Call to Order and Roll Call
A meeting of the Public Pension Oversight Board was held on Monday, October 26, 2015, at 12:00 p.m., 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; 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 Derrick Graham and Arnold Simpson; Hope McLaughlin, Government Relations Director, Kentucky School Boards Association; J.D. Chaney, Deputy Executive Director, Kentucky League of Cities; Shellie Hampton, Director of Governmental Relations, Kentucky Association of Counties; David Livingston, Scott County 7th District Magistrate; David Adkisson, President & CEO, Kentucky Chamber of Commerce; Jim Carroll, Co-Founder, Kentucky Government Retirees; Larry Totten, State KRS Liaison, Kentucky Public Retirees; Stephanie Winkler, President, Kentucky Education Association; Patsy Rainey, President, Kentucky Retired Teachers’ Association; Bill Thielen, Executive Director, Kentucky Retirement Systems; David Peden, Chief Investment Officer, Kentucky Retirement Systems; Brian Thomas, General Counsel, Kentucky Retirement Systems; Gary Harbin, Executive Secretary, Kentucky Teachers’ Retirement System; Beau Barnes, Deputy Executive Secretary, Kentucky Teachers’ Retirement System; Donna Early, Executive Director, Judicial Form Retirement System.
LRC Staff: Brad Gross, Committee Staff Administrator; Greg Woosley; Terrance Sullivan; Bo Cracraft; and Maurya Allen.
Approval of Minutes
Senator Bowen moved that the minutes of the September 28, 2015, meeting be approved. Mr. Bennett seconded the motion, and the minutes were approved without objection.
Testimony and Recommendations from Employee, Employer, and Retiree Groups
Ms. Hope McLaughlin, Government Relations Director, Kentucky School Boards Association (KSBA), stated that the KSBA represents all 173 local school boards in Kentucky. Healthy pension systems for all school district employees are a top priority for the KSBA. During the last legislative session, a large coalition of groups worked on legislation to address pension spiking not caused by abuse. KSBA has been working with the many unique constituent groups and Kentucky Retirement Systems (KRS) to find agreeable language to meet the needs of everyone affected by pension spiking. A solution to this issue is a top priority for KSBA in the upcoming legislative session. Employees have artificially inflated their compensation; however, there are school districts where spikes are triggered when an employee is on authorized leave without pay, such as Family Medical Leave Act (FMLA) leave. As a result, when legislation was created to address spiking, many school districts were forced to reconfigure existing budgets, taking money away from classrooms and the ultimate goal of educating children.
Finding a solution to the issues facing the Kentucky Teachers’ Retirement System (KTRS) is also a top priority for KSBA. Compromise and changes to the system are going to be vital to resolving the current liability, and KSBA looks forward to hearing the recommendation of the Governor’s workgroup. The largest concern from school board members is what impact changes will have on the quality of teachers being recruited to replace retiring teachers. Additionally, KSBA recognizes that the budget is currently strained, but asks that adequately funding the actuarially required contribution (ARC) for KRS and KTRS remain a priority.
Chairman Yonts stated that there was a solution proposed to resolve the spiking issue late in the previous legislative session, so it is the hope of the board that the issue can be resolved in the upcoming session.
Mr. J.D. Chaney, Deputy Executive Director, Kentucky League of Cities (KLC), spoke briefly about the retirement crisis and the perspective of city governments and the employers who participate in the County Employees Retirement System (CERS). He stated the KLC constituent groups are very satisfied with the language and impact of Senate Bill 2 from the 2015 Regular Session regarding CERS. Employer contribution rates are declining while the percentage of funding is increasing, so the organization feels that it is in a slightly better position relative to other retirement systems. As a result, KLC is not seeking any structural changes in regard to CERS. The KLC Board of Directors voted in June to explore the option of separating CERS from Kentucky Employees Retirement System (KERS), and KLC is seeking greater distinction between the two systems from the legislature in the future. Mr. Cheney said KLC is also very interested in the issue of pension spiking and will continue to seek a solution to the inadvertent effects of Senate Bill 2. Currently, legislation places the burden on employers to pay for abusive spikes, but a solution proposed last session and supported by a diverse array of organizations would have resolved the issue by capping an employee’s credible compensation used for retirement calculations. This legislative proposal has been refined to hopefully be satisfactory to all parties in the upcoming session. Finally, Mr. Chaney directed members’ attention to Bill Request 63 prefiled by Representative Butler for the 2016 Regular Session. The legislation would allow cities to operate the way sheriff’s offices do in regards to hiring, or rehiring, retired law enforcement officials without making an employer contribution for pension or health insurance. This is extremely important for smaller cities having difficulty entering new hires into the Department of Criminal Justice training program.
