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Read Article 1 and Article 3 in appendix before solving this question. The exercise below makes some simplifying assumptions to explain Article 1 and to show how a change in rate of return on pension assets is influencing the funding (and the tax required to fully fund the Illinois Teachers Retirement System)

• Pension Funds liabilities are $100 B with maturity of 12 Years (pensions will be paid as a 12Years ZCB).
• Fund has now $40B in an fin. assets
• Accountants expect these assets will yield 7% (with annual compounding).
• At 8% future returns, the Illinois Teachers Retirement System is overfunded (i.e., has more money than needed to pay all pensions) Approximately, how much overfunding the fund has?
• At 7% the Fund is underfunded by how much?
• At 5% the Fund is underfunded by how much?

Article 1 Funding State Pensions

Read the long quote from an article by Amit Sinha1 and then answer on questions below

The Chicago Tribune recently wrote about how the decision to reduce the expected-return assumption from 7.5% to 7.0% for the Illinois Teachers Retirement System resulted in the governor calling for approximately $400 million in additional taxes.

The Teachers Retirement System2 (now) assumes that investment returns over the long-term will average 7%. While the political positioning behind this small move of 0.5 percentage point is fascinating, it more importantly brings to the forefront the issue of how large future obligations are, and why there is a lot of fear and an incentive to hide.

Article 3 State pension system 'stable' and sufficient From China Daily 2019-07-20

Vice-minister says enough financing set aside for funding social programs

China's State pension system is "generally stable" and can pay for various social security programs in full and on time, You Jun, vice-minister of human resources and social security, said on Friday.

From January to June, China collected more than 1.9 trillion yuan ($276 billion) in employee basic pension funds from companies, while spending around 1.6 trillion yuan. By the end of June, the total pension insurance surplus was more than 5 trillion yuan, You said at a news briefing organized by the State Council Information Office.

As for the work injury insurance fund, China collected around 38 billion yuan in the first half of the year, and spent more than 36 billion yuan, with a total surplus of over 170 billion yuan at the end of June, ministry data show.

The unemployment insurance fund received an injection of more than 57 billion yuan from January to June, and spent more than 54 billion. It had a surplus of 580 billion yuan.

There have been some doubts recently on whether the country will lack pension funds, following media reports saying that those born after 1980 may not get enough of a pension after retirement. A report by the Social Security Research Center with the Chinese Academy of Social Sciences predicts the pension fund may face a shortage as early as 2035.

The government's move to alleviate companies' financial pressures by reducing their social security expenditures this year also fueled such concerns, as a lighter burden for companies may result in fewer contributions to the State social insurance funds.

Under the current mechanism, both individuals and employers should pay a certain amount of money to the State insurance funds.

To address the concerns, You made it clear that China's State pension system is operating smoothly, and "can pay for various social security programs in full and on-time".

In April, the State Council, China's cabinet, issued a new regulation on reducing companies' social security burdens, optimizing the pension system while ensuring various social programs are functioning properly.

If reducing the expected return assumption from 7.5% to 7.0% results in an additional $400 million- 500 million a year of taxes, then moving the liability discount rate to something closer to a risk-free rate of 3% may imply additional $5 billion in additional contributions (Note: the actual number is likely several times higher than this see the illustration below for some simplified math).

The dilemma we face is that we have made future promises and don't have enough money set aside today to pay them. Therefore someone has to make up the shortfall. Instead of trying to determine who makes up the shortfall, we try to bury our heads in the actuarial sand of high expected returns.

But where can Illinois get the additional $5 billion a year? And where can America get the additional $6 trillion? When risk-free rates were around 6%-7%, generating 8%-10% expected returns required minimal risk and complexity. However, with risk-free rates at 2%-3%, generating even 7% is a lot harder. While investment teams at pension funds such as Teachers are extremely capable, high expected returns are forcing them to take on additional risk, either in the form of increased leverage or complex investments. The Rockefeller Institute of Government points out that taxpayers and citizens may or not want this risk taken on their behalf, but they have little say in the matter. And they have no easy way out: If they want pension funds to take less risk, theyll have to increase government contributions by even more than contributions have gone up already .

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