Call to Order and Roll Call
The fifth meeting of the Public Pension Oversight Board was held on Monday, May 22, 2017, at 1:00 PM, in Room 154 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 Brian Linder, Co-Chair; Senators Jimmy Higdon, Christian McDaniel, Gerald A. Neal, Dennis Parrett, and Wil Schroder; Representatives Ken Fleming, James Kay, Jerry T. Miller, Arnold Simpson, and Russell Webber; J. Michael Brown, John Chilton, Timothy Fyffe, Mike Harmon, and Sharon Mattingly.
Guests: Mike Nadol and Sean McNeeley, PFM Group; Adam Reese, PRM Consulting Group; and Representative Derrick Graham.
LRC Staff: Brad Gross, Jennifer Black Hans, Bo Cracraft, Michael Callan, and Peggy Sciantarelli.
The minutes of the April 24, 2017, meeting were approved without objection.
In his opening remarks, Senator Bowen stated that through the work of the Public Pension Oversight Board (PPOB) members and others, it is now understood that many factors contributed to the current critical underfunding of the pension plans. It was primarily the work of PPOB members that led to the 2017 passage of Senate Bill 2—significant accountability and transparency legislation which added investment specialists to pension boards, made reporting requirements uniform and more transparent, made the pension plans subject to the Model Procurement Code, provided for Senate confirmation of board members, and gave the executive and legislative branches a larger role in management and oversight of the pension systems. Creation of the PPOB in 2013 has enabled the legislature to be better informed about the nature and extent of the pension funding crisis, and he looks forward to working with everyone on a longtime solution to the fiscal challenges. Senator Bowen noted that the meeting folders include a Revised Quarterly Investment Performance Update by LRC staff and that the next PPOB meeting is scheduled for June 26, 2017.
Public Pension Performance Audit – Interim Report #2
Mr. Chilton said the Office of the State Budget Director has been working on the audit with the PFM Group for several months. PFM produced Interim Report #1 in late December 2016, relating to transparency and governance. Interim Report #2 (“Historical and Current Assessment”) provides historical and current perspectives on the status of the various pension plans. Today’s presentation is a summary of the full report, and both will be available on the website of the State Budget Director (http://osbd.ky.gov).
Guest presenters were Mike Nadol, managing director, PFM Group; Sean McNeeley, Senior Managing Consultant, PFM Group; and Adam Reese, a principal with PRM Consulting Group and managing director of PRM’s actuarial services division. Their 52-page slide presentation—entitled “Commonwealth of Kentucky Pension Performance and Best Practices Analysis/Interim Report #2: Historical and Current Assessment”—addressed the following major areas: Magnitude of the Challenge, How Did We Get Here, Cash Flows and Solvency Analysis, Benefits Benchmarking, and Investment Analysis. Mr. Nadol said that he and his colleagues are humbled by the importance of the task at hand. They have approached it with seriousness and hope that their work will contribute constructively to positive steps going forward.
Mr. Nadol discussed the magnitude of the challenge. Kentucky’s unfunded pension liability is approximately $33 billion under published actuarial rates of return/discount rates. There is an additional $6 billion unfunded health care liability. The unfunded pension liability increases significantly when measured by alternative discount rates. The more conservative asset allocation approach better reflects the condition of the funds. It assumes a 5.1 percent rate for the Kentucky Employees Retirement System (KERS) and 6.0 percent for the other plans and projects the unfunded liability at $42 billion. This is consistent with the direction recently taken by the KRS board to use a more conservative set of assumptions. The Corporate Bond Index discount rate of 3.87 percent for evaluating private sector pension plans would project the unfunded liability as high as $64 billion. Under the 30-year Treasury rate of 2.72 percent, the liability would increase to $84 billion—more than seven times the recent annual General Fund spending. According to Standard & Poor’s 2015 comparison of the five states with the worst-funded pension ratios, Kentucky is the least well-funded in terms of the aggregate of state liabilities.