Regarding the proposal to separate CERS from KERS and creating an independent system, Senator Bowen asked if the relationship between school and municipal employees was good. Mr. Chaney answered that it was a good relationship.
Ms. Shellie Hampton, Director of Governmental Relations, Kentucky Association of Counties (KACo), was present with Mr. David Livingston, Scott County 7th District Magistrate, to speak regarding the state and county retirement systems. There are 1,500 county elected officials in the Commonwealth who, through KACo, appreciate the oversight the board has over their retirement systems. Funding for KERS may be even more urgently needed than that of KTRS, which is currently funded at 53 percent. KACo has members in both the KERS and CERS systems, as well as retired school professionals and former legislators, and therefore has a vested interest in all the public pension systems. Mr. Livingston briefly touched on three issues, the first being funding the ARC. He encouraged the legislature to remain committed to the schedule established by the latest pension reform legislation in order to provide 100 percent funding for the ARC. Secondly, he suggested the legislature explore options for a dedicated revenue stream to meet the ARC payment. Mr. Livingston stated that this was not a popular solution; however, there is an obligation the state must meet and increased revenue is necessary. Finally, he asked for an answer to the pension spiking concerns previously raised by other organizations. Mr. Livingston said that clean-up language was needed to reverse the unintended consequences of the previous legislation addressing pension spiking.
Mr. Dave Adkisson, President and CEO, Kentucky Chamber of Commerce, came forward to present testimony on behalf of 60,000 member employers. He said business people across the state are concerned about the pension system as well as the repeated downgrading of Kentucky’s bonds and the extremely low rating of the state’s financial situation. The Kentucky Chamber of Commerce is deeply committed to finding a solution to the pension crisis.
Mr. Adkisson presented four items, beginning with a recommendation for a performance audit for KRS. He was encouraged to see many members of government, including candidates for governor, candidates for auditor, and members of the Public Pension Oversight Board, also endorsing the need for an independent audit of KRS. He suggested that the board make a recommendation to the Legislative Research Commission (LRC) to appropriate existing LRC funds to finance the audit rather than waiting for a budgetary appropriation. Secondly, he suggested the board members look more deeply into the use of placement agents. The two major pension systems in the state have made contradictory statements regarding the necessity of using placement agents. Third, Mr. Adkisson stated that the depletion of investment assets for KTRS threatens tax payers with huge bills in the future. He mentioned his service on the governor’s working group seeking a solution to the funding concerns and his suggestion of a shared responsibility strategy much like that used for KTRS in 2010 regarding health insurance expenses. Additionally, he recommended structural changes in benefits to help ensure the system can be sustained, but that additional funding is necessary to meet current obligations of the system. Finally, if bonding will be part of the final solution, which the business community is skeptical of, it will be necessary to consider KTRS in relation to KRS regarding lack of assets. Any bonding capacity the state can use to rescue KRS should also be considered for KTRS, and it is unclear that bonding would be capable of restoring both systems in a cash-only eventuality.
