Interim Joint Committee on State Government


Minutes of the<MeetNo1> 5th Meeting

of the 2006 Interim


<MeetMDY1> November 20, 2006


The<MeetNo2> fifth meeting of the Interim Joint Committee on State Government was held on<Day> Monday,<MeetMDY2> November 20, 2006, at<MeetTime> 1:00 PM, in<Room> Room 154 of the Capitol Annex. Senator Damon Thayer and Representative Mike Cherry, Co-Chairs, jointly chaired the meeting. Representative Cherry called the meeting to order, and the secretary called the roll.


Present were:


Members:<Members> Senator Damon Thayer, Co-Chair; Representative Mike Cherry, Co-Chair; Senators Walter Blevins, Jr., Julian Carroll, Elizabeth Tori, and Johnny Ray Turner; Representatives Adrian Arnold, Eddie Ballard, Joe Barrows, Sheldon Baugh, Carolyn Belcher, James Bruce, Dwight Butler, Tim Couch, Joseph Fischer, David Floyd, Danny Ford, Derrick Graham, J. R. Gray, Mike Harmon, Melvin Henley, Charlie Hoffman, Jimmie Lee, Gerry Lynn, Paul Marcotte, Jon David Reinhardt, Tom Riner, John Will Stacy, Kathy Stein, Tommy Thompson, Jim Wayne, Mike Weaver, and Brent Yonts.


Guests:  Bill Hanes, Kentucky Retirement Systems (KRS); Gary Harbin, Kentucky Teachers' Retirement System (KTRS); Keith Brainard, National Association of State Retirement Administrators (NASRA); Rod Crane, Teachers Insurance and Annuity Association/College Retirement Equities Fund (TIAA-CREF); John Rogers, Sarah Jackson, Rhonda Farmer-Gray, and Connie Verrill – Registry of Election Finance; Rachel Phelps, Joe Mylor, and Richard Howerton - Kentucky Association of Professional Surveyors.


LRC Staff:  Joyce Crofts, Brad Gross, Alisha Miller, Karen Powell, Stewart Willis, and Peggy Sciantarelli.


Representative Cherry chaired the first part of the meeting. He recognized the following members who will be leaving the General Assembly at the end of the year, and the Committee honored them with a round of applause: Representatives Adrian Arnold, Joe Barrows, Jim Bruce, Gross Lindsay, Gerry Lynn, Paul Marcotte, Steve Nunn, Jon David Reinhardt, and Mike Weaver. Representative Cherry also introduced new committee staff member Brad Gross.


The minutes of the October 25 meeting were approved without objection, upon motion by Representative Belcher.


Discussion of public pension issues was next on the agenda, with a focus on "defined benefit" (DB) and "defined contribution" (DC) retirement plans. The first speaker was Rod Crane, Director, Institutional Client Services, Public Sector Market, TIAA-CREF, a financial services company that provides full retirement plans to public employees, mostly on a defined contribution basis. He was introduced by Jack Underwood, legislative agent for TIAA. Mr. Crane gave a PowerPoint presentation entitled "Issues and Strategies for Addressing Public Sector Pension Costs." Following are highlights of his presentation.


Mr. Crane clarified that he is addressing the Committee only as a subject matter expert and that TIAA-CREF is not taking a position on the appropriateness of either DB or DC plan designs. He went on to say that the key issue is not funding levels but rather how much it costs every year to fund benefits. The options for addressing pension unfunded liabilities, contribution rates, and unfunded retiree health benefits are somewhat limited. The solutions facing public policy makers will require them to rethink what they wish to accomplish with retirement benefits in general and how it will fit into budgets from the standpoint of overall governmental policy. Policy makers must also move past pension reform rhetoric about DB and DC plans.


