Interim Joint Committee on State Government


Minutes of the<MeetNo1> 3rd Meeting

of the 2002 Interim


<MeetMDY1> October 23, 2002


The<MeetNo2> third meeting of the Interim Joint Committee on State Government was held on<Day> Wednesday,<MeetMDY2> October 23, 2002, at<MeetTime> 1:00 PM, in<Room> Room 149 of the Capitol Annex. Senator Albert Robinson and Representative Charles Geveden, Co-chairs, jointly chaired the meeting. Representative Geveden called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Senator Albert Robinson, Co-Chair; Representative Charles Geveden, Co-Chair; Senators Walter Blevins, Charlie Borders, David Boswell, Ernie Harris, Alice Kerr, Ed Miller, Ernesto Scorsone, and Johnny Ray Turner; Representatives Adrian Arnold, Eddie Ballard, Joe Barrows, Carolyn Belcher, John Bowling, Buddy Buckingham, Dwight Butler, Jim Callahan, Larry Clark, Perry Clark, James Comer, Tim Feeley, Charlie Hoffman, Jimmie Lee, Paul Marcotte, Mary Lou Marzian, Tanya Pullin, Jon David Reinhardt, Arnold Simpson, John Will Stacy, Tommy Turner, and Jim Wayne.


Guests: Senator Tom Buford; Representatives Bob Damron, Don Pasley, and Dottie Sims; Clark Yaggy and Leon Joyner, The Segal Company; Carol Palmore and Diane Collins, Personnel Cabinet; Bob Brown, Kentucky Public Employees' Deferred Compensation Authority; Gary Harbin and Stuart Reagan, Teachers' Retirement System; Donna Early, Judicial Form Retirement System; Bill Hanes and Bob Leggett, Kentucky Retirement Systems; Sheila Redmond, Cabinet for Families and Children; Dr. David Carr; Joe Ewalt and Bill Thielen, Kentucky League of Cities; Jack Couch, Kentucky Council of Area Development Districts; Frances Steenbergen, Kentucky Education Association; and Bob Arnold, Kentucky Association of Counties.


LRC Staff: Joyce Honaker, Joyce Crofts, Mark Roberts, Tom Troth, Stewart Willis, Karen Armstrong-Cummings, Jim Roberts, and Peggy Sciantarelli.


The minutes of the September 25 meeting were approved without objection, upon motion by Representative Belcher. Senator Robinson and Representative Stacy recognized guest constituents in attendance from Menifee County.


Representative Geveden noted that this meeting is the final scheduled meeting of the 2002 Interim. He expressed appreciation for their service on the Committee to Representative Allen, Representative Bowling, and Senator Miller, who will be leaving the General Assembly in January. He also recognized committee staffer Tom Troth, who will be joining the Director's Office staff in November.


Next was a report on the impact of stock market trends on the Kentucky Public Employees Deferred Compensation Authority. Personnel Cabinet Secretary Carol Palmore introduced Bob Brown, Executive Director of the Authority, which is attached to the Personnel Cabinet for administrative purposes. Diane Collins, of the Personnel staff, assisted Mr. Brown with the PowerPoint presentation (copies were provided to the Committee).


Mr. Brown gave a comprehensive overview of the economic, educational, and psychological impact of stock market trends on the Authority. Key points of his presentation are summarized as follows. For FY 2001, the Authority experienced a net decrease of approximately $85.3 million in the fair value of its variable assets. For FY 2002, the Authority experienced its second consecutive net decrease, approximately $75.6 million, with net assets totalling $849 million at the end of the fiscal year. Also affecting net assets during this two-year period was the Authority's transfer of $36 million to Kentucky Retirement Systems and the Kentucky Teachers' Retirement System for participants' purchase of service credit.


Revenue also declined approximately $500,000 during the past two fiscal years. The Authority is a self-sustaining entity and does not receive any General Fund dollars. The Authority's primary revenue source is participant asset fees, which has also been directly impacted by the lower asset values experienced during the past two fiscal years. Fortunately, the Authority has been able to generate sufficient revenue to pay all administrative expenses to date. However, the revenue declines prevented the Authority's Board from implementing a participant fee reduction that was to take effect July 1, 2002. In the prior six years the Board was able to reduce the fees, which saved participants about $3 million annually. The Authority's reserves may have to be tapped in FY 2003, but participant fees will not be increased to cover any revenue shortfall. The declines in FY 2001 and FY 2002 are not attributable to the poor performance of any particular stock, since the Authority purchases only mutual fund shares, not specific shares of corporate stock. Participants currently may choose from approximately 34 different funds. Fund performance is reviewed quarterly with the Board by the investment consultant, Nationwide Retirement Solutions.