The unfunded liability of Kentucky’s two largest state pension systems—KERS-nonhazardous (NH) and Kentucky Teachers’ Retirement System (TRS)—has increased dramatically since 2002. Despite increasing state expenditures for these two systems, funded ratios have sharply declined (slide 6). Pension expenditures are growing much faster than revenue and are diminishing the capacity of the state budget to address other needs. A past report by the major rating agency Moody’s found that Kentucky’s net pension liability was 185 percent of total governmental revenue, compared to a national median of 60 percent. Pension expenditures are also high relative to salaries (slide 8).
Under the June 30, 2016, actuarial assumptions, KERS-NH was projected to decline from a 16 percent funded ratio, even with healthy earnings, high payroll growth, and full required funding. If the previous actuarial assumptions that were in effect prior to the most recent action of the KRS board were met, the plan would be projected to reach only a 28.9 percent funding level in 2033 and would still be one of the worst-funded plans in the nation. Slide 9 illustrates an alternative “level dollar” funding approach, instead of the historical “percent of payroll” approach. This alternative approach would improve the funding level over time but would require higher contributions in the near term. With a level dollar approach the funded ratio is projected to reach 60.7 percent in year 2033.
Slide 10 focuses on general fund budget estimates for the KERS-NH and TRS plans. Under the old actuarial assumptions, there would be steady growth in funding requirements from 2019 to 2033. Progress toward covering the liability would be negative in the first few years and modest in subsequent years. The level dollar approach is somewhat akin to a home mortgage, in that similar amounts would be paid every year. This approach would cost more in the near term; however, assuming other actuarial assumptions are met, the contribution rate would be more stable and would eventually decline as the liability is paid down. Slide 10 also illustrates projected actuarial funding requirements under lower assumed investment rates of return—rates that are consistent with, although not identical to, those recently adopted by the KRS board.
Mr. McNeeley discussed the status of retiree health care. (slides 11 and 12). Kentucky’s Other Post-Employment Benefits (OPEB) liabilities are relatively better-funded. The $6 billion unfunded liability is much lower than for pensions. Employees contribute toward future health care benefits, which is not typical. KRS implemented benefit reforms in 2003 and TRS in 2010. Kentucky has done more to fund OPEB than most other states and ranks near the median nationally, according to Standard & Poor’s data. Only two states with a higher funding ratio than Kentucky—Ohio and Alaska—also have a higher OPEB liability.
Senator Bowen questioned the rationale for use of the level percentage of payroll funding method. Mr. Nadol said the level percent of payroll funding approach is common. It is a way to spread out costs over time in recognition that payrolls generally rise over time. There is some thought that it provides greater intergenerational equity because employees will be earning more in the future and can contribute more. Slide 16 (Actuarial Backloading Illustrated) illustrates that the level percent of payroll method used by Kentucky’s systems assumes funding contributions grow along with payroll. Principal payments are allocated heavily to the end of the amortization period. In the early years of the period, payments may not be large enough to offset interest on the unfunded liability. The KERS-NH amortization period was reset to 30 years in 2013, and the TRS period was reset every year until 2014. When the amortization period is reset, payments do not progress to paying down the unfunded liability. KERS-NH actuarial valuations assumed between 4 percent and 4.5 percent annual payroll growth since 2005, yet covered payroll declined by a compound annual average of 1.1 percent. Negative amortization is the technical term for actuarial backloading.
Representative Miller asked whether a bifurcated funding method would be an option for Kentucky—using the percentage of payroll method for current service and the level dollar method for the historical unfunded liability. Mr. Nadol responded affirmatively. He said that normal cost for current service would typically be expressed as a percent of payroll, with a level dollar approach used for budgeting purposes. Effectiveness of that approach would be a key consideration, given the stressed condition of the systems. Mr. Nadol explained that he is not an actuary but that Mr. Reese is an experienced pension and health care actuary and is providing actuarial expertise and calculations for the audit. Their team has also been working with Cavanaugh Macdonald.
