Call to Order and Roll Call
The meeting of the Public Pension Oversight Board was held on Monday, November 24, 2014, at 1:00 PM, in Room 169 of the Capitol Annex. Representative Brent Yonts, 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; Representatives Brian Linder and Tommy Thompson; Robyn Bender, Tom Bennett, Jane Driskell, James M. "Mac" Jefferson, Sharon Mattingly, and Alison Stemler.
Guests: Greg Lovllen (sic), Retiree; Damian Stanton, Retiree (CERS); Paul R. Guffy, Kentucky Public Retirees; David A. Sallee, Retiree (CERS); Lowell Reese, Kentucky Roll Call; Jerry Frantz, Retiree; Russ Wright, Retiree; Dan Flaherty, Retiree; Prewitt Lane, Louisville, KY; Fran Salyers, Retiree; and Anna Baumann, Kentucky Center for Economic Policy.
LRC Staff: Brad Gross, Bo Craycraft, Terrance Sullivan, Greg Woosley and Marlene Rutherford.
Co-Chair Yonts recognized and welcomed Representative James Kay.
Bill Thielen, Executive Director of Kentucky Retirement Systems, invited the PPOB members to the KRS quarterly Board of Trustees meeting on Thursday, December 4, 2014 at 9:00 a.m. He said the meeting would be held at the retirement systems office, Perimeter Park West, 1270 Louisville Road, Frankfort, Kentucky. At that meeting, the 2014 fiscal year valuation will be presented by the actuaries, the result of which drives the contribution rates. The KRS Board will also receive the comprehensive annual financial report and will again review the experience study and take action on the actuarial recommendations. Mr. Thielen indicated that all ten plans administered by KRS with the exception of the Kentucky Employees Retirement System (KERS) non-hazardous and Kentucky State Police Retirement System (SPRS) pension plans have increased their asset base and funded status and that all the insurance plans are doing well. The KERS non-hazardous plan funded status has decreased to twenty-one percent, with a continuing negative cash flow in the amount of $182 million last fiscal year. He said that assuming KRS continues to meet its assumptions it will be at least a couple of years before the plan turns around and sees an increase in the funded status. Mr. Thielen indicated that he would ask the actuary to perform an analysis following the presentation of the valuation before the legislative session as to what affect an influx of some additional funding over the ARC in the KERS non-hazardous pension plan would have on the negative cash flow.
Approval of Minutes
Co-Chair Bowen moved that the Minutes of October 21, 2014, be approved, which was seconded by Mr. Bennett. The minutes were approved without objection.
Kentucky Retirement Systems Investment Update
David Peden, Chief Investment Officer, discussed investment performance. At the October meeting the September numbers were still preliminary, or unaudited; however, he noted that the final numbers did not change from the preliminary numbers. The pension plan for the fiscal year through September was down 1.41 percent versus the benchmark of 0.82 percent. For the month of October equity markets finished up 0.83 percent and for the fiscal year through October the plan is down 0.59 percent versus the benchmark at 0.17 percent. For the month of October U.S. public equity was up 2.77 percent, which he said is right on the benchmark. The large cap funds were up 2.44 percent, mid caps were up 3.08 percent, and small caps were up 6.59 percent. Although small caps were up for the month they are still negative on the year. Looking at the performance of the U.S. public equity asset class, value stocks are not performing as well as growth stocks, and there is a small over weight to small caps versus mid caps and large caps, with small caps not doing as well as large caps, which is negatively impacting the performance relative to the benchmark for both the month and fiscal year. He said the non-U.S. equity portfolio is down six percent for the fiscal year and down sixty basis points for the month, which was better than the benchmark that was down about one percent in October. He pointed out that the negative performance is attributed to the strong dollar. When investing in non-U.S. equity, which are stocks in companies that are purchased with the currency in the country they are located, the strength of our economy versus the strength of the European economies and Japan have negatively affected the non-U.S. equity performance. The emerging market equities are down three percent, slightly worse than the benchmark that is down 2.21 percent. The overall public equity return for the month of October is up 1.16 percent versus the benchmark of ninety-one basis points, and is slightly worse than the benchmark on the fiscal year. Public equity as a whole is down 1.98 percent versus the benchmark of a negative 1.77 percent. Fixed income in the insurance plan was up eighty-six basis points versus the benchmark that was up ninety-eight basis points. He said the recovery from the Bank of America settlement was placed in the portfolio in October. For the fiscal year, the fixed income portfolio is up 1.03 percent versus the benchmark of 0.95 percent. Real return was down for the month and down for the fiscal year 1.68 percent due to poor performance in treasury inflationary protected securities. The absolute return portfolio is up for the fiscal and down slightly in October, and most of the negative return was caused by activist offshore equity managers due to the tax inversion ruling that allows a U.S. company to buy a foreign company and take advantage of the tax rate of the foreign country. Although there are a few trading days left in November, the pension and insurance funds are down approximately twenty basis points fiscal year to date.