The Authority's investment in Enron was limited to five mutual funds and totalled approximately $382,000, or less than one-tenth of one percent of the total mutual fund investment pool of more than $473 million. The investment in WorldCom as of May 31, 2002, was approximately $689,000—in four mutual funds, representing about one-tenth of one percent of the total investment pool of approximately $541 million. Fixed contract fund investments have insulated the Authority from even greater decreases in the stock market. The fixed contract fund, with over $300 million in assets, accounts for about one-third of the Authority's total assets. The fixed contract and bond funds are the only funds currently generating positive returns. The Authority has processed thousands of exchanges during the past two fiscal years, moving monies out of equities and into the fixed products.


The Authority remains financially sound. Participants now number more than 58,000, and 117 new participants are being enrolled weekly, in spite of the down market. The Authority has more than 700 participating employers, and annual contributions are continuing to grow. In FY 2002, participants contributed $97 million, compared to $95 million in FY 2001. The Authority will continue striving to improve participant education and is exploring a new web-based education program developed by Morningstar. Kentucky has received national recognition for achievement in deferred compensation administration in each of the past eight years.


There were no questions and Representative Geveden thanked Mr. Brown. Senator Robinson assumed the chair. The next topic on the agenda was the impact of stock market trends on state-administered retirement systems. The first person to report was Donna Early, Executive Secretary of the Judicial Form Retirement System, which administers the judicial and legislators' retirement plans.


Ms. Early said that both plans are soundly funded and maintain that soundness by very conservative investments and close monitoring of asset allocation and diversity. She said that the judicial fund totals about $194 million and the legislators' fund totals about $50 million. The judicial fund from July 31, 2001, to July 31, 2002, had a negative return of 7.39 percent, including equities and fixed income. For equities, the return was –16.56 percent, but it exceeded the S&P 500 Index return of –23.66 percent for that period. The total return for the Legislators' Fund was –7.09 percent; the return was –14.77 percent for equities only. These figures and rates of return represent market value over original cost.


There was no discussion of Ms. Early's report, and Senator Robinson thanked her. Gary Harbin, Executive Secretary of the Kentucky Teachers' Retirement System (KTRS) gave the next report. He was assisted by Stuart Reagan, Chief Investment Officer. Copies of their PowerPoint presentation were provided to the Committee. Key points of Mr. Harbin's presentation are summarized as follows.


The assets of KTRS are divided among 18 complimentary portfolios that represent a variety of investment styles, with 49.5 percent of the assets in stocks, about three percent in real estate, 16 percent in corporate bonds, 23 percent in direct government obligations, and 8.4 percent in cash or "cash like" items. The System's financial foundation is solid. No benefit will be altered or adjusted as the result of a poorly performing stock in the investment portfolio. Over the last 20 years, the System's financial strength has improved considerably. In 1980, the System was approximately 45 percent funded; currently, it is about 90 percent funded. The improvement is the result of efforts by various governors, the General Assembly, the System's Board of Trustees, and outstanding investment results. At any one time, the System may own 700 different stocks. For the 10 years ended June 30, 2002, the annualized total return of the System's stock portfolio was 11.9 percent. The return of its benchmark, the S&P 500, for that same period was 11.4 percent. Over a 20-year period, the annualized return was 14.7 percent. The entire portfolio, including all asset classes, earned a 10-year annualized return of nine percent; over 20 years, the annualized return was 11.6 percent. The long-term actuarial assumed rate of return is currently 7.5 percent.


For FY 2001-02, stocks returned –14.5 percent (market value to market value), compared with –18 percent for the S&P 500. Total return on all investments, however, was –4.1 percent. The bond portfolio returned 9.5 percent, the cash portfolio 2.5 percent, and real estate 6.0 percent during that period.


The System has been fortunate not to own stock positions in several of the companies that in recent months have captured headlines because of alleged fraudulent activities. However, the System does own a significant position in WorldCom. The System successfully supported the application of the state of New York in being identified as the lead shareholder plaintiff in the suit against the Company. While companies like WorldCom have performed poorly in recent months, other corporate stocks owned by the System have been strong performers. The System's cash flow is positive, and it is able to maintain or even expand a position during market weakness. The System is a long-term investor that has benefited from holding stocks at the inception and throughout major stock rallies. In conclusion, Mr. Harbin said that despite short-term fluctuations in stock market values, no annuities have been or will be affected, and stocks on a long-term basis are the System's strongest performing asset class.


