Call to Order and Roll Call
A meeting of the Public Pension Oversight Board was held on Monday, August 24, 2015, at 12:00 Noon, in Room 149 of the Capitol Annex. Senator Joe Bowen, Chair, called the meeting to order. An official roll call was not conducted, however all members were present.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senators Jimmy Higdon and Gerald A. Neal; Representatives Brian Linder and Tommy Thompson; Robyn Bender, Tom Bennett, Robert Damron, Jane Driskell, James M. "Mac" Jefferson, Sharon Mattingly, and Alison Stemler.
Guests: Representatives Jerry Miller, Derrick Graham, and Arnold Simpson; Mary Martin; Doug Price; Lowell Reese, Kentucky Roll Call; L. B. Vanmeter, Kentucky Judicial Form Retirement System; Bob Rowland, Kentucky Retired Teachers Association; Kentucky Transportation Engineers Association; and Kentucky Association of State Employees, among others.
LRC Staff: Brad Gross, Bo Cracraft, Greg Woosley, Terrance Sullivan, and Marlene Rutherford.
Approval of Minutes
Representative Yonts moved that the minutes of the June 22, 2015, meeting be approved. Mr. Thompson seconded the motion, and the minutes were approved without objection.
Kentucky Retirement Systems Anticipated Budget Needs / Update
Bill Thielen, Executive Director, and David Peden, Chief Investment Officer, Kentucky Retirement Systems, discussed the budget needs and impact of the actuarially required contribution (ARC) on the 2017-18 budget and the investment performance of the portfolio for the month of June and fiscal year to date.
Mr. Peden stated that for the fiscal year ending June 30 the composite return for the entire portfolio was up 2.01 percent versus the benchmark return of 3.13 percent. Private equity was the best performer at 9.61 percent; the real estate return was 7.85 percent; U.S. public equity was up 6.04 percent; absolute return was up 5.489 percent; and fixed income was up 1.44 percent. The emerging market equities, non-U.S. equity and real return asset classes resulted in negative returns of -6.66, -3.99, and -3.98 percent respectively. For the year U.S. equity markets performed well, along with real estate, whereas emerging markets struggled the entire year, which was mainly due to commodity exposure. The non-U.S. equity portfolio performed well on a relative basis, beating its benchmark by eighty-six basis points; however, the portfolio could not overcome the movement or strength in the dollar, which resulted in the negative 3.99 percent return, and any inflation sensitive assets, such as commodities, particularly oil and energy generally, performed poorly last year. KRS was disappointed that the portfolio was unable to attain the 7.75 percent assumed rate of return on assets, but there were only three asset classes that performed up to the assumed rate last year, which were private equity, real estate, and if the U.S. public equity had kept up with the benchmark it would have performed at about 7.25 or 7.5 percent. Unfortunately there were not enough dollars invested in those asset classes, which was largely a function of the asset allocation decisions made five years ago. KRS is updating the asset allocation. The investment committee will review the recommendation proposal by R.V. Kuhns and a draft of the CEM benchmarking fee study at its next meeting.
In regards to the U.S. public equity and why it underperformed, Mr. Peden stated that KRS predominately uses active management and is overweight in a value approach–meaning stocks that are cheap on a price to earnings or price to cash flow basis–as opposed to a growth approach. So, for example, the Russell 3000 Growth Index was up 10.69 percent last year versus the Russell 3000 Value Index, which was only up 3.86 percent. This is in large part why KRS underperformed the U.S. public equity benchmark. He The markets are beginning to appreciate the value of traditional companies with good cash flow and earnings, which has not been the case over the last few years that have been dominated by super growth companies that may or may not have any actual earnings, or even that lose money, but have earned investors 20 to 50 percent over the last 12 months. Historically, value stocks have outperformed growth stocks, and KRS feels that is the best position long term. The KERS non-hazardous plan was the best performing plan during the last fiscal year, and was up 2.38 percent for the year. The reason it outperformed the other plans is because it has no emerging market equity exposure, which was the worst asset class last year, and because it has an unintentional over weight to private equity, meaning that it has a target of 10 percent to private equity but spent most of the year at 13 or 14 percent because the assets are shrinking faster than the private equity investments are maturing. This is the first year that post January 1, 2014, cash balance or Tier 3 employees receive a return on their investment, which will be a 7.78 percent return based on the five year performance number.
