Call to Order and Roll Call
The meeting of the Public Pension Oversight Board was held on Tuesday, October 21, 2014, at 1:00 PM, in Room 149 of the Capitol Annex. Senator Joe Bowen, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senator Jimmy Higdon; Representative Brian Linder; Tom Bennett, Jane Driskell, James M. "Mac" Jefferson, and Sharon Mattingly.
Guests: Brent Sweger, Kentucky Transportation Employee Association, Senator Julian Carroll, and guest speakers, among others.
LRC Staff: Brad Gross, Greg Woosley, and Marlene Rutherford.
Approval of Minutes
Co-Chair Yonts moved that the Minutes of September 25, 2014, be approved, which was seconded by Representative Linder. The minutes were approved without objection.
Co-Chair Bowen said the board will re-visit the meeting schedule at the end of the meeting because there has not been a consistent meeting date in recent months due to attempts to accommodate members’ schedules.
Kentucky Retirement Systems Investment Update
David Peden, Chief Investment Officer, discussed investment performance. The September performance is still in the unaudited stage, which is why the board was not provided a copy. In the first quarter performance from July 1 through September 30, most of the markets, especially the equity markets, were down, with total fund performance for the quarter being a negative 1.41 percent, which was less than the benchmark performance of 82 basis points or 0.82 percent. The equity markets have been negative since the beginning of the fiscal year. Over this period, the KRS U.S. public equity position was down 87 basis points, while the benchmark was flat. Non-U.S. equity was down 5.44 percent, which was in line with its benchmark. Emerging market equity was down 3.7 percent, and all those positions together resulted in a total public equity performance of negative 3.1 percent. Fixed income was also negative for the fiscal year to date, resulting in a negative return of 87 basis points, or 0.87 percent, and the benchmark performance was flat. The difference is a result of KRS having more non-investment grade exposure than what is in the benchmark.
The other component of the fixed income benchmark is interest rate sensitive assets. The assets and strategies sensitive to inflation, or the real return exposure, were down fiscal year to date 1.62 percent, which was slightly less than the benchmark. Absolute return, or hedge funds, was up 74 basis points for the fiscal year to date, real estate was up 2.03 percent, and private equity was up 1.49 percent. He said it has been a challenging start for the fiscal year. October has not helped performance either, with returns slightly worse. The portfolio was down three percent as of the close of business the day before the meeting. This performance picture is not unique to KRS, but rather is market driven. The equity markets have become increasingly volatile since the September meeting.
Responding to questions by Co-Chair Yonts concerning whether the downturn in the economy is related to the shortfall in the European economy and other factors around the world, Mr. Peden said all of these factors affect the market, so that the non-U.S. equity exposure is affected by what is occurring in Europe. However, the U. S. equity exposure is being affected, and it appears that fears over the Ebola epidemic were the tipping point. Mr. Peden did not believe that the Ebola situation directly attributed to the downturn, but the uncertainty of what could occur or the fear of a major outbreak caused some market fluctuations.
In response to a question concerning losses of peers compared to KRS during the downturn, Mr. Peden stated it depends on how much non-U.S. equity exposure peers, such as the Kentucky Teachers’ Retirement System, have because that market has not performed well, and actually worse than, U. S. equities. To the extent that KTRS has a majority of its public equity exposure in U. S. equities and despite having more than KRS, its relatively small exposure to non-U.S. equities may equalize the gap because of what has occurred in the rest of the world. If each entity had only U. S. equity then KRS would have done better than KTRS, but Mr. Peden could not give a definitive response because he did not know the level of KTRS’s non-U.S. equity exposure. Mr. Thielen said that the best returns KRS has seen in the first quarter are from the absolute return asset class, which has helped balance the negative returns in the domestic equity and international equity markets.