Representative Linder asked about projected funding levels for the next 15 years and beyond, in relation to accrued liability by tier. Mr. McNeeley said the challenge relates more to legacy than to the benefit being provided to Tier 3 employees. Slide 51 shows that as of the most recent valuation, the entire KERS-NH accrued unfunded liability is associated with Tier 1—at 76 percent for retired/inactive employees and 23 percent for Tier 1 active employees. The amortization method projects 100 percent funding by the end of the amortization period. He said that getting to 100 percent funding is somewhat independent of the changing composition between Tiers 1, 2, 3 over time. Tier 3 will help make the accrual of normal cost and additional service cost more manageable.
Responding to Senator Higdon, Mr. Nadol confirmed that when the KRS board recently changed the payroll growth assumption from four percent to zero, that effectively moved the plans to a level dollar approach. From PFM’s perspective, it was a prudent move that more realistically funds the plans in line with actual experience. Senator Higdon said that about a year ago KRS actuaries indicated that the unfunded liability was caused by legislative underfunding (20 percent), unfunded COLAs/cost-of-living adjustments (15 percent), faulty assumptions (20 percent), poor investment performance (20 percent), and “other” (25 percent). After multiple inquiries, staff learned that “other” referred to use of a percentage of payroll versus a level dollar funding system. Mr. Nadol said the audit’s update of past analyses reveals a similar breakdown. He agreed that the percentage of payroll funding method has been a major factor in the unfunded liability. Senator Higdon complimented committee staff for their efforts in responding to his information requests.
Mr. Nadol discussed components of the $25.3 billion increase in unfunded pension liabilities for all the systems (slide 14 – How Did We Get Here: Summary). Across all state systems the largest cause (25 percent) of the increase was use of the level percentage of payroll funding method (“actuarial back-loading” or “negative amortization”). This was amplified by pay growth assumptions far higher than actual pay increases over the 11-year period since 2005. Changes in actuarial assumptions (22 percent) and the benchmark investment market performance assumption (15 percent) were major factors. Another major cause (15 percent) was employer funding of less than the actuarially recommended rates—an issue for three of the six plans and a major cause of the increase in the KERS-NH plan. Unfunded COLAs was the fifth major cause (9 percent). Investment performance (8 percent) and plan experience (6 percent) also contributed to the increase in pension liabilities. Mr. Nadol said changes that were made to reflect actual investment return led to an increase in reported liability. The majority of investment underperformance has been due to the market as a whole rather than individual performance of the funds. In the earlier years of the review period, some unfunded benefit improvements added to the liability. Plan experience refers to general assumptions such as mortality.
Mr. Reese reviewed slide 15, which charts the dollar amounts of the increase in unfunded pension liability, by contributing factor, for each of the systems from 6/30/2005 to 6/30/2016. Reviewing slides 16-22, he explained the level percent of payroll method (actuarial back-loading). He said that underfunding the ARC was the largest factor in the increase in unfunded liability for KERS-NH. Both CERS plans funded the ARC during that period. The major cause for the increase in those plans was actuarial backloading, or negative amortization. In each of the 11 years, the interest on the unfunded liability for CERS-NH exceeded the ARC amortization payment. Over the period the aggregate amount was $1.3 billion.
For TRS, actuarial back-loading—attributable in part to the open/rolling amortization period that was annually reset until 2014—was the primary factor in the unfunded liability increase. Each year TRS amortization payment amounts have been less than the interest on the unfunded liability. While underfunding of the ARC was a meaningful factor, actuarial back-loading, changes in assumptions, and investment performance compared to the 7.5 percent discount rate were all larger causes of increase in the unfunded liability between 2005 and 2016. Although TRS investment returns have been better than KRS returns, investment performance contributed more to the increase in unfunded liability for TRS in dollar terms than it did for KERS-NH. TRS has a larger asset base; as a result, underperforming the valuation assumption by 1 percent would have a greater dollar impact. Mr. Nadol pointed out that TRS has outperformed the market for much of the time period. However, the market as a whole has performed below the expected TRS actuarial assumptions and assumed investment return rates.