Representative Bowling asked why the System does not have a larger investment in real estate. Mr. Harbin said that the investment advisors set the portfolio investment percentages. He said that real estate is a good asset class and has been a good performer; however, the rate of return has been considerably less than the return on stocks over the long-term. Mr. Reagan said that the System did not enter the real estate asset class until the 1980's and has been very conservative in its approach. He said this asset presents some difficulty with respect to property management and obtaining accurate appraisals; but it has done a nice job in terms of giving good cash "kickoff," and there has been little fluctuation in value. Investment in real estate may possibly be increased in the future. Representative Bowling asked whether the System had considered doing business with the state. Mr. Reagan said yes but that the investments that had been examined did not appear to be a good deal at the time. Senator Robinson commented on some of the risks inherent in certain real estate investments.


Representative Geveden asked whether the Alabama retirement system's investment in golf courses had been profitable. Mr. Harbin said that KTRS had asked for the rates of return but that the Alabama system values its own investments and does not share that information for the golf courses. He went on to say that there is no evidence that the golf courses have directly helped Alabama's rate of return. He also said that golf courses generally are not a good investment per se, although they may contribute toward tourism.


When asked by Representative Feeley, Mr. Harbin said that KTRS is a direct holder of its stock investments. Representative Feeley remarked that CalPERS (California Public Employees' Retirement System) has almost become the largest single stockholder in the nation and is wielding its power on corporate boards. He asked whether KTRS is moving toward being more than a passive investor and becoming involved at the corporate policy level. Mr. Harbin said that CalPERS has that capability primarily because of its size. He said that a major investor in a company can certainly have an impact on the board of directors but that KTRS's stock holdings are not strong enough to warrant a board of directors' seat. However, the System exercises its proxy voting rights. Mr. Reagan explained that CalPERS' position is so large that it is, in effect, "married" to some of the companies. They are forced to become more active in corporate governance, because they don't feel they can liquidate their position. Senator Borders commended KTRS for the success and diversity of its investment program.


Senator Robinson thanked Mr. Harbin and Mr. Reagan. The next presentation was by Bill Hanes, Executive Director of Kentucky Retirement Systems (KRS). He was assisted by Bob Leggett, Chief Investment Officer. Mr. Hanes said that since Kentucky Retirement Systems is a defined benefit plan, its members did not lose any money in the stock market. He commended the legislature for building features into the law that enable the Board and the investment committee to act as fiduciaries for the fund. He also complimented the Board and the investment committee for the good rate of return on KRS investments.


Mr. Leggett gave an overview of KRS investments. In summary, he said that two principals guide their investments: appropriate diversification and recognition of the long-term nature of the plans. The most recent asset allocation was put into place July 1, 2001. Over $1 billion was moved out of the equity market, reducing total equity exposure and increasing total fixed income exposure. The fixed income exposure was placed into Treasury Inflation Protection Securities (TIPS). As a result, there was an increased return relative to the equities and a gain for the portfolio of more than $313 million in only one year. KRS has more than 6,100 securities in its portfolio; of those, over 5,200 are stocks and 900 are fixed income securities. This helps reduce risks such as an "Enron" or "WorldCom." KRS has a comprehensive risk management oversight process that meets or exceeds industry standards. Additionally, on an ongoing basis, staff monitors the portfolio for compliance with asset class and security-specific guidelines pertaining to pricing, quality and security limits, transactions, recordation, and receipts. A compliance officer position has been established to provide another layer of oversight. KRS has achieved its long-term performance goals. Over the last 10 years, the portfolio has more than tripled—from $3.7 billion to $11.9 billion—while paying out over $735 million in benefits just last year. While return for the fiscal year ending June 30, 2002, was –4.3 percent, KRS beat the benchmark by 126 basis points. For the 10-year period ending June 30, there was an annualized return of 10.10 percent, beating the benchmark by 29 basis points. The equity portfolio over the last 10 years has averaged 11.9 percent per year. The investment functions have been operated at approximately one-third the average cost of pension funds of similar size and asset allocation.


Senator Robinson asked whether KRS has assets in real estate. Mr. Leggett said that KRS owns its office building and has approximately $400 million invested in real estate investment trusts. Mr. Hanes said it has been KRS' experience that there are "due diligence" and management issues associated with investing in real estate. Mr. Leggett explained that most of their real estate investment is now through the publicly traded market, so that "due diligence" issues that plagued the System in the past from investing directly in real estate are now moot.


