Call to Order and Roll Call
The 4th meeting of the Public Pension Oversight Board was held on Monday, May 23, 2016, at 12:00 PM, in Room 169 of the Capitol Annex. Representative Brent Yonts, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senators Jimmy Higdon and Gerald A. Neal; Representatives Brian Linder and Tommy Thompson; Mitchel Denham, Mike Harmon, James M. "Mac" Jefferson, and Sharon Mattingly.
Guests: Bill Thielen, Executive Director, Kentucky Retirement Systems; Beau Barnes, Deputy Executive Director, Kentucky Teachers’ Retirement System; and Donna Early, Executive Director, Judicial Form Retirement System; and Steve Shannon, Executive Director, Kentucky Association of Regional Programs.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, and Angela Rhodes.
Approval of Minutes
Representative Thompson moved that the minutes of the April 25, 2016, meeting be approved. James “Mac” Jefferson seconded the motion, and the minutes were approved without objection.
CY 2015 Investment Update/Peer Review (handout)
Mr. Bo Cracraft, Legislative Research Commission, brought attention to the revised March 2016 quarterly performance and stated that from a return standpoint, none of the systems’ total returns changed.
Mr. Cracraft continued on to discuss the 2015 calendar year investment performance for the three primary state administered systems. In this industry, most of the state pension plans are on a June 30 fiscal year end, thus a more comprehensive review is generally done after the close of that fiscal year. December 31st is that next best data point given it is a period where a lot of plans release information, and consultants are providing valuations of the industry.
Mr. Cracraft (referring to slide 2 of the handout) stated 2015 was a tough year for investors as most asset class returns had a low single digit or negative returns. The asset classes that did well were Private Real Estate and Non-U.S. Small Cap. Most pension plans are not going to have a healthy dose of private real estate and dedicated Non-U.S. Small Cap, and the winners from 2015 were not the traditional larger asset bases.
Equity markets were underwhelming, Developed Non-U.S. was slightly down, Emerging Market Equity was one of the worst performing asset classes, and U.S. Small Cap was down 4 percent. U.S. Large Cap is the only positive result, but a bit misleading as the actual price appreciation of the underlying stocks was basically zero. Returns were very stock dependent and returns dependent on holding a few stocks. Using the S&P 500 as an example, FANG (Facebook, Amazon, NetFlix and Google) stocks averaged up 83 percent for the twelve months ending December 31st. In addition, the top ten stocks of the S&P 500 were up an average of 23 percent, while the remaining 490 were down on average 2 percent. Bond Markets also struggled. U.S. Core Fixed Income, which is the Barclays Government aggregate, U.S. denominated bond index, was only up 50 basis points. The below investment grade bonds, such as high yield, were down 4 percent and global bonds were down about 3.5 percent. In a market where equities have some volatility and are not really producing returns, the safe haven that bonds had historically played in the past was not seen. Alternatives struggled as well, with anything that was tied to inflation, such as TIPS, or aligned with the U.S. dollar or exports, such as emerging markets or commodities, were down during the year. Absolute return was anywhere from 0 to down 1 percent.
Mr. Cracraft went on to explain the three peer groups (LRC Calculated, BNY Mellon and Wilshire) listed for the one year return produced an average return around 0.2 percent to 0.4 percent. Kentucky Retirement System (KRS) and Kentucky Teachers’ Retirement System (KTRS) were both near the median. KRS’ return is slightly below median, but if a fee is incorporated (which has historically run from 50 to 75 basis points), it will be slightly above median. KTRS is right at median using a gross return. The Legislative Retirement Plan (LRP) and Judicial Retirement Plan (JRP) continue to perform well and are above the median. Mr. Cracraft noted this is for calendar year 2015 and that there are still a few gross numbers, but as seen on the recent quarterly flash, all plans have moved to a net basis going forward.
Senator Bowen wanted to know if these were net figures. Mr. Cracraft answered that the presentation was done as of December 31st, and at that time it was still gross numbers, but the quarterly flash is net and going forward it will be net numbers.
Mr. Cracraft continued that when looking at the 10 and 20 year numbers that the Board has discussed over the last eighteen to twenty-four months, both of the two larger plans are still struggling to hit that actuarial return target. KRS is anywhere from 6.75 percent to 7.5 percent and KTRS is at 7.5 percent.
