Call to Order and Roll Call
The 10th meeting of the Public Pension Oversight Board was held on Monday, December 19, 2016, at 1:00 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; Representative Brian Linder, J. Michael Brown, John Chilton, Mike Harmon, James M. "Mac" Jefferson, and Sharon Mattingly.
Guests: Brad Gross and Bo Cracraft, LRC.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, and Angela Rhodes.
Representative Yonts announced that J. Michael Brown of the Attorney General’s Office is taking the place of Mitchel Denham.
Approval of Minutes
Senator Bowen moved that the minutes of the November 28, 2016, meeting be approved. Mac Jefferson seconded the motion, and the minutes were approved without objection.
Budget Director John Chilton gave an update on the Pension Performance & Best Practices project. He said that the audit is well underway and his office has been in regular contact with PFM Consulting Group, which is conducting the audit. The first report will address transparency and some governance issues that relate to the state-administered retirement systems. Some of the actuarial computations were not available until December, which contributed to a delay of the report.
2016 Recommendations
The following list of recommendations was discussed and adopted by the Public Pension Oversight Board (PPOB):
· PPOB staff should research and present information to the board regarding the cash flows of each state-administered retirement system including a historical view of system cash flows, how the additional funding in the current budget is impacting current cash flows, a future projection of cash flows, and what factors impact system cash flows the most.
· PPOB staff should provide the board with a brief summary document highlighting the differences in actuarial methods and assumptions between the various state-administered retirement systems.
· The Kentucky Retirement Systems’ (KRS) board of trustees shall by January 23, 2017, provide a plan for addressing the cash flow/funding issues facing the systems it administers, and in particular the cash flow issues facing the KERS nonhazardous pension fund. The plan shall be detailed with specific research performed for each plan option which shall include specific savings/costs for each option. KRS shall report this information to the PPOB, the House State Government Committee, and the Senate State & Local Government Committee.
· The Teachers’ Retirement System (TRS) board of trustees shall by January 23, 2017, provide a plan for addressing the cash flow/funding issues facing the system it administers, and in particular the funding issues facing the TRS pension fund. The plan shall be detailed with specific research performed for each plan option which shall include specific savings/costs for each option. TRS shall report this information to the PPOB, the House State Government Committee, and the Senate State & Local Government Committee.
· KRS, TRS, and JFRS shall study and report to the PPOB by January 23, 2017 on the fees paid directly or indirectly by each system (i.e. through incentive or partnership agreements) and shall provide a consensus recommended standard for investment fee reporting to be utilized by all systems.
· The KRS, TRS, and JFRS boards should evaluate and determine if certain actuarial assumptions (payroll growth, investment return) and funding policies/methods should be modified based upon experience (including trends in state employee salaries, changes in the total number of full-time employees due to outsourcing, employers avoiding payment of contributions on behalf of those employees) and financial condition of the systems and should incorporate any changes into the funding requests submitted to the 2018 General Assembly.
· The KRS board of trustees shall by January 23, 2017, study issues related to agency participation, including but not limited to KRS participating agencies that are utilizing contract employees or are not offering employees the opportunity to participate in the systems, and shall provide a listing of all agencies that are attempting various means to avoid paying contributions on employees along with the estimated number of employees not being reported as well as the anticipated financial impact to the systems. Based upon this information, the General Assembly should enact legislation to address the loss of employer contributions from KRS participating agencies that are utilizing contract employees or are not offering employees the opportunity to participate in the systems.
· Currently, the state-administered retirement systems are exempt from Kentucky Revised Statutes Chapters 45 (Budget and Financial Administration) and 45A (Kentucky Model Procurement Code) relative to contracting. Legislation to make the systems subject to Kentucky Revised Statutes Chapters 45 and 45A should be enacted, similar to provisions included in BR 242 that has been prefiled for the 2017 Regular Session.
· Legislation should be enacted, similar to provisions included in BR 242 that has been prefiled for the 2017 Regular Session, to require Senate confirmation of the KRS and TRS executive director/executive secretary and all Gubernatorial-appointed board members.
· Currently, the TRS board comprises seven trustees elected by the membership, with the two remaining members being the chief state school officer and the state treasurer. The General Assembly should enact legislation to add additional gubernatorial-appointed members to the TRS board, and the additional members should have investment experience.
· Measures to ban the use of KRS, TRS, and JFRS assets to pay placement agent fees, similar to the measures included in BR 242 that has been prefiled for the 2017 Regular Session, should be enacted.
