Public Pension Unfunded Liability: Fact Versus Fiction

Public Pension Unfunded Liability: Fact Versus Fiction
Californians for Retirement Security Fact Sheet
March 2013

What is a pension fund’s “unfunded liability?”

•    Unfunded liability simply is a mismatch between a pension plan’s estimated obligations and assets. Defined Benefit pension plans such as California’s CalPERS and CalSTRS are pre-funded, meaning regular contributions for each worker are made into the retirement fund during the course of that worker’s career. A pension plan’s obligations are the estimated dollar value of the benefits that have been promised by the plan, and earned by employees and retirees. A pension plan’s assets consist of financial holdings—cash, stocks, bonds, and other securities—that have been accumulated by the plan over the years. When investment markets drop or if benefits are improved, many pensions find themselves facing a funding gap, or unfunded liability, because the benefits owed to current and future retirees exceed the amount of money the plan has socked away to meet these obligations.  (

CalPERS and CalSTRS funding levels simply are not as weak as many critics claim.

•    CalPERS and CalSTRS each have reported a funded status is about 70 percent funded based on market value of assets, which is regarded by many experts as acceptable. Fitch Rating Agency recently stated that a 70 Percent funded status or above is adequate and under 60 percent is weak.

California’s public retirement systems are better off than they were during Gov. Jerry Brown’s first term in office.

•    CalPERS was about 55 percent funded In the early 1980s, the final years of Gov. Brown’s first term and following another severe recession.  As the economy rebounded, so did CalPERS funding status. By 2000, the system was 130 percent funded. CalSTRS was about 29 percent funded when Gov. Brown was first elected in 1975, and it increased to 57 percent in his last year in office.  As the economy rebounded, so did CalSTRS funding status. By 2000, the system was 110 percent funded. A pension plan's funded status or unfunded liability is a snapshot in time that can change significantly over the course of a few years, depending on whether the economy and financial markets are strong (better funding) or weak (poorer funding). (

Simply citing unfunded liability tends to promote fear mongering and misleads about the health of pension plans.

•    A plan’s “funded ratio,” calculated by dividing the plan’s assets by its obligations, is another way to describe unfunded liabilities. For example, a plan that has $90 billion in assets and $100 billion in obligations can be characterized as 90 percent funded, which sounds more manageable and positive than citing a “$10 billion unfunded liability.” According to CalPERS, “A better measure of a pension fund’s health is the steady progress toward a higher funded status level, not a snapshot in time. Understanding how a plan reached a funded level is more important than the absolute level.” (

Critics can change variables and assumptions to make the funding status look worse.

•    A big variable is the earnings forecast. Stanford graduate students, led by former lawmaker and notorious pension critic Joe Nation, claimed that California’s unfunded liability was far larger reported by cutting the earnings forecast of three state pension funds, then 7.75 percent, to a “risk-free” bond rate, 4 percent. Moody’s Investment Services recently announced that it would lower its assumed investment rate for public pension to 5.5 percent, which is far lower than CalPERS 30-year rate of return of more than 9 percent and CalSTRS 20-year rate of return of more than 7.5 percent, and would cause the perceived unfunded liabilities to balloon.

Defined Benefit plans base investment assumptions on facts, and invest for the long-term.

•    CalPERS and CalSTRS discount rate and assumed rate of investment return are both 7.5 percent. This amount reflects historical and expected CalPERS investment returns over the long term, and ensures that today’s taxpayers don’t overpay for public pensions. CalPERS 30-year rate of return is in excess of 9 percent, and 20-year returns are 7.7 percent. CalPERS calendar year 2012 returns were 13.3 percent. Fiscal year returns were 21.7 percent for 2011, and 13.3 percent for fiscal year 2010. CalSTRS 20 year returns are 7.5 percent and calendar year 2012 returns were 13.4 percent. Fiscal year returns were 23.1 percent for 2011, and 12.2 percent for fiscal year 2010.

Funding gaps can be filled gradually, over time, much like a home mortgage.

•    A funding gap does not need to be closed in a single year, but the payments can be spread out (or “amortized”) over a number of years—governmental accounting standards permit a pay-down period of up to thirty years. Most people do not currently have assets that come even close to 70 percent of their mortgage obligation. For most states and localities, filling funding gaps will be manageable. Researchers at Boston College project that if total contributions increase by just 2.2 percent of payrolls, state and local governments can pay off the total unfunded liabilities in 30 years.