Mr. Crane said that TIAA-CREF recommends the following process in moving toward a solution: (1) Inventory all retirement plans, including retiree health plans. (2) Assess the true funded status of all DB-type plans and promises. It is vital to test actuarial assumptions and methods for reasonableness in both the short and long term—particularly economic assumptions such as investment return and inflation. (3) Assess long-term affordability of the plans, taking into account other budget priorities. (4) Assess the short-term volatility of the plans with respect to contribution rates, funding rates, etc., in order to determine how much risk can be taken with the benefit promise. He said that TIAA-CREF recommends use of financial risk management principles to help in making good decisions and find the best achievable solution for plan design—whether DB, DC or a hybrid approach.


Mr. Crane said that DC plans will not solve funding problems. He emphasized that benefit promises made under DB plans are long-term and that the legacy of DB costs will continue for some time. Moving from a DB to a DC plan would still require meaningful and substantial funding for DC benefits and would neither help nor hurt funding for participants of the DB plan, although contribution rates might be affected to some extent. He said that DC plans can meet retirement objectives without undue employer or participant risk, if designed properly. However, DC plans may not fit all employee classes—e.g., in the area of public safety.


Mr. Crane described a good "best practices" DC plan. He said the plan would be mandatory for all participants, and enrollment would be automatic. Minimum contribution rates would range from 10 to 12 percent of pay, with about half of the contribution coming from the employer. The plan would mimic DB benefit accrual patterns by considering age or service-based contribution schedules and would provide for a well-designed voluntary supplemental plan. He said that TIAA-CREF believes that core DC plans should limit participant-directed investments and should consider appropriate employer-directed investments and mandatory life-cycle funds. DC plans should consider annuities in order to control risk. For participant-directed accounts, there should be an array of investments ranging from conservative to aggressive. The number of funds should be limited to approximately 20 to reduce costs and complexity. DC plans should provide participant investment education and advice. Like DB plans, DC plans should require mandatory full or partial annuitization at retirement, and should limit loans and lump-sum or hardship distributions in order to ensure that participants do not outlive their retirement assets. DC plans should also provide ancillary benefits, such as pre-retirement death benefits and mandatory employer contributions to disability, if those are not separately provided. Administration and fees for DC plans need to be tightly controlled. There should be a single, consolidated administrative platform. Total administration costs should not exceed 40 bps (basis points). Total plan costs, with investment expenses, should not exceed 100 bps. Mr. Crane noted that if a "life cycle only" plan were adopted, fees could probably be kept to 50-60 bps, which is not much greater than the fees for a DB plan.


In conclusion, Mr. Crane reiterated that DB plan funding levels and costs are a current and significant issue. Coupled with retiree health unfunded liabilities, the issue is causing state and local governments across the country to take a new look at retirement and health plan designs and to seriously consider DC plan designs. He said the bottom line is that DC plans will not solve funding problems but can do much toward managing the risks on a solvent considered basis.


The next speakers were Gary Harbin, Executive Secretary, Kentucky Teachers' Retirement System; Bill Hanes, Executive Director, Kentucky Retirement Systems; and Keith Brainard, Research Director for the National Association of State Retirement Administrators. Mr. Harbin and Mr. Hanes made brief opening statements prior to Mr. Brainard's presentation.


Mr. Harbin said that Kentucky Retirement Systems and Kentucky Teachers' Retirement System are among the best systems in the nation. He went on to say that KTRS is providing a defined benefit plan for teachers on a very cost effective basis, with administrative costs being at 40 bps and costs for investment management at four bps. He reminded the Committee that teachers in Kentucky and 13 other states are not subject to social security; their pension, therefore, is their "safety net."


Mr. Hanes said that DC type plans are not a panacea for the KRS funding problems. He said that, according to their actuary, it would cost $144 million the first year to convert to a DC plan in the Kentucky Employees Retirement System (KERS) and $130 million the first year to convert in the County Employees Retirement System (CERS). He said that although a DC plan may achieve savings over a period of time, as Mr. Crane indicated, the unfunded liability would remain. He pointed out, too, that the DB plans offered by KRS and KTRS provide retirement income that fuels an economic engine for the Commonwealth. Moving to a DC plan would be a major public policy change, and the total impact on public employees and the Kentucky economy would need to be taken into consideration. Concluding, he emphasized that KRS pension costs are very affordable but that funding of  the health insurance benefit is out of control and is the true problem.