Representative Pullin asked whether the Enron and WorldCom debacles impacted guidelines for KRS's market managers. Mr. Leggett said that KRS has significant risk management guidelines in place that limit exposure to any one specific security. They also exercise proxy voting rights for their corporate holdings. KRS is a member of the Council of Institutional Investors, which has significant leverage in the marketplace. He said that all of the market managers have their own internal research departments and make their own investment determinations. KRS is subject to the executive branch code of ethics. Investment managers are also required to comply with ethics provisions and must have professional liability insurance with a minimum of $5 million coverage for each wrongful act.


Senator Robinson thanked Mr. Hanes and Mr. Leggett. He then called on Dr. David Carr, who had asked to testify regarding his concern over actions taken by the Cabinet for Families and Children against the Beulah Mountain Christian Academy in McCreary County. Dr. Carr said that he is a broadcaster by profession and is testifying as a concerned citizen. He said that on February 14, 2002, nine state police troopers arrived at the Beulah Mountain Christian Academy, loaded the children on a bus furnished by the Cabinet for Families and Children, and transported them to a crisis center in Louisville, Kentucky, from which they were dispersed. This happened in the absence of the director, Blaine Shaw. Dr. Carr said that Cabinet staff "lied to the children" to coach them to board the bus and would not allow them to retrieve their personal items. Judge [Paul] Braden [McCreary Circuit Court] issued a temporary restraining order against the ministry, and 5˝ weeks later the director and his son were charged with three "trumped-up" counts of felony abuse. Two charges were dropped, and a jury acquitted them of the other abuse charge.


Dr. Carr said that in 1987 the institution changed its status from orphanage to a Christian academy because of a licensing conflict and that the change was permitted by law. He said the Academy has met all state, fire, health, and building codes through the years and is presently "current." He said the director of the school was not properly notified of any violations and wasn't given an opportunity to comply. The chairman of the school board, who resides in Louisiana, has yet to receive anything from the Cabinet. There has not been an administrative hearing. None of the children removed were from Kentucky. One child, aged 10, later tried to commit suicide. The "escapade" has cost the school nearly $20,000 in legal fees, and they expect to spend more in the future as a result of the "legal tactics of state government." He reiterated that the director and his son were found innocent, and he asked the Committee's help and consideration in this matter.


Representative Marzian said she is concerned about the accusation but stressed that she has always found the Cabinet for Families and Children to have the interest of the children at heart. Senator Robinson noted that the Cabinet has been advised of today's discussion. [Sheila Redmond was present from the Cabinet and later addressed the Committee.]


When asked by Representative Lee, Dr. Carr admitted that the school used corporal punishment to discipline the children. He said that the parents gave the school permission to administer corporal punishment. Representative Lee advised the Committee that the older children were administering the corporal punishment and that the complaint came from a parent whose child exhibited injuries from the punishment. Dr. Carr argued that he attended the court proceedings, that it was proven in court that the witness lied, and that the verdict was "not guilty." Representative Lee said that he chairs the Human Services Budget Review Subcommittee and that he is in favor of using whatever force is necessary to remove a child from any situation where corporal punishment is administered by children, some as old as 18.


Representative Marcotte asked that a transcript of this testimony be prepared by staff and provided to the committee members. He asked Dr. Carr what type of doctor he is. He replied that he is a doctor of theology.


Sheila Redmond, assistant general counsel, Cabinet for Families and Children, addressed the Committee. Ms. Redmond said that she has talked to the district court judge who has jurisdiction over juvenile court abuse and neglect matters and that the judge provided her with a written order authorizing her to disclose that the director of the facility, Blaine Shaw, his son Jeffrey, who is also employed at Beulah Mountain Christian Academy, and Beulah Mountain Christian Academy were adjudicated on May 3, or thereabouts, to have abused and neglected several children and placed the other children at risk through their disciplinary practices. After investigation, the Cabinet learned that the facility was using a procedure called "grouping," which means that children are allowed to inflict corporal punishment on other children. She said this procedure was outlawed—she believes in the 1970's—because children had died as a result. Children at Beulah Mountain were paddled with what they were told was a piece of a wing from a B-52 bomber. Their heads were butted, and they were kicked, screamed at, and called racial slurs. Beulah Mountain Christian Academy has had the opportunity to ask for a hearing to determine whether the restraining order should be lifted or whether there should be a permanent injunction but, to date, has not asked the court to hold a hearing. She said she is somewhat dismayed by the jury's verdict of "not guilty" in the criminal proceeding. She pointed out that a civil court did find that abuse and neglect occurred at the facility.


Ms. Redmond went on to say that during the course of the investigation, the Cabinet learned that the children had access to weapons for the purpose of hunting. She said that therapists were on board the bus to address the needs of the children and reassure them when they were removed. The court ordered the facility to return the children's personal items to them. She said she did not know how many state police were present when the children were moved but that the Cabinet felt that the action was absolutely imperative for the sake of the children's safety.


