In a defined benefit pension plan or retiree health care plan, unfunded liability is the difference between the estimated cost of future benefits, and assets that have been set aside to pay for them.
Municipalities can find their pension funded level and unfunded liability in their Annual Actuarial Valuation, a report provided to them each year. To learn more view the valuation resource page. In addition to using current membership and financial data, the valuation requires the use of a series of assumptions regarding uncertain future events. The assumptions and methods used in the valuation are those adopted by the MERS Retirement Board, after extensive analysis and recommendation by our actuarial firm, Gabriel Roeder Smith & Company.
There are several ways a municipality can close its unfunded liability gap, including:
Increase assets to close the funding gap, by either:
Borrowing to fund the gap (for example, bonding, which requires that you close the plan)
Paying more than the required minimum contributions
Reduce or eliminate liability moving forward:
Reduce the liability for new hires by offering a lower tier of benefits (either in the Defined Benefit or Hybrid plans) to new hires.
Reduce the liability for new hires and existing employees by “bridging” their benefit multiplier to a lower one and freezing final average compensation.
Eliminate the liability for new hires by closing the Defined Benefit Plan and offering a Defined Contribution Plan to new hires. Closing the pension plan to new hires won’t eliminate the funding gap. The only way to eliminate an unfunded liability is to pay it off. This is because, whether a pension plan is open or closed, the obligation to pay for benefits earned in the past will remain.
For more information, click on the managing UAL publication (pdf).