National Conference on Public Employee Retirement Systems

The Voice for Public Pensions


Frequently Asked Questions about Sustainability Valuation

In January 2022, NCPERS published a white paper introducing a new tool on Sustainability Valuation. In this article, we break down the concept and provide responses to frequently asked questions. 

Frequently Asked Questions about Sustainability Valuation

In January 2022, NCPERS published a white paper introducing a new tool on Sustainability Valuation. In this article, we break down the concept and provide responses to frequently asked questions.

Q. What does sustainability mean with respect to public pensions.

A. Sustainability is a complex idea, but fundamentally a plan is considered sustainable when it can reasonably be expected to be able to pay benefits for a very long time—even indefinitely. Sustainability can be difficult to gauge because it encompasses both observable facts, such as a pension's current funding level, and future variables, such as investment returns, enrollment levels, plan design changes, and fiscal stance of the state and local governments that sponsor pensions.

Q. Why is sustainability an important and timely topic?

A. The concept of sustainability is at the center of almost every discussion about the future of public pensions, so it's critically important. Policy recommendations about public pensions are often made on the basis of a flawed understanding of how pension funding actually works. To address this concern, NCPERS and other organizations have conducted extensive research on sustainability. One of our key takeaways from research conducted and published over multiple years has been that there is a disconnect in how fiscal adjustments are made to public pension plans.

Q: What can be done to enhance the sustainability of public pensions?

A:  Addressing the disconnect over fiscal adjustments can greatly improve sustainability. The discussion on pension sustainability frequently gets bogged down in debating the size of pension plans' collective funding shortfalls. Huge, distorted numbers get bandied about, all nuance gets lost, and policy makers throw their hands up in frustration, saying the gap is impossibly large to close. 

Our research shows that the size of the gap is the wrong question to focus on. For one thing, pension assets aren't a monolith; each plan and each sponsor is different, so it's necessary to focus on what is happening closer to the ground level.

The right question to ask is whether the relationship between a pension fund's unfunded liabilities and a plan sponsor's economic capacity is stable. Because as long as this ratio is stable, the pension plan is sustainable. This focus on stabilizing ratios isn't uniquely our idea; researchers from the Federal Reserve, the Bank of England, and the Brookings Institution made this observation and got the ball rolling.

This is where our new tool, Sustainability Valuation, comes in. It's a method for monitoring a pension plan's fiscal status on a continuing basis. We've learned that we can preserve public pensions over the long haul if pension systems incorporate a Sustainability Valuation component in addition to current best practices such as Actuarial Valuation, stress testing, and employer's (sponsor's)  funding discipline.  Pension plans can use Sustainability Valuation to monitor their fiscal status on a continuing basis, gaining insights that would enable them to identify their fiscal adjustments needed to stabilize pensions long-term.

Q: How does NCPERS define Sustainability Valuation?

A:  Sustainability Valuation is a method for monitoring a public pension plan's capacity to keep paying benefits on an ongoing basis, and for identifying the fiscal adjustments needed to keep the ratio between unfunded liabilities and economic capacity stable.

Q: How do Sustainability Valuation and Actuarial Valuation work together?

A: They are complementary, but first it's important to note how they differ. An Actuarial Valuation of a pension plan is an estimate of a plan's financial position at a specific point in time. A Sustainability Valuation helps a pension plan to look at the average sustainability ratio and make fiscal adjustments annually to keep the ratio stable. In combination, these two valuations can keep the ratio between unfunded liabilities and the economy stable.

Q: What are the benefits of utilizing Sustainability Valuation?

A: The key benefit of adding Sustainability Valuation on top of current pension funding policies and practices is that it shifts the focus away from the simple fear that unfunded liabilities mean the sky is falling.  Instead, it equips pension systems and policy makers to gain a deeper understanding of how unfunded liabilities stack up in relationship to the economic capacity of the plan sponsor, and how fine-tuning can enhance sustainability. Another benefit is that implementing Sustainability Valuation should help pension systems improve their funding levels. Our research shows that plans with relatively sustainable unfunded liabilities are better funded. Finally, incorporating Sustainability Valuation in pension funding policy and practice is likely to help state and local governments reduce their employer contribution rates over time.

Q: Why do you use 30-year time horizon and personal income instead of gross domestic product (GDP) as a measure of economic capacity in Sustainability Valuation?

A: We have used personal income instead of GDP as a measure of state and local economic capacity because GDP only measures output. An economy that uses its resources more efficiently has higher GDP in the short run, but it may compromise the performance of the economy in the long run. Also, the production of GDP in a state isn't necessarily “owned” by its residents, according to the Advisory Commission on Intergovernmental Relations, so focusing on it can create distortions in the analysis. Personal income is one of the key ways to measure tax capacity, and data on personal income is readily available on both the state and local levels.


You might also like: What Does It Cost To Make Unfunded Liabilities Fiscally Sustainable?Enhancing Sustainability of Public Pensions Why Do We Use A 30-Year Time Horizon?What Is The Difference Between Sustainability Valuation & Actuarial Valuation?; Sustainability Valuation And Actuarial Valuation;  How Can We Enhance Sustainability Of Public Pensions? What Do We Mean By Sustainability Valuation?.


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