Public Pension Funds Are Getting Healthier. Their New Problem: Paying the Bills

A few years ago, Andrew Junkin wanted the ability to balance his plan’s asset allocation without having to sell investments.

As CIO of the Virginia Retirement System, he was accustomed to debates over market returns, funding gaps and contribution increases. But as his fund’s financial position strengthened, another question moved to the forefront: How would the system keep paying retirees without being forced to sell investments at the wrong time?

The VRS decided then to shift its target cash allocation to 2% from 1%, and it held 1.8% of assets in cash as of June 2025. According to Junkin, the extra cash would cover, on its own, about six months’ worth of benefit payments, while giving the system the ability to use leverage at the total plan level. Doing so allows the fund to rebalance without having to sell assets at a discount; instead, it can use borrowed funds when necessary.

Public pension plans across the country are approaching stronger funding levels. Yet that improvement comes with a risk of sinking cash flows. As inflows fall while benefit payments continue to rise, pension systems have to balance fiscal management with market performance. If a fund lacks sufficient liquidity, it could need to access cash by selling from portfolios—often a last resort, because illiquid and public equity investments, two categories that often comprise a significant share of public pension plans’ assets, can sell at a steep discount.

“The worst thing that can happen,” Junkin says, “is that you’re a forced seller in any market.”

The funded ratio of the nation’s 100 largest public pension funds was projected as 84.7% as of November 30, 2025, according to a recent Milliman analysis. But as the report warns, the combination of plan benefit distributions and expenses continue to exceed contributions from employers and members. A 2023 report from the Pew Charitable Trusts reviewing 2021 data found that even as funding improved, 21 states continued to have “negative amortization, meaning that contributions were insufficient to keep the funding gap from growing.”

For years, underfunded plans could count on cash flows from employer and employee contributions to help cover the outflows of benefit payments. Investment portfolios could remain largely untouched, allowing funds to weather market volatility.

Now, as unfunded liabilities shrink, contributions have come down—even as benefit payments grow steadily as more public employees retire and live longer.

“The equation is shifting,” says Rick Funston, who consults on plan governance as the chief executive of Funston Advisory Services. Mature pension systems, he says, are moving from contribution-driven funding toward portfolios that must increasingly finance payouts themselves.

When Good News Changes the Math

Public pension funds are designed to become cash-flow negative over time. Contributions exceed benefits in earlier decades, building investment assets that later fund retirements. But reaching full funding accelerates the transition.

Todd Tauzer, a pension actuary and national practice leader at Segal, says many plans see contribution rates drop sharply once legacy debts are paid down.

“All of a sudden, you’re taking in a lot less in contributions, but you’re still paying out just as much—or more—in benefits,” he says.

The result is an even more negative cash flow: Instead of contributions covering benefits payments, plans must regularly sell assets to make payments. That dynamic can create risks that do not appear in traditional funding metrics.

The Liquidity Challenge

Over recent decades, public pension systems generally increased allocations to private equity, real estate and—most recently—private credit in pursuit of higher returns. Those investments, while potentially lucrative, are not traded on exchanges and are more difficult to sell quickly than public-market investments.

For example, a June 2025 report from the National Institute on Retirement Security and Aon found that between 2001 and 2023, the average public pension fund shifted about 20% of its assets out of public equities and fixed-income investments and into alternatives such as private equity, real estate, hedge funds and similar vehicles.

In a more recent example, the board of the California Public Employees’ Retirement System, the nation’s largest public pension fund, endorsed a strategy to ramp up its investments in private markets to 40% from 33% to maximize returns.

But when markets decline as benefit payments rise, funds may be forced to liquidate publicly traded assets at depressed prices, locking in market losses and missing eventual recoveries.

Junkin says pension funds can respond, as VRS has, by increasing cash reserves and introducing financing tools that enable it to rebalance portfolios without immediately selling assets.

A Paradox of Pension Recovery

The risk highlights the fact that stronger pension funding levels do not eliminate danger.

Recent guidance from the American Academy of Actuaries warned that even public pensions at or exceeding full funding still face significant uncertainty. A pension “surplus,” actuaries note, does not represent excess money, but merely indicates the plan is on schedule to meet obligations under current assumptions.

Reducing contributions too quickly could undermine stability if markets weaken later.

New funding policies increasingly call for gradual contribution reductions, liquidity monitoring and risk management strategies designed to preserve gains, rather than immediately translate them into relief for employers and employees.

As such, Funston argues that pension boards must now treat liquidity as a governance issue equal to investment returns. Without preparation, he says, downturns can create cascading effects—forced asset sales, missed rebounds and renewed pressure on government budgets and taxpayers.

Investing for a Different Future

The transition to greater-funded pension plans may ultimately reshape how pension funds invest. Maintaining larger pools of liquid assets could lower expected investment returns, complicating long-term funding assumptions. Yet failing to prepare could prove more costly.

Adding to the conundrum is the recent stress in the private credit market, from outflows and subsequent gating at Blue Owl Capital to the collapse of First Brands Group and Tricolor Holdings.

However, many plans are beginning to model cash-flow stress years in advance, adjusting private-market commitments and reconsidering how quickly contribution relief for employers and employees should occur.

For Junkin, the lesson is less about markets than about discipline. Pension funds, he says, must ensure they can continue paying retirees without sacrificing long-term strategy when markets inevitably turn.

“You just never want to be in a position,” Junkin says, “where you have to sell something because you need the cash.”