Senator Robinson said that the matter cannot be resolved today but that he believes it merits looking into by the Committee. Dr. Carr said it is his opinion that the Cabinet did not follow the law. He added that it has been said that the school will not be reopening without a license. Ms. Redmond said that Cabinet's position is that Beulah Mountain Christian Academy is an unlicensed child care facility, is not a corporation in good standing in Kentucky, and did not abide by its own policies and procedures. Representative Geveden said it is his understanding that the Cabinet had an order from the circuit judge of McCreary County to permit the Cabinet to do whatever was necessary to remove the children. Ms. Redmond said that is correct. She said they obtained a temporary restraining order from circuit court to close the facility and also had emergency custody orders from district court to remove the children. Representative Geveden asked whether the school has gone to court to try to dissolve the restraining order. She said that they filed an answer but have not asked for a hearing date to have the order lifted. Dr. Carr said that the Christian Law Association is representing Beulah Mountain Christian Academy. He said the trial on the felony charges concluded last Friday and that "they" will be hearing from Beulah Mountain. Senator Robinson thanked Ms. Redmond and Dr. Carr.


Representative Geveden assumed the chair. Next on the agenda was a report by The Segal Company, the actuarial and consulting firm which was hired to assist in the study mandated by HB 846, enacted in the 2002 Regular Session. [Section 3 of HB 846 directed the LRC to have a study conducted by the Interim Joint Committee on State Government, with assistance from the LRC Chief Economist, to determine the cost, if any, to members of the state health insurance group as a result of agencies participating in state-administered retirement systems while insuring their active employees outside the state health insurance group. It also directed LRC to hire an actuary to assist with the study.] The Segal report, entitled "The Impact of 'Unescorted' Retirees," was given by actuaries Clark Yaggy, Senior Vice President, and Leon "Rocky" Joyner, Vice President, of the Company's Atlanta office. Copies of their PowerPoint presentation were provided to the Committee.


Mr. Yaggy reviewed the study background, methodology, and results. His overview is summarized as follows. The premiums charged by the health insurance carriers are a blend of costs for all Commonwealth group participants. The premium rate blends what would otherwise be lower rates for younger, healthier, active employees with what would otherwise be higher rates for older, less healthy retirees. Many of the agencies that participate in the public employee health insurance program insure their active employees through the open marketplace but take advantage of the blended rates of the Commonwealth group to insure their retirees—these "unescorted" retirees thus being subsidized by the public employee group.


The study used data on claims and capitation costs from calendar year 2001 and employed two study methods. [The study defines "capitation" costs as "fixed per-member payments paid to certain contracted medical providers in lieu of claims payments of fee-for-service billings."] Costs for the unescorted retiree group were compared to costs for the total group and to costs for the active employees. The study also applied demographics of all program participants to a standard claims curve—i.e., a health actuary set of tables which define the relationship of claims cost to persons of different genders and different ages. The two methods produced corroborating results, which revealed that the total subsidy for the unescorted retirees in 2001 was $14.1 million. The cost subsidy represents 48 percent of the overall blended claims and capitation costs for unescorted retirees.


Average enrollment per month for the Commonwealth group in 2001 was 86 percent active employees, nine percent escorted retirees, and five percent unescorted retirees. Active employees accounted for 73 percent of the total claims and capitation costs; escorted retirees, 20 percent; and unescorted retirees seven percent. The average monthly claims and capitation costs for the total participants in the Commonwealth group was $203.79, compared to $302.17 for the unescorted retirees. The study calculates the per-participant subsidy as the difference between these two figures, or $98.38 per month. The 2001 total annual subsidy of $14.1 million was reached by multiplying $98.38 by the total number of unescorted retirees, including dependents (11,960), times 12. Applying a medical care inflation factor of 12.5 percent per year, the annual subsidy for unescorted retirees is projected to increase from $14.1 million in 2001 to $25.4 million in 2006. Mr. Yaggy's formal presentation concluded.


Representative Feeley asked whether the five-year projection factored in any expected increase in the number of retirees. Mr. Yaggy said no—that it is based on a stagnant population. Mr. Joyner pointed out that the Commonwealth group plan does not cover retirees after age 65, when they become Medicare eligible. He said the subsidy would gradually increase over time if the number of retirees under age 65 were to increase.