Mr. Brainard spoke on the issue from a national perspective. He provided two handouts to the Committee: a copy of his PowerPoint presentation, "An Overview of Public Pension Issues in the U. S. and Kentucky" and an accompanying four-page narrative entitled "Overview of Public Pension Issues."


In summary, Mr. Brainard said that state and local government employees comprise more than 10 percent of the workforce both in the nation and in Kentucky. He said that nearly all public employees in Kentucky and 90 percent of public employees nationwide have a defined benefit plan as their primary retirement benefit. Public pension fund assets in the nation are approaching $3 trillion. Kentucky public pension funds hold assets of $28 billion and distribute benefits annually of over $2 billion. He noted that, although there has been a lot of talk in the past few years about switching to DC plans, DB plans still provide the primary retirement benefit for 90 percent of public employees. He said that a year ago the Governor of California unsuccessfully proposed switching to a 401k plan for California public employees. About that time, Alaska switched to a DC plan. West Virginia, however, which had offered its teachers only a DC (401k) plan since the early 1990s, switched back to a DB plan for newly-hired teachers after determining that its DC plan was not saving money or assisting in the retirement prospects of teachers. Similarly, until a couple of years ago, all state and county employees in Nebraska had only a 401k plan. After finding that its DC plan was not achieving desired objectives, Nebraska switched to a cash balance plan—a hybrid DB/DC plan. Mr. Brainard said that one of the more impressive features of DB plans is their flexibility, while retaining the core elements—a benefit that cannot be outlived, a retirement benefit that reflects the participant's salary and length of service, and investment risk that is shared or borne by the employer.


Mr. Brainard emphasized that pension and medical benefits are fundamentally different and must be considered and resolved differently. He went on to say that on a national basis, data for 1982-2005 shows that investment earnings financed almost two-thirds (63.7%) of public pension revenue in the United States; combining those earnings with employee contributions (12%), a little more than three-fourths of the cost of all public pensions plans have been financed from non-taxpayer sources. He stressed the importance of making contributions in an adequate and timely manner with respect to the generation of investment earnings.


Mr. Brainard said that in the aggregate, public pension plans in the U. S. are well funded at 86.6 percent and that he expects that figure to increase. He said that this is not true for Kentucky plans, largely because a fair portion of the contributions that should have gone to the pension plans have been diverted for medical benefits. In the absence of spectacular market returns, the Kentucky pension plan funding levels will continue to languish.


Mr. Hanes interjected that KERS is 61.3 percent funded but that CERS is 81 percent funded. He said the major difference, in his opinion, is that CERS employers are required to make the recommended actuarial employer contribution rates and have done so, which is not the case in KERS. He added that Kentucky Retirement Systems has not experienced a rise in funding levels because of the underfunded employer contribution and the diversion of dollars to fund health insurance benefits.


Mr. Harbin said that KTRS has funded medical benefits primarily by borrowing from retirement contributions. He said that, since 1998-99, over $600 million has been borrowed from the pension plan to fund retiree health care.


Mr. Brainard said he appreciates Mr. Crane's remarks and that he considers him and TIAA-CREF to be one of the most responsible voices representing traditional DC plans. He went on to say that in the absence of best practices designs, DC plans are very unreliable vehicles for providing an assured source of retirement income. Studies of an array of geographic, employee, and plan types within the DC world consistently find that most or a large percentage of DC participants routinely make poor choices. They do not contribute enough, will take too much or too little risk, or will cash out when they change jobs or retire. Without the safeguards in plan design described by Mr. Crane, DC plans serve as a poor vehicle for delivering retirement income.


Concluding, Mr. Brainard said that in the past two years there has been increasing attention to the issue of the economic effects of public employee DB plans. He said that earlier this year, the teachers' retirement system in Texas commissioned an economic analysis of the system's benefits and found that they provide an important source of income, particularly in the rural areas; support more than 70,000 permanent, full-time jobs in Texas; and add significantly to the state's gross domestic product. Further, a study for the University of Pennsylvania's Wharton School Pension Research Council found that the higher investment returns which DB plans in the public sector generate, compared to DC plans, add significantly to the nation's economy.