Regarding the asset allocation standpoint, there is not as formal a review for the December 31st report because there is not as many plans to get the data. KRS approved a new target asset allocation and in December it began to move to these new targets and the equity went up almost 2 percent. Real return came down a couple percentage points. Private assets were one of the better performing asset classes, so market movements have increased. KTRS and JFRS are mostly market movements and neither are doing any major reallocations, just some rebalancing and cash flow type issues.
Senator Higdon asked how the policy benchmarks are determined and why the plans have different benchmarks. Mr. Cracraft responded that policy benchmarks are determined through the asset allocation process. KRS has an asset allocation that involves U.S. equity, non U.S. equity, core fixed income, high yield income, and private assets. Each asset class has a target allocation and a benchmark for return purposes. A policy benchmark is calculated by taking the target of each asset class and multiplying it by the benchmark return. Adding each component together results in a total policy benchmark return. If a fund such as LRP has a higher allocation to equity, and equity performs well, then the benchmark would be higher if a plan has more fixed income. Most of the plans are close to targets, and it is generally an underlying manager return issue that is causing the above or below benchmark performance.
Senator Higdon wanted to know if looking at the one year KRS return is 0 and the policy benchmark is 0.6 percent and the assumption that is used is 7.5 percent, how the two numbers relate. Mr. Cracraft answered the 7.5 percent is a target. When a plan is building their asset allocation, a capital market assumption is used for each asset class. For example, it might assume that U.S. equity is going to earn 6 percent and a standard deviation, or risk, is assigned. When building their asset allocation the Board is looking at several different asset mixes that try to get as close to that 7.5 percent target. The 0.6 percent is based on what actually happened over the last twelve months.
Mac Jefferson asked if, in future meetings when this report is produced and the difference between policy benchmarks is substantial, an appendix or some additional information could be added to help explain those differences. Mr. Jefferson also asked when looking at the peer group data, is the KRS returns net of fees and is the peer group constituents in an aggregate gross of fees. Mr. Cracraft answered that BNY Mellon and Wilshire both are labeled as gross, while the Legislative Research Commission Calculated is a mix of both.
Mr. Jefferson asked if there is an average or a benchmark assumed fee that he should back off these other plans to see how well it is doing. Mr. Cracraft responded that with KRS one could probably add 50 to 75 basis points. KTRS’ average is 25 to 35 basis points and would be reduced. LRP and JRP are about 10 basis points.
Public Pension Funding Policies Overview (handout)
Brad Gross, Legislative Research Commission, stated over the course of time, the Public Pension Oversight Board (PPOB) has been looking at how other states develop pension funding policies. Governmental Accounting Standards Board statements GASB 25 and 27 became a funding standard for public pension plans across the country since they were first established. GASB 67 and 68 standards have replaced GASB 25 and 27 and effectively divorced funding standards from accounting/reporting standards. This change resulted in the need for pension funds to develop a funding policy. In Kentucky, both KRS and KTRS have reviewed and developed written funding policies, KRS in 2013 and KTRS in 2014. Some parts of the policy are defined by statute and some are not. Recent legislative funding proposals, such as HB 1, have discussed adding statutory language on what the level of KTRS’ pension ARC would be over the long run. HB 443, which has not been discussed in length or detail, addresses JFRS’ request for a different amortization policy for their unfunded liability then what is currently written in statute.
Mr. Gross talked about how funding policies are developed and what other states are doing. He stated that pension fund management has various policies that will be put into play, such as, an investment policy, which will be discussed at a later time; benefits policies, essentially the benefits that are going to get paid out and are particularly described by statute; governance policy, how the systems are managed; and funding policy, a systematic approach for telling how much should be contributed and when. In general, pension funding is shown by the formula of C + I = B + E (contributions + investments = benefits + expenses), meaning what goes into the fund must ultimately equal what goes out of the fund. Pension funds hire actuaries to help determine what C should be and in turn what the employer contribution rate should be. Some of the common goals on developing funding policies include: benefit security, meaning will the money be there when the benefits come due; contribution stability, or achieving a contribution rate that does not have a lot of variance over the course of time; and intergenerational equity, meaning today’s retirement costs are not pushed off to future generations.
