Since 2000, public pension funds have increased the levels of asset risk in their portfolios, principally through their allocations to illiquid assets. Going forward, a stable public pension system requires policy with well-articulated rules for contribution rates, the use of market-based interest rates to value pension obligations, and a clear rule governing funding.

Despite the prolonged equity market rally, recent headlines suggest that pension funding continues to be a challenge for U.S. public funds. A long period of below-trend real economic growth could lead to further deterioration in pension funding ratios.

The foundation of better pension systems should be, in part, based on lifecycle portfolio choice models. These models provide clear guidance for policymakers on how to promote higher savings rates, foster appropriate investment risk-taking during working years, and encourage an alignment of institutional and individual discount rates.