Change the Funding Method for the Law Enforcement and Custodial Officers Supplemental Retirement Fund

The Legislature should change the funding method for the Law Enforcement and Custodial Officers Supplemental Retirement Fund.


Background
In Breaking the Mold , the Texas Performance Review (TPR) recommended that the state institute an actuarially sound method of financing the Law Enforcement and Custodial Officers Supplemental Retirement Fund (LECOSRF). 1 In addition, TPR noted that the LECOSRF had a large, overfunded actuarial liability, so a new method of funding could be delayed for four years without negatively affecting the fund s actuarial soundness. TPR has revisited this issue and finds the situation essentially unchanged. TPR s research for Breaking the Mold is updated and presented here again for the Legislature s consideration.

In 1979, the 66th Legislature created LECOSRF. This fund, in conjunction with the Employees Retirement System (ERS) Fund, provides commissioned peace officers and custodial officers enhanced retirement benefits. The program makes earlier retirement available for employees in hazardous, high-stress occupations, including: commissioned peace officers with the Texas Department of Public Safety, the Texas Alcoholic Beverage Commission, the Texas Parks and Wildlife Dep artment and custodial officers of the Texas Department of Criminal Justice.

These retirees receive a monthly annuity, payable for life, equal to a percentage of the average salary of their highest three years of service. An employee with 20 years of elig ible service as a law enforcement or custodial officer is eligible to retire with an unreduced retirement benefit based on 50 percent service credit, at age 50. The general class of ERS members with 20 years of service, however, are not eligible to retire early with reduced benefits. 2 This allows individuals employed in these hazardous positions to retire earlier and to receive a higher annuity than other state employees.

As of August 31, 1991, the LECOSRF program had 22,176 members, including: 1,284 fully vested, 1,240 annuitants and two vested terminated members. 3 By October 31, 1992, there were 24,152 contributing members of the LECOSRF program in the following agencies:

Active Funds from Annual
Members of which Salary
State Agency LECOSRF 4~ Salaries are Paid Expense

Department of Public Safety 2,760 Funds 001, 006, 099, 274 $ 90,000,000 Alcoholic Beverage Commission 242 Fund 001 11,000,000 Department of Criminal Justice 20,541 Funds 001, 156, 628, 695 455,000,000 Parks and Wildlife Department 609 Funds 001, 009, 064 20,000,000

Total 24,152 $576,000,000


The method of funding the LECOSRF fund is an inefficient use of the state s resources. The 71st Legislature even increased the funding for the LECOSRF from $1.50 to $2.25 of each Motor Vehicle Inspection Fee to reduce the retirement age from 55 to 50. This also had the effect of extending the solvency of the fund by ten year s, but the cost to the fund will still exceed the income to it by 1999. 5


Before 1992, the fund also received $3.75 of each two-year, new motor vehicle inspection fee. The 72nd Legislature voted to discontinue the two-year inspections, which had the effect of increasing the net allocations to LECOSRF. 6 The fund had received deposits of $3.75 over two years for each new vehicle inspection fee, but now receives deposits of $4.50 over two years for two annual inspections. The change in the fee structure probably extended the actuarial soundness of the fund for a time, although the fund s actuarial valuation has not yet been completed. Nevertheless, the funding method remains actuarially unsound since the funding levels are not related to the growth in the obligations of the fund.

In 1989, concern over the long-term actuarial soundness of LECOSRF prompted the 71st Legislature to establish a committee to review the program and report its findings and recommendations to the 72nd Legislature. The Committee to Review the Actuarial Soundness of CPO/CO Fund was made up of representatives from ERS, the State Pensio n Review Board and five state agencies. The committee found that the method of funding of LECOSRF, unlike other state retirement systems, had no relation to sound actuarial principles and recommended that it be financed through a percentage of payroll equa l to the normal cost of the fund plus the amount necessary to amortize any unfunded liability. 7

Since the normal cost of the fund increases as payroll increases, the percentage contributions would always keep up with the normal cost. Actuarial valuation reports consistently show that the fund will eventually become insolvent using the current funding methods.