There are a lot of components that are put into the actuarial valuation process, such as, assumptions and methods, with some prescribed by statute and some by policy; benefits and funding provisions, which are prescribed by statute, regulation, and board policy; and the actuarial experience of the plan over the course of time against the assumptions. The output of the valuation includes the funding level and unfunded liabilities and recommended employer contribution rates. Experience studies, actuarial audits and asset/liability modeling studies are things that help drive these values into the pension fund.
Funding policies decisions include the actuarial cost method, assumptions such as investment return and payroll growth, an asset valuation method, and an amortization policy. Out of that funding policy there will be an ARC calculation that generally includes the normal cost plus an amortized payment on an unfunded liability. The normal cost is the ongoing cost of the plan assuming all assumptions play out as anticipated. However, assumptions do not always play out, resulting in an unfunded liability and amortized payment. Actuaries tend to project out liabilities over the course of time, using assumptions such as retirement rates and life expectancy. Then these future liabilities will be discounted to today’s dollars using that assumed rate of return. Every year those liabilities grow by 7.5 percent.
Mr. Gross stated the following information came from a 2015 presentation by Segal Co. /Cheiron called “A Fresh Look At Actuarial Tools to Address Pension Funding Issues.” A funding policy is important and possible funding issues include: the ARC has not been paid; contribution volatility due to investment return fluctuations; the unfunded liability is growing despite paying the full ARC; contributions are growing as a percentage of payroll due to a lack of active payroll growth; overly optimistic assumptions resulting in greater funding; cost shifting is occurring between generations; and revenue growth that is not able to keep pace with the additional retirement contribution needs.
Mr. Gross continued by explaining that the actuarial cost method allocates cost to different time periods and ultimately between the actuarial liability and the normal cost, and it defines what the normal cost will be. There are two common methods: Entry Age Normal Cost and Projected Unit Credit. The entry age normal cost method typically front loads cost, whereas the projected unit credit typically back loads costs. For these pension funds, KRS uses the entry age normal cost method by statute. KTRS uses entry age normal cost by Board policy, but used the projected unit credit prior to FY 2011. JFRS uses entry age normal cost but statute allows either one. Forty-five of the 50 state employee plans use the entry age normal cost method and GASB 67 requires entry age normal cost methods for the computation of accounting liabilities.
The asset valuation method is a process to smooth investment gains and losses to reduce contribution volatility, and most pension funds use a five year smoothing method to smooth out those gains and losses. As an example, he stated that when the investment markets went down during the great recession and the FY 2009 returns were -14 percent and -17 percent for the public pension funds, the losses were not recognized all in one year; but were recognized incrementally over that five year period. Most states have the five year smoothing although some do have shorter and longer periods. The longer period has less volatility on rates. Once losses are recognized, it becomes part of the unfunded liability calculation. KRS, KTRS and JFRS use a five year smoothing method via policy.
One of the key assumptions is the investment return assumption. Mr. Gross stated that liabilities are discounted back to today’s dollars using the investment return assumption, and every year liabilities grow by that assumed rate of return. If there is a higher assumed rate of return, then it is going to produce lower unfunded liabilities today. If the investment return assumption is lower, then the unfunded liabilities are going to go up. KRS has a 7.5 percent investment return assumption that is changing in the 2016 valuation to 6.75 percent for the Kentucky Employees Retirement System (KERS) and State Police Retirement System (SPRS) pension funds. The lower rate was assumed in the budget calculations, but there has been movement of the rate over the course of time. It moved from 8.25 percent to 7.75 percent in 2006 and from 7.75 percent to 7.5 percent in the 2015 valuation and moving forward with the KERS and SPRS pension funds it is going to go down as well. KTRS is at 7.5. JFRS is at 7 percent and changed from 7.5 percent to 7 percent in 2009. An idea of what the investment return assumption does to unfunded liabilities and the ARC are exemplified when KRS reduced the assumed rate of return to 6.75 percent for KERS nonhazardous pension fund, which projections indicated the unfunded liability would increase by $900 million with the change from 7.5 percent to 6.75 percent. It did not change the ARC dramatically, 1.31 percent of pay because again that change will get factored in over the amortization period of the fund, which entails not paying that $900 million today. That is probably about a $20 to $22 million increase in the ARC. The National Association of State Retirement Administrators put together data work on public pension funds assumed rates of return since 2001 which indicate public pension funds have been changing assumed rates over the course of time.