Responding to a question by Co-Chair Bowen, Mr. Peden indicated that what will be recommended to the investment committee is that the asset allocation change very little in the CERS hazardous and non-hazardous plans, the KERS hazardous plan, and the five insurance plans, although there will be a decrease in fixed income, an increase in public equity, and a slight decrease in inflation sensitive assets, in order to meet the target of 7.5 percent. The KERS non-hazardous and SPRS plans will have significant recommended changes, but he said he would prefer to discuss those changes at the next meeting after the investment committee has had an opportunity to discuss the recommendations. Both plans need to have as much liquidity as possible, which will make it a challenge to earn 7.5 percent on those assets.
In response to questions by Co-Chair Yonts relating to the recent chaos in the stock market and the influence of a downturn in the economy of China, and how it will affect decisions made at the investment committee meeting, Mr. Peden said that it confirms the use of active management versus passive management for investing. He said that performance is reviewed quarterly but it has not been a part of the process to actively change the asset allocation more frequently than five years.
Responding to Representative Thompson, Mr. Peden stated the cash balance employees earning the 7.78 percent return received the benefit of the eight years the plan performed well; however, on a five year basis there are very few time periods where performance will not be better than a 4.0 percent return, which is the return guaranteed by the legislation.
Representative Miller commented that although the market is down 7.0 percent there is no liquidity problem that retirees should be concerned about and that KRS will be able to handle the variation in the current market. Mr. Peden agreed, stating that they are nowhere close to a situation where assets would be impaired or KRS would be unable to pay benefits.
In response to a question from Mr. Jefferson, Mr. Peden said it would be unfair to prejudge what the investment committee will decide at its meeting to address the situation and to meet the challenge of attaining the 7.5 percent target on investment return and how that process will unfold throughout the year.
Mr. Thielen discussed the impact of the actuarially required contribution (ARC) to KRS on the 2017-18 budget. The actuarial audit has been completed and will be presented to the audit committee and the full KRS Board at its September 10 meeting. At some point in the near future the Segal Company will present that report to PPOB.
He noted that the City of Hillview has filed a Chapter 9 bankruptcy petition and that the city is a participating employer with KRS, which is named as an unsecured creditor, although it does not appear that the city will try to extinguish any debt to the retirement system. KRS will monitor the case.
The information for the fiscal year will be provided to the actuaries who will begin the valuation process that will result in the recommended contribution rates for the 2017-18 fiscal years. Projected contribution rates have been submitted to the State Budget Office and LRC staff. The valuation will be presented to the KRS Board at its December meeting and historically the Board has adopted the rates as recommended by the actuary. Certain assumptions were made to determine the impact of paying 100 percent of the ARC for the KERS non-hazardous pension. Total payroll reported to KRS as of June 30, 2015, on which contributions were paid during the year was used, which was $1.669 billion dollars. A growth factor of 3.5 percent, which is the actuarially assumed growth rate, was then applied to determine an estimated total payroll for 2017 of $1.7 billion. In 2015, the total contribution for the pension plan was $526,756,713 at a contribution rate of 30.84 percent, and the insurance contribution was $135,446,846 at a rate of 7.93 percent, for a total contribution of $662,203,559. With the projected rates and contributions using the payroll growth factor of 3.5 percent, the total contributions for fiscal 2017 to pay the full ARC is $785.6 million, or an increase of $123,396,788 over what is being paid and was paid in fiscal 2015. The combined rate using these assumptions will be 45.46 percent of the projected payroll (36.93 percent for pension and 8.53 percent for insurance). The contribution rate set by the KRS Board will be for both years of the biennium.
The same assumptions were used to project the estimated contributions for 2017 for the KERS hazardous plan. Using a contribution rate of 20.05 percent with an estimated $29.5 million in contributions for the pension plan, and a contribution rate of 4.08 percent with an estimated $6.0 million in contributions for insurance, the total contribution in dollars will be $35.6 million or a decrease of about $2.0 million from the total contributions in 2015 of $37.5 million. The reason for this decrease is that the KERS hazardous insurance plan is over 100 percent funded, which dropped the rate about 6.0 percent.