Representative Cherry clarified that the Committee is again discussing pension funding to obtain more information about what is a very complicated issue, lay the groundwork for further examination of the issue, and to hopefully find a solution to minimize the increased costs.


Senator Carroll said that the real issue is health insurance and that underfunding in the retirement systems cannot be addressed until a way is found to reduce health insurance costs. He stressed the importance of wellness and disease management programs. He also said it disturbs him to hear talk of budget surpluses when millions of pension fund dollars have to be borrowed to fund health insurance for retirees. He said he believes it is the legislature's obligation to immediately effectively address the need for a program to reduce the cost of health insurance and that he believes it can be done.


Representative Cherry mentioned House Bill 290, enacted in 2004, which established a monthly insurance contribution accrual and an automatic increase in the accrual rate based on the consumer price index for employees who began participating in KRS July 1, 2003, and after. Mr. Hanes said that the KRS Board is concerned about the Commonwealth's overall public policy for management of health insurance costs, and he said there is tremendous opportunity in Kentucky to manage those costs—e.g., through wellness and disease management programs. Representative Cherry remarked that he, on behalf of the Committee, would welcome receiving from the speakers or anyone else a hard copy explaining possible solutions and how they can be legislated.


Senator Thayer asked Mr. Brainard why he believes DC plans are not a good idea in the public sector, when they seem to be working well in the private sector. Mr. Brainard said he is not sure he would accept the idea that DC plans in the private sector are working. He said that the cash balances of persons who lack traditional pension plans in the private sector show that the 50s-60s age group—the first generation that will retire under a DC plan—is woefully unprepared. He explained that federal law (ERISA) governing private sector pensions largely does not apply to the public sector and that those federal regulations are largely responsible for driving many private sector pension plans out of business. He said that GASB (Governmental Accounting Standards Board) rules that prescribe funding levels and contribution requirements for private sector pensions, for the most part, do not pertain to public sector pensions; those rules are largely premised on the possibility of a corporation going out of business. For all intents and purposes the public sector exists into perpetuity. As a result, having an underfunded pension plan is not necessarily a problem, because there is a long period of time in which to accumulate assets needed to address pension liabilities. Mr. Brainard said that, while some comparisons between the private and public sectors are valid, in his view, there is not a particularly valid comparison with respect to retirement policy.


Mr. Crane said he agrees that medical care is the "elephant in the room" and that it is a national and global issue. He went on to say that society in the United States does not have a solution for rising medical costs. Wellness programs, provider discounts, and other attempts to lower costs will only slow down health care costs, and any action that a state or local government takes to control those costs over the next 20-30 years will not be significant. Because containing the costs is to a great extent out of the state's control, the question is how to manage the financial risk of providing as much as possible with the resources at hand. Kentucky has already done that to some extent through the 2004 legislation that changed the nature of the financial promise to one that is limited in scope, while at the same time separately trying to manage costs. He said that a similar model will probably continue to be followed by other state and local governments.


Mr. Hanes agreed that health insurance is a national economic problem, but he said he somewhat disagrees with Mr. Crane about the effect of cost controls. He said he believes that wellness, disease management, and any other programs that can be implemented to control costs will have a major impact on the health insurance portion of KRS pension plans.


Representative Henley said he agrees with Senator Carroll that health insurance is the main problem. He noted that costs have declined in this country for two types of surgery—Lasik and cosmetic—because the consumer pays 100 percent of the bill, and doctors price the product accordingly. Therefore, the consumer makes better choices. He said that, from his perspective, in addition to wellness and disease management programs, it would be a good idea to require the patient to pay a greater portion of medical costs.


Representative Gray asked about Canada's retirement plans for public employees. Mr. Crane said that Canadian programs are primarily defined benefit and operate fairly efficiently, with excellent governance. However, they also have funding issues. Representative Gray asked whether Canadian pension plans are impacted by health care costs. Mr. Crane said it is his understanding that health care benefits are totally separate in structure and funding.


