March 16, 2010
The total unfunded liabilities of the ten major Chicago-area public pension funds reached $18.5 billion in fiscal year 2008. That is an increase of over $15.1 billion dollars in ten years, up from $3.4 billion in fiscal year 1999.
To put $18.5 billion in perspective, it is $5,821 of unfunded pension liabilities per Chicago resident. The debt grows to $10,037 per person when you add the State pension funds. The unfunded liability for the four City of Chicago pension funds alone is $10.8 billion.
What exactly are unfunded liabilities?
Simply put, unfunded liabilities are those liabilities for which there are not already assets set aside. More technically put, unfunded liability is calculated by subtracting the actuarial value of assets from the actuarial accrued liability of a fund:
Actuarial Assets – Accrued Liabilities = Unfunded Actuarial Accrued Liabilities
It can be useful to express unfunded liability as a percentage of payroll covered by the plan in order to see the relative size of the liability. The graph below shows that for some pension funds that unfunded liability is more than three or four times the size of the annual payroll.
Why is an unfunded liability a bad thing?
As we described in an earlier blog post on intergenerational equity, the existence of a significant unfunded liability means that some of the cost of employing today’s public sector workers is being pushed into the future. Small unfunded liabilities can crop up in any year when investment returns are less than expected, but those can be easily reduced by increasing employer or employee contributions in the following year to compensate. The existence of a large, persistent unfunded liability that is not being reduced over time signals the inability or unwillingness of a government to pay the full cost of benefits promised to today’s workers today. This may be convenient in the short-term but it is ultimately unfair to either your future self or to other future taxpayers who will have to pay more to make up for it.
Healthy pension funds are ones that reduce their unfunded liabilities over time; unhealthy funds are ones that experience substantial and sustained increases in unfunded liabilities over time.
Some people claim that there is no real need for governments to completely eliminate their unfunded liabilities, although federal law requires that private sector pension plans strive to do so. They argue that governments, unlike private corporations, are not at risk of dissolving and therefore never need to be prepared to pay out all their accrued pension liabilities at once. A small but stable unfunded liability may not pose a problem for a public sector pension fund. But if the unfunded liability is growing and the plan has no practical strategy for reducing it, this is cause for serious concern. The Civic Federation is seriously concerned about the health of Chicago-area public pension funds and so should be the residents of Chicago.
See the Pension Protection Act of 2006, Public Law 109-280, http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=109_cong_public_laws&docid=f:publ280.109.pdf. See also Deloitte, “Securing Retirement: An Overview of the Pension Protection Act of 2006,” (August 3, 2006) http://www.hreonline.com/pdfs/01012007Extra_Pension_SecuringRetirement.pdf. The Worker, Retiree and Employer Recovery Act signed into law by President Bush on December 23, 2008 loosened some of these requirements by, for example, extending from 10 to 13 the number of years an “endangered” (less than 80% funded) plan is given to implement an improvement strategy. See the Worker, Retiree, and Employer Recovery Act of 2008, HR 7327, Public Law 110-458, http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_bills&docid=f:h7327enr.txt.pdf.