The3rd meeting of the Subcommittee on Postsecondary Education of the Interim Joint Committee on Education was held on Monday, September 8, 2003, at 10:00 AM, in Room 149 of the Capitol Annex. Senator Jack Westwood, Co-Chair, called the meeting to order, and the secretary called the roll.
Members:Senator Jack Westwood, Co-Chair; Representative Mary Lou Marzian, Co-Chair; Senator Lindy Casebier, Ex-Officio; Representatives Hubert Collins, Bill Farmer, Mary Harper, Charles Siler, and Kathy Stein.
Guests: Jo Carole Ellis, Dr. Joe McCormick, and David Lawhorn, Kentucky Higher Education Assistance Authority; Bill Reimert, Milliman USA; Dennis Taulbee and Brenda Johnson, Council on Postsecondary Education; and Cindy Heine, Prichard Committee for Academic Excellence.
LRC Staff: Jonathan Lowe and Lisa Moore.
Senator Westwood told the members that the Strategic Committee on Postsecondary Education (SCOPE) was meeting in Louisville in conjunction with the events of the inauguration of President James Ramsey and Senator Neal and Senator Williams as well as others may not be in attendance at the subcommittee meeting as a result. He said the subcommittee would discuss Kentucky’s Affordable Prepaid Tuition Program (KAPT) and the Kentucky Education Savings Plan Trust (KESPT). He introduced Ms. Jo Carole Ellis, Executive Director, KAPT, Kentucky Higher Education Assistance Authority (KHEAA), and Mr. David Lawhorn, KESPT Program Administrator at KHEAA.
Mr. Lawhorn said the prepaid tuition plans and the college savings plans are considered qualified tuition programs. He said these types of programs are defined in Section 529 of the Internal Revenue Code and are also called 529 plans. They were enacted as part of the Federal Taxpayer Relief Act of 1997.
Mr. Lawhorn said qualified tuition plans are available in all 50 states plus Washington D.C. There are 53 savings plans, and 20 prepaid tuition plans nationwide. He said Kentucky has both types through KAPT and KESPT programs. Mr. Lawhorn said both programs were created to provide Kentucky families a way to save for higher education costs, both are administered by KHEAA, and neither program has an impact on the general fund. KAPT administration is funded by program earnings and fees, and KESPT administration is funded by program fees and agency-generated receipts.
Mr. Lawhorn said there are some basic features of the qualified tuition plans including: 1) Earnings used for qualified expenses are free from federal taxes; 2) Kentucky exempts earnings from state taxes for both programs; 3) 25 states offer a state tax deduction; 4) Contributions qualify for $11,000 annual gift tax exclusion; 4) Qualified expenses are tuition and fees, room and board, books, supplies, and equipment required for enrollment; 5) Funds can be used at Title IV-eligible institutions (accredited postsecondary); 6) Funds can be rolled over to family members; and 7) Non-qualified withdrawals incur a 10 percent federal tax penalty on earnings.
Mr. Lawhorn said KESPT was the first 529 college savings program in the country, originating in 1990. He said it is managed by the TIAA-CREF Tuition Financing, Inc. (TFI), and it offers a variety of benefits. Some advantages include: 1) No income limitations; 2) Account owner retains control of account; 3) Beneficiary is entitled to in-state tuition rates if certain requirements are met; and 4) Accounts are excluded from state aid eligibility calculations.
Mr. Lawhorn said there are three investment options. They are: 1) Managed Allocation Option – An investment allocation based on beneficiaries’ ages. As the beneficiary nears college age, money will moved into bonds and money market investments and out of equities; 2) 100 percent Equity Option (since February 1999) – All investments are in both domestic and international stock mutual funds (approximately 80 percent in TIAA-CREF Institutional Growth and Income Funds and 20 percent in TIAA-CREF International Equity Fund; and 3) Guaranteed Option (since May 2003) – Principal is protected and a minimum annual rate of return of 3 percent is guaranteed, with the opportunity for additional returns beyond the minimum rate. (Current rate of return is 3 percent.)
Mr. Lawhorn said that investment returns for this calendar year through July 31, 2003 ranged from 1.51 percent to 11.53 percent. He said in the last 12 months ending on July 31, 2003, investment returns have ranged from 2.98 percent to 9.55 percent. He said the program statistics as of July 31, 2003, are 7,000 account owners in KESPT with $36.8 million in total assets, with a $5,207 average account size. Mr. Lawhorn said that figure is slightly below the national average when compared to other 529 savings programs.
Mr. Lawhorn said there is an 0.80 percent management fee charged to account owners (one of the lowest state 529 programs), and no other fees are charged. He said the states of New York, Minnesota, Michigan, and California all have administration fees that range between 0.60 percent to 0.65 percent. On the high end, Arizona has a plan with an expense management fee of 2.10 percent.
