Call to Order and Roll Call
The 8th meeting of the Public Pension Oversight Board was held on Monday, October 24, 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; Senator Gerald A. Neal; Representatives Brian Linder; Mitchel Denham, Timothy Fyffe, Mike Harmon, James M. "Mac" Jefferson, and Sharon Mattingly.
Guests: J.D. Chaney, Deputy Executive Director, Kentucky League of Cities; Bruce Todd, President-Elect and Henderson County Magistrate, and Shelly Hampton, Director of Governmental Relations, Kentucky Association of Counties; Dave Adkisson, President and CEO, Kentucky Chamber of Commerce; Larry P. Totten, President, Kentucky Public Retirees; Jim Carroll, President and Russell Wright, Vice-President, Kentucky Government Retirees; Cathy Gullett, President, Kentucky Retired Teachers’ Association; Steve Shannon, Executive Director, Kentucky Association of Regional Programs; Jim Waters, President, Bluegrass Institute; Donna Early, Executive Director, Judicial Form Retirement System; David Eager, Interim Executive Director, Karen Roggenkamp, C.O.O., and Jennifer Jones, Assistant General Counsel, Kentucky Retirement Systems; Beau Barnes, Deputy Executive Director, Kentucky Teachers’ Retirement System.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, and Angela Rhodes.
Approval of Minutes
Senator Bowen moved that the minutes of the September 26, 2016, meeting be approved. Mac Jefferson seconded the motion, and the minutes were approved without objection.
Representative Yonts brought attention to items within the file, including: Director Chilton’s October 20, 2016 Memorandum regarding the status of the pension performance audit that is anticipated to be completed by December 31; an overview of 2016 legislation impacting the state-administered retirement systems; and the quarterly investment performance of the state-administered retirement systems.
Kentucky League of Cities 2017 Legislative Recommendations
J.D. Chaney, Deputy Executive Director, stated that the League of Cities has a long history as it relates to pension issues and pension reform and is aware of the impact of the public pension crisis here in Kentucky. However, cities and counties are in a different situation with the County Employees Retirement System (CERS) as compared to Kentucky’s other public retirement systems. Mr. Chaney stated that CERS is about 60 percent funded and pays over 60 percent of administrative costs. As a top priority, the League of Cities’ Board of Directors has voted to develop legislation that proposes separation of CERS from under the jurisdiction of Kentucky Retirement Systems (KRS). The proposal will also provide that all statutory regulated retirement systems, including legacy pension plans and cities, come under the oversight of the Public Pension Oversight Board. The League of Cities wants to address this issue to ensure that the employees and employers in CERS have an opportunity to govern their own system, to address investment experience differently instead of being co-mingled and combined with the other state retirement systems, and to provide adequate staff attention.
Mr. Chaney stated the other issue is spiking as cities get more and more bills and invoices from KRS related to pension spiking. Kentucky was well intentioned with the anti-spiking provisions that were included in SB 2 from 2013, but had not anticipated all the unintended consequences that resulted. Therefore, addressing these concerns will be a priority in 2017.
Kentucky Association of Counties 2017 Legislative Recommendations
Bruce Todd, President-Elect, and Henderson County Magistrate and Shelly Hampton, Director of Governmental Relations. Mr. Todd stated there are four issues to review. First is the continued funding of the ARC for all state-administered retirement systems, which is crucial to the health and welfare of not only the members, but also the unit of governments and their constituents who support them. The Kentucky Association of Counties (KACO) continues to honor this commitment by supporting the inviolable contract. Second is the CERS separation from KRS. CERS funding levels continue to increase and CERS employers are paying 100 percent of the ARC. Benefit changes to future hires should be based on the needs of each system and that a separate board should oversee the benefits, investments and administrative decisions of CERS. Third, county governments continue to push for a resolution to the difficult pension spiking burdens which have created undue hardships to county governments. KACO supported these pension spiking measures when enacted but clarifications are needed to address spiking charges that have resulted from situations where an employee is away from work for legitimate purposes such as FMLA leave and workers compensation. Lastly, the participation in the KRS Medicare supplement insurance benefits by reemployed Medicare eligible retirees should be addressed. This summer KRS sent a notice of termination of health insurance coverage to KRS members who have returned to work for employers who offer group insurance coverage to their employees. It is KACO’s understanding that KRS believes this is mandated by Medicare secondary payer laws. KACO’s research indicates that the Center for Medicare and Medicaid Systems (CMS) does not take a position that these reemployed workers must participate in a group healthcare plan offered by their employers. KRS has inquired of CMS and awaits its reply.
