M-RCBG Associate Working Paper No. 92

Assessing the Risk of Fiscal Distress for Public Pensions: State Stress Test Analysis

Greg Mennis
Susan Banta
David Draine



This paper summarizes the results of a stress test simulation analysis on the largest government pension plans in 10 states under different economic scenarios and assumptions for policymaker behavior. The simulation model applies both deterministic and stochastic methods. The model also uses state-specific actuarial projections and revenue forecasts, as well as a common set of capital market assumptions. Results are calculated for a variety of actuarial and financial measures over 30 years, with particular attention to downside economic scenarios and different assumptions on how officials are likely to respond to resulting increases in pension costs based on past behavior. We find that poorly funded plans face the risk of unfunded liabilities and high costs, and in some cases, insolvency under scenarios where returns are lower than expected. Conversely, we find that states with well-funded pension systems have achieved this result through a combination of fiscal discipline and adherence to policies specifically designed to manage the impact of market volatility in low-return scenarios. Finally, stochastic analysis of the state plans reveals that contribution policy — in addition to the timing of investment returns — is a significant factor influencing cost variability. We conclude that stress testing is not just an academic exercise, and recommend that it be a standard reporting practice for all public-sector retirement systems.

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