Public pension fund managers have run the same accounting maneuver for fifty years. It is entirely legal, widely practiced, and engineered to make a structural debt problem look like a funding gap. The logic is circular: decide what return you expect to earn, then use that number as the rate at which you discount what you owe. The higher the assumed return, the smaller the reported liability. The smaller the liability, the lower the required contribution. The lower the contribution, the more comfortable everyone in the room feels - until the bill arrives. That is where American public pension accounting stands in 2026.
I have spent thirty years in institutional investment management - private equity, private credit, hedge funds, UHNW wealth management. In every credit agreement, discounted cash flow model, and leveraged buyout valuation I have reviewed, a liability is marked to market: its present value reflects what a rational counterparty would pay for it today, priced at rates that capture the certainty of the cash flow. A guaranteed obligation - one paid regardless of how the portfolio performs - belongs at or near the risk-free rate, currently the yield on comparable-duration U.S. Treasuries, sitting in the 4% to 5% range. That is foundational pricing discipline, not a policy preference.
The private sector lives by that discipline. The Milliman 100 Pension Funding Index, released May 11, 2026, reported that the 100 largest U.S. corporate defined benefit plans - governed by ERISA and subject to SEC disclosure - carry a funded ratio of 107.8% and a surplus of $94 billion as of April 30, 2026. Their discount rate is 5.66%, derived from high-quality corporate bond yields, not from investment return aspirations. Those plans mark their liabilities to market. The corporate pension system is in surplus precisely because it was never permitted to do what public plans do routinely.
Public plans operate under GASB Statements 67 and 68, the Government Accounting Standards Board rules that allow funds to discount liabilities at their assumed investment return. As of April 2026, NASRA data show the average public plan still assumes 7.0%. According to the Reason Foundation, 86% of public plans assume returns above their own 23-year average. Over the past 20 years, 84% failed to beat a passive 60/40 portfolio, which delivered 7.9% annually against the public plans' average of 7.5%. Every plan in the sample trailed the S&P 500 over the same period, which returned 10.4%.
The gap between the official number and the real number is not a rounding error. Stanford finance professor Joshua Rauh and Hoover Institution research fellow Oliver Giesecke applied mark-to-market, risk-free rate discount methodology - the approach required of private-sector plans - to public pension data through fiscal year 2022. Their findings: total unfunded public pension liabilities rise from the officially reported figure to approximately $5.1 trillion, with an aggregate funding ratio below 50%. The fourfold difference reflects one accounting convention, applied differently between sectors.
The Equable Institute's State of Pensions 2025 year-end update, released January 8, 2026, put the aggregate public plan funded ratio at 82.5% with unfunded liabilities at $1.27 trillion under standard actuarial assumptions. Employer contribution rates hit a record 31.65% of payroll in 2025 - the fourth consecutive year above 30%. In 2001, governments contributed 9.41% of payroll. Taxpayers are putting in more than three times as much per dollar of salary, and the system is still 17.5 cents short on every dollar promised. Under Rauh's mark-to-market methodology, the system sits below 50% funded.
The structural reason public plans resist mark-to-market accounting is embedded in the incentive chain. A higher assumed return produces a lower reported liability, which reduces the required contribution, which frees up budget dollars, which relieves political pressure. Research by Andonov, Bauer, and Cremers, published in the Review of Financial Studies, found that U.S. public pension funds became the largest risk-takers among pension funds globally - a pattern traced directly to this incentive. Taking more investment risk raises expected returns. A higher expected return justifies a higher discount rate. A higher discount rate makes the fund look better funded. The structure does the work automatically.
The Reason Foundation's stress test, modeling a 20% market downturn, projects the average public funded ratio falling to 63% - a drop that would push aggregate unfunded liabilities toward $2.74 trillion. Under mark-to-market methodology, the starting point is already below 50%, making the stress scenario more severe and the recovery path longer. Between 2022 and 2025, public plans averaged 4.04% annual returns against a 6.87% assumed rate.
Under ERISA Section 404(a)(1)(B), a private-sector pension fiduciary who discounted guaranteed obligations at equity return assumptions rather than market rates would face regulatory and legal exposure for the resulting underfunding. A public-plan trustee who does the same faces reelection. States that have adopted genuine market discipline - South Dakota at 100% funded and Wisconsin at 96%, per Reason Foundation's 2025 rankings - got there by treating the discount rate as an actuarial input rather than a political variable.
Twenty-three million Americans hold public pension benefits. The Hoover Institution's September 2025 analysis found that state and local governments would need to contribute an additional $96 billion annually just to stabilize existing shortfalls under current accounting. That figure assumes the 7% return holds. Under mark-to-market rates, the gap is wider. The accounting does not change the obligation. It only changes when, and on whom, the cost lands.