· Legislation to more clearly define the qualifications of KRS appointed trustee positions that must have “investment experience” should be enacted, to:
o Refine the definition of “investment experience” in Kentucky Revised Statute 61.645 to ensure that truly qualified individuals are selected; and
o Provide that the Governor should request assistance from the CFA Society of Louisville to vet any potential applicants for future appointments/reappointments.
· Legislation to expand the PPOB to include more legislative members, similar to the measures included in BR 242 that has been prefiled for the 2017 Regular Session, should be enacted. Under the measure, 4 legislators would be appointed by the Senate President (currently 2), 4 will be appointed by the House Speaker (currently 2), and 2 members shall be appointed by the Minority Floor Leaders in both the House and Senate (currently 1 each).
· Legislation to develop consistent investment fee reporting requirements for the state-administered retirement systems should be enacted.
· Pension transparency measures for the state-administered retirement systems should be enacted and should include:
o Measures prohibiting KRS, TRS, and JFRS from using system assets to pay placement agents fees.
o Requirements for JFRS to develop a website and require specific information to be posted on the JFRS website similar to what is currently required for the KRS/TRS websites under Kentucky Revised Statutes 61.645(19) and 161.250(4).
o Limitations on the definition of “Investment Experience” for KRS Board members appointed by the Governor.
o Standardized investment expense reporting. The standard shall require, to the extent information is available, disclosure by individual manager/partnership and the dollars paid for direct fees and any profit sharing, carried interest, partnership incentives, in accordance with ILPA standards.
o Public disclosure of system offering documents.
o Contract disclosure at all times to trustees, Auditor, Governor, or legislators if a confidentiality agreement is signed.
o Requirements for all systems to report returns both gross and net of fees.
o Adherence to CFA Institute Standards, except for Asset Manager Code of Conduct.
· Legislation should be enacted to require the systems to provide supplemental data on the potential impact of a bill when an actuarial impact statement required by KRS 6.350 determines the bill’s impact is indeterminable/negligible.
· Legislation to require the disclosure of pension benefits of current and former legislators from all state-administered retirement systems, similar to the measures included in BR 260 that has been prefiled for the 2017 Regular Session, should be enacted.
· Legislation to publicly disclose the actual annualized monthly retirement allowance, or estimated allowance if the actual amount is not known, for LRP participants retiring on or after December 1, 2016, should be enacted. This provision should be enacted prospectively since it could present a legal challenge to the inviolable contract.
· Legislation to allow KRS, LRP, and JRP members to opt into the hybrid cash balance plan, similar to the measures included in SB 172 that did not pass into law during the 2016 Regular Session, should be enacted.
· The KRS housekeeping bill, similar to provisions included in House 241 that did not pass into law during the 2016 Regular Session, should be enacted.
· The TRS housekeeping bill, similar to provisions included in House Bill 470 that did not pass into law during the 2016 Regular Session, should be enacted.
· Legislation to address KRS employer concerns with “pension spiking” fees that resulted from the passage of SB 2 in 2013 should be enacted.
· Legislation to address KRS employer concerns with “pension spiking” fees that resulted from the passage of SB 2 in 2013 should be enacted. The legislation should limit the fees to a minimum threshold of $10,000 provided that exceptions are added, including but not limited to employees that return to work after unpaid authorized maternity leave, unpaid leave authorized under the Federal Family Medical Leave Act (FMLA), authorized sick leave without pay, employees that return from active or reserve military duty, and employees that received worker’s compensation benefits that were not reported as creditable compensation. The legislation should be fair and equitable to employees.
· Legislation to eliminate the option for Legislative Retirement Plan (LRP) participants to “spike” their legislative pension from salary earned through other public employment should be enacted.
· The General Assembly should evaluate the findings and recommendations of the performance audit being conducted by the PFM group and adopt a financially sound approach to address the funding issues facing the state-administered retirement systems.
· The General Assembly should evaluate the findings and recommendations of the performance audit being conducted by the PFM group and adopt a financially sound approach to address the funding issues facing the state-administered retirement systems. It should also evaluate how to best allocate the funds in the Kentucky Permanent Pension Fund among the state-administered retirement systems.
