Understanding Pension Contributions in the Final Budget
May 26, 2016
The issue of pensions for Kentucky public employees and teachers is complex, and the two main pension systems — the Kentucky Retirement Systems (KRS) and the Kentucky Teachers’ Retirement System (KTRS) — are in distinct but related predicaments.
While a number of factors are at play in the conditions facing these funds, the primary reason for the challenges facing them is the failure of the General Assembly in the past to make the actuarially required contribution (ARC). The ARC is the amount of money that should be contributed annually to pay the normal costs for current employees and the catch-up payments from past underfunding to ensure the system has the resources it needs to pay benefits.
The budget that begins July 1 makes big new contributions to these two plans. Here’s how those contributions break down and some background on what they mean for the systems’ challenges.
Kentucky Retirement Systems
Kentucky Retirement Systems is actually made up of three systems: The Kentucky Employees’ Retirement System (KERS), which contains a variety of state workers; the County Employees’ Retirement System (CERS), which covers primarily local workers; and the State Police Retirement System (SPRS). Within the KERS and CERS systems, there’s a plan covering hazardous duty workers and a plan covering non-hazardous duty workers. This blog will focus mainly on the KERS non-hazardous plan, since it’s the one in the most trouble. KERS non-hazardous currently has only about 17.7 percent of the assets it should have at this point to pay future benefits.
Following legislation that passed in 2013, the state began making the full ARC to this system. In the budget, these contributions are described as a percentage of employees’ pay. For the KERS non-hazardous plan, employers are contributing 40.24 percent of workers’ salaries for pensions in 2017 and 41.06 percent in 2018, amounts that equal the ARC. That’s a big increase from the previous budget, in which 30.84 percent of pay was contributed in 2015 and 2016.
The contribution rate went up in part because the Board of KERS lowered the system’s assumption about the future investment rate of return in recognition of its low level of assets, first from 7.75 percent to 7.5 percent and then down to 6.75 percent. Because it’s now assumed the plan will make less money on investments in the future, current contributions must go up.
Those contributions to KERS non-hazardous from all sources total $633.9 million in 2017 and $653.3 million in 2018. That’s an increase of approximately $324 million in employer contributions over the biennium compared to the previous 2 years. About half of that money comes from the state’s General Fund — the rest comes from other sources.
The new budget also makes additional contributions above the ARC to KERS non-hazardous: $58.2 million in 2017 and $67.6 million in 2018. Extra money is more than justified because the plan is so poorly funded and faces some risk of insolvency. Additionally, the budget includes $60 million in additional contributions over the biennium to the SPRS plan and the KERS hazardous plan.
Kentucky Teachers Retirement System
While state law requires Kentucky contribute the full ARC to the state employees’ plan, it doesn’t yet require the ARC be contributed to the teachers’ plan. Instead, by statute the employer contributes only 13.105 percent of teachers’ pay for their pensions (plus a small additional amount to pay for things like cost of living adjustments to pensions awarded in past years). For the upcoming budget that base contribution amounts to $388.8 million in 2017 and $397.5 million in 2018 from the General Fund. Those contributions are less than half of the full ARC.
This underfunding in recent years has resulted in KTRS’ assets dropping to 55.3 percent of what it should have to pay future benefits. Though KTRS is in a much stronger position than KERS non-hazardous when it comes to its funded ratio, KTRS has continued to be underfunded at a severe level — meaning it would end up in the same boat as KERS non-hazardous without a new commitment to paying the ARC.
For this reason, the new budget puts in another $498.5 million in 2017 and $474.7 million in 2018 to KTRS. That means in total the state funded about 98 percent of the ARC for KTRS in 2017 and 96 percent in 2018. That’s a dramatically higher contribution than the last budget contained.
“Permanent” Pension Fund and Moving Forward
Also, the budget put an additional $125 million into what’s called a “permanent” pension fund from monies transferred from the Public Employees’ Health Insurance Trust Fund. Of that amount, up to $3 million is available for a performance audit of the systems, and a request for proposals was recently issued for that study. The budget language says that the remaining monies in the permanent fund “shall not be expended or appropriated without the express authority within the enacted biennial budget.”
In total, the state responsibly stepped up its contributions to these pension plans in the new budget. But these payments represent just the first step in what must be a long term funding commitment.
Both systems continue to face negative cash flow situations, meaning they are paying out more in benefits than they are receiving in contributions. Because of that challenge, KERS non-hazardous is expected to face a precarious decade before its funded ratio begins to go back up. Volatility in the financial markets could put it at risk. And the state still hasn’t made the statutory commitment to fully fund the ARC for KTRS each year in the future. A version of House Bill 1 this session proposed to do so, but the bill did not pass.
Also, the additional contributions to pensions in this budget were made possible in part by a record amount of transfers of one-time money in the budget, especially the withdrawal of $500 million in total from the Public Employees’ Health Insurance Trust Fund ($125 million of which went to the so-called permanent fund). That amount of extra money is unlikely to be available the next time around. And the extra funding for pensions was also paid for by 9 percent cuts to many services provided by state government and 4.5 percent cuts to higher education — on top of 15 rounds of budget cuts since 2008.
Important strides were made this session in beginning to get these pension systems on the right path. But there is much work left to do in figuring out how to continue making these necessary payments in future years while also starting to restore much-needed funding for critical investments in education, human services and other areas Kentucky must have to thrive.