Senator Bowen questioned whether Kentucky’s response to the worsening unfunded liability has been slow. Mr. Nadol said the audit has focused on what to do going forward. A lot of market observers and systems have been rethinking their approach and heightening their scrutiny. The rating agencies have adopted more intensive methodologies for reviewing pension liability. Governmental Accounting Standards Board (GASB) rules have been revised, and many systems have been revising their actuarial assumptions. If judged slow to react, Kentucky would not be alone.
Senator McDaniel said that slide 15 indicates that TRS funded less than the ARC. It is his understanding that the General Assembly has a statutory obligation to the ARC for all systems except TRS, which is governed by a strict percentage of payroll contribution. He feels it is important to note the distinction that the statutory obligation to TRS is to a particular percentage, since this would be reflective of TRS board structure and initial founding.
Senator McDaniel said the current funding situation has resulted from decisions made at every level, especially by poor performance of the actuaries, in his opinion. Mr. Reese said that the audit recommends the establishment of best practices. The recommendations of actuaries need to meet certain standards of practice, and boards may or may not accept the recommendations.
Discussion followed regarding the meaning of “interest on the unfunded liability.” Senator McDaniel said he prefers to call it “discounted rate of return,” and Mr. Reese agreed that the terms are interchangeable.
Senator Higdon asked how increased benefit factors for KERS-NH affected the liability. Mr. Reese said that those updated multipliers were in effect prior to the period covered by the audit. The only benefit change occurring during the review period is the COLA. If the review had looked as far back as 20 years, an additional component would have been included for plan changes.
Representative Linder asked how much emphasis should be put on investment performance during the past 10 years, in view of the 2008 great recession. Referring to slide 33, Mr. Reese said they were concerned about the limited look-back period of 11 years relative to market performance. That is why they included a distinction between how investment return compared to market and how the market compared to a much longer term. Slide 33 illustrates how market downturns would increase TRS future funding requirements. Mr. Nadol said that, hopefully, the 2008 recession was an outlier, but the systems need to be mindful of risk exposure. Recovery has been tepid during many of the years since the great recession, and capital market projections for investment return are lower than most mainstream projections. Professional forecasts for the next decade are relatively modest.
Mr. McNeeley reviewed Cash Flows and Solvency Analysis (slides 24-33). From FY 2006 to FY 2016, KERS-NH had a negative cash flow of $4.2 billion, and TRS had a negative cash flow of $2.2 billion. (Cash flows excludes investment earnings.) The extent and severity of cash flow is a concern. Only the County Employees Retirement System-hazardous (CERS-H) plan had positive cash flow. Over the time period KERS-NH and TRS had to routinely liquidate assets in order to pay benefits. KERS-NH and the State Police Retirement System (SPRS) had a decline in net position (net assets) during the time period. Although the net position of TRS and CERS-NH increased in total, each had declines in net assets in five of the years. The increases in net position for KERS-H, CERS-NH, CERS-H, and TRS were significantly smaller than the offsetting increases in liabilities.
Based on the June 30, 2016, valuation and assumptions, KERS-NH is projected to continue to have negative cash flows until benefit payments begin to level off as the amortization schedule continues to increase. TRS is also projected to experience negative annual cash flows based on the assumptions, contribution requirements, and amortization schedule of the June 30, 2016, valuation. It is not uncommon for a mature system with a high retiree/active ratio to operate with negative cash flows and rely on investment earnings to offset changes in net position. The National Association of State Retirement Administrators (NASRA) has commented that investment earnings will be the largest source of revenues or inflows to a retirement system over its life cycle. The recurring negative cash flows of the magnitude projected for TRS indicate the level of risk and stress associated with a plan that is 55 percent funded. The negative cash flow would be greater in years where the earnings assumption is not met, payroll growth is lower than assumed, and authorized funding levels are lower than the actuarially determined contribution (ADC).