Mr. Jim Carroll, co-founder of Kentucky Government Retirees, was present to speak on behalf of 6,000 member retirees. He stated that more resources were needed for the KERS Non-Hazardous fund and the State Police Retirement System (SPRS) fund. Last year, the solvency issue was brought to light and that issue has gotten worse. As of the end of the fiscal year in June, the assets had declined by $248 million; in 2014 they had declined by $183 million; in 2013 by $212 million; and in 2012 by $556 million. This comes to a total of $1.2 billion of lost value over the course of the last 4 years, even when the assumed rate of investment returns was sometimes exceeded. Last summer, RVK Consulting (RVK) performed an asset liability study of KRS concluding there was a 5-8 percent chance of total insolvency for the KERS Non-Hazardous fund in the next 20 years, even with the assumption that the full ARC is paid and the 7.5 percent assumed rate of return on assets is met. There is also a risk of a cash-only portfolio as a result of low assets, meaning the foundation of the defined benefit system is destroyed. The chance of this happening is 56 percent according to the RVK study results. A cash-only portfolio would be catastrophic for the budget as $1.5 billion would have to come from agency funds to cover 100 percent of the employer contributions necessary to pay retiree benefits. Also, bond ratings by Moody’s and Standard and Poors would drop significantly. As a solution, Kentucky Government Retirees advocates an ARC plus strategy, where the full employer contribution is made with additional contributions to provide a cushion. However, the budget cannot sustain ARC plus, so a separate revenue stream must be found, such as an incremental bond issue of $250 million a year laddered over 8 years where bond payments would be nominal in the early years.
Mr. Larry Totten, State KRS Liaison, Kentucky Public Retirees (KPR), spoke briefly about recommendations for pension reform. He stated that member retirees are both upset and concerned about the future of public pensions, specifically about funding. Mr. Totten extended an open invitation to legislators to attend KPR chapter meetings to continue to foster an open conversation between the legislature and public retirees. He urged the board to consider several recommendations. First, he asked for continued commitment to fully funding the ARC in the upcoming budget. Second, to improve the condition of the most vulnerable fund, KERS Non-Hazardous, by exploring additional options such as a dedicated funding source to supplement, but not replace, the fully funded ARC. He recognized that this would require funding which is not readily available; however, it is KPR’s belief that not doing this will further erode the full faith and credit of the Commonwealth. Mr. Totten said that KPR had surveyed all the gubernatorial candidates and all were in support of fully funding the ARC. He went on to state that retirees on average receive $16,609 per recipient in pension benefits, and that KPR asks legislators to resist attempts to reduce the amount of benefits paid to current retirees who rely on these benefits. Mr. Totten also stated the housekeeping legislation to address KRS reforms was not passed in previous sessions, and that it is strongly recommended to pass such legislation in the upcoming session. Specifically, he focused members’ attention on the investment committee voting membership provision, stating it was necessary to increase the number of voting members to match the increase in the size of the board. Finally, by the end of the biennial budget that will be approved next year, KRS retirees will have had their benefits eroded by 6 years of inflation so some consideration of a cost of living adjustment (COLA) would be in order.
Representing Kentucky Education Association was Ms. Stephanie Winkler, President. She stated that members were dependent on their benefits and underfunded obligations were creating a growing problem. Many members are concerned that the pensions they have paid into over many years will not be there upon retirement. The KEA supported House Bill 4 during the 2015 Regular Session as a viable solution that the state could maintain. Bonding and a commitment to fully funding the ARC would have put KTRS on a path to solvency. As a result of failure to pass any kind of legislation addressing funding of the pension systems, specifically KTRS, Kentucky’s credit rating has been downgraded and the situation has become worse than before. Ms. Winkler reminded members that public employees provide valuable service to the state during their working years by paying taxes, supporting local economies, and sending their children to public schools. They continue to contribute to Kentucky’s economy in retirement as over 90 percent of state retirees remain in Kentucky and spend their retirement income in-state. KTRS pays over $1.6 billion in benefits every year and without those incomes coming into every county in the state, the recent recession would have hit small towns and small businesses even harder. Public employees do not receive wages equal to private sector counterparts, making it imperative that the retirement systems are maintained.
