Call to Order and Roll Call
The 3rd meeting of the Public Pension Oversight Board was held on Monday, April 25, 2016, at<MeetTime> 12:00 PM, in Room 169 of the Capitol Annex. Senator Joe Bowen, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senator Jimmy Higdon; Representative Brian Linder; John Chilton, Mitchel Denham, Mike Harmon, James M. "Mac" Jefferson, Sharon Mattingly, and Alison Stemler.
Guests: Bill Thielen, Executive Director, Kentucky Retirement Systems; Brian Thomas, General Counsel for Kentucky Retirement Systems; Karen Roggenkamp, Deputy Executive Director, Chief Operations Officer, Kentucky Retirement System; David Peden, Investment Officer, Kentucky Retirement System; Beau Barnes, Deputy Executive Director, Kentucky Teachers’ Retirement System; and Donna Early, Executive Director, Judicial Form Retirement System.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, and Angela Rhodes.
Chairman Bowen said that the Auditor of Public Accounts, Mike Harmon, will be recognized as a non-voting member.
Approval of Minutes
Representative Linder moved that the minutes of the February 22, 2016, meeting be approved. Representative Yonts seconded the motion, and the minutes were approved without objection.
KRS Update on HB 62 Implementation & Process (handouts)
Mr. Bill Thielen, Executive Director, Kentucky Retirement Systems, introduced Board of Trustee elected members Mary Helen Peter, Vince Lange, David Rich and Ed Davis. Mr. Thielen introduced Brian Thomas, General Counsel for Kentucky Retirement Systems. Mr. Thielen stated that Mr. Thomas and staff worked on the implementation of HB 62 (RS 2015) and the administrative regulation that creates the process for the voluntary withdrawal of certain types of entities from Kentucky Retirement Systems (KRS), as long as the withdrawing agency pays the full share of the unfunded actuarial liability that exists as computed by KRS actuary. KRS is still working on an involuntary removal process as provided by HB 62.
Brian Thomas discussed HB 62 (codified in KRS 61.522), the voluntary or involuntary withdrawal mechanism for the Kentucky Employees Retirement System (KERS) and the County Employee Retirement System (CERS). HB 62 created a voluntary and involuntary cessation mechanism that requires employers to pay the full actuarial cost of withdrawal and requires KRS to promulgate an administrative regulation to assist in the implementation of the voluntary and involuntary withdrawal process. The administrative regulation is pending and is expected to become final on or before June 3, 2016.
Mr. Thomas gave a timeline and overview description of the voluntary cessation process, which commences with an application deadline in December of the year prior to the cessation date. June 30 of the cessation year is the last day that employees of the employer seeking to cease participation will earn service credit. July 1 of that particular year will start the 60 day refund process, which is set forth in the statute, and employees that choose to take the refund will be implemented as a transfer to the employer’s alternative retirement plan. Those employees will be taken out of KERS or CERS and the actuarial cost will not be calculated or contributed to the ceasing employer. In December of the particular year of withdrawal, the actuarial cost will be calculated by KRS’s actuary and will be presented to the Board at the December Board meeting. Assuming the actuarial cost is accepted by the Board of Trustees, it would be communicated to the withdrawing employer so a decision can be made on the withdrawal process. There is a $10,000 administrative cost to offset fees that are associated with cessation. KRS 61.522 requires that the ceasing employer, not only pay the full actuarial cost, but also pay the administrative cost of cessation.
Mr. Thomas stated that following the application in December, the Board of Trustees will meet in February. For this application period, the Board of Trustees met in February 2016 and approved the processing of three applications for cessation. Following the cessation application, KRS has to undertake an audit process of all the member accounts that are associated with those employers and attempt to clean up any data inconsistencies or errors that are associated with those particular accounts. Additionally, KRS is charged with educating the employees regarding the impact of cessation on their particular retirement accounts and has worked with employers to do so. The employee population consists of active employees of the ceasing employers, retired employees and inactive employees, meaning employees that at one time worked for the ceasing employer and who still have that service credit on the books at KRS, but are currently not earning service credit with the ceasing employer or with another participating employer.