Kentucky Retirement Systems Update on 2015 Retiree Health Plan
Bill Thielen, Executive Director of the Kentucky Retirement Systems, provided an overview of the 2015 retiree health plan. KRS is in the open enrollment period for both the under sixty-five non-Medicare eligible members and the Medicare eligible members that are over sixty-five or disabled. For Medicare eligible members in 2015, KRS will continue the Humana provided Medicare Advantage plans. There is a premium plan, an essential plan, and a medical only plan for those who receive prescription drug coverage through another provider or they do not need that coverage. The current premium plan per member, per month cost is $212.39, and in 2015 the cost will increase fifteen percent to $244.25. The essential plan per member, per month cost now is $67.62 and will increase to $77.76 in 2015. There were three factors that caused the increase in costs. One principal factor was the pipeline of drugs being introduced into the market to treat diseases such as hepatitis C or cancer that are very costly. Another factor contributing to the increased cost is the lower net government reimbursements to the Medicare Advantage plans. Mr. Thielen said the other main factor is increased claims costs. KRS is in the third year of the Humana provided fully-insured Medicare eligible program, whereas before it was a self-insured program, and while the costs were projected at the beginning of the program there are now two full years of costs known that have exceeded what was anticipated. The under sixty-five members are insured through the Kentucky Employees’ Health Plan, and the KRS Board selected the Living Will Consumer Driven Health Plan as the plan for which KRS would pay the premium. In 2014, the premium was about $698 per month and will increase to $708 per month in 2015. This plan is closest to the actuarial equivalent plan to the 1994 Kentucky Care Standard. The contract with Humana will expire in 2015, and KRS will request an RFP in early 2015 for the plan year 2016 and thereafter. The KRS Board has already approved issuing that RFP.
In response to questions by Co-Chair Bowen about the recent departures of investment personnel and what is being done to address the vacancies, Mr. Thielen indicated that the employees left for different reasons. He said that one employee resigned and was moving out-of-state because his wife would be attending law school, and that one employee was offered better pay and resigned to take that offer, which is a challenge for KRS to retain highly-skilled individuals. He said an investment analyst position has been filled, and that KRS has posted two director positions and is taking applications and that he anticipates hiring for those positions in the near future. Mr. Peden noted it was an unfortunate coincidence that the resignations occurred at the same time, which has placed some stress on the remaining members, but that it is not a pattern. KRS positions are often filled within the regional market, but KRS does not limit itself and does post employment notices in Insurance and Investments online, a national outlet.
Responding to a question by Co-Chair Bowen concerning discussions by the KRS Board relative to the retiree health plans for 2015, particularly for the over sixty-five members, Mr. Thielen said the board did discuss whether to increase the deductibles for the medical and hospital costs and what impact that would have on rates and increasing the maximum out-of-pocket costs to members. Ultimately, the KRS Board decided not to increase the deductibles at this time, but will continue to look at possible changes in the plans going forward, and he noted that the impact on retirees compared to the minor difference it made in rates led to the choice not to make the changes.
Co-Chair Bowen inquired whether the 2015 health plan changes would result in an experience above or below the assumptions by the actuaries and the impact on the funding requirements. Mr. Thielen said that an actuarial analysis would have to be done after 2015 and that the actuaries did look at 2012-2013 and 2013-2014 and there were some actuarial gains and some losses relating to the various health plans during those years. For example, in 2014, the medical only plan showed an actuarial gain, as did the Capital Choice Living Well PPO plan, but two other plans showed actuarial losses. The assumptions are set based on what the actuary thinks will happen, but only after the experience can it be seen if the assumptions were met or not, and for 2015 it is unknown what the impact will be.
Responding to Co-Chair Bowen concerning the additional increase in pay provided to KRS employees over those awarded for regular state employees in the budget, Mr. Thielen said that in 2002 the Legislature separated the Kentucky Retirement Systems personnel plan from KRS Chapter 18A, the state’s personnel pay plan. The KRS operates with a separate personnel plan, although it is similar to the state plan, and KRS has for the last several years followed the state’s plan for salary increases. However, this year the KRS Board was given the option of granting an additional one or two percent to KRS employees based on the KRS pay for performance system, in place of time off that was extended to state employees, and that this amounted to about $102,000. The board took into account that when additional time off is granted there is a liability in that it increases overtime costs, and the board felt it was more beneficial to those employees who had exceeded standards in the performance system to receive an additional one percent increase in pay. Mr. Thielen stated that the matter was discussed before the Human Resources Committee, which is comprised of five board members, and then the issue was taken to, and voted on by, the full board.