The total contributions for the SPRS plan were $35.7 million in 2015. The same assumptions were made for this plan to estimate the contributions required for 2017. The rate of contributions required for this plan are 66.67 percent for the pension and 20.04 percent for insurance, for a total contribution of $42.3 million in 2017. This is an increase of about $6.6 million. The total impact in dollars is projected to be about $128 million more to pay 100 percent of the ARC in the 2017-18 fiscal years. The total contributions for all systems for 2016 are estimated at $863.5 million.
For the CERS hazardous and non-hazardous plans, payroll growth was decreased to 2.5 percent for the estimates. Using that assumed rate the total estimated contributions for 2017 for both the pension and insurance is $432.5 million, or 17.89 percent combined, compared to contributions in 2015 of $402.3 million, or 17.06 percent, representing an increase of $30.1 million to fully fund the ARC.
Responding to Representative Thompson, Mr. Thielen said that although the projections are for one year, the projected rates will be the same for both years. However, the payroll may grow more or less so that the dollar amount will be different but the contribution rate will be the same. He said the State Budget Office will address the amount out of the general fund that would be needed in its presentation.
Mr. Thielen indicated in response to questions by Representative Simpson that the 3.5 percent payroll growth is derived by the actuary by using national numbers charted on a long term basis. However, the experience study showed that payroll had not grown as anticipated, and therefore the assumed rate was reduced from 4.5 percent to the current 3.5 percent rate. KRS will be reviewing that number each year because the percentage of payroll growth has not been attained for a number of years, but not attaining that payroll growth also increases the contribution rate. Therefore, if the payroll growth does not increase to the 3.5 percent over the next biennium the estimated contribution would be inadequate to fully fund the ARC.
Responding to Representative Yonts regarding the GASB rules and any impact they will have on the CERS plans, Mr. Thielen said that no changes have been required in the manner in which the ARC is calculated as a result of GASB 67 because KRS was already using the actuarial method that GASB suggested. Therefore, they will not have any impact on the KRS plans, and no additional contributions will be required of the CERS participants.
Co-Chair Bowen asked Mr. Thielen to further explain the SPRS estimated contributions being almost 87 percent of payroll. Mr. Thielen stated that, a few years ago, the percentage was about 102 percent of payroll and that there are a number of factors for the unfunded liability in the plans, one being the shortfall in the contribution rate 15 out of 22 years. The health insurance plan for hazardous duty is very expensive.
In response to a question by Senator Higdon concerning the unfunded liability, Mr. Thielen indicated that the principle factors are investment losses experienced in 2008 and 2009. Mr. Peden stated some of those losses go as far back as 2000 through 2002 where there were three negative years in a row and that when those losses were full recognized actuarially in the mid-2000s is when the unfunded liability increased. He said that prior to 2008 cost of living adjustments (COLAs) were granted each year based on the consumer price index, some up to five percent. The COLAs, investment losses, shortfalls in the contribution rate, and compliance and funding for GASB 43 and 45 in 2006-07 for health insurance are all factors for the unfunded liability. Mr. Thielen also stated that there has not been a benefit increase since about 2002. The benefit factor currently for KERS is 1.97 percent. After House Bill 1, there is a phased benefit factor beginning at 1.5 percent, and depending on the years of service, the factor increases, and after 30 years of service, it becomes 2.0 percent for all years of service after 30 years, which results in a lower overall benefit factor for those hired on or after September 1, 2008 until December 31, 2013, when the hybrid cash balance plan tier became effective.
Co-Chair Bowen said that the benefit factor needs to be discussed at a later time.
Kentucky Teacher Retirement Systems Anticipated Budget Needs / Update
Gary Harbin, Executive Secretary, KTRS, discussed the budget needs for the next biennium. The rates for KTRS have not increased since 1999. Today KTRS is 53 percent funded. Teachers in Kentucky are not subject to social security, therefore the overall rates paid by the employer in the KRS system include an additional social security contribution at 6.2 percent. In 2001, on a national average, state and local pensions were 100 percent funded. He said that today all pension plans nationally are about 75-76 percent funded and on average the contribution rates plus the employer portion of social security has increased from just over 12 percent in 2001 to almost 24 percent. The universities and CERS have both pension plans in additional to a teachers’ pension in their field of membership. KTRS was 90 percent funded in 2001 compared to 53 percent funded today. The statutory contribution rate has remained the same throughout this period at 13.105 percent. The cash flow for KTRS has been negative since 2008 and it has had to sell over $600 million in assets to meet the $1.8 billion retiree payroll. Over the next four years KTRS will be selling $3.5 billion in assets to meet retiree payroll. KTRS is not in as good of a position as it was in 2008, when it had the ability to hold onto investments in the market downturn and the fund eventually realized really good returns on those investments. KTRS is now in the position where it cannot hold onto those investments and will have to sell $3.5 billion in assets to meet its obligations unless additional funding sources are identified and budgeted.
