Unfunded Liabilities – Smoke and Mirrors?

by Tom Yamachika, President Tax Foundation Hawaii

Recently, I was on a television program with two very prominent local politicians, and the subject of unfunded liabilities came up. We know that actuaries have looked at the Employer-Union Health Benefits Trust Fund, or EUTF, and have found that the plan is “unfunded” by a staggering amount, as in over $18 billion. One of the politicians spoke of the unfunded liability dismissively, like it was an imaginary number. Smoke and mirrors.

So I thought I would spend some time talking about what actually goes into this “unfunded liability” calculation.

Pension funds and benefit plans have income and expenses, like most of us. We gather the bills on our desk that we happen to have, take out our checkbook to pay them with the money we have at the moment, and then, hopefully, we have money that is left over. This is called a “pay as you go” system, and the money left over is our “cash balance.” The problem with this system is that it only considers what is due, or on hand, at the moment and does not consider the future.

To get a better picture of financial condition, benefit funds, insurance companies, and others with large obligations payable in the future try to predict the future. A benefit fund, for example, might not have to pay anything out currently, but if people have been promised health care benefits between the time they retire and the time they die, then it’s possible to estimate who is likely to retire, who is going to draw benefits, how much benefits are going to be drawn, when the benefits are going to start, and when they are going to end. We can’t see the future, but we can make some assumptions about what is going to happen in the future by taking a look at data from what has happened in the past. A similar analysis can be done to project future income.

We can estimate how often the money does come in, and in what amounts.

Once we have an idea of the income and expenses, we can see whether we are in trouble. If, for example, I had $5,000 in the bank, a job that paid me $1,000 on the 15th and 30th of the month, and a mortgage payment of $3,000 due on the 5th of the month, it’s pretty obvious that I am going to have a problem. I don’t have a problem at the moment because I can pay this month’s bill, but in a few months my money will run out. This is akin to a benefit plan’s actuarial unfunded liability.

Act 268 of 2013 established a mechanism to pay down the State’s biggest unfunded liabilities – EUTF and the Employees’ Retirement System – over time. That act called for fiscal discipline, and if governmental units did not cooperate it forced compliance by sequestering general excise or transient accommodations tax funds. One of the bills considered this session, that was pushed very hard by one representative in particular, claimed that we could avoid this pain without raising taxes, affecting workers’ benefits, or laying off people. The bill would accomplish this by abandoning the discipline of Act 268 and returning the State to a pay-as-you-go system. Pay-as-you-go systems are perfectly legal. Lots of governments and people use them. The question is whether this change would be prudent or fair to future generations, considering the future. This year, the bill made it to conference but thankfully died there.

Is the calculation of actuarial unfunded liabilities a meaningless and unnecessary exercise? Is it smoke and mirrors? Whether or not you believe the number, mounting debts and stagnant income is a recipe for future disaster. If we address the issue now, we may be spared much more pain that would otherwise await us in the future.

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