While we often hear the primary reason for the massive unfunded liability of the pension funds is due to “underfunding” by the state, that answer masks the primary cause — unrealistic investment return assumptions by the pension funds. Using TRS data, the unfunded liability increased from about $11 billion in 2000 to about $52 billon in 2012. From their “Reconciliation of Unfunded Liability” reports, $22 billion of the $41 billion increase to its unfunded liability was due to annual “investment returns” lower than assumed.
Now here’s the rub. In any given year should the state not immediately pay the necessary amount to cover the actuarial losses causing the unfunded liability to increase, then the lost investment income for the larger unfunded liability balance for all subsequent years gets attributed to “employer costs in excess of contributions,” also known as “underfunding.”
Since 2000, taxpayers contributed over $21 billion toward TRS pensions, which was meant to cover just the $10 billion employer “normal cost.” Instead it was fully consumed by the $22 billion “investment return” overestimation. Mostly because of these investment return misses, the unfunded liability increased each year despite the taxpayers paying more than twice what they should have. And just like the owner of a credit card who doesn’t pay the full month end balance, it simply gets worse when the interest charges get added to the unpaid amount.
By keeping its investment return assumptions so high, the pension funds hide the true cost of pensions. In June the Illinois Policy Institute suggested that should the pension funds use investment rates of return prescribed by Moody’s, the current actuarially computed unfunded liability could double. However, reflecting the true cost might highlight that employees are not paying enough toward their very generous pensions, something the unions don’t want to hear.
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