· The PPOB supports measures that would provide additional funding to improve the financial health of the state-administered retirement systems and in particular measures that would improve the cash flow issues facing the Kentucky Employees Retirement System (KERS) nonhazardous pension fund or that would improve the overall funding of the Teachers’ Retirement System (TRS) pension fund and the State Police Retirement System (SPRS) pension fund.
· The PPOB supports measures that would provide additional funding to improve the financial health/cash flow issues facing the KERS nonhazardous pension fund and the SPRS pension fund.
· The PPOB supports measures that would provide additional funding to improve the financial health of the TRS pension fund and that would include a long-term statutory plan to pay the actuarially required contribution.
Senator Thayer said that his caucus has discussed the possible recommendation that the House and Senate Chairs for the Appropriations and Revenue Committees be added to the PPOB.
Mac Jefferson moved that the 2016 Recommendations be approved. Representative Brian Linder seconded the motion, and the recommendations were approved without objection.
Senator Bowen moved that the draft PPOB 2016 Annual Report be approved. Sharon Mattingly seconded the motion, and the draft PPOB 2016 Annual Report was approved without objection.
2016 Financial/Actuarial Summary
Brad Gross, Legislative Research Commission, began by discussing the background on the different state-administered retirement systems, three of which include KERS, SPRS, and the County Employees Retirement System (CERS), which are administered under one entity known as the KRS. Each one of these systems have a pension and retiree health actuarial valuation, separate financial data, and also separate nonhazardous and hazardous duty benefit and contribution structures within KERS and CERS. The state systems also include TRS which has actuarial valuations for its pension, retiree health, life insurance benefits, and also separate benefit contribution structures for university and non-university employees. Lastly, the state systems include the Legislators’ Retirement Plan (LRP) and Judicial Retirement Plan (JRP), which are administrated under entity known as the Judicial Form Retirement System (JFRS) and have separate actuarial valuations for the differing funds.
Mr. Gross discussed the annual actuarial valuation from the state systems. The valuation produces information on plan status (funding level and unfunded liabilities), employer contribution rates (pension and retiree health), and reporting information required by standards established by the Governmental Accounting Standards Board (GASB). Mr. Gross stated the information that goes into the valuation and produces this information are the actuarial assumptions and methods (i.e. assumed investment returns and retirement rates), benefits and funding provisions (established by statute, regulation, and sometimes board policy), financial experience (i.e. actual investment returns), and demographic data and experience (i.e. actual retirement rates). There are also key studies that are performed that influence the actuarial assumptions used in the valuation. The Experience Study is a review of assumptions against experience with recommendations for adjustments. The study is performed at least once every five years. An Actuarial Audit is a secondary review by another actuary to review the current actuary’s work and is also performed at least once every five years. The Asset/Liability Modeling Study is typically performed following the experience study and evaluates various asset allocations against projected system liabilities with the ultimate goal of selecting a target asset allocation for the investment portfolio.
Mr. Gross discussed the actuarial data for the state-administered systems and noted that in general pension, funding level values went down in 2016 and retiree health funding level values went up. He stated there is a total of $32.792 billion in unfunded liabilities for the state pension funds and $5.86 billion in unfunded liabilities for the state retiree health funds as of June 30, 2016, which when combined, totals $38.652 billion. Mr. Gross said that KERS nonhazardous pension funding level went from 19 percent to 16 percent and the unfunded liability went from $10.01 billion to $11.11 billion. The major factor resulting in the change for this system was a drop in the assumed rate of return from 7.5 percent to 6.75 percent, which increased the unfunded liabilities by $900 million. The CERS nonhazardous pension declined as well and the funding level went from 60.3 percent to 59 percent and the unfunded liabilities went from $4.27 billion to $4.54 billion. TRS’s pension funding level went from 55.3 percent to 54.6 percent and the unfunded liabilities went from $13.93 billion to $14.53 billion, with the major contributing factor being underfunding in FY 2016. The retiree health funding has been positive compared to recent years where the funding levels have been improving and the unfunded liabilities have been going down.
Mr. Gross discussed how in 2000 the KERS nonhazardous pension was 139.6 percent funded and had a surplus relative to the unfunded liability of roughly +$1.93 billion and in 2003 the numbers began to separate. In 2012, prior to the SB 2 changes enacted in 2013, this pension fund was 27.3 percent funded and with an unfunded liability of -$8.26 billion. In 2016 this pension fund is 16 percent funded and the unfunded liability is -$11.11 billion. The retiree health fund for KERS nonhazardous in 2000 was 27.4 percent funded with an unfunded liability of -$1.06 billion, in 2006 it was 7.8 percent funded with an unfunded liability of -$7.20 billion, and in 2016 it is 30.3 percent funded with an unfunded liability of -$1.71 billion.
