Call to Order and Roll Call
The 5th meeting of the Public Pension Oversight Board was held on Monday, June 27, 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; 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, and Rogier Slingerland, CEM Benchmarking Inc.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, and Angela Rhodes.
Approval of Minutes
Mac Jefferson moved that the minutes of the May 23, 2016, meeting be approved. Representative Yonts seconded the motion, and the minutes were approved without objection.
Senator Bowen said the Public Pension Oversight Board (PPOB) is not a venue to articulate a political position.
KRS Pension Administration Benchmarking Report
Roger Slingerland stated CEM Benchmarking, Inc., performed a pension administration study for the Kentucky Retirement Systems (KRS) that looked at cost, efficiency, and service levels of the systems. The analysis included two kinds of comparisons, with the main comparison to a specific peer group and the secondary comparison to all funds that have participated in CEM’s benchmarking service. The comparisons are revealing because, even though each state and country had its own regulations and rules, pension funds around the country and throughout the world are about 90 percent the same.
Mr. Slingerland stated the most important part of the analysis was based on a custom peer group. For each of the funds evaluated, a peer group was picked that fits best. The actives and annuitants are examined to try to build a group that is as similar as possible. The reason is so the economies of scale can be eliminated as much as possible when trying to explain why costs are different from the peer group. For the Kentucky Retirement Systems, total pension administration cost was $77 per active member and annuitant, which was $35 below the peer average of $112 and $7 below the peer median of $84. Total pension administration cost was $19.5 million. This excludes the fully-attributed cost of administering healthcare, and optional and third-party administered benefits of $11.5 million. The reason why the fully-attributed costs is that only a small number of systems administer their own healthcare, which can vary greatly between systems. Reasons why the total cost was $35 below the peer average include:
· Economies of scale advantage;
· Lower transactions per member (workloads);
· Lower transactions per full-time equivalent or “FTE” (productivity);
· Lower costs per FTE for: salaries and benefits, building and utilities, HR and IT desktop;
· Lower third-party and other costs in front-office activities; and
· Paying more/less for back-office activities including:
o Governance and Financial Control;
o Major Projects;
o IT Strategy, Database, Applications (excl. major projects); and
o Actuarial, Legal, Audit, Other Support Services.
Senator Bowen wanted to know if there was any type of cost per member as it relates to the level or percent of funding. Mr. Slingerland answered there is not.
Mr. Slingerland continued with service levels. KRS’s total service score is 63, which is below the peer median of 80. The important thing to consider regarding the service score is only items that can actually be measured are incorporated into the score, such as how fast things are done, what is available, and what choices there are. He explained that CEM will make suggestions on how to raise the service score, but they will be in the context of the fund.
The key service measures where KRS is similar to peers are:
· Website;
· 1-on-1 Counseling and Member Presentations:
o Percent of active membership that attended a 1-on-1 counseling session;
o Percent of active membership that attended a presentation;
· Pension Inceptions; and
· Member Statements.
Key service measures where KRS differed with peers are:
· Member contacts, including total call wait time including time negotiating auto attendants. KRS call wait time is six minutes and nineteen seconds, and the peer average is two minutes and ten seconds;
· Menu Layers;
· Written Estimates – Turnaround time for KRS is 180 days; Turnaround time for peers is 20 days;
· Purchases; and
· 1-on-1 Counseling:
o Percent of membership counseled at 1-on-1 sessions in the field; and
o The wait time for a pre-scheduled in-house counseling sessions.
KRS’ complexity is one of the highest in the peer group and is driven by pension payment options, customization choices, and multiple plan types.
Senator Bowen asked if a correlation could be drawn between cost and service per member being low. Mr. Slingerland answered that the correlation is surprisingly weak and there is not a very strong relationship between cost and service. There are funds that are low cost and very high serviced and funds that are high cost and low service. There is some correlation at the specific service of level, for example, if KRS wanted a fully staffed call center, it would be expensive but the service would be good. When looking at the total cost, for example, the website is one kind of expense that would reap benefits over time without having the recurring cost.
