The impact of cash flow on public pensions

Introduction

The defined benefit (DB) pension plans governments use across the United States rely on combining contributions from members and the state with long-term investment returns. This is because they are intended to be prefunded, which ensures that retiree pension expenses are covered fully in the long run. Prefunding benefits this way allows more benefit payments to flow out of the plan than contributions are flowing in without compromising the integrity or solvency of the system.

Analyzing a public pension system’s cash flow—the rates at which money is entering and leaving the fund—is one way to anticipate imbalances in pension plans that must be fixed to ensure long-term solvency.

This policy brief uses the Montana Public Employee Retirement System (PERS) as a case study to illustrate the principles and importance of conducting a cash flow analysis of public pension plans.

Having negative operating cash flow does not necessarily indicate an inherent problem with mature pension plans. However, it can reveal certain risks that should be properly managed. Adopting a funding policy that is responsive to unfunded liabilities would minimize insolvency risk, and using a more conservative return assumption—particularly one that is aligned with short-term market expectations—would help plans better align return assumptions with funding targets.

Full Policy Brief: The impact of cash flow on public pensions