Publicpension governance and performance : lessons for developing countries

The author examines the relationship between public sector pension plan performance and management practices to improve the design and governance of public pensions in developing countries. Understanding this relationship is important because better yields on public pension plan investment reduce the need for additional taxes to support retirees - and well-funded plans stand a better chance of paying promised benefits. The author's model relates investment returns on public pension assets, as well as plan funding status, to features characterizing the pension systems'governance structure and authority, using new data set on U.S. state and local public sector plans. The following findings stand out. The higher the fraction of retirees elected to the pension board, the stronger the negative effect on investment return in 1990, and the more variable the returns. Systems fared about the same whether they had in-house or external money managers, or independent performance analysis (even if the external managers were drawn from the top 10). But public pensions performed better when fund and actuarial computations were done by professional actuarial and investment counselors rather than relying on former or current employees to choose investment strategies. Social investment rules hurt public pension yields. Public pension plans which mandated that a certain portion of investments be director to instate projects generated much lower returns. The data show that many public pension systems funded their plans satisfactorily but others did not. The results show the following. Fiscal stress reduced stock funding ratios. Stock funding rates were lower, the higher the fraction of elected retirees and elected active workers represented on the pension system board. Stock funding ratios were higher when a system had in-house actuaries, when the board authorized benefit levels, and when board members had liability insurance. Stock funding rates were unaltered by state statutes guaranteering that benefits be guaranteed by law, or by legally set funding requirements, or by the state's ability to carry budget deficits from one year to the next. Nor did they vary when dedicated or special taxes were earmarked for pension revenue. Policymakers in developing countries can profit from the mistakes made and lessons learned by U.S. pension analysis. Although no single package of pension plan practices can optimize investment performance for all systems across all time periods, care must be taken when designing the regulatory and investment environment in which these plans operate. Developing countries should study the work of the U.S. Government Accounting Standards Board. The author discusses some of the complex issues that must be confronted when establishing funding norms for defined benefit pension plans in the public sector.