After the June 30 of the application period, in this case 2016, there are several steps that the retirement systems and the ceasing employer must comply with. The ceasing employer will continue to make employer contributions that are equal to what it would have made regardless of the cessation process. The employer will continue to report all employees, but will not continue to report employee contributions. The 5 percent for nonhazardous employees will not come out of the employee’s check, and there will be no service credit earned on or after July 1, 2016. Once the audits and the 60 day refund period is complete, the KRS actuary will simultaneously undertake the valuation for the 2016 plan year and calculate the unfunded liability cost of the ceasing employer. It is expected that the valuation and the resulting full actuarial cost will be calculated and approved by the Board of Trustees sometime in December 2016. Once an approval takes place, a 60 day notice is given to the withdrawing employers of the full actuarial cost and the employer will consider whether that cost is acceptable and may decide whether to complete the cessation process. Between February and April 2017, KRS will receive notification if the employer wants to complete the cessation process, and the final proposal may be tendered to the Board of Trustees for approval. Following the approval, employers will have 30 days to either pay by lump sum or pay an initial down payment. At this time, three employers have filed applications to cease participation: Kentucky Employees Mutual Insurance, the Council of State Governments, and the Commonwealth Credit Union.
Mr. Thielen explained that under the statute only non-stock/non-profit corporations created under Chapter 273 can utilize this voluntarily withdrawal process. Other classes of employers, such as P1 state agencies, cities, and counties, are not permitted to voluntarily withdraw under KRS 61.522.
Senator Higdon stated he had received comments from some of these entities and wanted to confirm that KRS would not give a ball park figure of the cost until the process starts. Mr. Thielen answered that is correct and the actuary has done an estimated cost utilizing current assumptions, but the first cessation date based on the statutory language is June 30, 2016, so the 2016 actual valuation would be used to compute the actual cost.
Senator Higdon asked how the lump sum payment is calculated when an employee has transferred out of the plan. Mr. Thomas answered that KRS looks at current service credit, salary, and the estimated retirement benefit, if the member is not retirement age, and projects that person forward to normal retirement age, and then looks at the assets on hand to pay those benefits. Any assets that KRS does not have to pay those benefits as of June 30, 2016, will be calculated into the full actuarial cost for that employer.
Senator Higdon asked that if all three of these entities and the employees exercise this option, what type of cash requirement the system will have to be able to pay out the benefits. Mr. Thielen answered that an estimated number has been given and an upfront administrative fee designed to cover costs including the actuarial cost. If the fee is not sufficient, KRS will bill further as part of the withdrawal costs for any additional administrative costs plus the full share of the actuarial expense.
Senator Higdon asked what type of cash flow and what type of hit are the systems taking to pay lump sum monies back to the entities that are withdrawing. Mr. Thielen answered that the entities will be paying KRS.
Senator Higdon asked if KRS has the employees’ money. Mr. Thielen answered the employees can leave the money in the system or, if a refund is desired, KRS has to be notified within a 60 day period following June 30th. KRS will refund those monies and will not incorporate it into the calculation of what the employer’s liability will be. In a normal year or quarter, KRS may return approximately $13 million in refunds to employees that want money back out of the system.
Senator Higdon asked if KRS was going to pay out all the money that the employees had back to this new fund that the employer set out and is it optional whether a lump sum is taken or not. Mr. Thomas answered assuming cessation is complete, the statute established a 60 day cessation refund process and, if employees apply, KRS will take the account balances and transfer those to the new retirement plan. While that does take hard assets away from the plan, actuarially it may be a benefit to the system because that liability goes with those dollars.
Chairman Yonts asked what would happen if there was a non-agreement by either side and would the process stop at that point. Mr. Thomas answered the employer that is ceasing participation can withdraw that application for cessation at any point until KRS has been told the employer wants to finalize cessation and the Board has approved, which is basically the only point at which the employer is locked in.
Chairman Yonts stated there is some anticipation of an IRS ruling that says some entity may or may not be qualified to be in this system. If this occurs, the involuntary cessation of participation would apply and KRS will determine what is paid to get out or to force the agency out. Mr. Thomas stated that is correct and KRS is developing the administrative procedures for doing that.
Chairman Yonts asked how does the existing agencies verify the accuracy of KRS’s calculations and if there is data available for verification. Mr. Thomas answered that KRS provides the data that is provided to actuary on a de-identified basis by establishing age ranges, which allows the employer to estimate what the cost will be. The employer would not be able to specifically identify the actuarial cost based upon that data, but the statute establishes that KRS’ actuary shall determine the actuarial cost.
Chairman Yonts asked, if a dispute between the two parties were to arise and an agreement cannot be made, would the deal be called off until such time that the IRS would say the agency must exit the system. Mr. Thielen answered in the affirmative, unless the General Assembly changes the statute. At this point KRS’ actuary is only giving an estimated cost and would still have to produce a finalized actual cost.
Chairman Yonts stated that there is no process in the statute for that situation. Mr. Thielen agreed and added that KRS has tried to give as much information without violating the confidentiality statutes, because if individual employee data is given, it would be a direct contravention of the confidentially statute.