Responding to a question about the per-person subsidy from Senator Buford, Mr. Joyner explained that each member of the unescorted group would have to pay $98.38 more per month to cover the cost of the subsidy. Mr. Joyner and Mr. Yaggy later clarified for Representative Pullin that the average per capita subsidy cost for the remainder of the Commonwealth group would be only about five dollars each per month—the difference in average claims for the entire group ($203.79) and average claims for the "active and escorted" group ($198.63). Mr. Joyner said that if actives only are compared to all retirees, the subsidy for the actives would be about $30 per person.


Mr. Joyner said there are three ways to eliminate the subsidy: increase the amount being paid by the participants; lower the benefits; or find some other source of money to pay for the subsidy. He said the study lists eight possible options for addressing the issue. He noted that they are broad ideas that may or may not be legislatively viable under current Kentucky law. He explained that Option #1 would be to maintain the status quo; it might be decided that $5/person to pay for the subsidy is reasonable. However, the subsidy is projected to grow from year to year, assuming no increase in the number of agencies covering unescorted retirees. Option #2 would be to require agencies that accept the insurance for their retirees to also cover their active employees; or if they do not cover their active employees, require them to remove their retirees from the program. Option #3 would be to charge higher rates for unescorted retirees to offset the subsidy. The $98.38 monthly subsidy per participant that has been identified is based strictly on claims costs and does not include any additional subsidization that might result from retention, commission expenses, or other associated fixed costs. Option #4 would be to have the insurance companies charge separate rates for the active pool and the retiree pool—both escorted and unescorted. Premiums would be blended for the two groups, so the agencies would be paying about the same as before, but a higher premium rate would be associated with the unescorted retirees.


Representative Damron said that, in effect, active employees, teachers, cafeteria workers, etc., because of the structure of the bidding process, are actually subsidizing the retirement systems members. He asked what is the difference in cost for the retirement systems members versus the cost of the active employees. Mr. Joyner said that that question was not part of the study—that the study's focus was the subsidy afforded the unescorted retiree group. Representative Damron asked whether that figure that can be reached fairly easily. Mr. Joyner said fairly easily, except that the escorted retirees have a much larger per capita cost, and there might be some cost bleeding between the groups. He said that it would probably be in the neighborhood of $380-$385, based on the raw data that is available. Representative Damron asked Mr. Joyner whether he feels that the total retiree pool is large enough to be bid by the insurance carriers as a separate group, as suggested in Option #4. Mr. Joyner referred to Table 4 of the full report (One Year Claims Credibility). He said that a group consisting of both escorted and unescorted retirees would have credibility and that Option #4 should be a viable option to consider. The only caveat might be that carriers have their own rules relating to credibility and viability, and the Commonwealth might be forced into a situation that would limit the options available to the retiree group, as opposed to all the options that would be afforded active employees because their group is so large.


Representative Reinhardt said he believes the crux of the problem is to examine why the unescorted retirees "opted out" of the Commonwealth plan during their active employment. He said it was apparently because they enjoyed lower cost and/or better coverage outside the group. Mr. Joyner said this is not addressed in the study and that they were not provided any data relating to the health insurance programs of agencies that insured their active employees elsewhere. Representative Reinhardt said it appears that the active employees in the "escorted" group pay twice—because they are paying higher premiums to subsidize the unescorted retirees and then, because of the difference in claims costs, are subsidizing unescorted retirees by about $5/month. Mr. Yaggy said that is a reasonable supposition about cost, without considering benefit comparisons.


Senator Buford asked how many dependents are represented in the active enrolled group (205,113). He noted that the subsidy amount would be much greater for employees who are paying to insure their dependents. Mr. Joyner said the data does not have that breakdown, but he would roughly estimate that probably 120,000-125,000 of the 205,113 are active employees. Senator Buford asked whether the study found that the plan options are "overinsuring" the group. Mr. Yaggy and Mr. Joyner explained that analysis of the benefit package was not part of study but is suggested in the study as a possible option (#8 - "alter the benefits by the amount of the subsidy").


Representative Lee asked whether Option #4 (create separate rates in all plans for actives and retirees) might result in adverse selection for the insurance companies. Mr. Joyner said it would not if the number of people in the program is sufficient to give valid statistical data. He said the Commonwealth retiree group is large enough for valid rate setting. The rate for retirees, of course, would be much higher than the rate for active employees, but it would be sufficient to cover any risk associated with adverse selection.


Senator Robinson asked whether the study had considered constitutional restrictions. Mr. Joyner said that a few of the ideas discussed with LRC staff had been discarded because of constitutional issues or because they didn't seem to fit the program. The ideas that were incorporated into the study were believed to have some viability.


