Optimal funding of state public employee pension systems

This thesis focuses on developing an appropriate target for the funding level of public pension plans. Initially, a two-period model is developed that incorporates the relevant factors in a simple model, examines the comparative statics, and compares the results with actual funding levels. The results indicate that although the funding levels in different states vary widely, there is no significant relationship between actual funding levels and historical growth in the state's tax base. Incorporating the stochastic nature of the variables in a lattice model indicated that the greater the uncertainty about interest rates, the lower the optimal funding level and the greater uncertainty about changes in the tax base, the higher the optimal funding level.Later, a multi-period model is developed to examine the optimal funding levels under various employment and working patterns. The results indicate that when the economy grows faster than pension costs, later generations assume a greater pension burden than earlier generations and when the pension costs grow faster than the economy, earlier generations assume more of the pension liability than later generations. Simulation is used to incorporate the stochastic nature of interest rates and demonstrates that the interest rate volatility increases the optimal funding level, even though the effect is small.Current actual funding ratios by state are examined to see if the ratios follows the expected pattern suggested by the model. The results reject the hypothesis that actual funding strategies reflect the different economic and demographic variables representing individual states under multi-period scheme.Finally, the optimal funding paths to go from the current funding levels to full funding are determined for each state.U of I OnlyETDs are only available to UIUC Users without author permissio