Chairman Yonts asked what happens if the employee gives permission to release that data, would that change the outcome. Mr. Thielen answered yes the employee can get that data on their own and give the data to the employer.
Chairman Bowen asked how the overhead expense is calculated and what entity will cover that cost. Mr. Thomas answered KRS is tracking the hours the retirement system employees are spending on implementing HB 62 and working on these particular audits. Additionally, there are actuarial and legal costs that are associated with the cessation, and the statute sets up a process where the employer seeking cessation is responsible for those actuarial and legal costs which is part of what the $10,000 upfront administrative costs are intended to cover. If it exceeds that $10,000 sum, the additional administrative costs would have to be paid prior to the cessation date.
Chairman Bowen asked if KRS is aware of other entities that may attempt to go through the same exercise to get out of this system. Mr. Thielen answered KRS is aware of several other entities that may be interested, but unsure if a follow through would occur.
Mr. Thielen stated that about 13.5 percent to 15 percent of KERS nonhazardous plans consist of non-stock/non-profit type entities and that any of them could seek voluntary withdrawal.
Chairman Bowen stated if KRS hears of conversation in that regard it would be important to keep the Board apprised of any developments well in advance.
Mr. Mac Jefferson asked, if the process begins, and there is gap of six months or more between the initial start date and when the settlement occurs, and if the actuarial assumptions change mid-way through that process, is the process robust enough to capture changing assumptions that would increase the liability for that exiting organization and how that would work. Mr. Thielen answered no, the statute provides the cost be determined based on the previous year’s valuation using the assumptions that were in place as of the cessation date. When the Board heard about KRS lowering the assumed rate of return for this process, one of the justifications was that once the cost is determined and paid it would be final, but benefits still have to be paid out for 20 to 30 years. Going forward, if a bad experience occurs and assumptions ultimately end up changing, the state’s on the hook for the additional cost. KRS wants to be careful and calculate in a fair way, but in a way that captures the cost based on today’s knowledge.
Mr. Jefferson asked if it were to change, how leaving the state on the hook can be avoided. Mr. Thielen answered KRS is bound by the statute which says to determine the cost as of the previous year’s valuation.
Chairman Yonts asked about the issue of Seven Counties, who left owing roughly 90 million dollars prior to the legislation’s enactment, and whether this legislation could have changed the outcome. Mr. Thomas answered he believed HB 62/KRS 61.522 would have had an impact on Seven County Services, and it would have allowed KRS the ability to identify the full unfunded liability that Seven Counties was leaving behind and, if beneficial to the systems, possibly permitted that filing of a claim.
Chairman Yonts asked if the issue of bankruptcy is now on appeal to the U.S. District Court. Mr. Thielen answered that the U.S. District Court had decided in favor of Seven Counties and that KRS was going to pursue an appeal to the U.S. Circuit Court of Appeals.
Chairman Yonts asked when these three entities, and maybe more as the IRS makes a ruling, are not paying money into the system how does that impact the value of the system as far as unfunded liability. Mr. Thielen answered all these entities are trying to remove themselves from the KERS nonhazardous plan and the pension plan has $10 billion in unfunded liability right now and an additional $2 billion in health. KERS nonhazardous has about $12 billion or maybe a little under in terms of unfunded liability.
Mr. John Chilton, State Budget Director, stated that right now the employer and the employee both pay money into the system, and asked if an employee opts to cash out, will that employee get back their own money or part of what the employers pay. Mr. Thomas answered there are three tiers of benefits at KRS. Tier 1 and Tier 2 employees are basically the population that began participating prior to January 1, 2014. If those individuals choose to take the cessation refund, they will receive their account balances back which is the 5 percent or the 8 percent of pay for hazardous that they paid in plus interest. Tier 3 employees, which were established by SB 2 in 2013, are those employees will receive their 5 percent or 8 percent plus interest and in addition will receive the employer pay credit.
Mr. Chilton stated that Tiers 1 and 2 do not get any employer contribution back. Mr. Thomas answered that is correct.
Mr. Chilton asked if an employee stays in, would that person’s account be in a Tier 3. Mr. Thomas answered no, for those employees that do not take the cessation refund their accounts will basically go into a hiatus, and they would be eligible to go work at another participating employer and build on that particular account, or they are eligible to leave that account until retirement eligibility.
Mr. Chilton asked how it affects an employee’s account when there is an account the employees pay into and then another the employer pays into and to get out there will be an additional amount paid. Mr. Thomas answered that does not affect the employees account in any way. KERS and CERS are pooled multiple employer benefit plans and both the assets and liabilities are stretched across all participating employers. The monies that are brought in through the cessation process will be placed in a pool to pay benefits for all members of KERS or CERS.
