brief discusses how investment return assumptions are established and evaluated and compares these assumptions with public funds’ actual investment experience.