Retirement Systems Will Require a Bigger Share of State Funds

Technical Details

Key Assumptions

Table A.1:  Selected Scenario Assumptions

Return on Investment

The return on investment assumption is important because it affects the employer contribution rate. For planning purposes, the Kentucky Teachers Retirement System assumes a return on investment (ROI) of 7.5 percent. The Kentucky Retirement Systems has generated three different employer contribution rates out to 2014 depending on the ROI. The low-impact scenario utilizes the estimated required employer contribution rates in the column labeled “8.25%,” while the high-impact scenario uses those in the “Variable”(1) column (Tables A.2-A.5).

Table A.2:  KERS (Nonhazardous) Estimated Required Employer Contribution Rates

Table A.3:  KERS (Hazardous) Estimated Required Employer Contribution Rates

Table A.4:  CERS (Nonhazardous) Estimated Required Employer Contribution Rates

Table A.5:  SPRS Estimated Required Employer Contribution Rates

Covered Payroll

Covered payroll is affected by pay increases and the addition or subtraction of various groups to a system. In the low-impact scenario, we use the assumed rates for projections of 4.0% for KTRS and 5.0% for KRS. In the high-impact scenario, we assume that the average annual increase in covered payroll will follow its historical trend from 1991 to 2002. Figures A.1-A.5 illustrate the covered payroll, historical and projected, for the retirement systems analyzed (in current dollars).

Figure A.1:  KTRS Covered Payroll, Actual and Projected, 1991-2014

Figure A.2:  KERS (Nonhazardous) Covered Payroll, Actual and Projected, 1991-2014

Figure A.3:  KERS (Hazardous) Covered Payroll, Actual and Projected, 1991-2014

Figure A.4:  CERS (Nonhazardous) Covered Payroll, Actual and Projected, 1991-2014

Figure A.5:  SPRS Covered Payroll, Actual and Projected, 1991-2014

KTRS Average Contribution Percentage

As specified by statute, the required employer contribution rates are 13.105% for nonuniversity members and 13.84% for university members. However, in some instances the employer contribution rate is lower. For example, if a salary is federally funded, then the employer contribution rate is 9.855% (13.105 minus the 3.25% supplement).(2) Consequently, total required state appropriations to the KTRS as a percentage of total covered payroll averaged 11.5% from 1991 to 2002, but increased steadily. In the low-impact scenario, we assume that required state appropriations will equal 11.5%. In the high-impact scenario we assume it continues along its historical trajectory (see Figure A.6).

Figure A.6:  KTRS Total Required Appropriation as a Percentage of Total KTRS Covered Payroll, Actual and Projected, 1991-2014

KTRS Medical Insurance Fund (MIF), Additional 3.64%

The high cost of providing retirees with health care benefits is affecting the financial solvency of public and private retirement systems across the country. The KTRS consultant, Buck Consultants, generated four separate estimates of the covered payroll percentage needed to fund the KTRS medical insurance fund. These four scenarios represent pay-as-you-go funding for 3, 5, 10, and 25 years. We use the 10-year scenario since this time horizon is consistent with our KRS estimates. In order for the medical insurance fund to continue to have a positive balance through 2014, 3.64% of the covered payroll must be contributed in addition to the 1.5% from members and the employers. In the low-impact scenario we assume there is no additional funding for the KTRS MIF, and in the high-impact scenario we assume that an additional 3.64% of covered payroll is being paid by the employer. And we should note that these are conservative estimates. Buck Consultants points out that “no provisions have been made in these estimates for benefits that will be paid to future new entrants. Therefore, the actual required supplemental contributions will be larger … for the 10 and 25 year timeframes.”

The Fox Report(3) on tax policy issues presents lower and upper estimates of Kentucky revenue (General Fund and Road Fund) to 2010 based on two revenue elasticity estimates. Assuming revenue elasticity equals 1.0, revenue would grow at an average annual rate of 5.8 percent. However, revenue elasticity declined to about 0.65 from 1995 to 2000. Consequently, if it remains at this level, revenue would increase at an average annual rate of 3.8 percent. We extend these estimates to 2014 and assume a growth rate of 5.8% in the low-impact scenario and 3.8% in the high-impact scenario (see Figure A.7).

Figure A.7:  General Fund and Road Fund Revenue, Actual and Projected, 1988 to 2014

Not all employer contributions come from the state General Fund or Road Fund. For example, if federal dollars are used to fund a position, then ostensibly federal funds are used to pay the employer’s portion to the retirement system. In 2002, approximately 41 percent of Kentucky’s total state expenditures came from the General Fund, about 30 percent were from federal funds, and approximately 29 percent came from other state funds (e.g., Road Fund, Agency Funds).(4) According to data from the National Association of State Budget Officers (NASBO), about 85 percent of Kentucky elementary and secondary expenditures are from the General Fund. Therefore, in the high-impact scenario we assign around 85 percent of the necessary funds for the KTRS MIF to the General Fund. Otherwise, we allocate all of the KTRS employer contributions to the General Fund since our data represent the total required state appropriation (not total required employer contribution). We then estimate the funding source(s) for the noneducation portion of the state budget and assign that percentage to the estimated required employer contribution. Our analysis of NASBO data indicates that an estimated 41 percent of the state’s noneducation expenditures came from the General Fund and Road Fund, on average, from 1988 to 2002. Therefore, we take the estimated total required employer contribution in current dollars and multiply it by this percentage to estimate the combined General and Road Fund percentage going to the retirement systems.

Footnotes

1.  The “variable rate” assumes a return on investment of –1.7% for 2002-2003, 5.58% for 2003-2004, 7.21% for 2004-2005, and 7.38% for 2005-2006 to 2011-2012.   Return to text.

2.  The 9.855% would be paid with federal funds and the 3.25% with state funds. Return to text.

3.  William F. Fox, “Report to the Sub-Committee on Tax Policy Issues,” 27 Feb. 2002. Available online at: http://www.lrc.state.ky.us/ijcomm/a&r/taxpolicy/KYFINALREPORT.pdf.   Return to text.

4.  State Expenditure Report, 2001, The National Association of State Budget Officers (NASBO). Available at: http://www.nasbo.org/Publications/PDFs/nasbo2001exrep.pdf.   Return to text.