The final presentation was given by Ms. Patsy Rainey, President of the Kentucky Retired Teachers’ Association. Ms. Rainey opened by briefly describing her personal history with public service and the public pension systems as a teacher. She stated the need for a comprehensive and long-term solution for the crisis facing the public pension system without delay. She pointed out that over 90 percent of KTRS female retirees over the age of 80 are single, as are approximately 70 percent of KTRS male retirees over the age of 80, meaning that they are solely dependent on the benefits they receive from their KTRS pensions. KTRS has 144,000 active and retired educators who have contributed to the system and, as of October 19, 2015, there are 44,265 retired members receiving benefits. Historically, approximately 70 percent of monthly benefit payments, which average approximately $2,600, come from the KTRS’ diverse and conservative investment earnings. Ms. Rainey reiterated the sentiment that $2.1 billion in annual benefit payments have a significant impact on local economies. KRTA members are also active contributors to volunteer organizations at an estimated value of over $19.1 million given to state and local communities in the last year.
Ms. Rainey said that the solution to pension funding problems needs to be swift and to not repeat the mistakes made by other states that waited too long to implement solutions. She presented three aspects of a solution from the perspective of KRTA. First, it must ensure that retired teachers receive the benefits that they have earned over their many years of service. Second, the state must provide competitive pension benefits to active and future teachers, otherwise potential teachers will be lost to other states or professions. In other words, a failure to provide such benefits will undermine the pension system and make the state less competitive. Third, the solution must not make mistakes made by other states, such as the hard lessons learned from West Virginia, Michigan, and Alaska when switching from pensions to individual accounts. In conclusion, she said that KRTA supports a defined benefit group retirement plan.
Kentucky Retirement Systems Housekeeping Legislation and Litigation Update
Mr. Bill Thielen, Executive Director, Kentucky Retirement Systems (KRS) was present with Mr. David Peden, Chief Investment Officer, and Mr. Brian Thomas, General Counsel, to discuss housekeeping legislation and pending litigation. Mr. Thielen reported that, regarding investment performance, the system is down 4.8 percent over the first three months of the current fiscal year. He went on to direct members’ attention to a summary of the housekeeping legislation proposed for the upcoming legislative session and a copy of the bill, House Bill 108, as it stood at the end of the last regular session. A new version of the bill should be prefiled soon and will be very similar to the previous version. It is designed to bring the system into compliance with federal law changes, provide authority that will allow the system to increase efficiency, and resolve ambiguity in existing statutes. The mandatory requirement to issue benefits through electronic funds transfer or debit card in lieu of a paper check has been removed from the new language as it was highly controversial.
Chairman Yonts asked about the opt-out bill passed last session and the organizations wishing to exercise the ability to opt-out, specifically referencing KRS 61.522(7), and whether the system was going to establish a different assumed rate of return for the organizations wishing to opt-out, which would increase the costs to do so. Mr. Thielen stated that it would be up to the General Assembly and the KRS Board of Trustees to determine how the opt-out process will function. He went on to explain that KRS is in the process of drafting an emergency administrative regulation to establish the process used to withdraw, but that this is a complex issue with many aspects that were not defined when the initial legislation was discussed. Actuarial staff have stated that while it is possible to assess liability on an ongoing basis, it is difficult to assess liability for withdrawal. Approximately 15 percent of the organizations in the KERS Non-Hazardous plan could leave the plan under the new legislation. The major source of concern is in the risk carried by other employers should the 7.5 percent rate of return not be met. Because it is so rare for public pension plans to allow withdrawal, it is difficult to know how to design the system to allow for withdrawal without significantly overburdening those that remain. Chairman Yonts reiterated that the statute clearly states that if the organizations cover the assumed rate of return at the time of withdrawal in cash, they are allowed to leave and it is his understanding that the organizations that have expressed a desire to exercise the opt-out option are prepared to pay in cash and at the 7.5 percent assumed rate of return that the system currently uses. Mr. Thielen stated that he was not aware of that commitment at this time. He also stated that the KRS Board of Trustees would be ill advised from a fiduciary standpoint to make a decision that ultimately leaves considerable risk of additional liability on the state.
Senator Bowen asked to make a statement regarding a recent decision by the KRS Board of Trustees. He stated that he was troubled that the KRS Board of Trustees, in the midst of rising shortfalls, stagnant raises for state employees, unfavorable investment returns and a lack of transparency in fees paid, chose to raise the chief executive’s salary by 25 percent at their last meeting to nearly $250,000 per year. After the decision to extend this contract, one of the members of the KRS Board of Trustees noted that he was not concerned by criticism from the legislature because he does not work for the legislature. Senator Bowen stated that while that may be true, they all do work for the people of the Commonwealth, and he did not think tax payers would understand why government leaders should be granted huge raises while the people that pay these large salaries struggle to make ends meet.