Mr. Chilton questioned if the money is not segregated for the employees of these existing employers. Mr. Thielen answered there are some pension plans around the country that administer individual accounts but KRS does not. There is an employer account and employee account but it is a multiple employer cost sharing plan.
Senator Bowen asked if a vested employee would get employee and employer money back and if an employee that is not vested would only get employee money back. Mr. Thielen answered that if an employee working for one of these entities had ten years in the system and that service credit stops when the employer ceases to participate, the employee can leave money in until retirement eligibility and will get a benefit using a statutory formula that is based on the ten years of service. It would be high five final compensation, times the benefit factor for the plan, times the years of service. If the employee left money in and continued to work with one of these employers but then terminated and went to work for another state agency and built ten more years on to that service, then the employee would get the benefit of twenty years at retirement eligibility.
Senator Higdon stated he would like to see the relationship between the KRS Board and the General Assembly improve and perhaps have to two boards get together and discuss issues. Mr. Thielen answered that statement had been brought forward at the KRS Board meeting as well to possibly discuss things and get a better understanding of some of the issues the Board is facing.
Senator Bowen stated that he felt a discussion between the two Boards would be important. He believes there is a clear breakdown and that the perception on some sides is a little defiant by some with the KRS system, particularly as it related to the work in opposition to SB 2. Senator Bowen believes a more open conversation is important because SB 2 was all about transparency and open dialogue.
Quarterly Investment Update/Budget Update – Kentucky Retirement Systems (handout)
Mr. Thielen introduced David Peden the Investment Officer for KRS and Karen Roggenkamp the Deputy Executive Director, Chief Operations Officer. Ms. Roggenkamp is the Chief budget officer within the agency.
David Peden stated the first quarter of 2016, which is the 3rd quarter of the fiscal year, was an incredibly interesting but volatile quarter and gave some examples of what occurred. The index was down almost 5 percent in January but up over 6 percent in March, high yield was down 1.61 percent in January and was up 4.44 percent in March, and the Morgan Stanley index was down 6.79 percent in January and was up 8.21 percent in March. February was an inflection point. KRS started off first couple weeks in January as one of the worse starts to the equity markets ever, with that carrying on through the first part of February, and then February 11th was the low point in the equity markets and it is still not entirely clear what was going on. Mr. Peden explained the leading factors for the low point, including the selloff in oil commodities, material companies and their difficulties in terms of commodity prices, oil prices, materials like copper and the concern around those companies and their potential balance sheet issues and what that might lead to in terms of a mini financial issue with the banks. Also, the more obvious issues were oil countries that were relying on the price of oil and their ability to meet promised benefits to their citizens. While oil nations had rallied over the past few years, they had built up huge sovereign wealth funds and were having to sell those assets in order to meet payments promised to their citizens or at least in preparation for that prospect. In February, oil stabilized and that essentially led to a reversal in the equity markets. Mr. Peden pointed out that this was strange because equity is usually traded opposite of oil prices. The dollar had been extremely strong versus all other currency over the past few years, and that had started to reverse and many of the asset classes that had been a burden on KRS over the past 24 months started to help add value. One example is real return, inflation assets, were up 2.59 percent for the quarter. Non-U.S. equity had a sharp reversal in March which was driven by EME or emerging markets. Several meetings ago the discussion was about this asset allocation. KRS had a dedicated allocation to emerging markets which no longer exists in the portfolio, and KRS did not get the full benefit of the emerging markets rally but still had exposure. Also, value stocks have not done well until this quarter.
Mr. Peden went on to say in terms of asset classes for the quarter, everything was positive except for absolute return and it was great to see the contribution from many asset classes and that it had been a difficult period due to punishment for being diversified. Large cap equity, and to a lesser extent interest rate and fixed income, had been contributors. Finally, a well-diversified portfolio is being rewarded. As a reference, Mr. Peden explained that the asset allocation changes that occurred in January was one example, because there is going to be a bifurcation between the performances of each individual system when the end of the fiscal year is reached. A big difference will be seen between KERS hazardous, CERS hazardous, and CERS nonhazardous, versus State Police and KERS nonhazardous. The reason is the asset allocation increase in the equity exposure of the three healthy plans on the pension side, and all five systems on the insurance side. KRS was able to sell fixed income at the end of the year and buy into a low equity market in January and February and the eight healthy systems versus the two unhealthy systems have a much better return now and also through the end of the fiscal year.