In response to questions by Co-Chair Yonts, Mr. Peden indicated that U.S. equity stocks will continue to perform well into next year unless there is some unforeseen occurrence such as a terrorist attack or extremely bad weather conditions. He also said that the capital markets are benefitting from the slow down and troubles in other parts of the world, and as KRS goes through the asset allocation they need to be cautious not to overreact to poor performance in Europe and Japan. He also stated that the turmoil and sanctions in Russia are also having an impact on KRS investments.
In response to a question by Senator Higdon, Mr. Thielen indicated that KRS has had a maintenance budget for the last three budget cycles and that administrative expenses have decreased because of the decision to move from a self-insured Medicare eligible health plan to a fully insured plan. Over the last year salary expenses have also decreased although benefit expenses increased because of paying a higher contribution rate. He pointed out that Senate Bill 2 enacted in the 2013 session included language that prevented the KRS Board from changing the contribution rate for KERS and SPRS plans in the second year of the biennium. Prior to that time KRS had typically set a rate based on the valuation and when the next valuation was performed the rate was changed. However, in House Bill 235 the contribution rate was set for this fiscal year and next fiscal year at the same rate of 38.77 percent of payroll for KERS nonhazardous, which was based on the 2013 valuation. This year’s valuation will probably result in the actuarially required rate being higher than 38.77 percent, but state agencies will not be paying that higher rate, which means that when the 2015 valuation is calculated the numbers will be higher than the rate would have been had KRS continued to use annual valuations to set the rate.
Responding to another question by Senator Higdon concerning calls received concerning the spiking issue, Mr. Thielen stated that KRS has issued invoices and received some revenue from those invoices, but it is a small amount at this time. He said that LRC staff has been provided all the data KRS has available on pension spiking. He also noted that in addition to a proposal to address spiking that will be introduced in the 2015 session that KRS is working on proposals that may eliminate some of the problems with pension spiking, and that once the proposals are finalized they will be provided the PPOB. Co-Chair Yonts indicated that staff was monitoring these proposals closely and that the total bill for all spikes in all agencies is less than $1 million and many are nominal sums.
In response to a question by Representative Thompson concerning negative cash flow, Mr. Thielen indicated that the amount of the negative cash flow was $193 million for fiscal year 2014. He said that the negative cash flow for the first quarter of this fiscal year in the KERS nonhazardous pension fund is $70 million. Mr. Peden indicated that more than $182 million in assets would need to be liquidated in order to address the negative cash flow for payment of benefits, and that the $182 million was the amount that was not accounted for by contributions and investment.
Co-Chair Bowen indicated that some of the PPOB report will include legislative recommendations as well as administrative recommendations to the KRS Board. A recommendation that will not be included in the written report, but is being verbally recommended, is that PPOB meetings in 2015 include not only Mr. Thielen and Mr. Peden but also members of the KRS Board so the PPOB will better understand the operations of KRS and the function of the various committees. Co-Chair Bowen asked that Mr. Thielen work with Brad Gross to identify the proper individuals to attend the PPOB monthly meetings for conversation and to answer questions. Co-Chair Bowen also reiterated that the Board meeting schedule would be consistent for the fourth Monday of each month beginning in January 2015.
Recommendations for Consideration by the 2015 General Assembly
At the outset, Co-Chair Yonts indicated that both co-chairs had worked with staff since the last meeting to identify and arrive at a consensus of items, both administrative and legislative, to discuss at today’s meeting. Some of the legislative recommendations are the same as bills, with some minor changes, which were introduced in the 2014 session but did not pass. Also, he indicated that new legislative recommendations and administrative suggestions and study items would be discussed. As was stated in a prior meeting, there is a statutory deadline of December 1 for a report and recommendations to be sent to the Legislative Research Commission for consideration during the 2015 session. He said the draft report will be completed at the end of November to comply with the statute and then a final report would be approved at the December 15 meeting. A compilation of recommendations to issues was distributed to the PPOB members.
Brad Gross, LRC staff and CSA to the PPOB, stated the recommendations considered by the PPOB are grouped into two categories. One group relates to administrative recommendations and do not require a legislative change, the other group are recommendations that will require a change in the law. The recommendations were taken up and voted on individually.
Administrative Recommendations:
Recommendation No. 1 - Senator Bowen and Representative Yonts recommend that the Kentucky Retirement Systems should engage an independent actuarial firm, different from their current actuarial firm, to perform an actuarial audit of the assumptions/funding methods and should report the findings to the KRS Board and the Public Pension Oversight Board.