Earlier in the year, Senator Bowen had expressed concern to Chairman Yonts that KRS and KTRS were paying hefty hourly rates to law firms far in excess of the normal $125 per hour maximum without the responsibility to have these contracts reviewed by the Government Contract Review Committee. This is another instance of KRS awarding a large salary increase to an employee or contractor and the contract not being subject to review by the General Assembly, unlike almost every other state government agency or personal service contract. Both KRS and KTRS are currently exempt from the Model Procurement Code, which establishes conflicts of interest and anti-kickback rules, grants vendors the right to file protests with the Finance and Administration Cabinet over the awarding of a contract, and makes personal service contracts subject to review by the Government Contract Committee. The Public Pension Oversight Board was created by the General Assembly in 2013 to bring more transparency to the operation of KRS, and in 2015 the board’s authority was extended to include oversight of the legislator’s retirement plan, the judicial plan, and KTRS. This trend toward greater transparency should continue. KRS and KTRS should not operate as islands unto themselves, so he urged the board to adopt consensus legislation to remove these agencies’ exemption from the model procurement code so that personal service contracts, such as this one with the executive director, will be subject to review by the General Assembly.
Mr. Thielen explained that, in April, he announced his intention to retire at the end of the calendar year, but was willing to serve through the next legislative session because of his experience and depending on the needs of the KRS Board of Trustees. At that time, a request for proposal (RFP) was issued and a national search firm specializing in assisting public pension organizations was hired to help find an executive director. The firm, while meeting with the executive search committee, indicated that it would be a very difficult search for a number of reasons. Primary among them was the reality that the position was significantly underpaid, and the firm noted that in order to attract qualified applicants from outside the state and agency, it would be necessary to raise the pay range to $200,000-230,000 at a minimum. The executive search committee proceeded with their search and received a number of applicants, many of whom were not qualified. There were five applicants from out-of-state placed under consideration; however the search committee was not satisfied. At that time, they asked Mr. Thielen to remain with KRS. He stated that he would continue to serve as executive director, but not for the salary he was receiving at the time, because he agreed that the position was underpaid. The board of trustees was gracious enough to make an offer to meet his salary demands, so he chose to continue working as executive director for KRS for 30 months, to try to assist the system in these difficult times and make the changes that need to be made. It is Mr. Thielen’s understanding that the board feels a fiduciary responsibility to the system and its members and believes that his experience far exceeds that of the applicants and that he would be a benefit to the system at this time.
Senator Higdon stated that the pay raise was concerning to him as well and that the size of the increase was particularly glaring in light of the 1 percent pay raise for state employees and no cost of living adjustment (COLA) for retirees. He also asked that the board include in its recommended legislative changes a proposal to make non-elected members of the KRS Board of Trustees subject to Senate confirmation and to make any executive director pay raise above normal consumer price index (CPI) subject to contract review. Senator Higdon also expressed concerns about the cost of the search committee and costs related to spiking.
Mr. Thielen responded that he had been working with KRS for nine-and-a-half years and has approximately 41 years of experience with the General Assembly. He also worked for local governments that participate in the retirement systems for 23 years. This demonstrates his wealth of experience and that experience is what is needed for the system at this time. He further explained that it would be possible to hire a new director for a much lower salary, but they would have no experience with the General Assembly or knowledge of local governments or of the extremely complex system that KRS has become with its recent reforms.
