Tuesday, July 5, 2011

Unfunded Liability and Sustainability of a Pension

Two solutions from The National Institute on Retirement Security (June 2011) that will address a pension plan’s affordability and sustainability are changes to benefits should be actuarially valued and properly funded and annual, required employer pension contributions must be paid in full each year.

The Center for State and Local Government Excellence (April 2008) adds that a payment to amortize a pension plan’s unfunded actuarial liability must also be made and that the amount of money that a state needs to put aside each year depends on the actuarial cost method adopted.

According to Pew Center on the States (June 2011), the Governmental Accounting Standards Board is going to adopt new regulations to ensure that all states use the same method for calculating their pension liabilities. “The new systems would take an ‘accounting-based’ approach that employs a longer-term view to ensure that the overall costs of providing benefits are accounted for,” instead of using a yearly “funding-based” approach. The new rules will also calculate investment returns by smoothing investment gains and losses over a five-year period.

Furthermore, state governments would no longer “use historical rates of return to determine long-term liabilities if they haven’t set aside enough money to pay retirees. Instead, they’ll have to use a combination of a historical rate of return and a lower rate pegged to the municipal bond market, which will make their long-term liabilities appear larger.”

Indeed, new rules for calculations will provide more reasons to fret or not to fret. For instance, determining public pension costs or projecting benefits to be paid out have depended upon the value of benefits earned by retirees, the value of pension obligations to active employees (based on their current salaries and years of experience), the effect of future salary increases on the value of pension rights already earned by active employees, and the benefits that will be earned by current employees over the remainder of their working lives (The Center for State and Local Government Excellence). Undeniably, the slightest change to these actuarial suppositions could have a significant impact on the amount of required contributions needed or the amount of the pension benefit.

Dave Urbanek, TRS Public Information Officer, states that the “Teachers Retirement System (TRS) does not calculate ‘what if’ scenarios…, [for] an endless number of outcomes can be derived through use of statistical data. The numbers can be manipulated in innumerable ways…, using those calculations to accomplish a partisan political or policy goal…

“[Unfortunately, some] pension critics have done a great job of convincing a lot of people that the [State’s] unfunded liability must be paid off all at once at some point in the future, [but] the unfunded liability really has little to do with the practical sustainability of the system…

“In fact, even under the accounting and actuarial definition of ‘full funding,’ (70 percent or 80 percent of total long-term liabilities, depending on who you ask), the [TRS] system would still carry a real unfunded liability of several billion dollars… Full funding would be necessary if, at some point in time, TRS needed to pay everyone it owed all the money due them. But that can’t happen under the way the System is structured [because] TRS is a perpetual government agency…

“Private plans can cease to exist and must plan for a time when they must pay out all obligations at the same time. Many times, pension critics believe that a public plan, like TRS, should operate and be treated like a private plan. But it’s really apples and oranges…

“TRS has survived for more than 70 years – because over the long term, the System’s income and accumulated assets continue to be greater than what are required to pay out in any given year… The only way TRS [will run] out of money is if income from all sources – teachers, school districts, investments and the State – dries up for a lengthy period of time. Not just one or two sources, but all sources.”

Legislators can change the funding date (Public Act 88-0593 requires that the State of Illinois to bring total assets to 90% funding by 2045 for all five pension systems), the assumed rate of return (currently at 8.5 percent), “or lower the definition of ‘full funding’ if they want… Either of those moves would cut the state’s annual contribution and help ease the cash flow problem, [but] doing that would not really change the current fiscal health of TRS” (Dave Urbanek).

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