Responding to questions from Representative Floyd, Mr. Hanes discussed KRS' contractual promise to provide retiree health care. He noted that Alaska and Georgia are the only two other states that have a contractual obligation toward a certain level of health insurance. Representative Floyd asked whether the contractual promise could be modified, with the agreement of retirees, to provide that the retiree pay more of the cost. Mr. Hanes said that the benefit could not be diminished statutorily and that, on a voluntary basis, retirees would not be willing to accept a lesser benefit.


Representative Harmon asked whether figures are available yet on the number of employees who chose the new Commonwealth Select health plan for 2007, which includes a health reimbursement account. Mr. Hanes said he did not have that information. Representative Cherry asked that someone get that information for Representative Harmon.


Discussion of retirement issues concluded. Representative Cherry thanked the speakers, and Senator Thayer assumed the chair for the remainder of the meeting. Next on the agenda was the fourth and final in a series of presentations on campaign finance reform in Kentucky. Present from the Registry of Election Finance were John Rogers, Chair; Sarah Jackson, Executive Director; Rhonda Farmer-Gray, Assistant Executive Director; and Connie Verrill, General Counsel. Mr. Rogers introduced Mr. Lee Jones, new member of the Registry.


Mr. Rogers thanked the Committee for studying the issue of campaign finance reform. In followup to his September 27 review of legislative proposals of the Advisory Task Force for Development of the Registry's Legislative Package, he briefly explained the following additional key changes recommended by the Task Force.


■ Define "campaign depository" or "campaign account" to mean "the campaign account of a candidate or slate of candidates for public office into which all contributions, including the candidate's own money, must be deposited and from which all expenditures must be made."


■ Require all contributions to be deposited in a campaign account within 10 days  after receipt (in-hand possession) of the contribution.


■ Amend KRS Chapter 121 to use the term "currency" rather than "cash."


■ Define "allowable expenditures" and non-allowable expenditures" in KRS 121.015 as they are currently set out in KRS 121.175(1).


■ Exempt any statewide candidate from a full mandatory audit if the candidate receives or spends less than $5,000.


■ Include the term "candidate campaign committees" in KRS 121.120(4)(j) so that those candidates who report through a committee may also be randomly audited.


■ Require permanent committees to provide affiliation at the time of registration with the Registry and continue to update.


■ Eliminate any distinctions between state and federal permanent committees created by operation of KRS Chapter 121.


■ Require candidates to personally indicate their approval of broadcast messages in a manner consistent with federal law.


■ Eliminate the need for broadcast and print media employees to file financial disclosure reports.


■ Replace "report due date" with "close the books date" and replace "grace period ends date" with "report due date."


■ Move the annual "close the books" date to December 31, with the report due on January 5.


■ Authorize formation of gubernatorial exploratory committees, along the lines of those previously allowed under former KRS 121A.015.


■ Provide candidates 180 days from each election to accept contributions to recoup personal loans to their campaign for that election.


■ Provide candidates 180 days from each election to accept contributions to retire net debts outstanding from that election, provided that: (a) the contribution is designated for that election; (b) the contribution does not exceed the contributor's limit for the designated election; and (c) the candidate's campaign has net debts outstanding for the designated election on the day it receives the contribution.


■ Permit the establishment of "building accounts" by the two executive committees whose slate for governor received the highest number of votes in the last gubernatorial election. Require contributions to building accounts to be noncorporate and reported to the Registry in the course of the executive committees' regular reporting obligations. Impose no contribution limit for building accounts, but require that any contributor making a contribution in excess of $5,000 in any calendar year be ineligible for any no-bid contract issued by the state for the four years immediately following the date of the contribution which exceeded the $5,000 threshold.


■ Eliminate the "administrative costs" distinction set forth in KRS 121.150(11), thereby allowing the leadership of executive committees to expend money without regard to an arbitrary allocation as to "administrative" and "campaign spending."


■ Recognize political party subdivisions and affiliates as being separate and distinct committees.


■ Eliminate contribution limits for contributions to political issues committees set forth in KRS 121.150(6).