Senator Bowen asked if more service might be required of KRS given the funds level of funding and the anxiety that members might have as a result. Mr. Slingerland responded that when a fund is in the news negatively two things happen, satisfaction surveying scores go down without reason and call volumes tend to go up. Also, as more information is made available, the calls received increase because the calls are different, people are more educated, so the member is smarter about the pension, which leads to longer phone calls and more complicated questions for staff.
Responding to a question from Mac Jefferson, Mr. Slingerland said actives and annuitants are the ones that drive costs and are the main driver of cost. Inactives generally do not drive costs.
Bill Thielen stated KRS appreciates the work CEM has done and is already looking at the results and has started to react to improve customer service. For instance, several months ago KRS implemented a call back assist feature so a member can get a call back if that member does not want to wait on the line. The acceptance rate of call back assist is only about 26 percent to 30 percent at this time. KRS is reaching out to several of their peer public pension plans that have been identified by CEM to see what their staffing is with their call centers and what their best practices are to see if KRS can improve productivity. Also, KRS is looking at live web chat to allow members to go online and chat with counselors. At this time, KRS is hiring new retirement counselors, but given the complexity of the system, there is a training process of 6 to 9 months.
Responding to questions from Representative Yonts regarding the CEM report on call waiting average, which was 2 minutes 10 seconds for the peer average but 6 minutes 19 seconds for KRS, Mr. Slingerland said that too many calls could be the reason KRS gets undesired outcomes and that CEM does look at the number FTE (total productivity) and the size of the call center staff and functionality. Also, there is no national standard of the number of people in relation to size of call system and call volume.
Responding to a question from Representative Jerry Miller regarding why written estimates take 180 days when the benchmarks are 20 days for most written estimates and 32 for purchases, Mr. Thielen stated that over the past several years a significant backlog has developed because of resource demands on staff due to the implementation of HB 1, SB 2, HB 62, pension spiking, and technology advances. The Chief Benefits Officer and staff have instituted a backlog reduction plan over the last several months.
Senator Bowen stated that the most important function KRS could provide is a reasonable response time for benefits. Mr. Thielen said that KRS recognizes that is an important function and they are working to reduce the backlog. Some members call two to three years before intending to retire and ask for benefit estimates for several dates. KRS provides an online self-service so members can create a very accurate benefit assessment with a little information. In addition, there’s a quality control audit for accuracy, which takes extra time.
Responding to questions from Senator Bowen, Mr. Thielen stated that he could not give a timetable on the backlog not knowing what may need to be implemented by the General Assembly that will take also staff resources. Also, compared to other states, Kentucky has a more complex system by having to administer both pension and health benefits.
Representative Arnold Simpson asked if the executive summary excludes the fully attributed cost of administering healthcare and third-party administered benefits of $11.5 million. Mr. Slingerland responded that it was decided that the focus was on the pension plans administration because some systems will administer not only healthcare but also certain plans that are not part of the pension service.
Responding to questions from Representative Simpson, Mr. Slingerland said that KRS took on the difficult task of segregating calls for the study, whether it was pension or health insurance.
Responding to a question from Representative Simpson, Mr. Thielen stated KRS had not undertaken a review of the healthcare administration.
Senate Bill 2 – Analysis & Discussion of National Trends
Jennifer Black Hans and Bo Cracraft, Legislative Research Commission, spoke on a staff study regarding SB 2 and the legislative purposes that arose out of SB 2 during the 2016 legislative session. Staff reviewed the proposals and analyzed certain key aspects and some national trends related to the proposals.
Mr. John Chilton, State Budget Director, asked if the board of either of the retirement systems takes a position on any of these legislative incentives. Ms. Hans said KRS wrote legislators to oppose SB 2 as it was originally written.
Mr. Thielen disagreed, saying that he had sent two letters to Co-Chair Bowen and Co-Chair Yonts regarding the proposals in SB 2, but that he never took the position on behalf of the board or himself opposing. He pointed out there were issues raised by the various proposals, and they need further study.
