Wednesday, November 28, 2012

Understanding funded ratio and unfunded liability from the Center for Tax and Budget Accountability

What is a funded ratio?

The funded ratio places the unfunded liabilities in the context of the retirement system's assets. Expressed as a percentage of a system's liabilities, the funded ratio is calculated by dividing net assets by the actuarial accrued liabilities. The result is the percentage of the accrued liabilities that are covered by assets. At 100%, a system has sufficient assets to pay all benefits earned to date for all its members. However, in a February 2012, article for Governing magazine Girard Miller states that to actually be fully funded a pension system should have a funded ratio of 125% (calculating assets at market value). TRS is approximately at 46%.

Source: All funded ratios are from each system’s Fiscal Year 2011 Comprehensive Annual Financial Report, which are available online.
What is an unfunded accrued liability?

An Unfunded Accrued Liability (UAL) is also known as the Unfunded Actuarial Accrued Liability (UAAL) and is commonly referred to as the unfunded pension liability. An unfunded accrued liability is the difference between accrued liabilities and the value of assets accumulated to finance an obligation. While similar to the funded ratio, an unfunded accrued liability is commonly expressed in dollar amounts.

However, only looking at the dollar amount can be misleading, and another way to examine an unfunded pension liability is to calculate the ratio of the UAL to active employee payroll. For example, for fiscal year 2010 the UAL for the Illinois Teachers' Retirement System was $39.84 billion, which as a percentage of payroll is 430.8%.1 The smaller a ratio is, the stronger the system is.

1. Source: Illinois Teachers' Retirement System. 2010. Comprehensive Annual Financial Report.

What is the source of Illinois' unfunded pension liability?

At the end of FY 1995, Illinois' state retirement systems' unfunded liabilities totaled almost $19.5 billion. By the end of FY 2006, unfunded liabilities totaled $40.7 billion. According to the Illinois Commission on Government Forecasting and Accountability, the failure to make employer contributions at a normal-cost-plus-interest level over the ten year reporting period has been the most significant catalyst in the increase in unfunded liabilities of all five State-funded systems. As of 2011 the unfunded liability had grown to roughly $83 billion.1

1. Source: Illinois Commission on Government Forecasting and Accountability. 2011. Monthly Briefing, November 2011. Please note that that CoGFA brief contains two different unfunded liability figures. The difference between the two figures is how assets are calculated. One calculation uses the asset market value technique, whereas the other calculates assets using the actuarial value of assets method (this is the method used by the state pension systems).

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