Senator Higdon asked about the 7.5 percent assumption and how that had been reduced to an assumption of 6.75 percent. Mr. Peden answered that for the two unhealthy pension plans, KERS nonhazardous and State Police, had been lowered to 6.75 percent.
Mr. Thielen commented that the next three months will result in getting back to zero if not better because year to date KRS is down about 1.8 percent and stated that news is not good for the year. He was hopeful that if the market continues to do well between now and June 30, so KRS can get back to at least zero or above.
Mr. Thielen stated there was an interest in determining the impact of the budget that was just passed and the cash flows for KERS nonhazardous plan in particular. KRS had staff put together charts from 1998 through fiscal year 2016 that show the difference between the contributions, inflows to each of the plans versus the outflows, and what is being paid out in benefits, refunds, and expenses.
Mr. Thielen went on to state, referring to the handout, the impact of the new budget that was enacted for the 2017 and 2018 fiscal years, which showed the inflows expected and estimated for 2016. An assumption was made that the KERS nonhazardous payroll would increase 1 percent. The pension contribution on that payroll is 30.84 percent and is estimated that the total employer contribution to the pension fund will be $481 million. The employee contribution for fiscal year 2015 is estimated at $100 million with a projected net investment return of zero. A total inflow for the year would be $581.4 million. The outflows show $933 million in benefits assuming a 3 percent increase in benefits over the previous year. The refunds are kept the same at $13.5 million for 2015 and basically $10.5 million for administrative expenses. The total outflows are about $930 million. If a zero net investment return is seen, the outflows and inflows are as estimated, there will likely be a loss of about $348 million from the KERS nonhazardous asset base which would be characterized as a negative cash flow for the fund for the 2016 fiscal year.
Mr. Thielen went on to say that the 2017 employer pension contribution is going to increase from the previous 30.84 percent to 40.24 percent for KERS nonhazardous under HB 303. KRS assumed a 1 percent increase in the payroll up to $1.58 billion and that the employer contribution is going to increase from the previous years' $481 million to $633.9 million. The employee contribution, with an assumed 1 percent increase in payroll, will increase $101.4 million, and if a 6.75 percent net return on investments is achieved on the $2 billion asset base, there would be roughly $135 million in net investment returns. The total inflows would be $928.5 million in 2017 for KERS nonhazardous. The expected outflows, with a 3 percent benefit increase, are about $961 million for benefits, $13.5 million for refunds, and $10.5 million for expenses. The total outflow will be about $985 million. A negative cash flow or a decrease in the asset base will still be seen but it would only be $56.5 million compared to about $348 million the year before.
Mr. Thielen continued on for fiscal year 2018. The employer pension contribution rate for KERS nonhazardous goes up to 41.06 percent of pay, resulting in an expected inflow from all income sources of $956.3 million and expected outflow of $1 billion. So again there would be a negative cash flow of $57.5 million. If benefits do not increase 3 percent or if payroll increases more than 1 percent it will offset that negative cash flow.
Senator Bowen commented that getting off of the zero in returns would help. Mr. Thielen answered this is assuming a 6.75 percent return.
Senator Bowen commented that KRS has netted down expenses and that obviously it gives a true picture of the implications and that the Board is glad there is no overhead that is not accounted for in the net figures.
James “Mac” Jefferson asked if the assumed increase in benefits of roughly 3 percent a year is just more people retiring. Mr. Thielen answered that historically benefits have gone up some every year, 3.1 percent in 2015, so the same value was used. Karen Roggenkamp also stated that baby boomers retiring provided for more eligibility. Mr. Thielen stated that at some point it would level off because the baby boomers will have retired and expects it to become much flatter a few years out.
Mike Harmon, Auditor, asked what items are included in the administrative costs. Mr. Thielen answered that it excludes investment costs because those are reported separate. Otherwise, it includes all costs for administration of the plans on the pension side.
Mr. Harmon asked if administrative costs included salaries, actuarial expenses, and legal expenses. Mr. Thielen agreed and stated that the $10.5 million is the KERS nonhazardous plan share of the administrative costs. Total costs were about $31 million last year.
Senator Higdon commented about retirement legislation and that when asking about costs to the systems, a lot of times legislators are told that the actuarial analyses are indeterminable which is then taken as a green light to go ahead and pass the bill. Senator Higdon stated that in the future he will recommend retirement bills go through the A & R Committee to find out what the costs will be and that there needs to be a better understanding of costs. Mr. Thielen responded that there is almost nothing that does not have some cost and many times it is indeterminable because KRS cannot guess how many people might take advantage of a particular bill or situation.