Kentucky Chamber of Commerce 2017 Legislative Recommendations
Dave Adkisson, Kentucky Chamber President and CEO, stated that the chamber has asked for the past several years for a full comprehensive performance audit of KRS and is pleased that it is currently taking place. KRS has announced that it is getting out of hedge funds and the resulting higher fees. The chamber is concerned that the systems are not meeting the assumed rates of return on investments, even after the assumed rate of return was lowered for some plans in KRS. The payroll estimates are still potentially overstated, which means future ARCs will be even higher.
The chamber continues to support the key features of SB 2 on transparency including: placing the state-administered retirement system under the Model Procurement Code like the rest of state government, adding members to the KRS Board with investment experience, publicly posting investment fees. The chamber believes these measures should be acted on in the 2017 session.
With regard to the funding in the 2016 session, Mr. Adkisson stated that the chamber is pleased with the commitment by the Governor and the legislature to budget additional and substantial funding for pensions. However, the chamber is somewhat concerned that the extra funds were not accompanied with reforms to the system. The chamber is eager to hear from the consultants doing the current review about how to move forward to make the retirement system structurally sustainable which may include options such as more required years of service, a higher required retirement age, doing away with the spiking costs by including sick days in the final retirement calculation.
One other major issue that overshadows the transparency and funding issues that were discussed in the 2016 session is whether to “save” the Kentucky Teachers’ Retirement System (KTRS), or in other words, whether to tweak the system with a few structural changes and balance that with the required funding to make it sustainable so the state can make good on its promises to current and future members or should KTRS be converted to a defined contribution plan similar to the 2013 plan for state and local workers under KRS.
Kentucky Public Retirees 2017 Legislative Recommendations
Larry P. Totten, President, stated that Kentucky Public Retirees (KPR) is a non-profit 501(c)(5) membership organization with a mission to protect and preserve the benefits of public retirees covered by KRS. Mr. Totten stated the two issues that are to be resolved relating to KRS are the Governor’s Executive Order relating to the reorganization of KRS that is being challenged in court and awaits a decision by the judge whether its provisions become proposed legislation next year, and the audit of KRS and recommendations for the pension systems.
Mr. Totten discussed a concern with the increased size of the KRS Board. KPR believes balance should be restored between the number of elected and appointed board members so that the appointed members need buy-in from at least some of the elected members before important decisions are made. KPR recommends that KRS 61.650(1) be amended to increase the size of the KRS Investment Committee to seven and mandate that these two additional seats be reserved for elected members of the board.
KPR believes that conversation must be started regarding the public pension funding issue that will be decided again in 2018. Mr. Totten stated that to the outside observer it will appear that much of the increased funding for public pensions came from a transfer of hundreds of millions of dollars from the Public Employee Health Insurance Trust Fund and, possibly, cuts in the operational budgets throughout state government agencies. He said that, in the next budget, money has to be replicated just to maintain a status quo in pension funding.
Mr. Totten stated that it is time to review the state tax expenditures, not only for revenue that might be applied for pension plan recovery, but also for public and higher education, roads, public health, workforce development, and other areas that rely on state government resources. A broader tax base supports the needs of all Kentuckians, and a reformed tax system might mitigate the effects of an inevitable downturn in the economy.
Kentucky Government Retirees 2017 Legislative Recommendations
Jim Carroll, President, stated Kentucky Government Retirees (KGR) is an advocacy group representing more than 8,300 Kentucky Retirement Systems’ stakeholders. Mr. Carroll said KGR will continue to advocate additional funding to ensure the long-term stability of the pension funds. KGR fully supports actions that enhance transparency and believes KRS should follow the state model procurement code, follow the best practices in its investment fee disclosures, adoption of the CFA codes of conduct for KRS staff and advisors.
Mr. Carroll said that KGR will be examining bills that address the representation on the KRS board and will support a bill that restores some reasonable measure of representation by elected trustees. KGR is concerned about effort to abandon the cash-balance plan that was adopted as part of 2013 SB 2. The cash-balance plan has done what it was intended to do, namely reduce employer risk and lower long-term costs.
Mr. Carroll stated that any consideration of a 401(k) plan should be accompanied by an actuarial analysis that gauges the fiscal impact on the legacy plans, and that it appears that depriving the legacy plans of new contributors will be a disastrous misstep for a system that is already vulnerable.
