There’s a better argument that includes "the purpose of the measurement." The choice of discount rate should align with why the liability is being measured in the first place.
For example:
For plan funding purposes, like those governed by GASB for public plans or ERISA for private plans, the goal is to assess long-term sustainability based on the plan’s ongoing investment strategy. In this context, using the expected return on assets is consistent with the plan’s ability to invest over decades and meet obligations as they come due.
For plan termination purposes, such as in the case of private-sector plans being shut down and liabilities transferred to an insurer, a risk-free discount rate is appropriate—because the obligation becomes immediate and must be backed by secure, guaranteed assets.
Applying a risk-free rate universally, as some critics argue, may be theoretically appealing but practically misleading. It assumes an immediate wind-up scenario, which is not the case for ongoing pension plans. These plans have taxing authorities behind them, long investment horizons, and stable benefit payout patterns.
So while it's true that using higher expected returns lowers reported liabilities, it's not necessarily a perverse incentive—it’s a reflection of the economic reality under which these plans are designed to operate.
There are plenty of stories about pension funds taking on more and more investment risk in order to achieve higher returns. Would they be investing as aggressively if the discount rate were tied to the risk-free rate rather than to the target return rate? I suppose they might. After all, they'd be even more underfunded in that case and the bigger the gap the bigger the temptation to try a Hail Mary investment strategy.
I think the key feature of public pensions is one you mention: there's always a taxing authority behind them with the implicit assumption that future taxpayers can be forced to bail them out if the risky investment strategy falls short.
Doesn’t CalSTers offer healthcare to retirees? Why does SFUSD offer duplicative benefits?
With respect to your second footnote....
There’s a better argument that includes "the purpose of the measurement." The choice of discount rate should align with why the liability is being measured in the first place.
For example:
For plan funding purposes, like those governed by GASB for public plans or ERISA for private plans, the goal is to assess long-term sustainability based on the plan’s ongoing investment strategy. In this context, using the expected return on assets is consistent with the plan’s ability to invest over decades and meet obligations as they come due.
For plan termination purposes, such as in the case of private-sector plans being shut down and liabilities transferred to an insurer, a risk-free discount rate is appropriate—because the obligation becomes immediate and must be backed by secure, guaranteed assets.
Applying a risk-free rate universally, as some critics argue, may be theoretically appealing but practically misleading. It assumes an immediate wind-up scenario, which is not the case for ongoing pension plans. These plans have taxing authorities behind them, long investment horizons, and stable benefit payout patterns.
So while it's true that using higher expected returns lowers reported liabilities, it's not necessarily a perverse incentive—it’s a reflection of the economic reality under which these plans are designed to operate.
There are plenty of stories about pension funds taking on more and more investment risk in order to achieve higher returns. Would they be investing as aggressively if the discount rate were tied to the risk-free rate rather than to the target return rate? I suppose they might. After all, they'd be even more underfunded in that case and the bigger the gap the bigger the temptation to try a Hail Mary investment strategy.
I think the key feature of public pensions is one you mention: there's always a taxing authority behind them with the implicit assumption that future taxpayers can be forced to bail them out if the risky investment strategy falls short.