Representative Jerry Miller stated the ROI assumption is still 7.5 percent but the 10 year return for KRS pension is 4.8 percent. Representative Miller asked with the voluntary cessation calculation, which future return is going to be used, is it the 4.8 percent that will be assessed or the 7.5 percent assumption. Mr. Thielen answered that KRS has to use the assumptions of the most recent valuation and that for the KERS nonhazardous system it is 6.75 percent.
Representative Miller stated KRS has not earned 6.75 percent over the last ten years. Mr. Thielen commented that was correct and there was discussion at one point about lowering the assumed rate of return a couple of percentage points for purposes of withdrawal.
Sharon Mattingly asked if the $10 million of KERS nonhazardous portion of the administrative costs was divided per head or pro rata. Mr. Thielen answered that at the beginning of each fiscal year KRS determines each plans percentage of participation based on the number of members. Throughout that fiscal year, based on that pro rata share of the membership, KRS assigns that percentage of administrative costs to each plan and the health plans. By statute it has to be taken out of the employer account which is within the pension plans.
Quarterly Investment Update/Budget Update – Kentucky Teachers Retirement Systems (handout)
Beau Barnes stated there is some really wonderful news and Kentucky Teachers Retirement System (KTRS) was deeply appreciative and very thankful to members of the General Assembly and the Governor for the progress that has been made in the budget for funding KTRS.
Mr. Barnes said that the additional funding that was requested by KTRS is in large part included in the budget. KTRS requested $1,030,000,000 in additional funding for the two years of the upcoming budget. At present, with the version of the budget that was passed by the General Assembly, $973,000,000 of that $1,030,000,000 was provided, which is roughly 94 percent of the additional funding requested. In the current fiscal year leading up to the new budget cycle, KTRS is projected to sell over $600,000,000 in assets to pay retirement benefits. Without the funding provided in the budget, that sum would grow to $800,000,000 in fiscal year 2017, $900,000,000 in fiscal year 2018, and so forth. With the additional funding, KTRS is projected to sell about $250,000,000 in fiscal year 2017 and $350,000,000 in fiscal year 2018. This additional funding not only allows KTRS to preserve assets, but it also provides the funding to take advantage of buying opportunities seen in the market.
Mr. Barnes went on to explain the permanent pension fund that was created by HB 238 and funded under the current version of the budget bill passed by the General Assembly. The purpose of the permanent pension fund is to address the unfunded liabilities of both KTRS and KRS. A total of $125,000,000 was appropriated to the permanent pension fund.
Turning to the quarterly update, Mr. Barnes said that KTRS’ more recent returns for the quarter, fiscal year to date, and one year returns have lagged behind the benchmarks. The primary reason for the lagging returns are with actively managed equities, because active equity managers are moving away from some of the hot stocks that are overvalued. For the three and five year periods, KTRS outperformed the benchmarks and over the last 30 years, the rate of return has been 7.97 percent, which exceeds the 7.5 percent assumed rate of return. Over the last five years, KTRS ranked in the top 7 percent compared to other national large public pension plans.
Senator Bowen stated that he believes that Mr. Barnes is giving gross numbers and the handout has been netted down. The recommendation of the Board is to report the same in giving net numbers. Mr. Barnes answered he had provided net numbers here.
Senator Bowen stated that on the handout were gross numbers. Mr. Barnes stated that was correct and he will have their investment accounting staff make sure that when presenting numbers in this chart (handout) that it is net numbers and will provide an updated chart to show the net numbers.
Senator Bowen stated that the Board wants all systems reporting investment returns net of expenses.
Representative Graham asked if there are pieces of legislation that the General Assembly is working on to make KTRS compliant with the Internal Revenue Code, which all retirement systems are expected to comply. Further, if the statute is not addressed or changed what kind of impact would that have over the long haul. Mr. Barnes responded that the compliance language is addressed within the KTRS housekeeping bill, and it does put in the statute requirements for employers to follow to ensure compliance with the Internal Revenue Code and it is something that will need to be addressed.
Representative Graham asked how the impact will affect retirement costs. Mr. Barnes answered that it will not have an actuarial impact, but there are concerns about not having some of the requirements in statute, such as the return to work provisions. KTRS will try to encourage members and employers to voluntarily comply with these federal requirements.
Representative Graham appealed to both Chairmen, members of the State Government Committee, as well as the leadership of both the House and the Senate that this issue will be addressed in the 2017 legislative session.