In response to Senator Higdon as to where the funds came from for the additional increases, Mr. Thielen stated that the KRS administrative budget comes from the trusts and is shared by the health insurance trust and the pension trust – coming initially out of the pension trust but some is reimbursed by the health insurance trust depending upon the allocation – and any funds not spent are returned to the trusts at the end of each fiscal year.
Testimony from Employee, Employer, and Retiree Groups
J. D. Chaney, Deputy Executive Director of the Kentucky League of Cities, and Bryanna Carroll, Kentucky League of Cities Advocacy Manager, highlighted issues of concern to cities relating to pension reform in the CERS. Mr. Chaney said that KLC has advocated strongly for pension reform over the last several years leading up to Senate Bill 2, enacted in the 2013 Regular Session. City officials supported Senate Bill 2 and the pension reforms in it because the bill embraced many of the policy objectives cities viewed as important such as: limitations on investment risks for employers and the taxpayers; addressing the issue of unfunded COLAs; and providing immediate short-term rate relief to cities. Employer contribution rates prior to Senate Bill 2, which were at 25.88 percent, will decrease by the year 2032 to 13.32 percent after the passage of Senate Bill 2, which makes it much more affordable for cities and if the projections hold true, city governments will save about $1.5 billion over that period. Pension issues and policy adjustments will always be needed, and the creation of the Public Pension Oversight Board and the inclusion of less restrictive inviolable contract language applying to employees covered under the hybrid cash balance plan, or those employees hired after January 1, 2014, which is an important provision of Senate Bill 2. He said that over the next several years KLC would probably be looking to distinguish CERS from KERS because CERS is on a different financial footing than KERS. The immediate need is dealing with clarification in the anti-spiking provision of Senate Bill 2, and therefore in 2015 cities are focused on getting the spiking provisions clarified.
Ms. Carroll stated that KLC was supportive of Senate Bill 2, but subsequent to passage of the bill some cities have had issues with spiking and the manner in which the anti-spiking provisions are being implemented. She explained that when an employee’s creditable compensation increases greater than ten percent over the last five years of employment, the last employer receives a bill for that increased actuarial cost. One difficult issue with how the process works has simply been educating member city employers and employees of what is meant by creditable compensation and salary increases in the context of Senate Bill 2. 2014 Regular Session Senate Bill 142 attempted to address the spiking issue, but the bill ran into problems with certain employee groups such as the Transportation Cabinet employees. She said that she had met with the groups and had good discussions, and that they understood KLC’s goals were not to end overtime for employees but rather to fix situations where spiked salaries were being triggered in the last five years of employment and were not due to abuse. Senate Bill 142 allows an employee to increase compensation up to ten percent, but any amounts over that level would not count toward creditable compensation unless the increase was caused by certain excepted reasons, such as where agencies except grants that require overtime work, authorized sick leave without pay, unpaid maternity leave, or workers compensation. She said another issue that developed when the bill was considered was with the legislative and judicial retirement plans, and that KLC has worked with a representative of those systems to develop suitable language. It is not the goal of KLC to place a burden on employees to not receive the hours that are needed to do the work by the employer, but to deal with the circumstances that have led to abuse of spiked pensions. She indicated that a meeting has been scheduled with various supporters of Senate Bill 142. Ultimately the bill was widely supported, but there was a problem with the Transportation Cabinet employees because of emergency situations that cause required overtime work and increased compensation levels.
Responding to a question by Co-Chair Yonts concerning the spiking issue and adjusting the spike from ten to fifteen percent, Ms. Carroll indicated that KLC was given limited parameters for solving the spiking issue because the Senate did not want to roll back Senate Bill 2. Co-Chair Yonts indicated that the fifteen percent may be a middle ground to resolve the issue without shifting the burden to the employee. Mr. Chaney, for clarification, stated that a bill was received by a city that was of a substantial amount, and that the situation was where the city had implemented a civil service system and a mayor had permitted an assistant chief of police to work that job and also at the same time perform electrical inspections, and the overtime that accrued for a year was exorbitant. Mr. Chaney indicated that the elected mayor and council attempted to address the situation, but that situations occasionally occur, especially with police and fire personnel where work hours are statutorily defined and is out of the control of elected officials. Co-Chair Yonts asked for suggestions to change laws to limit such collusion of city officials.
