Public Pensions, Public Budgets, and the Risks of Pension Obligation Bonds

Budgeting is the core financial task in subnational governments. Although limited research has outlined the relationship between the annual operating budget and public pension funds, the existing literature has not considered the manner in which financial resources are measured within government budgets, how this measurement of resources might affect public budget decisions, and how the interaction of the budget with the actuarial model can lead public budget managers to engage in financially damaging transactions such as pension obligation bonds. This paper fills this void, and argues that the short-term nature of public budgeting coupled with the actuarial model's use of expected investment returns rather than a market discount rate for pension liability measurement causes governments to shift risk to future generations. This paper also recommends that a blended discount rate for pension liabilities be considered more appropriate when governments fund their annual pension expenditures using debt rather than equity (such as tax revenues).