Per statute, the employer rates for KERS nonhazardous are set as a percentage of payroll. When looking at the 2000 valuation when this pension fund was 139.6 percent funded and a surplus actuarially, the actuarially required contribution (ARC) was 5.89 percent for pension and retiree health combined, of which the pension component was 0.00 percent. Looking five years later the trends began to change and the pension costs started going up. Since FY 15 the ARC has been funded in the budget. In FY 2018 the ARC was 47.28 percent of pay but the General Assembly budgeted in excess of the ARC utilizing a lower assumed rate of return and providing supplemental funds above the ARC. In FY 2017 the projected total employer contributions will be roughly $868 million from all fund sources. Of this total, funding from the General Fund is roughly 45-50 percent of the total. Total funding in terms of dollars will depend upon what the actual payroll ends up being. KRS is utilizing a more conservative payroll number so it is possible for some slight differences.
Relative to CERS nonhazardous, in 2000 the pension fund was 156.9 percent funded with a surplus relative to the unfunded liability of +$1.92 billion, in 2008 it was funded 78.5 percent with an unfunded liability of -$1.57 billion, and in 2016 it is funded 59.0 percent with an unfunded liability of -$4.54 billion. In 2000 the CERS nonhazardous retiree health fund was funded 21.8 percent with an unfunded liability of -$1.15 billion, in 2006 it was funded 16.9 percent with an unfunded liability of -$3.83 billion, and in 2016 it is funded 69.6 percent with an unfunded liability of -$0.91 billion.
With the CERS nonhazardous employer rate, the rate was down to 6.41 percent in FY 2002. In FY 2016 the rate was 17.06 percent. Mr. Gross said that the CERS nonhazardous rates are not in the budget and are payable based upon the valuation results. He also noted that the CERS pension contribution has always been paid at the full actuarially determined rate. The retiree health contribution is being phased in to the full actuarially determined rate through FY 2018 based on the 10-year schedule established by HB 117 passed in 2009. Prior to the 2009 legislation, various KRS board policies to phase into the full actuarially required contribution rate were used to determine the retiree health rate.
Mr. Gross discussed the actuarial data for TRS and stated the pension funds experienced similar downward trends but not nearly as severe as KERS and CERS. In 2000 the TRS pension fund was 95.7 percent funded with an unfunded liability of -$0.57 billion, in 2008 it was funded 68.2 percent with an unfunded liability of -$7.14 billion, and in 2016 it was funded 54.6 percent with an unfunded liability of -$14.53 billion. The TRS pension fund is one in which the GASB standards matter significantly because there is not a funding plan in statute. GASB 67 values (reporting requirements) show in 2016 it is funded 35.2 percent with a Net Pension Liability (NPL) of $30.92 billion. With the retiree health fund in 2000 it was funded 2.4 percent with an unfunded liability of -$2.15 billion, in 2009 it was funded 3.5 percent with an unfunded liability of -$6.23 billion, and in 2016 it is funded 21.9 percent with an unfunded liability of -$2.84 billion.
Mr. Gross discussed the funding mechanism of TRS in stating that the historical fixed contributions of 13.105 percent of pay, known as the “match” and “overmatch”, are set by statute to fund pension and retiree health benefits and are paid mostly (85 to 90 percent) by general fund dollars. The state pays the costs for all non-federally funded school teachers for this historical fixed contribution. Over time, additional funding has been provided through direction appropriations to TRS in the budget and are paid solely by general fund dollars. Direct appropriations to TRS includes: amortized payments for sick leave, ad hoc COLA’s, the state shared solution part from 2010 HB 540 (health), and also the additional $973 million in pension funding in current budget biennium. Direct employer funding was established by HB 540 in 2010 and is essentially a 3 percent of pay contribution made by individual employers participating in TRS and helps fund retiree health. The total value of employer contributions from all sources in FY 2016 was $745.1 million. Using this value, plus the additional funding in FY 2017 of $498.5 million, total employer funding is projected at roughly $1.2 billion from all sources.