LECOSRF - Projection of Actuarial Cost and Fund Financing - November 1991
(In millions of dollars)

Motor Vehicle Income Overfunded/(Underfunded)
Fiscal Inspection Normal Minus Actuarial Liability at
Year Fee Income Cost Cost Beginning of Year

1993 $27.68 $15.60 $12.08 $147.46
1994 27.96 18.32 9.63 171.80
1995 27.96 21.35 6.61 195.56
1996 27.96 22.93 5.02 218.07
1997 27.96 24.63 3.33 240.73
1998 27.96 26.46 1.50 263.45
1999 28.24 28.41 (0.18) 286.09
2000 28.52 30.52 (2.00) 308.79
2001 28.80 32.78 (3.97) 331.41
2002 29.09 35.21 (6.11) 353.80
2003 29.38 37.81 (8.43) 375.75
2004 29.68 40.61 (10.94) 397.05
2005 29.97 43.62 (13.65) 417.44
2006 30.27 46.85 (16.58) 436.66
2007 30.58 50.32 (19.74) 454.36
2008 30.88 54.05 (23.16) 470.19
2009 31.19 58.05 (26.86) 483.74
2010 31.50 62.35 (30.85) 494.52
2011 31.82 66.96 (35.15) 502.03
2012 32.14 71.92 (39.79) 505.67
2013 32.46 77.25 (44.79) 504.77
2014 32.78 82.97 (50.19) 498.61
2015 33.11 89.11 (56.00) 486.34
2016 33.44 95.71 (62.27) 467.04
2017 33.78 102.80 (69.03) 439.69
LECOSRF (Continued)

Motor Vehicle Income Overfunded/(Underfunded)
Fiscal Inspection Normal Minus Actuarial Liability at
Year Fee Income Cost Cost Beginning of Year

2018 $ 34.11 $ 110.41 $ (76.30) $ 403.13
2019 34.45 118.59 (84.14) 356.09
2020 34.80 127.37 (92.57) 297.14
2021 35.15 136.81 (101.66) 224.70
2022 35.50 146.93 (111.44) 137.03
2023 35.85 157.82 (121.96) 32.19
2024 36.21 169.50 (133.29) (91.98)
2025 36.57 182.05 (145.48) (237.86)


The ERS fund, on the other hand, is a contributory system. Employees and the state each contribute a percentage of an employee s salary to the fund. In fiscal 1993, employees will contribute 6 percent of their salary and the state will contribute an additional 6.43 percent of salary. Since contributions are related to payroll, there is a rational relationship between c ontributions and the actuarial cost of the plan. The contributions based on the normal cost of the retirement fund grow at roughly the same rate as payroll.

Funding for LECOSRF is provided entirely by the state, without employee contributions. However, the problem is that the funding source designated portions of the motor vehicle inspection fee is completely unrelated to either payroll or to actuarial funding requirements. Therefore, the amount paid into the fund each year may exceed or fall short of the actuarial normal cost.

Since LECOSRF was created, motor vehicle inspection fees have generated funding in excess of actuarial costs, resulting in an overfunded system and placing an unfair demand on the state s limited revenues. It is important also to point out that the motor v ehicle inspection fee revenue is projected to increase at a much slower rate than the fund expenditures for retirement benefits, and the overfunded actuarial accrued liability is projected to be depleted in the year 2024. 8


Recommendations
A. The Legislature should stop funding Law Enforcement and Custodial Officers Supplemental Retirement Fund (LECOSRF) from designated portions of motor vehicle inspection fees. Future contributions should be a percentage of the members salaries, out of the funds paying those salaries. In addition, the Legislature should statutorily reallocate to the General Revenue Fund those fees designated for transfer to LECOSRF.

The current method of funding is not based upon sound actuarial principles, and the fund will become insolvent in the year 2024. The Legislature should authorize an actuarial valuation to determine the percentage salary required to maintain the actuarial soundness of LECOSRF. TPR estimates the percentage at about 3.5 percent of the salary expenditures for eligible law enforcement an d custodial officers.

B. The Legislature should initiate the new funding method for LECOSRF in fiscal 1998, with no contributions to the fund in fiscal 1994 through 1997. Due to the large overfunded actuari al liability of LECOSRF, the fund could continue to cover costs for more than four years by spending down the overfunded balance, without affecting the benefits for current retirees. 9

Implications
Based on this recommendation, since contributions based on the normal cost of LECOSRF would increase as payroll increases, the long-term solvency of the fund would be assured. In fact, the fund would remain solvent indefinitely. These changes do not affect retirement benefits for law enforcement and custodial officers in the near term, and in the long term will increase the fund s stability, ensuring benefits for future retirees. The contributions to the fund will be paid out of the funds which pay the employees salaries, much as the employees retirement program is financed today and as most retirement systems in the state are financed.