Ms. Hans discussed Executive Order 2016-340, issued on June 17, 2016. The Governor’s Executive Order addressed the board’s composition by (1) abolishing and replacing the KRS Board of Trustees with KRS Board of Directors and transferring the powers of the KRS Board of Trustees accordingly; (2) expanding the KRS Board from 13 to 17 members; (3) reappointing 13 existing trustee positions as provided by KRS 61.645; (4) adding 4 new appointed trustee positions for a total of 10 appointees (renaming those to director positions); (5) requiring 6 appointed directors to have investment experience as defined by KRS 61.645 without changing that definition of investment experience in any way; (6) and providing that the Governor shall name the Chairperson and Vice Chairperson, and named those individuals. The Executive Order provides provisions similar to SB 2 as passed by the Senate: (1) effective 90 days from the Order, placing the KRS staff, except for the Executive Director, under State Personnel System; (2) imposing CFA (Charter Financial Analyst) Institute Standards on KRS; and (3) effective July 1, 2016, requiring posting to the KRS website of all investment holdings, fees and commissions, including underlying managers in fund of funds, profit sharing, carried interest and partnership incentives, and all contracts or offering documents for services, goods or property purchased by KRS without any specific exemptions.
Mr. Mitchel Denham, Kentucky Office of the Attorney General, said that the legality and constitutionality of the Executive Order are being challenged in Franklin Circuit Court.
Ms. Hans discussed the Model Procurement Code (MPC). KRS was exempted from the State Purchasing Laws in 1972. The State Purchasing Law preceded the MPC. In 1978, KRS was exempted from the MPC as part of the passage of that law. KRS had specific exemptions under KRS 61.645(2)(d) & (f) which granted contracting authority directly to the board. The justification, according to the board’s minutes, was that the Board of Trustees needed independence and had direct fiduciary responsibility to its members. In 1994, the General Assembly amended KRS 61.645(2)(d) to remove the exemption, putting KRS under the Finance Cabinet’s regulations and requiring it to report its contracts to the Government Contract Review Committee. The exemption was again restored in 1998.
The Kentucky Teachers’ Retirement System (KTRS) has a written procurement policy which has been adopted by its board and has some parallels to the MPC. At one time, KTRS was under the State Purchasing Laws, and in 1972 it was exempted from the State Purchasing Laws. In 1978, KTRS was specifically exempted from the MPC where it was granted contracting authority to the board and given specific exemption. KTRS now has a written procurement policy that has been adopted by the board.
The Judicial Form Retirement System (JFRS) was subject to the MPC prior to 1994. 1994 HB 183 amended KRS 21.540(1) to exempt JFRS from the MPC. The justification according to the board’s minutes was that continuity of service of its contracts and vendors was very important, and changing vendors could be detrimental to the funds. To avoid the burden of MPC, JFRS needed the exemption. The statutory language in KRS 21.540(1) grants contracting authority to the board without the limits of MPC. JFRS has no written procurement policy.
LRC staff surveyed all states and the District of Columbia to review statutes and policies. Twenty-nine states have no exemption for their state retirement systems, which were thereby subject to the state’s procurement code; 20 states had an explicit exemption from the MPC for their state retirement systems; and 2 states were indeterminable (California and Louisiana). Illinois is exempt from its procurement code, but required by statute that the retirement system adopt a written procurement policy. It has codified into the language what that procurement policy needs to include and the exceptions to that procurement policy such as, when an exemption from an RFP process can occur, when it can have sole source contracts and how it needs to be justified and transparent to the public.
Senator Bowen asked if that was a recent enactment. Ms. Hans stated it is fairly recent, but did not have a date.
In response to questions from Representative Yonts, Ms. Hans said that KTRS and KRS both had procurement policies similar to the MPC.
Representative Yonts asked if there are substantial differences in terms of getting contracts and how bids are advertised. Ms. Hans said it is substantially the same, and there are dollar differences in terms for RFP. The dollar exemption for KRS is $40,000, at which point it must bid for an RFP. For KTRS, soliciting bids at a $30,000 level is required.
Representative Yonts asked about processes if an entity moves from being exempt to being subject to the MPC. Ms. Hans said the entity would be subject to Finance’s regulations and process.
Senator Bowen asked if there were contracts that are under the $40,000 and $30,000. Ms. Hans does not have that information but presumes there are contracts under that limit.