Representative Miller asked, if the position does require such a wealth of experience, what experience Mr. Thielen had when he first took the position nine-and-a-half years ago aside from being a member in a public pension plan. He also commented that he did not know of any situation in the private sector where a failing CEO would threaten to leave and then be given a 28 percent pay increase to stay. Mr. Thielen covered his personal history, highlighting his service in the U.S. Air Force, attendance at and graduation from the University of Kentucky’s law school, his work for the Chief Justice of the Kentucky Supreme Court and for the U.S. Attorney’s Office in Washington D.C. After returning to Kentucky, he said he began working for KLC, serving 23 years as general counsel. During that time he served as de facto director of legislative services for KLC during the 1984, 1986, and 1988 legislative sessions. In those sessions he worked to fight legislation that would force city governments into the CERS plan, and was well aware of the requirements of CERS at the time, which ultimately became law in 1988. Prior to 2000, he was in attendance at KRS board meetings because of KLC’s interest in the CERS system, and in 2000, he was instrumental in putting together the documentation to allow KLC to begin participation in CERS. He served as chief operations officer for KRS before he began as executive director, a position he has held for four years.
In response to reports of low investment returns of 2 percent last year, Senator Higdon asked if the investment strategies were expected to change. Mr. Thielen stated that an asset liability study had just been completed to inform the change in asset allocation that is expected to happen in upcoming board meetings and that this should improve investment returns. KRS has already begun investing KERS Non-Hazardous plan funds differently because of many issues with that plan; however, those funds cannot be invested in long-term investments because of cash-flow requirements. Mr. Jefferson asked, regarding testimony in a previous meeting, if there were any decisions made at this time about liquidity issues for the more severely unfunded plans. Mr. Peden answered that the asset discussion had been tabled after the August meeting, but it was expected to be taken up at the November 4, 2015 investment committee meeting. He did not anticipate any issues receiving approval for the three relatively healthy pension systems or the five insurance plans; however, it is likely the committee will not take action on the KERS Non-Hazardous or SPRS plans. He noted that because of liquidity concerns for those funds, it is not possible to construct a responsible portfolio that will earn the desired 7.5 percent return, so there is a conflict that the investment committee and the Board of Trustees will delay addressing until the May investment committee meeting after the legislature responds to the ARC request in the upcoming budget session.
Mr. Thielen then testified regarding Kentucky Community and Technical College Systems’ (KCTCS) cessation of reporting new employees to the KRS in January 2014. He stated there is a perceived ambiguity in the statute, which has prevented KRS from challenging the action, and that KRS prefers to wait for the General Assembly to determine through legislation whether KCTCS can use this mechanism to leave the system. Chairman Yonts stated that he recalls the statute in question, passed in May of 1997, which took individuals out of the University of Kentucky system in order to separate the systems. KCTCS was seeking to redefine and eliminate choices established by that statute by using it to justify not reporting new employees into the KERS or KTRS system, an effort made to save money. Mr. Thielen stated that other organizations were using the same mechanism to avoid making contributions and that this process is starving the system for the current members. He asked to come before the board at the November meeting to more fully discuss this issue.
Representative Graham asked that if it was the case that KCTCS had decided not to provide KRS or KTRS membership for new employees, what the ramifications would be if KCTCS chooses to come back into the system in the future. Chairman Yonts stated that to his knowledge there is no mechanism for that at this time. Representative Graham stated that if KCTCS does take this action to leave the system, they should be prohibited from returning to the system in the future. Mr. Thielen concurred that there is nothing in statute to address the issue of returning at this time and if they chose to return, the biggest concern would be omitted contributions going back over the years that employees had not been reported. Chairman Yonts agreed that it would also be necessary to have a representative from KCTCS present to speak on this issue at the November meeting. Further discussion of this item was tabled until that time.
Mr. Thielen informed the board that the KRS Board of Trustees had passed a resolution at their last meeting requesting a comprehensive audit and benchmarking study. The audit will establish a baseline of comparison to other systems and will be independently performed and paid for, although costly. Estimates currently place an independent comprehensive audit at roughly $1 million. Recommendations were that the Auditor of Public Accounts should hire an independent auditor and the funds be appropriated by the General Assembly apart from monies appropriated to KRS for the ARC.