Mr. Lawhorn said, in conclusion, that KESPT offers: 1) Tax-advantaged savings on earnings for the account owners; 2) Opportunity for all Kentuckians to start saving for college; 3) Professional investment management; 4) Flexibility for account owner to change the account beneficiary, withdraw funds, or change investment options.
Representative Marzian asked if enrollments were still open for a KESPT plan. Mr. Lawhorn said there is no enrollment period, and Kentuckians can enroll at anytime. Representative Marzian asked if grandparents who live outside of Kentucky could participate in KESPT. Mr. Lawhorn said that provision was changed last year, and KESPT is open to any United States citizen as long as the person has a valid social security number. He said this is a trend across all 50 states. Representative Marzian asked if the beneficiary had to attend a Kentucky college. Mr. Lawhorn said no, any accredited 2 or 4 year institution is acceptable as long as it meets the federal Title IV requirements, including overseas institutions.
Representative Farmer asked if people took advantage of the 5-year option on the $11,000 contribution. He wondered if KESPT received very many lump sum contributions of $11,000. Mr. Lawhorn said they have not experienced the really heavy up-front funding, although there have been some large account deposits. He does not have the exact figures, but he will research the numbers for the past year and get them to the members.
A motion was made by Representative Stein and seconded by Representative Collins to approve the minutes of the August 4, 2003 meeting. The motion was approved by voice vote.
Senator Westwood asked if the range of 1.51 percent to 11.53 percent on the investment returns from this calendar year through July 31, 2003, was on the high end or low end or in the middle. Mr. Lawhorn said it was pretty much in the middle, however the discrepancy is the 100 percent equity option which has higher returns, while the lower end is 1.51 percent. He said KESPT is right in the 7.5 percent range for the last eight months.
Ms. Ellis introduced Bill Reimert, F.S.A., Principal, Milliman USA, and Steve Roland, Financial Consultant to the Unclaimed Property Fund, who were available to help answer questions at the end of the presentation. Mr. Reimert said he was retained by KAPT a little over a year ago, with a primary role to do an annual actuarial evaluation of the financial soundness of the tuition fund, and when KAPT is open to sell new contracts (they are currently not open), he assists in developing appropriate prices. Mr. Roland said he has conducted evaluations for KAPT as to how it related to KRS 393.015.
Ms. Ellis said KAPT was created by the 2000 General Assembly and was launched in October 2001. She said there have been three enrollment periods held, with over 7,000 accounts opened. Ms. Ellis said as of July 31, 2003, the KAPT program fund held over $48.7 million in assets and is expected to receive approximately $700,000 in monthly contributions in Fiscal Year 2004. She said KAPT would not have its first beneficiaries eligible for tuition payouts until the fall of 2004, which is a class consisting of approximately 200 students.
Ms. Ellis said the administration of KAPT was transferred from the State Treasurer’s Office to KHEAA per House Bill 269 in the 2003 Session of the General Assembly. She said this transfer was effective on July 1, 2003, per Executive Order, and the KHEAA Board of Directors now governs the KAPT program. Ms. Ellis said the budget bill language also suspended the selling of KAPT contracts during Fiscal Year 2003-2004.
Ms. Ellis said KAPT is designed to allow families to purchase tuition to be used in the future at lower prices today. She said there are three tuition plans offered - the Value, Standard, and Premium plans. She said the value plan cost is based on current tuition and fees at the Kentucky Community and Technical College System (KCTCS). She said the standard plan cost is based on current tuition and fees at the highest priced Kentucky Public University. Ms. Ellis said the premium plan is based on today’s average cost of Kentucky’s private institutions, and the payout value will grow at the same rate of tuition increase that is experienced at the University of Kentucky over the life of the account. Ms. Ellis said participants can purchase one to five years of tuition, payments can be made in a lump sum or in monthly payments, and KAPT guarantees the payment of benefits.
Ms. Ellis said key points regarding KAPT investments are: 1) Board-approved investment policies; 2) Strategy designed to meet or beat tuition inflation over the long term; 3) Fifth Third Bank manages investments; 4) Investment consultant reviews performance quarterly; and 5) Current Asset Allocation of the KAPT portfolio is approximately 60 percent equity and 40 percent fixed income.
Ms. Ellis said that thanks to recent gains in the stock market, KAPT has enjoyed some positive returns during the past 12 months. She said in Fiscal Year 2003, the return on investment was 5.97 percent. She said for the calendar year through July 31, 2003, the investment return was 9.15 percent, and for the 12 months ending July 31, 2003, the return was 8.75 percent.