Mr. Gross discussed the total unfunded liability of the state administered systems over time. In 2006, the total was $28.4 billion, with 62 percent or $17.6 billion attributed to retiree health benefits and the remaining 38 percent or $10.8 billion attributed to pension benefits. If you look ten years later it has grown to $38.7 billion with $32.8 billion or 85 percent pension and the remaining $5 billion or 15 percent retiree health.
Mr. Gross discussed key assumptions, including investment return, payroll growth, and data from a sensitivity analysis that show what happens if these assumptions change. The investment return assumptions for each system and the impact to changing the investment return assumption are:
· Current Assumptions: The KERS nonhazardous pension fund and SPRS pension fund has an assumed rate of return of 6.75 percent. The KERS hazardous, CERS, and TRS pension funds have a 7.5 percent assumed rate of return. In recent years, the assumed rate for KERS, CERS, and SPRS funds have been lowered by the KRS board.
· Sensitivity Analysis: A 1 percent decrease in the investment return assumption for the KERS nonhazardous pension fund to 5.75 percent would reduce the funding level from 16.0 percent to 14.0 percent, would increase unfunded liabilities by $1.4 billion, and would increase the ARC by 2.3 percent of pay. A 1 percent decrease in the investment return assumption for the CERS nonhazardous pension fund to 6.50 percent would reduce the funding level from 59.0 percent to 52.3 percent, would increase unfunded liabilities by $1.4 billion, and would increase the ARC by 3.7 percent of pay. A 1 percent decrease in the investment return assumption for the TRS pension fund to 6.50 percent would reduce the funding level from 54.6 percent to 48.9 percent, would increase unfunded liabilities by $3.75 billion, and would increase the ARC by 8.41 percent of pay.
The state-administered retirement systems typically amortize unfunded liabilities over a 30-year period. Both KRS and TRS utilize a level percentage of payroll method to determine the amortized payment which takes into account payroll growth over time. The investment return assumptions for each system and the impact to changing the investment return assumption are as follows:
· Assumption/Methods: The KERS and CERS pension unfunded liabilities are amortized over 30 year closed-period using the level percentage of payroll method and a 4 percent payroll growth assumption. In recent history, the KRS board and the General Assembly by legislative action have reamortized the unfunded liability and the KRS board has lowered the assumed payroll growth assumption over time. Actual payroll growth experience in recent years has varied by system. For the KERS nonhazardous pension fund, total payroll has fallen from $1.816 billion in 2012 to $1.662 billion in 2016. For the CERS nonhazardous pension fund, payroll has increased over time from $2.301 billion in 2012 to $2.414 billion in 2016.
· TRS pension fund unfunded liabilities are amortized by policies adopted by the TRS board of trustees. Per policy, legacy unfunded liabilities are amortized over a 30 year closed-period and any new sources of unfunded liabilities are amortized over separate 20 year periods. Per policy, the amortized payment is determined by the level percentage of payroll method and a 3.5 percent payroll growth assumption. In recent history, the TRS board has both reamortized the unfunded liability and lowered the payroll growth assumption. For the TRS pension fund, payroll has increased over time from $3.480 billion in 2012 $3.537 billion in 2016.
Mr. Gross discussed the cash flow for KERS nonhazardous and TRS pension funds. In FY 2016, assets for the KERS nonhazardous pension fund fell by an additional $347 million to $1.980 billion. For the first quarter of FY 2017, with the increased ARC and supplemental appropriations and favorable investment returns, assets of the KERS nonhazardous pension fund increased slightly by $32.6 million. In FY 2016, the TRS pension fund assets fell by $1.236 billion to $16.813 billion. For the first quarter of FY 2017, with the increased appropriations and favorable investment returns, assets of the TRS pension fund increased by $482 million. Both the KERS nonhazardous and TRS retiree health funds showed positive cash flow in FY 2016.
Responding to a question from Representative Miller, Mr. Gross stated that the tier 3 essentially operates as another tier within the system so employers pay the exact same employer rate and the unfunded liabilities includes the tier 3 individuals.
Responding to a question from Representative Linder, Mr. Gross stated that with CERS nonhazardous the additional ARC would be 3.7 percent of pay and with a $2.4 billion payroll, the additional cost of a 1 percent decrease in the investment return assumption would be roughly $89 million.
Senator Bowen and Representative Graham announced that Representative Yonts had worked on committees with great distinction for the Commonwealth of Kentucky and thanked him for his efforts in his 20 years of service for the General Assembly.
With no further business, the meeting was adjourned. The next regularly scheduled meeting is Monday, January 23, 2017.