Representative Damron said that the current process of rating all retirees and actives in one group is called "community rating." To recap, he said that Option #4 proposes splitting the risk between the active and retiree groups. The state would still be responsible for the same dollar figure, except that those entities that are now sending their "unescorted" retirees into the group would be paying a higher contribution to the retirement system for their retirees' health insurance, which would in turn be paid to the carriers. The state would probably be paying a much lower contribution rate for the active employees and paying a higher contribution rate for the retirees, but the difference should probably be the $14.1 million (amount of the annual subsidy for unescorted retirees). Those dollars would be going to the retirement system from entities that do not have their active employees in the Commonwealth group. Representative Damron went on to say that HB 250 called for community rating and created an uproar among younger healthy persons who didn't want to subsidize an older, less healthy population. What has actually been taking place now is that the younger active teachers and other constituents who have been contacting their legislators because they are concerned about paying more for health insurance than they would have to pay outside the group are actually subsidizing the retirement system. Mr. Joyner said that it would be possible to split the active and retiree groups and still have one blended rate for entities that are covering both their actives and retirees—i.e., you wouldn't necessarily have to change the structure for entities that cover both groups. Representative Damron said that he didn't think it would be feasible for the insurance companies to bid the unescorted retirees as a class by themselves because the group would not be large enough actuarially to offset adverse selection issues that might come into play. Mr. Yaggy said that if the same multiple choices would be available to them, the numbers of the unescorted would become even smaller and less credible as they break out into the various plan options. Representative Damron went on to say that if actives and retirees are to be bid separately, both the escorted and unescorted retirees would have to be bid together. It would then be up to the General Assembly to fund the escorted retirees through the retirement system and to fund the actives through the normal active health insurance programs.


Mr. Joyner continued reviewing the possible options suggested in the study. Option #5 would be to charge each agency retrospectively for the subsidy actually generated by the unescorted retirees. He said that this would be similar to a participating insurance arrangement. At the end of each year premiums paid would be compared to claims cost, and the extra cost at the end of the year would be billed back to the appropriate agencies. The alternative would be to make the chargeback prospective and add it into the cost in future years. Option #6, previously discussed, would be to create a separate plan for all unescorted retirees. This would involve limiting health choices for the relatively small unescorted group. Option #7 would be to prefund the subsidy during the working lifetime of the active employees, which would be similar to funding for a pension plan. It would be another way of spreading the cost. In addition to the premium for the retirees, the agencies with unescorted retirees would be charged an additional contribution to prefund for their retirees. Option #8, as mentioned earlier, would be to alter the benefit structure. Mr. Joyner added that other ideas outside the scope of the study would also merit consideration—e.g., self-funding of the health insurance program. Discussion concluded, and Representative Geveden thanked Mr. Yaggy and Mr. Joyner.


Senator Kerr, Co-chair of the Task Force on Elections, Constitutional Amendments, & Intergovernmental Affairs and the Joint Subcommittee on the State Health Insurance Program, reported briefly on the activities of the two subcommittees. She noted that the Task Force is scheduled to meet again in November. The Joint Subcommittee will be meeting in November and plans an additional meeting in December.


The Committee next heard from several organizations that were invited to comment on the Segal report. Bob Arnold, Executive Director of the Kentucky Association of Counties (KACO), spoke of another subsidy which he feels should be considered, as well as the $14.1 subsidy identified in the Segal report. He said he is referring to county and city employees' annual $13.77 million subsidy of the retirement benefit for school board employees, who are members of the County Employees Retirement System (CERS), but do not work a full 12 months each year.


Next to speak were Joe Ewalt, Director of Advocacy, Kentucky League of Cities, and Bill Thielen, General Counsel for KLC. Mr. Ewalt expressed appreciation for receiving a copy of the Segal report and the opportunity to comment. He said that any group health insurance, by its nature, will be a collection of subsidies. Young workers will be subsidizing older workers. Everyone will pay a little more, for the common good of the group. He said that local government employees are in the state retirement system because the legislature put them there. He does not believe that local government employees opting out of the state health care plan is at issue. In some situations, local government employees have looked at the Commonwealth plan and realized that they can pay lower rates and get better benefits elsewhere. Mr. Arnold pointed out that local government employees were not permitted to join the state health plan until 1992.


Mr. Ewalt said that if the subsidy for unescorted retirees of local government entities were charged back to the local governments it would have the effect fairly quickly of forcing all the local government employees into the state group. This would cause major disruptions. Many of the employees have coverage through Anthem, which is available in all 120 counties. In the Commonwealth group Anthem will be available in only 16 counties in 2003. He cautioned that some of the suggested solutions, which may sound simple, could result in unintended consequences.