Mr. Carroll said he wished to restate what he said in addressing the Public Pension Oversight Board (PPOB) last year, namely that the only reasonable way to provide ARC + in future budgets is through the adoption of comprehensive tax reform and that a tax structure is needed that grows the economy and meets critical needs and that anything less will fail the pension system and fail the economy as a whole.
Kentucky Retired Teachers’ Association 2017 Legislative Recommendations
Cathy Gullett, President, stated that the Kentucky Retired Teachers’ Association (KRTA) has a membership of 30,000. Teachers’ Retirement System (TRS) benefits are critical to the financial security of retired teachers and are particularly important to the older retirees, who are single and rely on TRS for self-reliance. More than 90 percent of teachers retired over age 80 are single and about 70 percent of those retirees over 80 are single women with TRS as their sole source of income. Contrary to misconceptions that have been expressed about TRS pensions, TRS is not a benefit rich plan.
Ms. Gullett states that recent proposals to bring more transparency to TRS have been coupled by ill-advised provisions to grant Governor appointees a controlling majority on the TRS Board of Directors. KRTA supports transparency. The details of TRS operations and benefits should be easily accessible, and the PPOB should continue to review testimony on TRS investment performance and other issues. However, TRS must continue to be independently governed by its members and not subject to the political influence of the Governor and the legislature.
The recommendations moving forward are to continue funding the annual required contribution of the ARC until TRS is fully funded, keep TRS a defined benefit system group retirement plan, make no changes to TRS governance structure, and require valuations of TRS performances to be based on the long term and not the recent recession period.
In response to a question from Senator Bowen, Ms. Gullett stated once structural changes are proposed, KRTA will determine whether to support the changes.
Kentucky Association of Regional Programs 2017 Legislative Recommendations
Steve Shannon, Executive Director, stated that the Kentucky Association of Regional Programs (KARP) is concerned about pension-spiking provisions as related to unpaid leave time such as military time and leave authorized under the Family Medical Leave Act (FMLA). If a person takes five weeks of uncompensated leave in a one year time period, a spiking provision results in the next year.
Mr. Shannon stated that KARP recommends a provision that excludes FMLA and military leave from the spiking provision or looks at the three year window, the year prior to uncompensated time and the year after. Spiking is a real issue and KARP believes there should be a statutory solution.
Bluegrass Institute 2017 Legislative Recommendations
Jim Waters, President, stated that the Bluegrass Institute is a state-based, free-market public policy think tank founded 13 years ago and is making government at every level a vital mission to become more transparent.
Mr. Waters stated that the board has supported disclosure of retirement systems’ investment fees and practices and asked for strong support for transparency into the largely untouched arena of benefit structures and benefits paid to individual retirees. Taxpayers have access to the salaries and benefits of all workers enrolled in the retirement systems if working. However, on the day of retirement, KRS 61.661 pulls the blinds on publicly funded retirement benefits, even though the same taxpayers who fund the working positions also fund the retirement benefits.
The Bluegrass Institute is doing its part by offering legislators the opportunity to lead by example by signing the Legislative Pension Transparency Pledge.
Judicial Form Retirement System 2017 Legislative Recommendations/Investment Update
Donna Early, Executive Director, stated that the Judicial Form Retirement System (JFRS) is the state agency that is charged with the administration of the Judicial Retirement Plan and the Legislators’ Retirement Plan. The system’s housekeeping bill was passed during the 2016 session and the Board of Trustees supported HB 443, which dealt with retirement funding. At the recommendation of the actuary, JFRS would like to advance this piece of legislation so that it will move from a rolling amortization of unfunded liabilities to a fixed period amortization. Ms. Early anticipates that the board will again support this type of legislation and will welcome debate and dialogue.
Ms. Early stated that the quarterly investment returns ending September 30, 2016, were 2.1 percent for the defined benefit plans and 2.8 percent for the hybrid cash balance plans in each fund. Returns were led by stock portfolios with fixed income providing very low returns.
In response to a question from Representative Yonts, Ms. Early stated in regards to the 25 year level dollar approach to financing unfunded liabilities, an anticipated first year contribution will probably stay the same. With a couple of variables in the proposed legislation, the board believes the contributions will increase depending on market gains or changes to the benefit structures.
