-



U.S. DEPARTMENT OF LABOR
Employment and Training Administration
Washington, D. C. 20210

CLASSIFICATION

TURA

CORRESPONDENCE SYMBOL

TURA

ISSUE DATE

October 13, 1981

RESCISSIONS

None

EXPIRATION DATE

September 30, 1982

DIRECTIVE

:

UNEMPLOYMENT INSURANCE PROGRAM LETTER NO. 44-81

 

TO

:

ALL STATE EMPLOYMENT SECURITY AGENCIES

 

FROM

:

T. JAMES WALKER
Administration and Management

 

SUBJECT

:

Reserve Adequacy

  1. Purpose. To provide States with guidance in determining the idequacy of the Unemployment Snsurance trust funds.

  2. References. FY 1982 State Agency Program and Budget Planning (PBP) Guidelines.

  3. Background. The vast majority of States do not have adequate trust funds. Restoring these State trust funds to solvency and adequacy is a Secretarial Objective for 1982. Most of the national office effort will be toward assisting those States with loans to restore solvency. The FY 1982 PBP requires that States with inadequate reserves should develop detailed action plans for restoring financial adequacy to their trust funds.

    There is no one definition of an adequate reserve in the UIS. However, the most widely accepted criteria is that of the reserve multiple. The National Commission Unemployment Compensation (NCUC) also looked into question of adequacy and solvency measures. In order to assist SESAs in developing their action plans, these two criteria are discussed below. A more complete explanation will be presented in the Third Issue of the UI Research Exchange.

  4. Reserve MultipleTotal wages provide the most ntable measure of program liability and for estimating potential liability. Moreover, the use of this stable measure makes possible more valid comparisons, over time, of this impact of unemployment levels on benefit costs. In other words, for different years with similar unemployment levels, benefit costs, if expressed in terms of percentages of total wages, will be approximately equal. Consequently, the ratio of benefit payments to total wages during the worst prior recession period provides a guide to the the minimum reserve level required to finance a similar recession in the future.

    The required ratio may be obtained by relating benefit payments to total wages during the 12-consecutive-month period in which this ratio was the highest. A severe spell of unemployment, however, is almost never confined to a single 12-month period, but typically extends 18 months or more. On the average, the cost of such a spell is about one and one-half to two times the cost of the 12 consecutive months in which costs have been the highest. Thus, a reserve fund equal to no less than one and one-half times the ratio of benefits to total wages during the highest-cost 12 month period gives an indication of a bare minimum of reserve adequacy.

    A reserve equal to this minimum level will pay the costs of one spell of unemployment as severe as the worst previous spell in the recent history of the program, with a margin of safety added. The tax revenue collected during a recession period would help to pay the benefit burden should the cost exceed any previously experienced. This revenue would also provide a base upon which to rebuild the reserve fund after the spell of unemployment was over.

    This is referred to as the reserve multiple concept. A State should have a reserve multiple of a least 1.5 at the onset of a recession. The reserve multiple is defined as the ratio of the State Reserve Ratio to the State's highest 12-month benefit cost rate or

    Reserve Multiple = (Reserve Ratio)

    (high benefit cost rate)

    = (Current year reserve/current year's total wages)

    (highest 12-month co-qt.-total wages for same period)

    This reserve multiple is referred to as a static measure in that it measures the adequacy of a State's fund at a point in time. Shortcoming of the measure is that it is only valid at one point in any business cycle--the beginning of a downturn. However, it is a useful measure in that it is a level which all States should be building toward. A State can gauge where it is in the cycle and should be able to evaluate whether it is likely to reach this desired level at the appropriate time.

  5. NCUC Findinqs on State Solvency Measures. The Commission recognized that States are in a critcal period of restoring the financial solvency and integrity of their UI programs. Long-range financial planning on the part of States is a necessity. Increased resources at all levels-State, regional, and national need to be devoted to this effort. The Commission strongly urged each State to develop effective solvency measures based on the following analysis.

    Both reserve levels and the system's revenue-generating capacity should be considered in designing the specific solvency measure. Past experience indicates that reserves as a percentage of total wages at the beginning of a downturn should be between 1.5 and 3.0 times the State's average annual benefit cost rate for some prior period. Using an average of several high benefit cost rates provides more stability than a one-year rate, which could shift dramatically from year to year. The past measurement period should be responsive to changing economic conditions and therefore be a moving base period, e.g., the most recent 15 years of experience.

    With respect to the tax structure-adequacy, the Commission's review indicated that State laws should provide for a maximum income rate, or revenue-generating capacity, that is in excess of the expected long-term benefit cost rate. The excess allows for planning error and added fund rebuilding capacity.

    Those States opting for a relatively low reserve multiple, less than 2.0 perhaps, accordingly should utilize a higher maximum income rate, and vice versa. Obviously, the combination of reserve level and revenue-generating capacity are for the most part determined by State economic conditions and political preferences.

    The Commission's review also found that the use of an absolute or fixed measure, e.g., absolute dollar amount to adjust tax inflow into the fund can lead to financial difficulties. A fixed measure simply does not keep pace with the changing liabilities of the system and risk to the fund. The Commission believes that a provision stated in terms of relative criterion (such as total wages or flexible taxable wages) more accurately reflects the changing financial responsibilties of the system.

  6. Action Required. SESAs should implement their action plans in accordance with the FY 1982 PBP guidelines, heeping the above measures in mind. The plans should analyze the net impact of projected revenues and projected benefit payments. Requests for actuarial assistance should be directed through your Regional Office.

  7. Inquiries. Inquiries should be directed to your regional offices.