Teachers contribute about 13 percent of pay and of that amount 9.105 percent goes into the pension and 3.75 percent into the medical plan. For fiscal 2017, the budget request for the contribution funded through the SEEK formula in the Department of Education budget is $388 million, increasing to $395 million projected for fiscal 2018, and assuming a three percent increase over and above the current payroll. For all new members after July 1, 2008, there is a matching 14.105 percent contribution, a portion of which funds retiree health insurance benefits. There are annual expenditures requested out of the general fund budget for sick leave and other expenses, which amounts to approximately $5 million per year. The state’s portion of the health insurance shared responsibility funding is projected to be $71 million in fiscal 2017 and $78 million in fiscal 2018, and as the retiree numbers grow those amounts will increase. Total annual expenditures that will be requested in the next biennium for this item will be $76 million in the first year of the biennium and $83 million in the second year. There is a 1.5 percent COLA built into the contribution rate by statute. From time to time COLAs were awarded over and above the 1.5 percent level up to the consumer price index and were amortized over 20 years, and payments for these COLAs has decreased from $80 million in fiscal 2013 to $52 million in each of the next two years of the biennium. Benefits for minimum benefits, sick leave salary benefits, and prior years medical benefits were also amortized. In fiscal 2017 the requested amount is $114 million and in fiscal year 2018 it is $112 million. There has been a shortfall in past budgets in the SEEK formula and in the next biennium there is an expected shortfall of $35 million in the SEEK formula. The compounded effect of the additional funding requested that was not appropriated has resulted in a total additional contribution required of $520 million in fiscal 2017 and $488 million in fiscal 2018 that is being requested. The debt service that was paid on bonds to fund the state’s portion of shared responsibility and transition funds for funding of legislation in 2010 for healthcare totaled over $800 million. The bonds amortized over 10 years costs $103 million in fiscal 2013, $124 million in 2014, $120 million in fiscal 2015, $116 in fiscal 2016, and is projected at $107 million in 2017, and $97 million in fiscal 2018. The rate on these bonds is about 2.5 percent. It was proposed that as these monies decreased for debt service that the monies be applied to the shortfall of $520 million in fiscal 2017.
KTRS investment performance for the fiscal year ending June 30, 2015, was strong at 5.1 percent. The returns were 12.3 percent over a three year period, 12.0 percent over five years, 7.0 percent over 10 years, and 7.6 percent over a 20 year period, which are very comparable to the California State Teachers Retirement System (CalSTRS) that has $191.4 billion in assets and is 68 percent funded. The assumed rate of return for the KTRS is 7.5 percent.
To accommodate a scheduling issue for the State Budget Office, Mr. Harbin was asked to defer the remainder of his presentation until after the presentation by Ms. Driskell and Mr. Hicks.
Anticipated General Fund Budget Needs for KRS and KTRS
Jane Driskell, State Budget Director, and John Hicks, Deputy State Budget Director, discussed the costs for budgeting of the KRS and KTRS pension systems.