Mr. Gross continued that the amortization policy becomes a critical piece of how pension funding rates are determined. A term of thirty years is probably most common, but some are shorter. Some offer a layered approach where there is a thirty year amortization on some components and if there is a new unfunded liability source it will be financed over a new amortization period. There is also the difference between a closed and open period. A closed period would be much like our home mortgage and at some point the liability is paid off. With an open period, the unfunded liability is amortized every single year and may never get to a point where it is paid off at all. The amortization method is also important, meaning is the liability amortized using a level percent or level dollar method. Most pension funds are on a level percent of payroll method. Level dollar would be like a home mortgage, it is a set dollar generally speaking over the life of the thirty year period. Level percent would be equivalent to a mortgage that assumes payroll is going to grow 4 percent a month where the home mortgage payment is to be the same percentage of the pay over the life of that mortgage. The percentage may stay the same but the dollars that are expended are going to grow because the pay is going to grow. Layering or separate bases is simply like a common practice. Under one approach legacy liabilities, which is what has happened in the past is amortized over a certain time period, and then if there are other changes to the unfunded liability they are amortized over separate periods. KRS is on a thirty year closed period and that period started in 2013. This is required by statute for KRS except for whether the period is closed or open and the payroll growth assumption, which is determined in the experience study by the KRS Board in consultation with their actuary. That period has been reset twice in recent history, in 2007 by the KRS Board and the General Assembly reset the period in SB 2 (RS 2013). For KRS, the payroll growth assumption initially was 5 percent and has moved down twice over the course of time and is now 4 percent. KTRS also has a thirty year closed period on legacy liabilities and are amortizing new sources of unfunded liability over a twenty year closed period. KTRS uses a level percent of pay method with a 4 percent pay growth. Generally, this is all by Board policy. An interesting distinction is that KRS has statutory requirements regarding amortization of the unfunded liability while KTRS is set in Board policy. JFRS has a statutory policy that is different from almost any pension fund that is seen in the review of other states. JFRS pays the interest, which is 7 percent, plus 1 percent of the unfunded liability. One of the concerns in the actuarial community is negative amortization, and that occurs when the amortized unfunded liability payment is less than the interest on the liability.
Representative Yonts stated that relevant to negative payroll growth, since 2008 there has been a loss of four plus thousand people and that there are also a lot of privatization which is being researched now. Mr. Gross stated the negative payroll growth was not an issue with all systems. Representative Yonts continued that bottom line is that we should expect that if negative payroll growth is reflected in a new assumption change, then the ARC goes up substantially next cycle. Mr. Gross answered yes.
Responding to questions from Senator Bowen, Mr. Gross confirmed that all the calculations in the presentation included the hybrid cash balance plan and that the calculations reflect the payroll growth.
Senator Bowen stated that the benefit is going to be different for new hires and asked if there would be an offset between lacks of payroll growth. Mr. Gross answered that when talking about payroll growth, it is total payroll, not individual employee salaries. Currently, there is a lack of growing employees’ salaries which does impact individual benefit costs. The hybrid cash balance plan is for new hires going forward and that will play out over time, but when that plan was started all employees were not enrolled in the cash balance plan but rather will become a greater percentage of the population over time.
Senator Bowen asked if the hybrid cash balance plan should have its own amortization schedule. Mr. Gross responded that Judicial and Legislative did so, but that the statute prescribed that the KERS and County Employee Retirement System (CERS) hybrid cash balance plan would be together in the one respective pool.
Senator Bowen asked if he was correct with regards to the payroll growth and when taking in new people after 2013, with the hybrid cash balance plan a lot of people are making the assumption they are in a different plan and are not contributing to the funding of the total plan. Mr. Gross responded that was correct and their individual money (their employee contribution rate) is getting put into an account and there is an employer credit, which is not the employer contribution. There is still a single ARC over the course of time on all employees. There is not a different employer’s rate for a cash balance participant in KERS, CERS and SPRS versus someone in the traditional defined benefit plan. It operates more just like another tier within the plan.