Fiscal Impact
There will be a gain to general revenue in 1994 to 1997 due to the transfer of motor vehicle inspection fee revenue to the General Revenue Fund rather than LECOSRF. Based upon projections, the General Revenue Fund should receive more than $27 million in deposits in each of these years. 10 This will constitute a loss in potential revenue to LECOSRF, but due to the large overfunded actuarial liability, the fund should easily meet its obligations. During the four-year period, LECOSRF would meet its expenditures by spending its fund balance.

Assuming an average 8-percent annual growth in salary expenditures for eligible law enforcement and custodial officers over the nex t five years, salary expenditures should reach $846.4 million by fiscal 1998, the year in which contributions will resume to LECOSRF. In fiscal 1998, the funding for LECOSRF will be based on a percentage of employees salaries to be paid from the same sour ce as those salaries, much like ERS is funded. Assuming that salary expenses will increase at the rate projected in the actuarial assumption, and that salaries will continue to be funded from their current source, the following table cites the estimated ex penses from each fund.

Fund from which Estimated Salaries Estimated Salaries Payment of 3.5 %
Salaries are Paid in FY1993 in FY1998 to LECOSRF in FY1998

General Revenue Fund 001 $457,200,000 $671,800,000 $23,500,000 State Highway Fund 006 71,900,000 105,640,000 3,700,000 Game, Fish and Water Safety Account 009 17,400,000 25,570,000 895,000 State Parks Account 064 1,300,000 1,910,000 67,000 Operators and Chauffeurs License Account 099 16,500,000 24,240,000 848,000 Industrial Revolving Account 156 8,700,000 12,780,000 447,000 DPS Federal Account 222 370,000 543,600 19,000 Public Building Bond Project Fund 628 2,600,000 3,820,000 134,000 Public Finance Authority Fund 695 57,500 84,500 3,000

Total $576,027,500 $846,388,100 $29,613,000

Calculated at 3.5 percent of salary, total contributions to LECOSRF in fiscal 1998 should be $29.6 million, of which $23.5 million comes from general revenue and more than $6.1 million comes from the highway and other special funds.

(Loss) to
Fiscal Gain to the General (Loss) to Other Dedicated Change
Year Revenue Fund 001 11~ LECOSRF 12~ Accounts or Funds in FTEs

1994 $27,865,000 $(27,865,000) $ 0 0
1995 28,252,000 (28,252,000) 0 0
1996 28,655,000 (28,655,000) 0 0
1997 29,102,000 (29,102,000) 0 0
1998 6,065,000 48,000 (6,113,000) 0

Endnotes
1 Comptroller of Public Accounts, Breaking the Mold, Vol. 2, Part I (Austin, Texas, July 1991) EB3, pp. EB 21.
2 Members are eligible to retire at age 50 with 30 years of service, age 55 with 25 years of service, and age 60 with 5 years of service.
3 Leslie P. Finertie and Steven R. Rusher, Towers, Perrin, Forster & Crosby, Law Enforcement and Custodial Officers Supplemental Retirement Fund of the Employees Retirement System of Texas, August 31, 1991, Actuarial Valuation Report, November 27, 1991, pp. 4,7.
4 According to Steven Rusher, Towers, Perrin, Forster & Crosby, November 24, 1992.
5 Leslie P. Finertie and Steven R. Rusher, p. 10.
6 Senate Bill 2, Section 2.34.
7 Law Enforcement and Custodial Officer Supplemental Retirement Fund, Report to the Governor and Members of the 72nd Legislature , interim study, Committee to Review Future Needs and Actuarial Soundness of CPO/CO Fund, January 31, 1991.
8 Ibid.
9 Ibid.
10 Motor Vehicle Inspection fee estimates are based on the Comptroller s January 1993 Biennial Revenue Estimate.
11 1998 Calculation is based upon: $29,565,000 (estimated revenue to GR from MVI fees)
23,500,000 (% of salary expense to be deposited in LECOSRF)
$ 6,065,000 NET gain to GR in FY 1998

12 1998 Calculation is based upon: $29,613,000 (estimated deposits to LECOSRF under new method)
29,565,000 (estimated MVI fee revenue to LECOSRF old method)
$ 48,000 NET gain to LECOSRF under new method of funding