Shellie Hampton, representing the Kentucky Association of Counties (KaCo), discussed concerns of KaCo. She noted that retirement payments have surpassed jail payments out of the general fund in some counties, and therefore the largest issue is the actuarially required contribution (ARC) level. Because the ARC level is vital to all of the member counties, KaCo continues to monitor how the issue will be dealt with in the budgeting process. KaCo is also concerned about the Seven Counties Services bankruptcy proceedings, and that the $90 million share of unfunded liability attributed to SCS that cities and counties may have to pay is certainly an issue. She said there is definitely discussion within KaCo and with its members about the differences between CERS and KERS and whether KaCo wants to actively pursue any steps toward different governing structures for the two systems.
In response to a question by Representative Linder concerning hazardous duty pay and the hazardous duty employer rates before the passage of Senate Bill 2 (57.81 percent) and after the passage of Senate Bill 2 (dropping to 29.15 percent by the year 2030), and whether there was any concern by counties and discussion of eliminating that type of pay for sheriff’s deputies for future hires, Ms. Hampton said that this had not been mentioned by the counties.
Jim Carroll spoke on behalf of the Kentucky Government Retirees. Mr. Carroll is the co-founder of a Facebook organization that represents more than 4,000 stakeholders in the KRS. Mr. Carroll discussed the cash crisis facing the KERS non-hazardous fund and requested the PPOB make recommendations to the 2015 General Assembly to alleviate the problem. The fund is facing a threat of insolvency because it has lost half of its value since 2008, from approximately $5 billion to $2.5 billion, while continuing to pay out about $915 million in annual benefits. He said he and his organization understand that all pension plans suffered substantial losses during the downturn in the market in 2008 and 2009, with KERS losing more than $700 million and $1.4 billion respectively, but that the major concern is that over the past three years the fund, while exceeding its assumed rate of return, has lost $952 million, which indicates that a positive market performance has become disconnected from asset growth. He acknowledged that although the full employer contribution will be made for the next two years, which adds roughly $220 million in additional funds each year, that this is still not enough in the short term to reverse the trend and turn losses into the substantial gains needed to reverse the funding status of the plans. The system needs more assets. Some people argue a fee restructuring in state government could help if this led to increased revenue that could be used to finance a pension obligation bond. Whatever the solution, action needs to be taken soon to keep the system from becoming insolvent and that the passage of time only makes solving the problems more difficult. Mr. Carroll proposed that the PPOB form a subcommittee to examine pension funding solutions over the next couple of months so that the board could adopt recommendations for the upcoming 2015 session, and that stakeholders would be happy to be a part of that process.
Co-Chair Bowen thanked Mr. Carroll for attending and making retirees’ voices heard and highlighting the challenges the state and PPOB is facing. He noted that this is a very challenging subject for all states, as reflected in recent discussions he had with legislative leaders at a conference for the legislatures of the states in the southeastern United States.
The Fraternal Order of Police also expressed concern relating to retirement. Mr. Dave Mutchler, President of the FOP Lodge 614 and Sheriff John Aubrey, Jefferson County Sheriff were identified as stakeholders to discuss the FOP concerns relating to pensions. However, because of an unexpected death of a fellow member that did not allow those representatives to attend the meeting, Mr. Bill Burch, Jefferson County Sheriff’s Department and a representative for the State FOP in Frankfort, was in attendance and brought to the PPOB’s attention three areas of concern for police officers that the FOP would like to see addressed. First, FOP has some concerns with the prohibitions relating to pre-existing employment agreements and the impact it has on an employed deputy or police officer that is eligible to retire but is not permitted to approach a potential new employer prior to retiring without violating the prohibitions. Second, there is concern over the requirement that a retiree has to have participated in the Kentucky Law Enforcement Foundation Program Fund (KLEPF) before being hired under the provisions of House Bill 364. Individuals have been identified who retired before sheriffs were eligible for the KLEPF, and this requirement would mandate new training for those individuals. The third concern is that, after retiring and before a person can accept another peace officer position, the retiree cannot be re-employed for at least one month following retirement, if in a hazardous position, or at least three months, if in a non-hazardous position. Under the current rules, there are no penalties or costs to the employer, employee, or retirement system, but some labor contracts require a vacancy to be filled in a period less than ninety days, which can make these individuals not be eligible for those jobs. FOP would work with the PPOB to find mutually agreeable solutions to these concerns.