Ms. Ellis said the KAPT plan has a two fund structure – there is a program fund and a reserve fund. She said the KAPT Program Fund receives program contributions and earnings, and pays for program administration and tuition payouts. She said there is $48.7 million currently in the program fund. Ms. Ellis said the KAPT Reserve Fund was created by the General Assembly to serve as a financial backup if the KAPT Program Fund experienced any shortfalls. She said there is currently $14.8 million in this fund.
Ms. Ellis said KAPT and all other prepaid tuition programs have actuarial evaluations conducted to analyze the programs’ funding status and help the programs determine the appropriate way to price new contracts. She said the actuarial study uses tuition inflation and investment return assumptions to compare the estimated value of program assets to the estimated value of program liabilities. She said assumptions used in the preliminary Fiscal Year 2003 actuarial analysis was 7.5 percent tuition increase for the next five years, 6.5 percent tuition increase for the next 17 years, and a 7.0 percent annual investment return.
Ms. Ellis noted the preliminary findings of the actuarial study show KAPT to be 87 percent funded (before reserve fund). She said this is a $12.8 million actuarial deficit (before reserve fund), and the first shortfall not occurring until 2021. Ms. Ellis said the KAPT reserve fund is greater than the actuarial deficit, and results in a $2 million net surplus today.
Ms. Ellis said that KAPT can strengthen fund status by selling contracts with premiums. For example, if all other assumptions remain true, and KAPT could sell 2,000 contracts per year and add a five percent premium, there would be no deficit in 11 years. She said if a ten percent premium was added, there would be no deficit in 4.5 years. Ms. Ellis said if 3,000 contracts were sold per year and a five percent premium was added, there would be no deficit in 6.4 years. She said if a ten percent premium was added, there would be no deficit in 2.9 years.
Ms. Ellis said KRS 393.015 is the statute that provides support of the Unclaimed Property Fund to KAPT. The statute states that 75 percent of the balance of the Unclaimed Property Fund is available to meet any unfunded liability of KAPT. She said a specific KAPT reserve fund was set up by the Division of Statewide Accounting Services to reflect the amount of Unclaimed Property receipts set aside for the KAPT reserve. She said the current balance of the account is $14.8 million and beginning in Fiscal Year 2005, approximately $3.5 million is expected to be placed in that fund each year going forward.
Ms. Ellis said as of today, the KAPT Program Fund added with the KAPT Reserve Fund is $63.5 million for a combined fund status. She said the KAPT Program Fund deficit of $12.8 million added to the KAPT Reserve Fund of $14.8 million results in a combined actuarial status of $2.0 million. She said the 2026 Fund Preliminary Actuarial status adds the KAPT Program Fund of -$38.5 million plus the projected KAPT Reserve Fund of $95.3 million for a combined actuarial status of $56.8 million in 2026.
Ms. Ellis concluded that a final actuarial study will be released by Milliman USA in October. She said the study will then be presented to the KHEAA Board of Directors and they will review the study and consider options regarding reopening the program in 2004-2005.
Senator Westwood asked if KAPT would affect the General Fund now or in the future, and what would happen if the investments and fees do not cover the yearly payments of KAPT. Ms. Ellis said actuarial studies will be conducted every year, and this information is analyzed to see if assumptions should be adjusted or if premiums need to be added. Senator Westwood asked for clarification that KAPT would not affect the general budget through at least 2026. Mr. Roland said if all sources of revenues that are contained in the enabling legislation, both program funds as well as 75 percent of the annual balance in the Unclaimed Property Fund be reserved for KAPT, the figures show that there will never be a year in which there is not a balance of at least $45 million in the KAPT program. Mr. Roland said there would not be a time where the KAPT Board would have to ask the legislature for a general fund appropriation to support the contracts at least through 2026.
Senator Westwood asked if the Unclaimed Property Fund was segregated from the general fund. Mr. Roland said it is not segregated at this time, but that over the last several months the Division of Accounts has created a KAPT Reserve account within the general fund which has $14.8 million. He also said it is not prohibited for the legislature to appropriate those funds for another use. Senator Westwood said there has been a big push to alert citizens to their unclaimed properties and the marketing of this program has been substantial and successful. Mr. Roland said over the last three years, there has been more money returned to the rightful owner than any three years in the history of the Unclaimed Property Fund. Also, reporting has been accelerated from seven years to three years. He said over $11 million has been returned to rightful owners in the last three years. He said the plan is to continue this aggressive plan of returning money to its rightful owners.