In his summary remarks, Mr. Thielen stated that KRS is very near a solution for the problem of spiking. Also, there was a two-and-one-half year inquiry by the Securities and Exchange Commission (SEC) on the use of placement agents, in addition to a nine-month comprehensive audit performed by the state Auditor, which showed that KRS had not contracted with a firm using placement agents for over five years. The total amount of commissions theoretically paid to placement agents over a ten-year period, as disclosed in the state audit, was $12 million. There is now a comprehensive placement agent disclosure policy in place and that has reduced the reliance on placement agents to nothing. Senator Bowen stated that he felt it was not necessarily the use of placement agents, but rather the lack of transparency concerning fee payment that was more concerning. Mr. Thielen responded that KRS was moving toward greater transparency than the industry standard in terms of reporting fees and commissions. All fees and commissions are reported per investment manager and per each class of investment. Additionally, KRS is working with its custodial bank to receive additional information that would allow for reporting of fees that are not typically reported by public pension plans.
Senator Bowen asked about the disclosure of fees, as current testimony is at odds with previous testimony where it was stated that reporting fees would negatively impact bid prices. Mr. Thielen answered that at the time, and in many sectors today, that was the thinking, but there is now a national trend toward disclosure of unreported fees among public pension systems. Mr. Peden stated that the system is now reporting fees because they are being requested and that the information is relatively inconsequential from a decision-making standpoint. Private equity fees being shown are predominantly performance fees paid when earnings exceed 8 percent. The better performance, the higher the fees, so in some ways high fees are preferable as they reflect high earnings. Mr. Peden also noted that for the KERS Non-Hazardous fund, which is facing liquidity challenges and cannot invest in private equity, the expected rate of return will decrease, the ARC will increase, and the unfunded liability will increase. Last month only two asset classes, real estate and private equity, showed positive trends, which demonstrates that the fears of alternative investments costing the system are unfounded. Mr. Peden said that the only reasons the systems did poorly with respect to its peer groups so far this year are because emerging markets and non-U.S. equities are down. When those trends revert to the mean, losses will be recuperated. He also explained that currently all the groups in private equity report fees differently and there is a request for standardization among the peer group systems, but in reality the fees do not impact performance.
Mr. Brian Thomas, General Counsel, Kentucky Retirement Systems spoke briefly about litigation involving KRS. Currently the case with Seven Counties Services is under appeal at the federal district court level and KRS has requested that the court seek guidance from the Kentucky Supreme Court regarding the contractual nature of the relationship between KRS and Seven Counties Services. Chairman Yonts clarified that KRS is certifying a question to the Kentucky Supreme Court regarding whether Seven Counties Services is a proper quasi-governmental agency. Also, there are local litigation cases regarding the City of Fort Wright and Mr. Damien Stanton asserting that some of the investments are not authorized by the CERS enabling statute. KRS maintains that the General Assembly amended the investment statutory scheme to allow KRS to invest CERS, SPRS, and KERS monies to a point where they can earn a competitive return. These cases are before the Kentucky Court of Appeals concerning claims of sovereign immunity. Chairman Yonts asked if any of the groups that had filed suit against KRS had returned to the system after litigation was decided. Mr. Thomas said that yes, in the case of Bluegrass Oakwood versus Kentucky Retirement Systems, Bluegrass Oakwood had filed a declaration of rights seeking to remove one of their associated organizations from KERS. That case went to the Court of Appeals, but an agreement was reached and the case was dismissed, vacating all of the orders of the Franklin Circuit Court.
Kentucky Teachers’ Retirement System Housekeeping Legislation and Litigation Update
Mr. Gary Harbin, Executive Secretary, KTRS and Mr. Beau Barnes, Deputy Executive Secretary, KTRS, were present to speak regarding housekeeping legislation and litigation against the system. Chairman Yonts asked what the perspective of KTRS was regarding KCTCS not reporting new employees into the public retirement systems. Mr. Barnes answered that there were major concerns about KCTCS not reporting new hires, similar to those voiced by the KRS representatives. Chairman Yonts asked if there can be a declaration of rights suit filed. Mr. Barnes said that the understanding is that KCTCS has changed job descriptions so that no new positions at KCTCS qualify for participation at KTRS as a way to circumvent participation and payment into the system.
