In recent years, the term "pension liability" is heard increasingly when dealing with the budgets of local, state and federal governments. The term is also used when companies go through bailout, merger or bankruptcy. It is on the lips of investors and analysts pouring over financial statements, too. With public or private-sector defined benefit pensions, calculating pension liability requires a fairly straightforward formula. However, the underlying assumptions for each portion of the calculation are more complex.
Simply put, pension liability is the difference between plan assets and plan obligation. In most cases, the plan obligation is larger than the plan assets, thus creating the liability. The quick and easy calculation for pension liability is found using this formula: Pension assets minus pension obligations equals pension liability.
Plan assets or plan net assets are defined as the value of the investments held by the specific pension plan. These assets can range from cold hard cash to fixed income assets, equities and even alternative investments such as hedge funds. Pension funds hold mixes of these assets and earn interest on the assets to pay present and future benefits of the plan membership. In plan documents, assets are labeled "actuarial value of assets," or AVA.
The terms "pension obligation" and "benefit obligation" describe the amount of total obligation a defined benefit pension plan has accrued for its past and present members and retirees. These obligations are often seen as a liability and calculated against plan assets. Plan obligations are labeled "actuarial accrued liabilities," or AAL.
Future Pension Benefits
In technical terms, pension liability is called the "unfunded actuarial accrued liability," or UAAL. Pension liability is calculated using this formula: AVA minus AAL equals negative UAAL. However, this calculation doesn't take the future into consideration. Over time, many things happen to a defined benefit pension plan. Each year benefit levels, investment returns, employee and employer contributions, and plan expenses are subject to change. The present value of these future pension benefits is complicated and calculated by actuaries trained for this task.
In 2012, the Governmental Accounting Standards Board announced two statements, No. 67 and 68, that affect the reporting of government pension liabilities. Total pension liability, or TPL, is a measure that also takes into account future benefits promised by an employer and earned by the worker. When compared with the pension plan's net assets, the difference between the two is labeled a "net pension liability," or NPL. These changes are designed to provide more transparency in governmental pensions and will be in effect for employers with fiscal years ending June 30, 2015.
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