Public pension plans should capitalize on strong investment returns to build long-term stability 

Most public pensions benefited significantly from strong equity returns in 2024. According to Reason Foundation’s data, the average total asset return reached 9.9%, compared to the average assumed rate of return of 7%. This positive financial momentum for most public pension plans provides a critical opportunity for policymakers to address unfunded liabilities, safeguard retirement benefits, and reduce the potential burden on taxpayers. 

Public pension systems rely heavily on investment returns, which account for over 60% of the revenues needed to pay for promised retirement benefits. Sustained periods of investment returns coming in below expectations directly impact the solvency and sustainability of pension systems, so it is crucial for plans to not only set realistic return rate assumptions but also apply what investment gains they get from the good years to be prepared for the bad years.  

In 2024, most pension plans reported investment performance above their long-term assumed rates. The Georgia Teachers’ Retirement System emerged as a top performer with a 14.5% return during its 2024 fiscal year, easily surpassing its long-term assumed investment return of 6.9% and its benchmark of 13.88%. The Louisiana State Employees’ Retirement System also delivered strong results, achieving a 14% return for the fiscal year that ended June 30, 2024. The highest-performing investment type for the Louisiana plan was U.S. Equities, which returned 21.8%. Global Multi-Sector/Opportunistic assets followed with a 14.3% return, while Non-U.S. Equities and Emerging Market Debt contributed returns of 13.6% and 9.7%, respectively. 

Each public pension uses its own risk profile and investment strategy, resulting in a range of outcomes each year. Even in years that generate, on average, good investment returns, there are plans that still fall low on the distribution. For example, the South Dakota Retirement System reported only a 5.9% return in 2024, falling short of its 13.81% benchmark and 6.5% assumed return. Over the past three years, South Dakota’s annualized net return has been just 3.62%, well below expectations. 

In general, public pension investment performance has become more uniform in 2023 and 2024 compared to the massive range of outcomes experienced in 2022. The improvement in 2024, with investment returns concentrated around the mean value of 9.9% compared to the average assumed rate of return of 6.9%, mirrors broader equity market trends, where a select group of large technology companies has generated significant market gains.

In 2023 and 2022, public pension plans earned 6.9% and -5.0% on average. 

However, it is important to understand that while returns have become more concentrated among pension plans, this does not necessarily indicate reduced risk or greater reliability. This narrowing of outcomes reflects cyclical market forces, as portfolios remained tethered to tech-sector dominance with undiversified correlations. It also increases systemic risk, as a single shock could ripple across the entire system because pension plans are exposed to the same drivers. 

As of 2023, total unfunded liabilities across state and local pension plans reached $1.59 trillion, with state pension plans holding the lion’s share, according to Reason Foundation’s Annual Pension Solvency and Performance Report.

Stress testing indicates that a recession could exacerbate this figure, potentially raising national unfunded pension liabilities to $2.71 trillion. This highlights the urgency of using additional funds to prepare for potential market outcomes.

In periods when investment returns exceed expectations, policymakers must reserve those gains to act as a buffer for future market downturns. They must resist the temptation to use recent gains to justify new or improved benefits, as cutting out a plan’s upside returns will leave it in a tough spot when fortunes reverse.  

Given recent favorable returns and projected budget surpluses, policymakers should prioritize using recent gains to strengthen their financial footing by accelerating efforts to eliminate unfunded liabilities. Unfunded pension obligations are debts, the cost of which rises significantly the longer a government takes to pay them off. Any effort to address unfunded liabilities (either making supplemental payments or establishing faster amortization schedules) lowers long-term costs on government budgets by reducing mounting interest on that debt, which accounted for 25.6% of added unfunded liabilities from 2000 to 2022. 

To mitigate future risks, it is also prudent to lower the assumed investment return rate, as most public pension plans have been doing over the last decade. While such a move will increase the actuarial costs of future pension benefits and result in additional calculated unfunded liabilities in the short term, it sets a more realistic expectation for asset growth and dramatically reduces the chances for unexpected costs down the road. Historically, underperforming investments accounted for 27.7% of added unfunded liabilities from 2000 to 2022. Adjusting return rate assumptions now will reduce the likelihood of future funding shortfalls and better prepare plans for economic downturns. 

The strong equity returns of 2024 provide a real opportunity for policymakers. They should resist the call to use these returns for additional retirement benefits, especially when most public pension plans remain dangerously underfunded. Instead, they should use this opportunity to improve the long-term stability of public pension plans.

By using these gains to make surplus payments to pay down unfunded liabilities and by adopting more realistic investment return assumptions, public pension systems can safeguard retirement benefits while reducing future risks. This strategic approach ensures that public pension systems remain resilient despite economic uncertainties and continue to fulfill their promises to retirees and taxpayers. 

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Source: https://reason.org/commentary/public-pension-plans-strong-investment-returns/