Mr. McNeeley said that public plans continue to use the expected long-term rate of return on investments when discounting the value of future benefit payments to a present value liability figure (the discount rate). The size of the liability and annual funding requirement are therefore sensitive to the discount rate and other actuarial and economic assumptions. Private plans subject to the federal Employee Retirement Income Security Act (ERISA) typically discount liabilities for both reporting and funding purposes, based on high-quality corporate bond rates like the Corporate Bond Index. The practice in public plans is to continue to use the earnings rate for funding purposes. For reporting purposes, GASB statements 67 and 68—recently implemented by state and local pension plans and plan sponsors—adopt a hybrid of the traditional earnings-based assumption and bond-based assumption. The FY 2015 and FY 2016 TRS and Judicial Form Retirement System (JFRS) reports used such a blended rate.
KRS is revising its asset allocation approach to reflect the varying degrees of stress and diminished assets of the plans. The audit report includes alternate return assumptions for a 10-year investment horizon and two levels of increased liquidity positions generally consistent with updated KRS policy. Under these assumptions, expected return for the most stressed systems is 5.1 percent and 6.0 percent for the less stressed systems. These assumptions were based on PFM Asset Management’s expected 10-year return for a portfolio with increased allocation to short-term bonds and cash. These rates also apply to TRS and JFRS.
The KERS-NH and TRS plans were tested under several alternate assumptions and scenarios to identify whether the plans would be projected to remain solvent. The additional amounts appropriated for KERS-NH have had a significant benefit. If future funding of KERS-NH reverted to the prior pre-FY 2016 pattern of funding roughly 60 percent of the ARC, assuming zero percent payroll growth, the plan is projected to become insolvent within four years, even with 7.5 percent investment return.
The amounts appropriated in the FY 2017-2018 budget were significantly higher than the ADC. If these amounts are maintained and the revised asset allocation or corporate bond index rates are achieved every year on average, the plan is projected to remain solvent, even with zero percent payroll growth. Other alternate scenarios project insolvency for KERS-NH in FY 2022, FY 2028, FY2033, or FY 2037. Mr. Chilton explained that insolvency is defined as entire depletion of assets.
Mr. McNeeley said that TRS is more stable but also pressured. If the recommended employer contribution levels are fully achieved in FY 2019 and thereafter—which would be the first time since FY 2004—and assets earn the revised asset allocation return of 6.0 percent per year, the plan is projected to remain solvent. It could become insolvent if the employer contribution reverts to pre-FY 2017 levels. The plan is also projected to become insolvent if the average of the FY 2016-18 budgeted amounts is maintained in future years and payroll growth is initially a reduced 1 percent to 2.5 percent per year. If assets earn the revised asset allocation return of 6.0 percent per year, insolvency is estimated to occur in FY 2044; insolvency is estimated to occur in FY 2036 if the plan earns the Corporate Bond Index rate.
In addition to the solvency analysis, the audit has modeled the impact of an immediate economic downturn on the ADC funding requirement. Market downturns would increase future funding requirements. The asset base of KERS-NH is now so low that deviations would not have a large, short-term impact on contribution requirements or solvency. A market return of one standard deviation lower than the return assumption for TRS would raise the ADC by $104 million, a 9 percent increase, after smoothing the losses.
Senator Bowen asked about sensitivity studies and whether it would be beneficial to do experience studies more often than every five years. Mr. Reese said that five-year experience studies are in line with most states and provide more reliability for resetting future assumptions. Sensitivity analysis is helpful to gauge which assumptions are most important and ensure that the decision makers have full awareness of those assumptions.
When Senator Parrett asked about the potential effect of another great recession, Mr. Reese said that would be a rare event. With a minus 28-30 percent return, the insolvency horizon would be foreshortened by several years. Mr. Nadol said a one-time quick fix cannot solve all of the challenges. What is needed is a long-term commitment to make structural adjustments to support the plans.