Ms. Driskell and Mr. Hicks provided a perspective of how the budget office budgets for retirement costs and the budgetary treatment for KERS and KTRS, which are treated differently. Ms. Driskell discussed the employer contribution rates, the amount that is included in the current budget for the 2016 fiscal year, and an estimate of how much more is needed in the 2016-18 biennial budget for the KERS plans. In the budget process, the actuarial recommendations are reviewed for the pension systems. The agencies also receive biennial budget request instructions that define how they determine what should be included for the pension costs, which in the current biennium and in future budgets is the full ARC. The State Budget Director’s Office works with the Governor in preparing the executive budget recommendations for consideration by the General Assembly. The statutory employer contributions rates are used for SEEK and other state government participating employers for the KTRS, and estimates from the actuarial analysis are provided by the KRS for the employer contributions rates. The amounts for pension are explicitly budgeted in all three branches. Other agencies are treated differently, with amounts partially included, such as for participating universities and KCTCS, public health departments, and mental health/mental retardation boards. The contribution rates for the KERS employers for the pension plans have increased from 26.79 percent for the non-hazardous plan in fiscal 2014 to estimated rates of 45.46 percent in fiscal 2017 and 45.80 percent in 2018. The hazardous rates have decreased from 32.21 percent in 2014 to estimated contribution rates of 24.15 percent in fiscal 2017 and 23.71 percent in fiscal 2018. The SPRS contribution rates have increased from 71.15 percent in 2014 to estimated rates of 86.71 percent in fiscal 2017 and 88.0 percent in fiscal 2018. She said the non-hazardous rates rose 44.7 percent in fiscal year 2015 and are estimated to rise another 17.3 percent in fiscal 2017. She said that in the 2016 budget an additional $194 million was added to fund the full ARC for KRS, of which $106 million came from the general fund. In fiscal 2017 those rates will require an additional estimated amount of $108 million with about $60 million coming from the general fund.
Mr. Hicks discussed costs of the KTRS in the 2015-16 budget. He said there are two approaches to funding KTRS from a budget standpoint, the statutory employer contribution rate that provides funding targets that are placed in the SEEK appropriation. There was $380.5 million general fund dollars within the SEEK budget that represented 13.105 percent of the statutory employer contribution rate for school districts and $14.2 million in state agency employer contributions, of which $8.6 million was from the general fund, and $31.9 million in federal funds from the school districts. He reminded the board that for the contribution rate school districts do participate much like health insurance to the extent they have federal grant funds that flow through the districts. The KTRS receives direct general fund dollars to cover any amount that is not covered by the ARC and other elements of the system that are not funded by the employer contribution rate. In fiscal 2015-16 there was $299.3 million in direct general fund appropriations to KTRS and a total of about $726.0 million to the system that is placed in the SEEK formula and other state agencies, of which $688.4 million was from the general fund. This amount in the general fund is about what is placed in the general fund for Department of Education’s health insurance for all the school districts. The 2014-16 budget bill language contained a pledge that as bonds issued in 2011 to repay the pension fund and to phase in the higher medical fund contributions were paid down that the funds to make those bond payments would be applied to the unfunded liability. By the end of fiscal 2024 that amount would be $116.5 million that could be diverted and used for paying the unfunded liability. He said that the additional amount needed to get to the full ARC for KTRS will be $520.4 million in fiscal year 2017 and for fiscal 2018 the amount has not yet been determined and will be available in November.
In summary, Ms. Driskell indicated the total amount included in the 2016 budget for retirement costs for the KRS was $731.5 million of which $301.9 million were general fund dollars, and for the KTRS was $725.9 million of which $688.4 million was general fund dollars, and for the two systems the amount is $1.457 billion with $990.3 million coming from the general fund.
In response to questions by Co-Chair Bowen, Ms. Driskell stated that the $520.4 million in the 2017 budget is the additional amount that will be needed to make the full ARC payment for KTRS and will catch up the unfunded liability since 2008 to fully fund the ARC.
Responding to questions by Representative Simpson concerning the payroll growth assumptions for the KERS, Mr. Hicks said that in looking at the valuation each year and the five year experience study the payroll growth is an important assumption to determine how many dollars are flowing into the system and how many benefits flow out. Payroll growth is a gross amount of wages and salaries that are applicable and that when employees retire and annual and compensatory leave time is cashed out and now the “spiking” provision, these amounts are included as well because it is real money. Another component is the turnover and hiring of employees, and he noted that career advancement changes salaries.
In response to a question by Co-Chair Yonts relating to the KTRS employer contributions, Mr. Hicks said that all funds for KTRS is about $725.9 million, which represents what is budgeted, plus the additional amount for fiscal 2016 of $487.4 million, the shortfall for the current fiscal year, added to the $725.9 would be the equivalent of the full ARC.
Responding to Co-Chair Yonts concerning both the KRS and KTRS ARC and any projections for receipt of any surplus funds for payment, Ms. Driskell said that the budget office would go through the process to determine what the amount of revenue will be in the next biennium and the plan or approach for addressing the issue of payment or funding.
In response to a question posed by Representative Thompson concerning the $990.3 million general fund portion of the retirement costs for both systems, Ms. Driskell said this amount is about 10 percent of the total budget. Combining the $688.4 million and $520.4 million, or about $1.3 billion, would fully fund the ARC for 2017 for KTRS.