Rate increases for employers are inevitable and don’t indicate mismanagement or outrageous pensions.

•    John Bartel, an independent actuary, said while the goal of actuaries is to reach 100 percent funding, future events are unknowable and the goal is “a movable target” requiring contribution adjustments. He made a comparison with seeing a rainbow while driving in a car. “It’s very difficult to find the bottom of that rainbow, no matter where you go,” he said. “You sort of chase after it. That’s the nature of paying the unfunded liability.” CalPERS is working on changes to its policies to make rate increased more predictable. and

Defined Benefit plans save taxpayer dollars through smart, long-term investments.

•    These contributions are invested, allowing investment earnings to compound over time and shoulder the bulk of the work of paying for benefits. Earnings on investments have historically made up the bulk of public pension fund receipts. Nationally, between 1993 and 2007, 10.3 percent of total state and local pension fund receipts came from employee contributions, 19.4 percent from employer contributions, and 70.4 percent from investment earnings. (

CalPERS investments now pay 64 cents of every dollar in pensions paid.

•    According to the latest analysis of data as of June 2012, CalPERS participating employers contribute 22 cents of every pension dollar paid. Public employees who retire with a CalPERS pension benefit contribute 8-11 percent of their take home pay to help fund their own pensions. (

CalSTRS investments now pay 58 cents of every dollar in pensions paid.

•    According to the latest analysis of data as of June 2012, CalSTRS employers, including the state, contribute 25 cents of every pension dollar paid. CalSTRS members contribute 8 percent of their earnings to help fund their own pensions.

California public pensions are modest, contrary to popular belief

•    In fact, the average retirement pension nationwide is only about $19,500 per year. For this, taxpayers contribute less than 26 cents for every dollar paid out in pension benefits. In California, the average annual public pension is $26,000. At CalSTRS, the average annual public pension is $26,000 replaces only 53 percent of the final salary of the retiring member, with no Social Security for their service.

In fact, unexpected market swings and poor public policy choices cause shortfalls.

•    Many states have experienced funding shortfalls because they failed to make contributions to the pension fund and/or due to a downturn in market conditions.  States and local governments have to make “catch-up” contributions when markets go down, if they took a contribution holiday when markets were up. Most states that continued to make their required payments during the market upswing, did not need to make radical changes when markets took a turn for the worse.  It is important to note that workers are also required to contribute to their pension plans – which they do in good times and bad. (

Closing a pension plan to newly hired employees will not eliminate a funding gap and make even make it harder to fill.

•    “Freezing” a pension plan and moving new hires to a new, riskier defined contribution plan, like a 401(k) or 403(b) plan can actually increase costs to the state. This is because, whether a pension plan is open or closed, the obligation to pay for benefits earned in the past will remain. Like a mortgage, the balance on the mortgage does not vanish simply because you move out of your house—what is past owed remains owed. (

Experts agree, DB plan are the least risky choice for taxpayers and retirement security.

•    Countless studies have concluded that a well-managed group defined benefit pension plan is the most economical way to achieve retirement security. A recent analysis of the cost to achieve a target retirement benefit under a group pension structure, as compared with a defined contribution plan based on individual accounts found that a group pension can do the job at almost half the cost of the defined contribution plan. (Almeida, B., and Fornia, W. 2008. A Better Bang for the Buck: The Economic Efficiencies of DB Plans. Washington, DC:  National Institute on Retirement Security) Time and again, states that have carefully studied the issue have concluded that, even in tough economic times, continuing to provide retirement benefits via cost-effective group pension plans meets the joint interests of fiscal responsibility for employers and taxpayers, and retirement security for employees. (

Pension critics fail to take into account the other fiscal contributions pensions plans make to government coffers and economies.

•    According to a 2010 study of economic impacts of CalPERS pensions, pensions created more than 93,000 jobs, added more than $600 million into California’s treasury through sales and property tax and boosted the state’s economy by at least $26 billion. (, According to a 2007 study of economic impacts of the $6 billion in CalSTRS pension payments, CalSTRS benefit payments supported over 60,000 jobs, generated $600 million in new state and local government revenue and generated total economic output of $9.23 billion. Those numbers have undoubtedly increased with the increase in benefit payments now totaling $10 billion annually.