Quarterly Investment Update/Budget Update – Judicial Form Retirement System (handout)
Donna Early, Executive Director, Judicial Form Retirement System (JFRS) presented an update on the budget funding for the Judicial Retirement Plan (JRP) and the Legislators’ Retirement Plan (LRP). Ms. Early pointed out that the JRP funding appropriation was provided through the Judicial Budget Bill, HB 306, and the LRP appropriation was provided through the Legislative Budget Bill, HB 499, and that JFRS was pleased that the appropriation requests were met for both plans.
In reviewing the quarterly performance review, the returns for JRP and LRP were good and exceeded established benchmarks. All the performance figures that were provided have been posted to the JFRS website. She noted that JFRS has had a twenty year long standing relationship with Hilliard Lyons Trust Company and in that vein the returns that have been posted and provided have been the performance based on Hilliard Lyons solely. However, for various periods in the past portions of the portfolio were managed by another investment firm and some funds were held in a SPDR account but the impact on the reported returns is negligible. As an example, the ten year JRP performance for Hilliard Lyons was 7.98% compared to the total return of 7.92%. For twenty year returns values it will be a little different. Instead of the 8 percent return for Hilliard Lyons, the total returns will fall to 7.48 percent. It is important to realize the reported values are not actually total fund returns for the twenty year period. For the other periods, it does not have much of an impact because the funds have been all 100 percent managed by Hilliard Lyons for those periods and JFRS will make that qualification on the website.
Legislative Update (handout)
Brad Gross and Jennifer Black Hans, Legislative Research Commission staff, presented a legislative update of bills that passed the 2016 session. Mr. Gross provided an overview of HB 303, the Executive Branch Budget. He explained that the KERS and the State Police Retirement System (SPRS) remained consistent throughout the Governor’s budget, the House budget, the Senate budget, with all of the funds containing the actuarially required contribution (ARC) rates for those two systems. Mr. Gross noted that when looking at the budget there will be differing numbers and percentages for the various systems, with KRS values being included as a percentage of payroll and KTRS values established as a specific dollar amount. Often people will provide projections about what those numbers are for KRS, which is similar to what Mr. Thielen did in his presentation based upon projected payroll dollar values. Additionally, supplemental or ARC + contributions for KRS were provided in the budget totaling: $58.2 million in fiscal year 2017, $67.6 million in fiscal year 2018 for the KERS nonhazardous pension fund, $15 million and $10 million in the two years for the KERS hazardous fund, and $25 million and $10 million in the two year period for the SPRS pension fund.
Relative to KTRS, Mr. Gross confirmed what Mr. Barnes had indicated. KTRS has an appropriation that funds a fixed statutory rate that has historically been in the budget plus supplemental funding. He noted that KTRS has been requesting additional funding in the budget biennium of $520 million fiscal year 2017 and $513 million in fiscal year 2018 to meet the actuarially required contribution. In the budget, additional funding of $498.5 million and $474.8 million was provided. Mr. Barnes indicated the value was roughly 94 percent combining the two years together. When taking an individual look, the additional funding amounted to roughly 96 percent and 93 percent of the ARC. Mr. Gross stated that there was a lot of discussion this year about a permanent fund or a permanent pension fund and ultimately the fund received a $125 million appropriation to assist all pension funds in the future, and $3 million of that fund will go toward the performance audit that is to be done during the biennium. Also, in reference the budget, Mr. Gross pointed out that the Governor still has line item veto privileges on HB 303.
Mr. Gross went on the say that HB 306, the Judicial Branch Budget Bill and HB 499, the Legislative Branch Budget Bill, provided the full ARC to JRP and LRP funds as well.
Jennifer Hans presented HB 153, an act relating to volunteer service with an employer participating in KRS. This legislation came about as a result of volunteer service in general, but in particular firefighters’ volunteer service and the run fees and reimbursements for expenses these members receive. The act amends the definition of creditable compensation to exclude fees paid to volunteers up to $500 a month. The act also allows retired volunteers to receive reimbursements for those actual expenditures without falling into the reemployment rules subject to certain specifications. Mr. Gross added from a new hire coming into the system, ultimately those volunteers will not have to participate and contribute to the retirement systems. For example, a volunteer would end up in the retirement systems if working full time for one fire department and volunteering at another where he or she received some form of compensation for volunteering. On reemployment after retirement, the act would allow some of the issues that have come up to be resolved. Now, if someone retires after being a fire fighter and then wants to go back to being a volunteer, there will be no issues when receiving some nominal form of fees.