Mr. Gross continued with how sensitive the payroll growth assumption is in the actuarial valuation. KRS has implemented sensitivity analysis and it is required for all systems going forward by HB 238. If the payroll growth assumption was decreased from 4 percent to 2 percent the pension contribution alone would grow by 9.07 percent of pay. The retirement systems also did an analysis on level percent of pay versus level dollar. Mr. Gross stated for all fund sources that in 2018 the projected ARC is anticipated to produce $823 million in contributions. Using the level dollar method, that would grow to $1.2 billion, a difference just shy of $400 million in additional contributions if payroll growth was taken out of the equation. That would eliminate cash flow discussions in the short run.
Mr. Gross discussed funding policy issues with the individual state funds. The KERS nonhazardous pension fund has a low funding level and cash flow issues which is impacted in part by payroll. Payroll over time is decreasing, which is in part due to a lack of pay raises but also a decline in participation of the Community Mental Health Centers, health departments and some higher education agencies. There may be question of what the ARC + should be or should the ARC simply be a higher value to address cash flow considerations, which can be achieved through a funding policy. KTRS, which has a fixed employer rate by statute and receives some supplemental contributions but then produces a valuation that does describe an ARC, has no clear long term funding plan in statute. As a result, there is a huge variance between the GASB liabilities at $24.4 billion and funding liabilities at $13.9 billion. Relative to JFRS’ current statutory process of paying interest plus 1 percent of the unfunded liability, a bill was introduced this year that was requested by JFRS to move to a twenty-five year closed period on the legacy liability and utilize a 20, 15, and 10 year amortization period on future liability changes depending upon whether it was a legislative change, assumption change, or future gain in loss. JFRS also wants to move to a level dollar amortization method.
Finally, Mr. Gross discussed pending issues for consideration by the committee. With the funding policy risk management, HB 238 requires standardization with reports as well as projections. The permanent fund has been set aside to help address issues with the pension funds.
Inviolable Contract Exceptions - Kentucky Retirement Systems (handout)
Mr. Bill Thielen introduced Brian Thomas, General Counsel for Kentucky Retirement Systems (KRS). Mr. Thielen also introduced KRS Board members Vince Lang, Elected KERS Member; David Rich, Elected CERS Member; and David Eager, Investment Consultant, new appointee. Mr. Thielen spoke about inviolable contract language and that it is a legal concept that has been a part of Kentucky law long before it was put into the pension statutes. The inviolable contract was recognized between the Commonwealth and various parties under various circumstances going back to the turn of the century, but the language that is in KRS 61.692, which is the KERS statute, states the benefits promised to a member constituted a inviolable contract of the Commonwealth and shall not be subject to reduction or impairment by alteration, amendment, or repeal.
Representative Yonts stated that inviolable means that it cannot be broken or changed and, if it is, then a cause of action arises for those who are affected negatively by it. Mr. Thielen agreed and stated that basically the law over time has morphed into the retirement benefits promised to members are deferred compensation and members are entitled to those benefits from the begin time of employment with the Commonwealth. This language establishing the inviolable contract for KERS, CERS, and SPRS is identical in all three statutes.
Beginning on and after January 1, 2014, pension benefits are no longer protected by the inviolable contract. The statute does provide the benefits that are earned up to the time the changes are made are protected but not thereafter. The cost of living adjustment (COLA), statute KRS 61.691, is not protected by the inviolable contract and may be changed. In HB 1 and SB 2, the General Assembly made substantial changes and there would be no expectations for the long term for a COLA award.
Representative Yonts stated in regards to no expectation of any COLAs, that this is the case, unless the General Assembly or the system has cash on hand to pay them right then.
Finally, Mr. Thielen stated the health insurance benefit that is promised in the statute beginning July 1, 2003, is not protected by the inviolable contract, and since that time significant changes were made in terms of the period of time of service before it is earned.
