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In previous modules we briefly mentioned that pension fund “underperformance” was a major reason some retirement systems today are dealing with pension debt. Recall that the funding formula for a pension plan requires contributions plus investment returns to pay for benefits. Governments and pension boards are counting on investment returns to help provide money to pay promised benefits. And when investment returns are less than expected, this can create a shortfall.

There is no controversy about the basic fact of pension financing that underperforming investments can lead to pension debt. However, there has been significant debate about what pension funds should be using for their assumed rate of return. This is an important debate because the assumed rate of return is the benchmark against which performance is measured, and it helps determine contribution rates.

A higher assumed rate of return will mean lower contribution rates from employers and teachers today and a higher chance that investments will underperform—leading to future contribution rate increases in the form of pension debt payments. A lower assumed rate of return will mean higher contribution rates today, but a lower likelihood of underperformance.

This module will walk through some of the key aspects of the debate around what public pensions should be using for their assumed rate of return. Becoming fluent in this area is a key step to understanding the intricacies related to public pensions.