Ms. Hans continued with HB 238, an act relating to public pension plan reporting. The act standardizes reporting requirements for actuarial analyses, reports and experience studies which are already reported to the General Assembly. This act tightens those requirements and requires a 20 year projection on these reports to detail the impact of the changes and requires a little bit more in terms of what those actuarial analyses are required to contain. It gives a tighter timeframe and more requirements in terms of what those reports need to provide to both to General Assembly and the legislative oversight committees during the session. Also, it requires the experience studies to be conducted once every five years and requires the actuarial valuations to include 20 year projections and sensitivity analysis. These are things already optional and being conducted by some of systems, but this codifies the provisions and puts these into statute. The bill also requires the PPOB to retain an actuary (costs paid by the systems) to perform an actuarial audit at least once every five years and to evaluate funding needs of the systems prior to each budget biennium. It also establishes the Permanent Pension Fund in statute. Mr. Gross added that there are multiple reports the members of the PPOB have reviewed over time, including the annual actuarial valuation and the five year experience study which is where the systems review their assumptions periodically. Also, the actuarial audit, which is a second review of the assumptions, was reviewed this past fall by the PPOB when the systems hired another actuary to perform the audit.
Ms. Hans continued with HB 271, an act relating to the Public Pension Oversight Board. It requires the state-administered retirement systems by November 15 of each fiscal year to collectively file a report to the PPOB containing the following information for each member of the system: (1) a unique identification number for each member created solely for the report; (2) the status of the member – contributing, inactive, retired, beneficiary, or retired reemployed; (3) for each retired member or beneficiary, the annualized monthly retirement allowance he or she is receiving; and (4) for each member that has not yet retired, the estimated annual retirement allowance that the member is eligible to receive at his or her normal retirement date. This is sort of the comprehensive report that would be receive to see what the membership and benefit payments look like across all of the systems.
Mr. Gross continued with HB 281, an act relating to retirement benefits for local elected officials. Relative to reemployment after retirement, HB 1 in 2008 was one of the pension reform bills of years past that dealt with reemployment after retirement and prospectively prohibited second retirement accounts from KRS and established standardized breaks in employment and prohibitions on pre-arranged agreements. What HB 281 did, was if an individual is a member in KERS or SPRS and also a Mayor or member of a city legislative body but not participating in CERS as that Mayor, then that individual could still retain the Mayor position without having to give it up upon retirement from KERS or SPRS.
Jennifer Hans continued with SB 113, an act relating to legislative recommendations from the JFRS which is a housekeeping bill. The bill makes technical and clerical changes for the Legislators' Retirement Plan and the Judicial Retirement Plan.
SB 203, was an act relating to death in the line of duty benefits. The act permits beneficiaries/spouse of a deceased member awaiting a decision regarding death as a result of an act in the line of duty to receive normal death benefits and to have benefits recalculated if a final determination results in a finding of eligibility for in the line of duty benefits. It makes provisions retroactive to any matter pending before the KRS or on appeal. Normal benefits can be received whether or not the individual has been granted the death in the line of duty benefits.
SB 206, an act relating to reemployment of retired police officers. The bill allows cities to establish a program to reemploy KERS, CERS, and SPRS retirees as police officers, provided certain requirements are met, and exempts the cities from paying employer contributions and health reimbursements to KRS for retirees reemployed under the program. Provides that individuals employed under the section may be employed for a term not to exceed one year, which may be renewed at the discretion and need of the city, and also limits the number of individuals hired by the city under the program.
SB 209, is an act relating to agencies that discontinue participation in KRS. This is a follow-up to HB 62 (RS 2015) (codified at KRS 61.522), which allows employers to voluntarily cease participation in the KERS or the CERS by paying the full actuarial costs of exiting the system and providing an alternative retirement plan to employees. SB 209 provides that the mandatory employee contributions made to the alternative retirement plans created by these non-participating employers may be “picked-up” by those employers so that the contributions will be made on a tax-deferred basis.
Mr. Gross continued with the Housekeeping bills that did not pass into law. Several transparency measures, SB 2 and SB 45, resulted in multiple discussions and various proposals introduced either in floor amendments or in substitutes or other bills. He also noted a measure on funding for KTRS to pay the full ARC in future years which would address issues regarding GASB 67 reporting liabilities.
Senator Bowen commented that there is a lot of disappointment on the bills that did not pass, but that is the way the legislative process works at times. Senator Bowen said he was extremely disappointed that SB 2 did not pass and was sure that Co-Chair Yonts was equally disappointed that some of the legislation that he was interested in did not pass as well.
With no further business to come before the Board, the meeting was adjourned at 1:55 p.m. The next regularly scheduled meeting of the board will be Monday, May 23, 2016 at 12:00 p.m.