Representative Farmer asked the result of not charging a premium on the contracts. Mr. Reimert said premiums could be charged in order to pay down the fund’s actuarial deficit. He said the view of actuaries is that all prepaid programs should charge a premium because it is hard to predict tuition increases and investment returns for the future. He said a 10 percent premium is sufficient and recommended it as a stabilization resource in case of adverse effects in the stock market, etc. Mr. Roland said the existing graphs and projections of surpluses of money in the handout through the years 2026 for the KAPT program are not based on utilizing premiums.
Representative Farmer asked how accurate the actuarial analyses have been so far and what methods KAPT is using to adjust investment strategies. Ms. Ellis said for tuition and inflation the assumptions were good for the first year of the program. She said the investment returns was not very good because February of 2002 was not a good time to get into the market, and losses were realized in the first year of the program. Mr. Reimert said that over the 12-month period ending last June 30, 2003, the fund had a negative return of 7.8 percent. He said there has been a slightly positive return under the fund since inception, which is certainly short of the actuarial assumption. He said the declines in the assumptions are a reflection of the decline in interest rates, the point being that when KAPT goes to the market to buy fixed income investments, it will not get the return on those bonds going forward than it would have one or two years ago.
Representative Farmer asked about administration and marketing fees for KAPT are paid, and how substantial those burdens to the cost of the program are. Ms. Ellis said the management and marketing comes straight out of the KAPT program fund, which are derived from contributions, earnings, and fees. She said the only current fees charged to KAPT holders are a $50 application fee, $2.00 per month account administration fee, and a $150 refund fee if a contract is cancelled. Ms. Ellis said the KAPT budget for Fiscal Year 2004 is $840,000, which is down 40 percent from last year’s budget because there is no marketing costs this year since the program is not open for new enrollments this fiscal year. She said in Fiscal Year 2003 there was a $1.4 million budget, and $750,000 was for marketing.
Representative Marzian said constituents in her district really support the program, and want enrollments to re-open. She said the program gives Kentuckians of all income levels the chance to go to college that they might not have otherwise had. She said it seems that it would make perfect sense to open the program back up to be able to access those contributions and invest them in a market that seems to be on the upswing now. Mr. Reimert said yes, provided that KAPT can make reasonable forecasts of tuition growth and estimates of enrollment. He said there will be periods of adversity, but it makes fiscal sense to keep enrollments and the program open to the public.
Representative Marzian asked about a five percent premium for a contract and the estimated costs to families. Ms. Ellis said she does not have those exact numbers, but it would be interesting to compare and she will do an analysis.
Senator Westwood discussed the preliminary finding showing KAPT to be 87 percent funded before the reserve fund. He asked about the $12.8 million deficit and how much of that can be attributed to financial losses. Mr. Reimert said last year it was assumed that tuition would grow at a rate of 6.5 percent per year. He said for this year’s evaluation, the 6.5 percent assumption was raised to 7.5 percent for the next five years. He said this one change in an assumption about the future increased the deficit by $4.4 million. Mr. Reimert said $7 million out of $12 million is due to actual tuition increases from fall of 2002 to the fall of 2003. He said the other almost $6 million is a combination of investment losses and tuition increases. Ms. Ellis said since the inception of KAPT in February 2002, the only positive returns on investments occurred this year.
Senator Westwood asked if the marketing costs contributed to the deficit. Mr. Reimert said that in developing prices, KAPT builds the budgeted marketing costs into prices. He said the deficit is affected by the extent to which actual expenditures differ from the budget that is determined at the beginning of the year. Ms. Ellis said the amount budgeted for marketing is exactly what was used. He said expenses were not a contributing factor to the deficit, but two factors that did contribute to the deficit were adverse investment results and adverse tuition increases. Senator Westwood asked how much in real dollars is spent on the administration of the KAPT program. Ms. Ellis said in Fiscal Year 2004, the budget is $840,000 and it will probably use $800,000. The budget does not include advertising, since KAPT will not be open for enrollment.
Representative Stein said this legislation for these programs passed with a great deal of bi-partisan support and has meant wonderful things to a number of parents who are so interested in the education of their children. She asked whether the reserve fund would keep the KAPT program healthy. Mr. Roland said if the legislature does not alter the existing KAPT legislation by changing KRS 393.015, and it is implemented by the administration, the KAPT program runs no risk. He said the reserve fund serves as a safety net and makes Kentucky’s KAPT program stand out from other programs across the country.
Representative Stein said the unclaimed property fund should remain untouched, and she does not think that KAPT should be discontinued or money returned to initial investors. She thanked the presenters for their information and offered support to keep the KAPT program open.
Senator Westwood told the members that in their folders are copies of the KESPT and KAPT presentations, as well as background documents for the Executive Order transferring KAPT from the State’s Treasurer Office to KHEAA, the budget language for House Bill 269, and the statutes governing KESPT and KAPT.
The meeting adjourned at 11:20 a.m.