■ Amend KRS 121.180(10), which relates to disposition of any remaining campaign account balance on hand post-election, to clarify that the five options for disposition of funds are intended for funds remaining after the election is over.


■ Amend KRS 121.180(10) to clarify that slates dispose of unexpended campaign funds in the manner permitted for candidates, to conform with 2005 SB 112 and the repeal of public financing.


■ Abolish or further regulate vote hauling.


■ Monitor efforts of other jurisdictions to regulate organizations formed under Section 527 of the Internal Revenue Code; and pass a resolution encouraging Congress to increase the disclosure obligations of such organizations to promote greater transparency in elections.


Mr. Rogers concluded his presentation. Representative Baugh repeated a concern that he expressed at the September 27 meeting—that the Task Force recommendation to require separate campaign accounts for each election would be unduly burdensome. Mr. Rogers said one option would be to adopt regulations to require campaigns to differentiate the accounts in their bookkeeping, which would allow use of the same checking account. Senator Thayer pointed out that he and Representative Cherry do not plan to include that Task Force recommendation in their draft campaign finance legislation.


Representative Baugh asked about a rumor circulating during the last session that the Anderson case would allow an elected official who leaves office to keep any remaining campaign funds. Mr. Rogers clarified that that would not be permitted.


Senator Thayer thanked the speakers and said that he and Representative Cherry look forward to working with the Registry in the 2007 regular session.


The final item on the agenda was discussion of legislation proposing to amend Section 100 of the Kentucky Constitution to establish requirements and eligibility for the office of county surveyor. Senator Thayer noted that the legislation, SB 156, was introduced in the 2006 regular session by Senator Gibson but that the Senator was unable to attend today's meeting. Present from the Kentucky Association of Professional Surveyors were Rachel Phelps; Joe Mylor, incoming president of the Association; and Richard Howerton. Ms. Phelps explained that Mr. Mylor and Mr. Howerton are elected county surveyors in Gallatin and Greenup Counties, respectively. She also noted that Joe Curd, county surveyor for Morgan County, was in the audience.


Ms. Phelps said that the legislation, which would require an elected county surveyor to be licensed as a land surveyor, was also introduced in 2004 by Representative Robin Webb. She said she, Mr. Mylor and Mr. Howerton are here today to ask the Committee's support for the legislation and to address concerns that were raised when the bill was heard by the Senate State and Local Government Committee in 2006.


Mr. Mylor said that the proposed legislation would provide that current county surveyors not licensed prior to the effective date of the amendment would remain eligible to serve—i.e., they would be grandfathered in. Counties without a surveyor would contract with an adjacent county surveyor or a licensed surveyor. He said that currently there are 75 elected county surveyors who are licensed and nine who are not. Thirty-six counties do not have an elected county surveyor.


Mr. Mylor said that the Senate committee in 2006 questioned the duties of county surveyor and the necessity for the office. He said that aside from statutory and constitutional duties, the county surveyor is the "de facto" defender of the land system and is a vital player in the filing system and in tracking property within a county. In addition, the county surveyor is in an ideal position to advise the county on issues involving geographic information systems, property acquisitions, and property transfers. He noted that there would be no additional cost to counties if the amendment should pass. He said some county surveyors are currently provided office space and paid a salary but that this is not mandated. The amendment would simply require surveyors to be licensed. He added that he truly believes the amendment is needed in order to professionalize the office and to add professionalism to the land system.


Ms. Phelps said they understand that no constitutional amendments can be placed on the ballot until 2008 and that this legislation may not be a high priority for the General Assembly. She said, however, the Association plans to continue discussing the issue and educating regarding its merits, in hopes that it will be considered by the legislature.


Mr. Howerton said he has been the Greenup County surveyor for 21 years and has been reelected for another four years. He said he believes that county surveyors provides resources that are important to counties. He added that it is important to him that his replacement be a learned and licensed surveyor who can deal with the issues of county court deeds.


Senator Thayer thanked the speakers and said that they make a good argument for the legislation. Business concluded, and the meeting was adjourned at 2:36 p.m.