Representative Yonts wanted to know from Mr. Thielen about the last KRS Board meeting. Mr. Thielen responded that on April 20 he received an Executive Order that removed Thomas Elliott as trustee. A Board meeting was schedule on April 21, and Dr. William Smith reported to Mr. Thielen that he had been appointed as Chair to replace Mr. Elliott. Mr. Thielen stated that he informed Dr. Smith that based on an opinion of the Attorney General that he believed the Governor did not have the authority to remove Mr. Elliot from the Board, and therefore, Mr. Elliott still served as Chair on April 21. On May 2, 2016, an Executive Order was issued appointing Mr. Eager to fill a vacant position on the Board, and subsequently, he was elected Chair of the Investment Committee. Before May 18, 2016, another Executive Order was issued appointing John Farris to a vacancy. On May 18, 2016, Mr. Thielen received an email that stated that since Dr. Smith had declined the appointment, that Mark Lattice, CPA had been appointed. On May 19, 2016, about thirty minutes before the Board meeting was to start, several members of the Board and Mr. Elliott were told that if Mr. Elliott attempted to take part or chair the meeting that he would be arrested and charged with an offense under KRS 525.150. Mr. Thielen stated that there were at least four state police officers in attendance.
Representative Yonts wanted to know if anyone else was prohibited from participating. Mr. Thielen answered there were threats that if certain events occurred there would be consequences to other Board members.
Representative Yonts wanted to know who the threats came from. Mr. Thielen answered they came from the Secretary of Personnel and the General Counsel for the Personnel Cabinet.
Representative Kay wanted to know if there was opportunity for public comment at the KRS Board meeting. Mr. Thielen answered for several months there has been an item on the Agenda allowing public comment and there is thirty minutes set aside for that purpose. He advised that one person had signed up, but that person decided to decline due to the atmosphere.
Responding to questions from Representative Yonts, Mr. Thielen confirmed there was a subsequent Attorney General opinion, OAG 16-004 related specifically to this situation, and that the opinion was that the Governor did not have authority to remove Mr. Elliott and appoint another to his trustee position.
Representative Yonts wanted to know if the people who are appointed are to serve at the pleasure of or for a term of years. Mr. Thielen answered they serve a term of four years.
Representative Yonts asked when Mr. Elliott’s term ends. Mr. Thielen said Mr. Elliott has under three years left.
Senator Bowen stated that he does not want the PPOB to overstep its responsibility and the Executive Order was lawful and the PPOB should not pretend that the gubernatorial power and control of the Board has not occurred in the past and he does not think this is unprecedented and the drama of the political dynamics have highlighted this in some measure is unfair.
Representative Yonts responded that is a good point and that the PPOB has no jurisdiction in that matter but it is a matter of concern and interest for this Board because our jurisdiction is to overview the processes of that system.
Inviolable Contract Exceptions – Kentucky Teachers Retirement Systems (handout)
Beau Barnes, Deputy Executive Secretary, Kentucky Teachers Retirement System stated that KTRS has an inviolable contract with similar wording as in the KRS statute. In 2007 then Governor Ernie Fletcher established a Blue Ribbon Commission on Public Retirement Systems and one of the areas that it studied in the operations of the Public Retirement Systems was the inviolable contract and, to assist, the services of two out of state law firms, one from Florida and one from California, were enlisted. Their analysis of the inviolable contract is set forth on page 32 of that Blue Ribbon Commission report. The report states that when analyzing the state’s inviolable contract, the legal opinion makes a distinction between pension benefits and medical benefits. In regard to pension benefits, the existence of an inviolable contract seems clear. Further, in the report, the Kentucky statement of intent in regard to the inviolable contract is one of the strongest among the states. There are exceptions, because within the statutes that are covered by the inviolable contract those statutes provide exceptions.
· Retirement allowances calculated on average of member’s 3 highest salaries if member is at least 55 and has at least 27 years. [KRS 161.220(9)]
· Postretirement re-employment provisions. [KRS 161.605((1)-(8)]
· Retirement benefits for members providing part-time or substitute teaching services. [KRS 161.612]
· 3 percent retirement factor for qualifying years exceeding 30. [KRS 161.620(1)(c) and (d)2]
· Retiree health insurance – only guaranteed access to group coverage. [KRS 161.675]
· Sick-leave payments used for retirement calculation purposes. [KRS 161.155(10)]
Mr. Barnes continued explaining the maximum savings from three benefits that could potentially be reduced or eliminated despite the inviolable contract. Eliminating the ability to have the retirement allowance calculated on the three high salaries opposed to the five high salaries for those age 55 with 27 years of service saves a percentage of pay of about 0.65 percent, which is a savings of $24 million. Removing the 3.0 percent formula multiplier for service beyond thirty years saves a percentage of pay of about 0.25 percent which is about $9 million. For the sick leave treatment (shift from salary credit to service credit), the system saves a percentage of pay of about 0.66 percent, which would save $24 million. The reasons these are labeled maximum savings is because there are potential consequences of these benefits going away for everyone July 1, 2017. Essentially, the concerns are that with one in four teachers eligible to retire and if the benefit just suddenly goes away, there will be a lot of people who are going to retire July 1, 2017, who would not have retired. Having teachers alter their retirement pattern and retire years earlier would mean paying out pensions and medical insurance years earlier would have a huge actuarial impact. The workgroup’s actuary last advised that some of these benefits should be removed in a thoughtful way.