In response to a question by Representative Linder concerning the shortfall since 2008 for KTRS, Mr. Hicks indicated it is the shortfall from not only investments but what goes into the performance of the system and the benefit payments and revenue stream.
For clarification of her understanding of the ARC for KTRS, Ms. Stemler asked if the ARC is the current year required contributions to fund the benefit that is being earned plus an amortization of the shortfall or what has not been paid or is behind, Mr. Hicks agreed and believed that KTRS had reinstituted a 30 year period, but that could better be addressed by Mr. Harbin.
Responding to questions by Senator Higdon, Mr. Harbin indicated that although the numbers are not final it is projected that the additional funding for the full ARC in fiscal 2018 will be approximately $488.0 million with the liability being amortized over 30 years and there are 29 years remaining. He said the amortized sick leave salary benefit of $52.2 million from 1999 to 2018 is the liability created to the retirement portion of the benefit not the benefit itself.
In response to a question by Representative Thompson, Mr. Harbin stated that the KTRS is right at $18 billion in asset base.
Co-Chair Bowen commented that in light of the market volatility in the last few days that the General Assembly made a good decision not to bond $3.3 billion in anticipation of a 7.5 percent return, Mr. Harbin indicated that the real issue is not the $3.3 billion but rather how the state will get from adding no additional dollars in for the ARC to the $520.0 million needed by the end of this year. The $3.3 billion bond is a “bridge loan” and is a valuable tool and will cover KTRS’ cash flow for an eight year period and help pay for the assets that it will have to sell to make benefit payments. Without the additional cash flow from either the ARC payment of $520.0 million or some other outside funding, KTRS may find that it must sell investments that have been devalued by a market downturn.
Responding to Co-Chair Bowen about the cashing in sick leave as a benefit upon retirement, Mr. Harbin said the benefit for allowing this is for the continuity of the teacher in the classroom and so that a school district does not have to compensate a substitute. He said that there are about 17 percent of school employees who do not receive that benefit.
In response to a question by Representative Linder concerning the bonding issue and the volatility of the markets and the economies of other countries and the global market, and how KTRS is invested in the market going forward, Mr. Harbin indicated that the market correction is a natural process that occurs in the stock market. He noted that corrections can be opportunities to buy stocks when they are low and that during the downturn in 2008 KTRS was able to take advantage of that situation. However, he stated that KTRS is not in that same position today, and instead is in the position of being forced to sell investments to meet retirement benefits. KTRS is invested heavily in stocks, with about 19 percent of its assets in international stocks and about 38 percent in U.S. equity.
Review of Kentucky Retirement Systems Non-hazardous Cash Flow Issues
Brad Gross, LRC staff, discussed cash flow issues with the KERS non-hazardous plan as to the funding impact with the provisions of Senate Bill 2, discussions from the 2012 pension task force, the preliminary financial statements for 2015, historical cash flow data, assumptions, and funding options. The basic funding principle for pensions is contributions (C) plus investments (I) equals benefits (B) plus expenses (E). Most employees contribute five percent of their pay under the statute that goes to the pension and any new hire after September 1, 2008, contributes six percent, but the additional one percent goes into retiree health. The ARC for KERS non-hazardous is at 38.77 percent of payroll, which includes a pension contribution and a retiree health contribution. There are two separate valuations, one for the normal contribution, which is the amount the actuary budgets for the upcoming year’s costs, and a payment to the unfunded liability. In Senate Bill 2 three provisions impacted cash flow: 1) the payment of the full actuarially required contribution (ARC); 2) ending the cost of living adjustments (COLA); and 3) a re-amortization of the unfunded actuarial liability. The ARC went from 26.79 percent of payroll to 38.77 percent in the current budget. In 1996, a measure was passed to provide an automatic COLA based upon the consumer price index (CPI) but it contained language that stated it could not be funded until after it was awarded, therefore each COLA was adding to the unfunded liability. Re-amortizing the unfunded liability over a new 30 year period also affected cash flow.