Mr. Nadol discussed benefits benchmarking. He said traditional defined benefit pensions are increasingly rare in the private sector, where a 401k style approach is most prevalent. The Commonwealth has made significant strides toward making retiree health care more affordable, but that is a benefit hardly seen now in private industry. A recent third-party study found that, for comparable positions, state employees in Kentucky have somewhat lower wages than their private sector counterparts within the state but, because of the cost of benefits, have a higher overall total compensation cost. That is problematic. As pension contribution requirements continue to rise and erode available resources for wage increases, state and local governments will become less competitive. Retirement benefits matter, of course, but when trying to get the best talent to meet the Commonwealth’s needs, salaries get more attention than retirement benefits for most entrants into the work force. Growth in benefit costs squeezes out not only resources that serve the public but also resources to develop and offer competitive pay packages for state and local government workers.
Mr. Nadol said that the full report includes extensive benefit benchmarking information. The report includes information on past and current benefit provisions for the Kentucky systems, detailed in Appendix A. For comparison, it also includes information for 20 other state systems for civilians, state police, teachers, and judges. This detailed information is contained in Appendix B. The 20 states include those contiguous to Kentucky, other states where teachers are not in the Social Security system, and other regional competitors or states with relevant benefit provisions. Slide 37 summarizes plan structures. State civilian plans in the 20 other states include 15 defined benefit (DB) plans for new hires, four hybrid DB/defined contribution (DC) plans, and one DC plan. The KERS-NH employee contribution is at the median for the plans reviewed. The review reflects a trend toward cost containment. There is still a prevalence of defined benefit plans for general state worker plans but also a trend to restructure those to greater affordability and sustainability, with movement more toward hybrid or even defined contribution approaches. State teacher plans in the states that were studied include 17 DB plans for new hires and three hybrid DB/DC plans. The TRS employee contribution is below the median for the plans in states where teachers are not enrolled in Social Security. TRS also has one of the earliest retirement ages observed in the benchmark review.
Mr. Reese reviewed the value of KRS and TRS retiree benefits, compared with those of seven other states—Illinois, Indiana, Missouri, Ohio, Tennessee, Virginia, and West Virginia (slides 38-42). The KERS-NH Tier 3 cash balance plan continues to provide a competitive benefit that is in line with the comparative states. The KERS-NH Tier 1 plan accounts for most of the unfunded liability. Current employees in that plan receive an above-average benefit and favorable retirement eligibility. They are eligible to retire at age 55 with 27 years of service. In many states the benefits would be materially reduced for retiring that early. Retiree benefits in the KRS plans have a higher value than the benefits offered by most of Kentucky’s largest private sector employers. Compared to the other states, the TRS plan provides an above-average benefit, particularly through the employee contribution—which is below average—and the relatively generous retirement eligibility provisions. Kentucky teachers may retire at any age with 27 years of service, at age 60 with five years, and at age 55 with 5-10 years (depending on the date of hire). The Illinois and Ohio plans do not even offer an unreduced benefit for retirement at age 62 with 30 years of service. A comparison of Kentucky with 13 other states shows that Kentucky teachers earn full benefits early. If hired at age 22 they can retire with an unreduced benefit at age 49; if hired at age 27, they can retire at age 54. This is well below the average of the states reviewed.
Mr. Nadol discussed investment analysis. He said KRS investment performance has lagged not only in the investment return assumptions but because of market performance as a whole. Allocations to asset categories has led to underperformance as well as overall benchmark performance. As indicated on slide 44, KRS total performance falls in the bottom quartile for all trailing periods provided and significantly lags the investment return assumption. Performance at the asset class level has generally been in line with the relevant index for longer periods (10+ years), with the exception of real estate, indicating that asset allocation rather than manager selection has been the primary detractor of performance. (A detailed analysis of the investment allocation, performance, and risk profile of each of the Commonwealth’s retirement systems is included in the Appendix to full Report 2.) He remarked that turnover in KRS investment leadership has been a factor, but his team has observed that the new investment committee members are thoughtful and knowledgeable and laser-focused on the issues.
Mr. Nadol said the TRS pension fund underperformed relative to market from a longer term perspective, but over the past decade TRS has been a top quartile performer relative to market. The system has not met actuarial assumptions because the market has not generated returns as strong as were seen in the actuarial evaluation. Since adopting a more flexible approach to investment categories, including international equities, TRS has done well and hopefully will continue to do so. The plan has become more aggressive, with increasing levels of risk over time. From this perspective the last decade has been very positive.
