A look into the United States' Underfunded Pension System

Abstract

The public pension crisis has come under increasing scrutiny over the past decade as shifting demographic trends, harsh economic conditions and the very nature of pension funds have changed, and not for the better. Pension funds create valuable saving and investment tools for an individual's retirement. They make what seems like the impossible daunting task of saving sufficient funds for retirement completely feasible. All indications lead to these trends continuing, therefore pension plans need to adapt and reform. This paper is to address the pension crisis in the U.S. and intends to provide some recommendations for policy makers.

This paper used the U.S. Census Bureau pension data for the fiscal years 2005-2014 to select a sample of 15 states. The time series data will be analyzed using the MDA (Multiple Discriminant Analysis) methodology to assess if a pension plan is bound to fail. MDA is used in the banking industry as a method to predict financial distress or default of bank loans. Once the regression line is determined, it can be utilized to estimate the probability of default. This methodology will be used to determine financial health of public pensions selected in the sample.

The Multiple Discriminant Analysis model can be utilized to run a stress test on the public pension plans of those states selected in the sample. The Multiple Discriminant Analysis will enable public pensions and policy makers to somewhat predict the viability of their pensions. The contribution of this paper will be providing pre-warning signals and some policy recommendations for local governments to sustain their pension systems.