Mr. Thielen said that if the matter is one of fairness, the General Assembly should also look at the local government $13.77 million annual subsidy of school board employees. He said that city and county employers and other local agency employers are subsidizing the retirement for 46,000 noncertified school board personnel. He suggested that if it is felt necessary to eliminate the subsidy on the health insurance side, the same should occur on the retirement side, because local government employers cannot bear the burden of both subsidies. Mr. Ewalt said that Kentucky Retirement Systems had assembled data for KLC relating to the retirement subsidy. Copies of the following documents were handed out to the Committee: Data on Classified Employees of School Boards in Kentucky," September 2002; "Breakdown of School Board and Nonschool Board Employee Numbers and Wages Reported to KRS," by county; and "Estimated CERS Nonhazardous Contributions for 2002-2003," by county.


Bill Hanes commented on the $13.77 million retirement subsidy and the information in the handouts. He explained that a percentage of payroll—of boards of education, cities, counties, and other local government entities—is assessed to prefund the CERS retirement benefit. The subsidy has resulted from the inequity between the salary of the average school board employee ($14,145), and the average salary of nonschool board employees in CERS ($26,327).


Representative Geveden said that the study mandate had not directed the Segal Company to seek input from KACO, KLC, or other organizations but that the Joint Subcommittee on the State Health Insurance Program will be interested in hearing from all interested parties as review continues of this very complex issue. The Subcommittee Co-Chairs Senator Kerr and Representative Damron concurred.


Mr. Hanes complimented The Segal Company for their report. He said he thinks it is irrefutable that there is a subsidy and that he believes the public policy was set in 1978 when retirees were brought into the state group. He went on to say that he believes that KRS' inviolable statutory contract will vastly limit what can be done to address the subsidy. He believes it would clearly breach the inviolable contract to set separate premium rates for retirees, to place them in a separate group, or make their benefits less than those of state workers. He said that KRS wants to cooperate but has concerns about being burdened with collection or some other process that will be time-consuming, cause administrative problems, and hinder them in their primary role of distributing retirement benefits. [Mr. Hanes also provided the Committee with copies of a chart relating to the health insurance subsidy, "Estimated Subsidy Per County for Unescorted Retirees."]


Senator Robinson said he shares Mr. Hanes' concern about the imposition of any additional mandates and said that the legislature needs to remain aware of KRS' intended purpose and that any additional workload on the Systems would necessitate additional staff or funding. Representative Geveden said he doesn't believe the legislature would expect anyone to be burdened with additional administrative duties without providing  the expanded staff or monies that would be needed. Mr. Ewalt said that KLC also is concerned about the administrative requirements and costs that would be associated with implementing a collection process in connection with the subsidy.


Jack Couch, Executive Director, Kentucky Council of Area Development Districts (KCADD), said that his organization represents mayors, judges, and area development district staff throughout Kentucky. He said that one of their goals is to hold down the cost of health insurance. KCADD wants to do what is best for the people it represents. The Council also wants to work with the legislature and will be glad to provide whatever assistance is possible. He also advised the Committee that the area development district staff participated in a self-insured pool up until this year, but 13 of the 15 districts are joining the state group because it's a better deal than what was offered in the self-insured pool. Representative Geveden thanked Mr. Couch and noted that his organization has a vast array of resources and data that could be useful in the Subcommittee's study of the subsidy issue.


The last speaker was Frances Steenbergen, President of the Kentucky Education Association (KEA). In summary, Ms. Steenbergen said that KEA endorsed the study to identify the costs of "unescorted" retirees from nonparticipating agencies. KEA has consistently urged the legislature to take the necessary action to protect the state health insurance group and its members from the adverse selection that unescorted retirees represent. The additional cost of unescorted retirees falls not only upon state government but also upon state group members who need dependent coverage and who pay the additional cost to subsidize nonparticipating agencies directly out of their own pocket. KRS has been hearing numerous reports for some time of state group members who cannot afford dependent coverage waiving insurance coverage altogether and using their FLEX account reimbursement to cover day-to-day medical expenses for their families. This would leave them financially devastated by any major illness or injury. Adding any additional burden, such as the cost resulting from unescorted retirees, to those who must bear the entire cost of dependent coverage is terrible public policy and totally unacceptable. KEA urges legislators to take needed action to address this unfair and troubling issue for the state health insurance group. (Ms. Steenbergen provided the Committee with copies of her prepared remarks.)


Representative Geveden thanked Ms. Steenbergen. Business concluded, and the meeting was adjourned at 4:00 p.m.