Concluding the presentation, Mr. Nadol said that as work is underway to develop options and recommendations for Report #3, it is important to note the difficult reality that the majority of accrued liability in the largest systems is associated with members who are already retired or inactive (slide 51). Past reforms so far have only addressed a small percentage of the total challenge. Report #3 will present ideas and alternatives for improving the long-term security, sustainability, and affordability of Kentucky’s retiree benefit programs.
Mr. Nadol said they welcome input from everyone involved and are hopeful to learn from and incorporate the best ideas to help make their work better and more useful. Areas to be addressed include actuarial method and assumptions, investment practices and approach, benefit levels and risk exposure, and funding policy. In closing he stated that it has become clear that the status quo is not sustainable.
Representative Kay expressed concern about the high fees that have been charged by investment managers and asked whether those fees are considered when determining investment return. Mr. Nadol said that the full Report #2 includes some analysis of fees, and they are also addressed to some degree in Report #1. In percentage terms, fees are not a big driver in the underfunding. Of course, it is important to be mindful of those dollars, especially when considering the current condition of the funds.
Senator McDaniel spoke about the enormity of the problem and said that whatever has to be done will be difficult and will require action at every level. He thanked the speakers for a good report, their guidance, and their contribution to today’s meeting.
Senator Schroder said today’s presentation has been helpful. He asked for an opinion about TRS investment levels in international equity and fixed income (slide 48). Mr. Nadol said he believes the 19 percent increase in international equity is relatively consistent with the national median, but he is not comfortable discussing specifics regarding the quoted percentages. They were compiled by the registered investment advisers, but he would be happy to follow up with anyone who has questions about details of the investment analysis.
Representative Miller said it appears to him from slides 9 and 10 that the difference between the level dollar and percentage of payroll funding methods would require generation of an additional $700 million per year for the foreseeable future. Mr. Chilton said he believes that amount is in the “ballpark” of the increase that would be needed in the General Fund.
Responding to Ms. Mattingly, Mr. Nadol clarified how the negative numbers in the tables for KERS-NH relate to the assumptions revised recently by the KRS board and those that were quantified under the old assumptions.
Responding to questions from Representative Fleming about factors affecting poor investment performance by KRS, Mr. Nadol said that changes in leadership and investment staff led to shifts in the approach to investment allocation. Turnover and transition and lack of a consistent investment philosophy had eroded overall performance. It is the observation of his team and their colleagues with investment expertise that the addition to the investment committee of individuals with significant financial and investment experience has been a positive step. Also, elements of enacted 2017 legislation have provided for better oversight and more transparency.
Senator Bowen thanked the speakers for an excellent and informative report. He said that often the legislature has taken the brunt of the blame but had to act on the information that was available. It is time to move beyond toward resolution, and he invited input from PPOB’s constituents and those in attendance. Hopefully, Report #3 will be presented at the June meeting, since PPOB typically does not meet in July. Mr. Chilton said they will target the June 26 date. They are currently working with calculations provided by Cavanaugh Macdonald regarding the potential effect of future changes to the benefits, both prospectively and retrospectively. It is also important to get feedback and input from all stakeholders, including employees and pensioners.
Mr. Chilton said that last week the KRS board did not make any decision regarding CERS assumptions. He understands that TRS will consider assumptions at the August board meeting. He is not aware of any consideration that the other two systems might undertake. The focus of the KRS board last week was primarily on KERS. The context of the discussion today has been somewhat different, since the focus was on all the systems. He pointed out that the percent of payroll funding method is required in statute, and changing to a level dollar calculation would require statutory change. He thanked PPOB members for hearing the report and stated that there is no happy way to solve the problem. It will be painful for everyone; therefore it is necessary to be thoughtful in suggesting the way forward.
Business concluded and the meeting was adjourned at 3:41 p.m.