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Why has pension funding declined?

Multiple Factors Drove the Decline

Multiple factors contributed to the deteriorating funded status of Kentucky’s pensions across the past decade, with the relative impact of these factors varying among the Commonwealth’s different plans. 

In the aggregate for all plans, the largest single factor underlying the decline was an actuarial funding approach that effectively “back-loaded” payments such that – even if the Commonwealth and other member employers had met all of the calculated actuarial funding requirements each and every year – these payments would still have been less than the annual interest on the Unfunded Actuarial Liability (“UAL”), causing the UAL to grow.  (This “actuarial back-loading” is explained in another FAQ on this website.)

In addition, each of the plans has changed various actuarial assumptions from time-to-time – for example, adopting somewhat more conservative investment return assumptions and reflecting improving longevity by adjusting mortality rates.  Together, the actuarial back-loading and assumption adjustments drove nearly half (47%) of the aggregate growth in underfunding, and led to a majority of the shortfalls in the Teachers’ plan and the County Employees’ non-hazardous plan.

The past 10 years also saw many years of weak investment returns. Performance below actuarial assumptions led to about one-third of the aggregate funding decline.  Although much of this experience was driven by the failure of the overall market to meet actuarial assumptions, investment performance below market-wide results was also a factor for most of the plans.

As seen in PFM’s Report #2, for the Teachers’ plan and the Kentucky Employees’ non-hazardous plans in particular, state payment levels below the Actuarially Required Contribution (ARC) was also a significant factor, leading to 15% of the total funding decline across all plans.  Other contributing factors were cost of living adjustment (“COLA”) benefit enhancements that were granted but not funded, and other elements of plan experience (such as mortality rates) that varied from actuarial assumptions then in effect.

 

Source: PFM Group Consulting report, May 22, 2017.  For more information about this topic, click here to see relevant portions of that report.



Factors Increasing the Unfunded Pension Liability 6/30/2005 to 6/30/2016

(Amounts in $Millions)


CausesTRSKERS-NHKERS-HCERS-NHCERS-HSPRSKJRPKLRPTOTAL% of Total
Actuarial Back-loading$3,278$1,153$89$1,269$353$111$31$2$6,28625%
Actuarial Assumption Changes1,9582,31982984249502555,67222%
Plan Experience232539393721071074321,4416%
Investment: Market Performance Below Assumption1,9266398093129745523,92515%
Investment: Plan Performance Below Market1,014610(5)2078281401,9308%
Funding Less Than the ARC1,5882,561(10)(220)(133)42(11)33,82015%
COLAs 01,29168672267722732,4009%
Total$9,996$9,112$343$4,215$1,222$435$133$17$25,473100%

 

Source: PFM Group Consulting report, May 22, 2017.  For more information about this topic, click here to see relevant portions of that report.