Mr. Barnes went on to discuss the housekeeping legislation package to be presented during the upcoming legislative session. In its current form, the legislation is identical to House Bill 500 from the 2015 Regular Session. The legislative committee and the KTRS Board of Trustees will meet once more and may recommend some minor additional changes, but the draft is largely considered complete. Proposed legislation makes technical amendments to the plan to ensure continued compliance with federal tax law, to take advantage of efficiencies from a recent overhaul of the information technology used by the system, and a couple of other technical changes that will not change current practice or procedure. Additionally, he noted there were some substantive changes, specifically recommendations to tighten provisions that allow retired members to return to work and provisions relating to disability.
In regards to litigation, Mr. Barnes reported that there were no large litigation matters, and most of the KTRS cases were appeals by members regarding benefits. One item filed in Louisville by three plaintiffs, including two active teachers and one retired teacher, has been reported as a class-action lawsuit but has not been certified by the court as a class. Additionally, the plaintiffs filed without the assistance of counsel and are seeking for KTRS to lobby members of the General Assembly for funding for the pension fund and to undo the 2010 shared responsibility legislation. Finally, they are requesting to restrict KTRS’s ability to invest in government-backed bonds and debt obligations, certificates of deposit with banks, and real estate approved by the Franklin District Court. Mr. Barnes stated that, for the sake of argument, if the system invested in that manner it would never invest in stocks.
Mr. Jefferson drew attention to the KTRS Board Summary document distributed to Public Pension Oversight Board members prior to the meeting. In the section on proposed changes, KRS 161.6202 and KRS 161.6205 were mentioned with the suggestion to update ad hoc COLA language and make technical amendments. The change would allow KTRS to request funding for ad hoc COLAs, which would be a COLA over and above the guaranteed 1.5 percent. He asked if this meant that KTRS is currently receiving a guaranteed 1.5 percent COLA. Mr. Barnes stated that yes, teachers are guaranteed a self-funded 1.5 percent COLA every July 1st, which is built into the contribution rate structure. He stated that the reason for this is because teachers do not participate in Social Security, which typically also incorporates an annual COLA.
Judicial Form Retirement System Housekeeping Legislation
Ms. Donna Early, Executive Director, Judicial Form Retirement System, was present to speak regarding housekeeping legislation. She directed members’ attention to a handout that summarized the proposed legislation from the JFRS, which consists primarily of technical corrections to Senate Bill 2 of the 2015 Regular Session. As implementation of hybrid plans has begun, the system has discovered the need for more direction and some ambiguities that need clarification. Additionally, there are some items that deal with legislative intent or federal regulations. Chairman Yonts asked about the practice of continuing healthcare benefits to dependents up to age 26, which KERS attempted and then had to change after the Affordable Care Act specified that coverage had to be offered but not necessarily paid until age 26. This language, if adopted, would make the policies governing JFRS beneficiaries different from the policies in the other public pension systems.
Ms. Early stated that the system is already different and currently the statutes refer to a minor but there are many different definitions of minor in statute. These language changes will better reflect the intent of the legislature to make the judicial system more similar to the legislative system by specifically defining minors. Chairman Yonts agreed that while that is a noteworthy goal, it is essential to have all the public pension systems uniform in their approach to providing insurance coverage to dependents. He then asked, regarding the ARC payments, if an additional 1 percent was being paid toward the unfunded liability. Ms. Early answered that yes, it is part of the rolling amortization schedule currently in place rather than a fixed amortization schedule. It has been recommended to the JFRS board by actuarial staff that the system needs to transition to a fixed schedule in order to allow for the liability to be paid down. Chairman Yonts asked if that would result in an instant unfunded liability situation. Ms. Early answered that according to actuarial staff, the liability will remain constant for the first few years, after which it would increase. However, there would eventually be an endpoint where the liability will be paid off. She clarified that it was still an ongoing discussion with the board.
In other business, Representative Thompson asked for the representatives of the pension systems to provide an analysis of the ratios of active members versus retired members, essentially comparing the amounts being contributed to the system to the amounts being paid out as benefits. He asked that they provide information for the last five years and a forecast of the next five years.
There being no further comments or questions, Chairman Yonts thanked the members and the meeting was adjourned. He announced that the next regularly scheduled meeting would be on November 23, 2015 at 12:00 noon.