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Finance Glossary

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Unfunded Pension Liabilities


If a municipality offers a pension to its employees, that's a financial obligation that stays on the books. But that pension seems far away, so the municipality doesn't put any cash away for those pensions. They're not sure when money will be needed, and there's no extra money available anyway because the politicians spend it all.

As long as no money is being put aside for the pension, it's an unfunded obligation. 


Welcome to Detroit. A city worker—let's say a janitor—would make (today's dollar, inflation adjusted) $37,000 a year with 5 weeks off for vacation and get $8,000 a year invested into his pension fund. He also got $3,000 worth of health care benefits and other perks. So it cost the city $48,000 plus various city taxes to employ the janitor. He was paying into the pension with the understanding that he'd have money to live off when he was too old to work. 

And all of this was fine until, one day, a clever union negotiator tweaked one phrase: "defined contribution" became "defined benefit" and all of the sudden, the city was on the hook for making up losses that the janitor might have suffered in the stock market with his investments. 

This worked fine—and was generally unnoticed when the market went up 10% a year for a long time—but along came the crash of 2008/9 and, well, that was the end of Detroit courtesy in large part to its pension liability. The janitor and others like him who had paid into their pensions suddenly weren't getting the money they were promised. The janitor paid into the pension but the city used up the cash on other things and went bankrupt.


The result was that the pensioners sued and will likely end up getting only a small part of their pensions. That's what happens when great negotiating and financial mismanagement collide.