Kentucky Retirement Systems 2017 Legislative Recommendations/Investment
David Eager, Interim Executive Director; Jennifer Jones, Assistant General Counsel, and Karen Roggenkamp, Chief Operations Officer discussed the Kentucky Retirement Systems (KRS) legislative recommendations and investment update. Mr. Eager stated that for the quarter ending September 30, 2016, the returns were 3.5 percent to 4.0 percent in each of the five funds and that four of the five KRS funds beat their benchmark. The absolute return asset class was around 4.0 percent.
Ms. Roggenkamp stated that positive steps in funding were enacted in the budget including payment of the Actuarial Required Contributions (ARC), plus 185.8 million of additional pension funding for Kentucky Employees Retirement System (KERS) and State Police Retirement System (SPRS) over the two year period. For KERS hazardous and SPRS, additional funding will create noticeable improvement in the cash flow situation for the next two years.
Ms. Roggenkamp discussed that, with the new leadership and improved investment committee expertise, there are a number of works in progress such as reviewing all actuarial assumptions/methodologies by plan, developing specific short-term and long-term investment strategies by plan, implementing investment structures that reduce the number of investment managers and fees while improving transparency, maintaining effective and transparent communications with all constituents, and partnering/implementing recommendations as needed from the PFM audit.
In looking at the different systems, the KERS non-hazardous system requires a different funding solutions since cash flow is a key concern and the desire is to at least get a positive or break-even net cash flow. A conservative investment strategy to pay (immunize) benefits and preserve assets while paying benefits is a goal. Other goals include working closely with the actuaries and looking at fiscal years 2015 and 2016 in terms of negative payroll growth, refining actuarial benefit assumptions by tier, looking at the assumptions in regard to active and inactive members on future benefits, and developing objectives and determining required combinations of contributions/investment returns to meet objectives. To address KERS hazardous, SPRS, and CERS should have unique funding requirements based on each plan’s actuarial assumptions and investment strategies specific to the plan’s needs.
Ms. Roggenkamp discussed retiree health funds, which will maintain positive cash flows across all plans, improve funding levels through ARC management, and maintain cost control while meeting membership benefit needs.
Ms. Jones discussed the proposed KRS housekeeping bill, which includes provisions to ensure compliance with federal law, fix some unintended consequences of HB 1 and SB 2, make the systems more efficient, and allow better operation for members. There is a need to amend the definition of “final compensation” and synchronize the CERS board elections. KRS needs to conform to the Uniformed Services Employment and Reemployment Rights Act (USERRA) and make purchasing of service credit conform to the Internal Revenue Code and private letter rulings. For KRS to operate more efficiently, it needs to eliminate membership form requirements, amend the definition of “creditable compensation” of lump sum payments, and amend the definition of “regular full-time.” Additionally, the housekeeping bill proposes to clarify retirement procedures, allow KRS the option to offer members electronic board voting, clarify reciprocal service and require multiple plan members to retire within one month of each other. Finally, the bill would allow KRS the option to promulgate a regulation and employ electronic voting for board position elections and delete unnecessary language regarding a federal consent decree that no longer exists.
Ms. Jones discussed investments, saying that KRS needs to make KRS 16.642 and 78.790 consistent with KRS 61.650 as it relates to the type of allowable investments.
Mr. Eager discussed HB 62, saying there are 1,492 employers in KERS and CERS, and 142 of them are eligible for withdrawal. Three have applied and 1 has withdrawn. The process withdrawal is:
· The employer submits a request;
· The board decides whether to accept;
· The employer establishes a new retirement plan for its employees;
· A 60-day transfer for employees begins;
· The board approves the cost (liability) as determined by the KRS actuary;
· The employer decides whether to pursue;
· The employer selects a payment option; and
· The board makes its final decision.
The cessation of participation by employer under KRS 61.522 provides the employer shall pay the full actuarial cost based on an actuarial study, which the employer can pay in a lump sum or up to a 20-year installment. If an installment is used, the employer must pledge assets; if the employer becomes delinquent in payments, KRS can file an action in Franklin Circuit Court.
Representative Yonts stated that, in regards to the Council of State Governments withdrawal of application and the verification of the calculations by KERS, KRS should address how to accommodate an employer’s request for member information without violating privacy.
Mr. Eager discussed KRS’s recommendations for HB 62 to use a standard valuation methodology and procedures, tie to a fair market rate, use only a lump sum approach, and require a lawsuit waiver.
In a response to a question from Senator Bowen, Mr. Eager stated he will obtain input from colleagues and look at the possibility of the Legislators’ Retirement Plan moving under KRS.