Representative Graham wants to know if he is correct when looking at a current memberships sick leave treatment, if shifting from salary credit to service credit if it would impact the local school districts for those teachers who have accumulated quite a bit of sick leave and this change would impact the cost of substitute teachers, teachers not completing out the year, and possibly ending the year with sick leave time if they are able to go. Mr. Barnes responded with yes, and there was some discussion during the teachers funding workgroup last year about some of the nonretirement issues that can develop, such as teachers using their sick leave and the school having to pay for a substitute teacher.
Representative Graham asked if the savings is based upon the five years rather than the three years. Mr. Barnes stated that there are going to be some savings doing away with the high three, but not as great as what the actuary predicted.
Representative Thompson asked Mr. Thielen if any of the sick leave adjustments are protected by the inviolable contract. Mr. Thielen answered he thought so.
Representative Thompson asked Mr. Thielen in regards to sick leave, where is the standing for KRS. Brian Thomas responded that sick leave service for state employees has already been adjusted with SB 2 in 2013. If participating on or after January 1, 2014, that calculation is not used in the retirement benefits.
Inviolable Contract Exceptions – Judicial Form Retirement System (handout)
Donna Early, Executive Director, Judicial Form Retirement System, introduced Judge Laurance Vanmeter, Kentucky Court of Appeals to speak on the legal analysis/opinion. Judge Vanmeter stated the inviolable contract extends to Judges and Legislators who are elected membership before January 1, 2014. The exceptions are:
· Judges and legislators electing membership in JRP or LRP after January 1, 2014.
· Cost of living adjustments.
· An LRP member, or former member, convicted of a felony relating to legislative duties.
· A JRP member removed for cause.
· Health benefits for legislators are not subject to the inviolable contract except perhaps for members taking office between 1980 and 2005.
Pension Spiking Concerns
Steve Shannon, Executive Director, Kentucky Association of Regional Programs, stated pension spiking occurs within an employee’s last five fiscal years when one year’s compensation increases by 10 percent over the prior year. It will drive up a person’s retirement and that is a problem. There are two conditions that will negate pension spiking, one is a bona fide promotion, and second is career advancement. Another problem that should be addressed by a statutory exemption to pension spiking relates to the Family Medical Leave Act (FMLA). If a person needs to stay home with a health problem and take leave within the last five years without compensation and the next year a person goes to work and works all fifty-two weeks of that year, there results a discrepancy. For example, one year a person works forty-seven weeks due to FMLA; the next year the person works fifty-two weeks, then 5 of 47 exceeds the 10 percent criteria. Therefore the employer gets an assessment, which includes the increase as well as the actuarial value of that increase. However, it is not really an increase that leads to an increase in pension benefit. Also, it may decrease a person’s high five and therefore that person will draw less benefit. In one situation, a person lost $9,000 in compensation.
Representative Yonts stated there is also a situation where a person is off on workers compensation or a policeman goes to training.
Responding to a question from Senator Higdon, Mr. Shannon confirmed there was an appeal process and people have gone through the process and the retirement system is fully supportive of a legislative change, but can do nothing on appeal under the law as written.
Representative Graham stated he wanted to clear up a statement and that based upon statute, the PPOB’s role and responsibility shall be to review, to analyze, to provide oversight to the General Assembly on the benefits of the administration, the investment, the funding, the law, the administrative regs, and the regulation pertaining to the administered retirement system. Therefore the oversight role is to also to deal with the issue of administration and those that are carrying out the administration and selecting the executive directors of those boards.
Representative Yonts said he concurred 100 percent.
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, June 27, 2016 at 12:00 p.m.