Mr. Bill Londrigan, who had been identified to speak on behalf of the Kentucky AFL-CIO, was not able to attend the meeting.
Mr. T.J. Gilpin, representing the Kentucky Association of Transportation Employees and the Kentucky Association of Transportation Engineers, discussed the concerns of those groups. Mr. Gilpin is the President of the Kentucky Association of Transportation Employees and is a member of the Kentucky Association of Transportation Engineers. These organizations represent over 2,300 members of the Transportation Cabinet. The groups are concerned with Senate Bill 142, introduced in the 2014 Regular Session, and he said that the transportation groups had met with the Kentucky League of Cities for the purpose of discussing their opposition to the bill. The groups have two major concerns with the bill. The first is that the bill as previously drafted would move the obligation for the cost from the employer to the employee in that it would reduce future retirement benefits by removing legitimate overtime pay for hours worked during emergencies, such as with snow and ice removal or inspecting roadways of on-going projects. The second concern is that the bill may violate the inviolable contract as provided in KRS 61.692, but that the groups will continue to research and determine what affects Senate Bill 142 will have on the employees and continue to work with the KLC to work on a mutual agreement.
Co-Chair Bowen encouraged Mr. Gilpin to continue conversations with his groups and KLC and that hopefully these concerns can be addressed to the satisfaction of all concerned.
Paul Guffey and Shirley Clark, representing the Kentucky Public Retirees, also addressed the board. Ms. Clark is the State Legislative Chair of the Kentucky Public Retirees, and Mr. Guffey is the President of the organization. Ms. Clark indicated that the organization has fifteen chapters throughout the state and includes retired state employees, and retired state police and city and county members. These retirees are concerned with the stability and solvency of the KRS and want to ensure it continues to be fully funded. Retirees have not received a cost of living adjustment in four years and hope that the General Assembly will pre-fund a COLA for retirees in 2016. The organization had reviewed the bills that were discussed at the September PPOB meeting and decided to take a neutral position on those bills that did not directly affect retired members. The organization supports House Bill 323 that included the judicial, legislative, and teachers’ retirement systems to the oversight by the PPOB, and the removal of the prohibition on employee or retired members serving in appointed positions of the committee, and will support those provisions in 2015. She said the organization also supported House Bill 324, the KRS housekeeping bill with the House floor amendment that was added, and that the organization will support the bill with the amendment in 2015. The House floor amendment addressed the concern of the organization over the imbalance on the KRS Board, and it would allow equal representation on the board by allowing a vacancy that might occur of an elected member to be filled only by the elected members of the KRS Board, not the full board. The organization hopes that this amendment would be included in the proposed bill for the 2015 session.
Co-Chair Bowen thanked all the groups for taking their time to appear before the PPOB and for sharing their perspectives on the challenging issues facing the pension systems.
General Discussion on Legislative Proposals
Co-Chair Bowen indicated that at the November meeting the PPOB would be discussing and voting on recommendations to be included in the annual report for consideration by the 2015 General Assembly. He asked members to make suggestions that they felt were important to be included in the annual report and should be discussed at the meeting. He indicated the board may also discuss the cash flow concerns and options for addressing that issue.
At the December meeting the board will be reviewing end-of-year financials of the KRS Board and the actuarial data and will develop a work plan for 2015.
Co-Chair Yonts asked board members and others desiring to submit suggestions for consideration to do so by submitting them to LRC staff well in advance of the November meeting so that all topics can be listed in order to facilitate the discussion.
Other Discussion
Co-Chair Bowen advised that, after talking with Co-Chair Yonts, the PPOB will return to its regular monthly meeting date of the fourth Monday of each month and that the November monthly meeting will be held on that date. However, the December meeting will be held on the third Monday because the regular meeting is during the week of the Christmas holiday.
Ms. Mattingly asked Mr. Peden to provide the first quarter investment update as soon as it is available.
Co-Chair Bowen encouraged Mr. Thielen and Mr. Peden to make the necessary plans in scheduling activities of the KRS to keep with the PPOB’s meeting dates discussed during the meeting.
There being no further discussion, the meeting adjourned at about 2:20 p.m.