In response to a question from Auditor Harmon, Ms. Jones stated that, with a lawsuit waiver, it is how it will be phrased, and currently, in the regulation if a lawsuit is started everything ends and the process starts over.
Representative Yonts stated that KRS 61.522(9) requires an employer who voluntarily ceases participation or is required to involuntarily cease participation to hold the Commonwealth harmless from damages, attorney’s fees, and costs from legal claims brought by a member or retired member of the departing employers. This may cover the issue.
Representative Kay stated that his understanding was that the Governor’s Executive Order included provisions from SB 2 and that KRS is not abiding by those provisions. He stated that he would like oversight board to note that KRS is not complying with the investment transparency that the Executive Order required.
In response to a question from Mac Jefferson, Mr. Eager stated that there needs to be expertise on the board even if KRS outsources the investment function. This is a concept called an “Outsourced CIO” in which a retirement system delegates investment responsibilities on a nondiscretionary or discretionary basis.
Kentucky Teachers’ Retirement System 2017 Legislative Recommendations/Investment Update
Beau Barnes, Deputy Executive Director, discussed quarterly investment returns and potential 2017 legislation. The returns for the period ending September 30, 2016, were 4.34 percent for the quarter, 9.22 percent over one year, 10.47 percent over 5 years, and 6.08 percent over 10 years. For comparative purposes, returns for the fiscal year ending June 30, 2016, were -1 percent gross of fees and -1.29 percent net of fees for the one year period. Over the last 30 years, the compounded annual return has been 8.15 percent gross of fees.
Mr. Barnes discussed potential housekeeping legislation for 2017 that will be proposed by TRS. Most of the housekeeping provisions are technical and do not change TRS practice or procedure, but a few substantive changes focus on reemployment after retirement with a TRS participating employer and also disability retirement.
Relative to reemployment after retirement, the proposed changes are to require retirees under age 60 who return to work for a TRS employer to observe a mandatory separation from service even if the person is returning to a position that is not eligible to participate in TRS. The other reemployment after retirement provisions are to provide that: the starting date for any separation from service begins from the member’s effective retirement date instead of the last day of employment; separation from service shall not be met if there is a prearranged agreement between the employer and the retiring member to return to work after retirement; critical shortage provisions, which do not limit income to reemployed retirees, are also available to KDE for persistently low-achieving schools; and college and university retirees under age 60 will also follow the return to work provisions effective July 1, 2018.
The disability retirement provisions of the proposed housekeeping bill relate to minimum benefit provisions provided under law. For members working part time/substitutes who file disability retirement applications on or after July 1, 2017, recurring payments from any other state-administered retirement system shall be considered in determining whether the minimum disability allowance of $500 has been met. In addition, these part time/substitutes who file disability retirement applications on or after July 1, 2017, shall not be eligible for disability retirement if they are eligible for an unreduced service retirement. TRS is also proposing that these provisions apply to new full-time employees who enter the system on or after July 1, 2017.
Mr. Barnes said that, in the past, bills would have provided permanent funding plans for TRS including stepping into the full ARC over a period of years. It may be proposed in this session that TRS have statutory language to provide a permanent funding plan.
In response to a question from Senator Bowen, Mr. Barnes stated the board has not taken an official position on any type of structural changes, but the TRS funding workgroup had discussed a new tier for new TRS members and items outside the inviolable contract for existing members. An employee has the opportunity for reemployment and earn a second retirement benefit but with limitations on income and reduced benefits while paying the full cost that a member with a first time account would pay.
In response to a question from Representative Graham, Mr. Barnes states that most of the retire and return to work provisions are to ensure that TRS remains in compliance with the Federal Tax Code and specifically qualified under 401(a) of the Internal Revenue Code as a retirement plan for members. It is important to pass legislation to keep TRS in compliance to be a qualified plan under section 401(a) of the Internal Revenue Code because it allows members to make their contributions to the TRS on a tax deferred basis. If KTRS were not in compliance, it could jeopardize the qualification where the IRS would say KTRS is no longer a 401(a) qualified plan and that employees and employers are going to have to start making contributions on a post-tax basis. Individuals not complying with the Internal Revenue Code retirement provisions could see significant penalties for retiring under a plan that was supposed to be a qualified plan.
With no further business to come before the board, the meeting was adjourned. The next regularly scheduled meeting is Monday, November 28, 2016.