Action: Senator Higdon moved that the Board adopt this recommendation. Representative Thompson seconded and the motion carried 10-0-1. Mr. Bennett passed due to a conflict of interest as a result of his employment with the state Auditor’s Office.
Recommendation No. 2 – Representative Yonts recommended that the KRS board should: (1) consider the results of any actuarial audit that is completed prior to the board’s adoption of any specific assumption/method changes; (2) evaluate the cash flow needs of the KERS non-hazardous pension fund as it relates to the assumptions/methods; and (3) move quickly on adoption to ensure a timely completion of the asset/liability modeling study and to ensure sufficient notice is provided to employers if any change in employer contributions will result.
Action: Co-Chair Bowen moved that the Board adopt the recommendation. Mr. Jefferson seconded and the motion carried 11-0.
Recommendation No. 3 – Senator Bowen recommended that KRS should take more action in publicizing KRS board meeting dates/times, including but not limited to: (1) improving electronic communication regarding meetings via the KRS newsletter, website, and social media pages; and (2) distributing meeting times/dates electronically to employee, retiree, and interest groups.
Action: Representative Thompson moved that the Board adopt Recommendation No. 3. Mr. Bennett seconded and the motion carried 11-0.
Recommendation No. 4 – Mr. Jefferson recommended that the Board receive quarterly cash flow statistics from KRS and mandate a study of cash flow issues facing the systems and to study investment oversight/structure of other public pension funds. Senator Higdon recommended a study of KRS administrative expenses and how they are approved, in comparison to other systems; to study the personnel and compensation system of KRS; and to study and review data on other public pension funds as it relates to investment fees, expenses, and required disclosure.
Action: Co-Chair Bowen moved that the Board adopt the recommendations as stated. Representative Linder seconded and the motion carried 11-0.
Recommendation No. 5 – Sen. Bowen recommended that in developing the 2016-2018 executive branch budget for presentation in the 2016 Regular Session of the General Assembly, the Governor should include the actuarially required contribution rate as required by state statute for KERS and SPRS.
Action: Mr. Jefferson moved that the Board adopt the recommendation. Representative Linder seconded and the motion carried 10-0-1. Ms. Driskell asked that the record reflect a “pass” vote for her due to conflict as the State Budget Director.
Legislative Recommendations:
Recommendation No. 6 – Senator Bowen and Representative Yonts recommended that the Kentucky Retirement Systems housekeeping bill, similar to provisions included in House Bill 324 that did not pass during the 2014 Regular Session, should be enacted.
Action: Representative Thompson moved that the Board adopt the recommendation. Co-Chair Bowen seconded and the motion carried 11-0.
Recommendation No. 7 – Senator Bowen and Representative Linder recommended that legislation to address pension “spiking” issues similar to the measures proposed in Senate Bill 142 from the 2014 Regular Session should be enacted, and Representative Yonts recommended legislation to address pension “spiking” that retains the existing statutory language but raises the threshold for a pension “spike” from a 10% annual increase in creditable compensation during the last 5 years of employment to 15% should be enacted.
In response to a question raised by Ms. Driskell and for clarification, Co-Chair Yonts indicated that the Board, by taking action on the stated recommendations, is recognizing that the issue needs to be addressed and is adopting the concept of the recommendation, rather than a particular recommendation, and that it would be the prerogative of the General Assembly to act on a recommendation to best address the issue.
Action: Mr. Jefferson moved that the Board adopt the recommendations for consideration by the General Assembly. Co-Chair Bowen seconded and the motion carried 11-0.
Co-Chair Yonts noted KRS is working on proposed language that may resolve the issue of “spiking” and the liability for the cost being placed on the employer.
Recommendation No. 8 – Senator Bowen and Representatives Yonts and Linder recommended that legislation including the Kentucky Teachers’ Retirement System, the Legislators’ Retirement Plan, and the Judicial Retirement Plan to the oversight duties of the Public Pension Oversight Board (similar to the measures proposed in House Bill 323 from the 2014 Regular Session) should be enacted.
Action: Ms. Mattingly moved that the Board adopt the recommendation. Senator Higdon seconded and the motion carried 11-0.
Recommendation No. 9 – Senator Bowen, Representative Yonts, and Mr. Jefferson, recommended that legislation be enacted that requires each of the state-administered retirement systems to conduct an actuarial experience study once every 5 years (similar to HB 389 from the 2014 Regular Session) and that the analysis should be conducted by a different actuary than the actuary completing the annual valuation.