Mr. Cracraft spoke about investment expense reporting and how the discussions have centered around transparency and additional disclosure. He referenced the trend over the past several years to ban Placement Agents and how much of the industry is now in agreement. With regards to disclosing fees, there appears to be a similar trend occurring.
The major components of investment expense are Management Fees, Incentive or Performance, and Other Fees (such as underlying Fund of Fund fees). Management Fees are the most readily available, calculated as a flat or percentage of market value, paid regardless of performance or markets, and very typical for traditional assets. They are very easy to calculate and most plans are reporting this type. Incentive or Performance is largely related to private equity, hedge funds, or other partnership level agreements. These represent agreements between the limited partner and general partner to share a portion of the excess return or profit of the fund. Most plans do not report these expenses. Other or Fund of Funds is where a plan hires a parent fund and gives it capital, and the parent invests in several underlying funds. A fee is generally only reported at the top level. KRS and KTRS are using Fund of Funds.
In regards to the 2016 proposals, Mr. Cracraft stated that SB 2 and the later compromise would require disclosure of all Management Fees, Incentive or Performance, and underlying Fund of Funds Fees. The proposed House substitute would have required Management Fees and Incentive or Performance, but only to the extent they were available and required the plans to make a good faith effort to gain information.
KRS is recording almost all private Management Fees and Incentive or Performance Fees and are getting 90 percent to 98 percent of their private equity and alternative fees. KRS is not getting the underlying Fund of Fund fees. Either proposal would require additional disclosure, such as manager level data and underlying Fund of Funds information would be required under some proposals.
KTRS is reporting all Management Fees. The carried interest is treated as profit sharing and is not disclosed. KTRS utilizes Fund of Funds within private equity, but does not disclose the underlying fees within those Fund of Funds. That would be an additional disclosure required.
JFRS is unique in that it is a smaller fund, has a single asset manager, and does not have any performance related or alternative structure deals.
Mr. Cracraft commented that all three plans are recording net of fee bases that began in 2016 for KTRS and JFRS. KRS made the change a few years ago.
No two states are the same, but almost all plans are reporting Management Fees. A handful are recording private equity and alternative asset fees as expenses and another handful are saying the fees are there, but are netted. There are a lot of state funds that are just netting against income and there is no specific foot note.
Senator Bowen commented about how important it is to have investment professionals on these boards, because without, it would be hard to properly process the information.
Representative Yonts asked in regards to the Fund of Funds, if it is impossible to require the information to be disclosed and how much is KRS using Fund of Funds. Mr. Cracraft responded that he believes the information is not being asked for. KRS is using it on the absolute return side which is approximately 5 percent of the portfolio and is working on cutting out the Fund of Funds parent. KTRS has a small private equity Fund of Funds. It is a smaller percent but has a lot of underlying managers.
Mr. Cracraft spoke about contract disclosure. The Senate proposal required contracts to be publicly disclosed on a website, where the House version removed contracts and only identified the offering documents. Within both proposals, and more specifically as it relates to the Senate side since contracts would be publicly disclosed, there was language to exempt those contracts that if made public would negatively affect the plan the ability to invest or have access to a specific asset class. With SB 2/PHS, there is no requirement to publicly disclose contracts, and all contracts regardless of exemption, would be subject to review by the board, State Auditor, Governor, or member of the General Assembly provided the individual signs a confidentiality agreement. Investment manager agreements are not generally public. Fee information is negotiated and may include guidelines and portfolio characteristics. None of the Kentucky state plans provide fee information publicly.
Ms. Hans discussed board composition for KRS, KTRS, and JFRS. KRS has been affected by the Executive Order, and SB 2 would have had Governor appointees subject to Senate confirmation and redefined investment experience by eliminating “university professor teaching economics” or “any other professional with exceptional experiences in field of public or private finance.” For KTRS, SB 2 would have had additional Governor appointees. Two would be required to meet a revised “investment experience” definition. No changes were proposed for JFRS.
Senator Bowen commented on the differences between the procurement codes of the system and the MPC. Protests are handled internally as opposed to the Finance Cabinet resolving any protest under the MPC.
With no further business to come before the board, the meeting was adjourned. The next regularly scheduled meeting is Monday, August 22, 2016.