When Senate Bill 2 was considered, there was an actuarial analysis that showed that if the same funding schedule to slowly phase into the ARC and the COLAs continued, that the projected employer contribution rate would grow from 26.79 percent up to about 65.0 percent of payroll. It also showed that beginning to immediately pay the full ARC would cause it to move to 38 percent of payroll and then level off to 40.0 percent of payroll in the long term. In other words, in the short term Senate Bill 2 required additional contributions, but in the long term produced savings. In terms of the dollar amount, the contribution rate increases because it is assumed that the payroll will increase. The assumed payroll growth annually is four percent and is used in the actuarial valuation and projections, and the 3.5 percent is the inflationary component. Mr. Gross also pointed out that, although the percentage of payroll increased between the projection under Senate Bill 2 and the latest projections, the dollar amounts are basically the same in the out years.
During the 2012 pension task force discussions, there were cash flow items that were discussed but not adopted. The issuance of bonds was discussed, paying additional contributions beyond the ARC, and raising the employee contribution rates. There has also been discussion of proposals using various sources of revenue for deposit into the pension funds.
In terms of cash flow for the 2015 fiscal year, employee contributions at five percent contributed about $100 million to the pension fund; employer contributions contributed $523.0 million, with $132.0 million going to retiree health; and about $13.0 million was derived from other sources such as court settlements and spiking. KERS non-hazardous investment income for the year was 2.38 percent, with the net investment income of $44.0 million for the pension and $8.7 million for health. So, there was a total of $681.4 million to the non-hazardous pension plan and $144.0 to the health plan. Benefit payments and expenses totaled $929.8 million in fiscal 2015, resulting in a net decrease of $248.4 million on the unaudited financial statements. The assets from the beginning of the fiscal year dropped from $2.6 billion to $2.3 billion. There was positive improvement in the retiree health and assets continue to improve.
In 2000, the funding level for the KERS non-hazardous pension fund was at 139.6 percent with a $1.9 billion surplus. In 2014, the funding level was at 21.0 percent and the unfunded accrued liability (UAL) was $9.13 billion. The plan assets have decreased from $5.48 billion in 2001 to $2.33 billion as of June 30, 2015. However, the retiree health fund assets have grown from $396.3 in 2001 to $665.6 as of the current fiscal year.
Mr. Gross said current funding projection indicated that the funding level will fall from 21.0 percent in fiscal 2014 to 14.9 percent before improvement is seen, and that asset values are anticipated to drop to around $1.9 billion. The 2015 asset liability modeling study indicates that there is a five to eight percent probability that the KERS non-hazardous plan could fully deplete assets in the next 20 years, assuming all assumptions are met, and that returns would have to be about 24.0 percent over the next 10 years or 15.0 percent over the next 20 years to achieve the 100 percent funding levels.
Moving forward, key factors for improving cash flow are paying the full ARC, payroll growth, and investment returns. If no additional action is taken for funding, the ARC is anticipated to increase by $112 million in fiscal 2017 based upon the payroll, with $100 million going to the pension fund. Legislative action could be taken to bond additional contributions, and KRS has analyzed the impact of additional funding of between $1 and $5 billion, as well as the impact of adding additional funding in increments of $250 million for four years for $1 billion, or $250 million over eight years for $2 billion. Another option to increase cash flow is to supplement the funds flowing into KRS by setting the employer contribution rate above the ARC.
Projected asset levels over the next 20 years range from $2.389 billion in 2015 to $3.951 in 2033. The projected amounts for the different potential funding options were provided over this 20 year period also. The funding levels for this same period of time in the current projections range from 19 percent in 2015 to 29 percent in 2033. He said of interest is when looking at the infusion of $1 billion and $2 billion in increments of $250 million over the four or eight year period of time and the $1 billion and $2 billion at the incremental level in the out years there is not a big difference between funding levels.
Co-Chair Bowen indicated he was not opposed to bonding; however, efficiencies need to be identified and could serve as a revenue stream to support the bond payments.
In response to a question by Mr. Jefferson, Mr. Gross said that if the actuarial projections in terms of dollars had been made and had the return on investments been met it would still be short of necessary funds. One issue is the liabilities are growing faster than the assets actuarially, so the unfunded liability continues to grow even if the full ARC is being paid.
Co-Chair Yonts pointed out that state government for the last eight years has had the lowest number of employees, which affects payroll growth.
Co-Chair Bowen announced that the next meeting is scheduled for Monday, September 28.
The meeting adjourned at 2:20 p.m.
Copies of the PowerPoint presentations are on file in the Legislative Research Commission Library.