Action: Co-Chair Bowen moved that the Board adopt the recommendation. Representative Thompson seconded and the motion carried 11-0.
Recommendation No. 10 – Senator Higdon recommended that the General Assembly should secure additional funding to avert any insolvency issues facing the Kentucky Employees Retirement System pension fund.
Action: Mr. Jefferson moved that the Board adopt the recommendation. Ms. Stemler seconded and the motion carried 11-0.
Recommendation No. 11 – Senator Bowen and Representative Yonts recommended that the Public Pension Oversight Board support measures that would provide additional funding to improve the financial health of the systems administered by Kentucky Retirement Systems, and in particular, measures that would improve the cash flow issues facing the Kentucky Employees Retirement System non-hazardous pension fund.
Co-Chair Yonts indicated that there are areas that additional funding could be achieved, such as monies for uncollected sales tax from internet transactions that the state may receive from the Marketplace Fairness Act in the event legislation is passed by Congress, and could be earmarked or dedicated to the unfunded pension liability.
Action: Co-Chair Bowen moved that the Board adopt the recommendation. Mr. Bennett seconded and the motion carried 11-0.
Recommendation No. 12 – Senator Bowen and Representative Yonts recommended that legislation to address KRS agency participation issues that includes measures for voluntary and involuntary cessation of participation (similar to SB 216 from the 2014 Regular Session), should be enacted.
Responding to a question by Ms. Driskell concerning whether this recommendation is appropriate in light of the litigation currently pending in the courts relating to agency participation, Mr. Thielen stated that given the parameters of the proposed bill in the 2014 Regular Session the types of agencies that may take advantage do not have the funding for ceasing participation because an agency would only be allowed to cease if they paid the unfunded liability over a period of time or had the reserves or collateral to support the payment. He also indicated that the Internal Revenue Service has been in the process over the last several years of looking at what constitutes a governmental plan and the types of entities that should be allowed to participate in those plans and if the IRS issued regulations and if KRS had to transition any entities out of the plan over time this proposal would assist in that transition.
Co-Chair Yonts indicated that the bill that he will be pre-filing relating to agency participation will state that if an agency wants to pay its way out of the pension plan based on what KRS indicates is owed and it reduces the time period from thirty years to ten years for payment if the agency does not have the cash on hand to pay its way out in a lump sum. The bill also attempts to define “adequate security” by requiring a financing statement or a real estate mortgage to be filed and will also provide that the existing agency is required to hold harmless the pension system from liability from damages, including interest and court costs, if a lawsuit is brought by individuals in the system who did not want to be a part of transitioning out of the system since it is the agency paying into the system that is taking the action to get out of the system.
Mr. Thielen noted that the enactment of legislation would not impact the KRS case pending in the courts and would be prospective only.
Action: Co-Chair Bowen moved that the Board approve the recommendation. Mr. Jefferson and the motion carried 11-0.
Recommendation No. 13 - Mr. Jefferson, Representative Yonts, and Senator Bowen recommended that legislation to require KRS to incorporate sensitivity analysis into their annual actuarial valuation on key assumptions, the impact on plan funding statistics, and funding requirements should be enacted.
Mr. Jefferson indicated that the thought process for this recommendation was that integrating the sensitivity analysis into the annual actuarial report may provide the KRS Board of Trustees and the PPOB a better understanding of what the impact may be if certain actuarial assumptions are achieved, and may allow the legislature an opportunity to prospectively begin implementing changes or adjustments that would need to occur as opposed to retrospectively reacting to any negative impact. This would improve the oversight and function of the Board of Trustees and the PPOB.
Mr. Gross noted that the impact of certain assumptions on plan funding requirements whether the experience is up or down in future years can have a dramatic impact on plan funding requirements, which is also a basis for this recommendation.
Action: Mr. Thompson moved that the recommendation be approved. Ms. Mattingly second and the motion carried 11-0.
Co-Chair Yonts stated that the recommendations will be presented for consideration by the 2015 General Assembly and will also go into the PPOB annual report that will be prepared by staff as a draft copy for submission to the Legislative Research Commission by December 1. He also stated the final version of that report will include these recommendations, but will also include a summary of the KRS administration, benefits, funding, and investment data and a summary of testimony given to the PPOB over the last year. The PPOB at the December 15 meeting will review and provide input on the final draft and its publication as a final 2014 annual report.
Co-Chair Bowen moved that the actions for finalization as stated by Co-Chair Yonts above be accepted. Ms. Stemler seconded and the motion carried 11-0.
Co-Chair Yonts indicated that when the draft report has been completed by Mr. Gross it will be disseminated to the PPOB for review and any discussion at the December meeting.
The meeting adjourned at approximately 2:15 p.m.