Call to Order and Roll Call
The first meeting of the Interim Joint Committee on State Government was held on Wednesday, July 21, 2010, at 1:00 PM, in Room 154 of the Capitol Annex. Representative Mike Cherry, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Damon Thayer, Co-Chair; Representative Mike Cherry, Co-Chair; Senators Walter Blevins, Jr., Julian Carroll, Ernie Harris, Jimmy Higdon, Alice Forgy Kerr, Mike Reynolds, John Schickel, Elizabeth Tori, and Johnny Ray Turner; Representatives Eddie Ballard, Johnny Bell, Dwight Butler, John "Bam" Carney, Leslie Combs, James Comer, Tim Couch, Will Coursey, Joseph Fischer, Danny Ford, Mike Harmon, Charlie Hoffman, Sannie Overly, Darryl Owens, Tanya Pullin, Tom Riner, Carl Rollins II, Sal Santoro, Kent Stevens, Tommy Thompson, John Tilley, Jim Wayne, Alecia Webb-Edgington, Ron Weston, and Brent Yonts. (NOTE: Representative Derrick Graham was not present but participated in the meeting via telephone.)
Guests: Mike Burnside and Brent Aldridge, Kentucky Retirement Systems (KRS); Jim Voytko, R. V. Kuhns & Associates; Marcheta Sparrow, Tiffany Yeast, Gerry van der Meer, and Mona Juett - Tourism, Arts and Heritage Cabinet; Fred Nelson, Dinah Bevington, Joe Cowles, Stephanie Marshall, and Walt Gaffield – Personnel Cabinet; Bill Riggs, Robin Kinney, and Phil Baughn - Finance and Administration Cabinet (FAC); Rick McQuady, Kentucky Housing Corporation; Wanda Mitchell-Smith, Leslie Thorn, and John Stovall – American Federation of State, County and Municipal Employees (AFSCME).
LRC Staff: Bill VanArsdall, Kevin Devlin, Sean Donaldson, Brad Gross, Alisha Miller, Karen Powell, Greg Woosley, and Peggy Sciantarelli.
Kentucky Retirement Systems – Asset/Liability Modeling Study
Jim Voytko, President and Senior Consultant, R. V. Kuhns & Associates, Inc, gave an overview of the study prepared by his firm. Testifying from KRS were Mike Burnside, Executive Director, and Brent Aldridge, Interim Chief Investment Officer. Copies of the slide presentation were provided to the Committee.
Mr. Voytko’s presentation focused primarily on the KERS-nonhazardous pension fund. He pointed out the factors that are contributing to the current pension funding problem:
§ Current statutory pension benefit levels;
§ Existing accumulated unfunded pension obligations;
§ Rising number of pensioners versus active contributing employees;
§ Statutory contribution policy enacted in HB 1 (2008 Extraordinary Session) that keeps contributions to the pension fund below actuarially required levels for the next 14 years; and
§ Growing constraints that negative cash flows from the pension plan place on the system’s investment program.
He testified that as of June 30, 2009, the KERS-nonhazardous pension plan was 34 percent funded, based on the market value of the plan’s assets. This means that the state had incurred $7.07 billion more in pension obligations than it could fund with the plan’s existing assets plus a hoped-for investment return on those assets of 7.75 percent each year for the next 20 years. The subsequent recovery in the investment markets has likely modestly improved the situation, but new pension liabilities have also been created. Aside from the shortfall in pension assets, the unfunded liability for the KERS-nonhazardous insurance plan was $4.1 billion. Even assuming an investment return of 7.75 percent annually over the next 15 years, the pension deficit will grow to nearly $11 -$12 billion in the next 12 years. Assuming the suppressed—versus actuarially required—contributions called for in HB 1 (2008 Extraordinary Session) for the next 14 years, with 7.75 percent investment returns each year, pension contribution rates will rise from 15 percent in 2009 to roughly 30 percent in the next seven years. Ten years into the future they will be approximately 34 percent, and in 20 years they will approach 50 percent. These rates do not include 12-22 percent in additional rates for the KERS-nonhazardous insurance plan.
Mr. Voytko said that if future investment markets and the need to avoid excessive risk do not permit the fund to earn 7.75 percent on average, the pension fund’s assets will shrink as pension obligations continue to grow. Shrinking assets would make long-term investments such as real estate and private equity difficult or impossible for the KRS Board’s investment program to utilize. Though such investments are less liquid, their yield is usually higher. This could substantially reduce the ability of the investment program to produce expected returns. Under the worst possible outcomes, the plan’s assets could possibly shrink to zero before the higher contributions called for by HB 1 in the years 2022-2029 begin to gradually create a smaller pool of assets available for investment.
Mr. Voytko said he would never say the plan is not sustainable, but it is far more expensive than envisioned. The KRS Board faces a difficult decision—whether to adopt a more conservative investment policy with lower returns and less risk or to become more aggressive in order to seek higher returns with greater risk. KRS pension fund performance has followed a pattern similar to all public pension plans of comparable size, but he thinks it is unlikely that KRS will be able to earn its way out of the funding dilemma.
Representative Cherry agreed that the picture is grim, but he pointed out that HB 1 creates a floor—not a ceiling—for actuarially required employer contribution rates (ARC). He maintained that as long as there is compliance with the graduated payment schedule specified in HB 1, the system will remain viable, and KRS will be able to continue meeting its pension obligations. Mr. Voytko said he agrees, so long as the investment markets cooperate and there are assets in the fund.
Representative Cherry asked whether the General Assembly has any other options to address the problem, outside of the ARC and possible elimination of the annual cost-of-living increase (COLA) for retirees. Mr. Voytko said any action that would cause the actuary to reduce the expectation of future benefits paid will contribute to solving the challenge. He stressed that change to negative net cash flow has nothing to do with actuarial outcome of the fund but everything to do with the ability to make long-term investments.
Mr. Burnside said he understands the importance of the COLA, especially for retirees who are drawing a small benefit; however, it could be reduced or eliminated because it is not covered by the inviolable contract. The 1½ percent COLA implemented July 1 incurred an additional unfunded liability of $200 million. He also said he is not advocating adjusting the ARC schedule proposed in HB 1.
Responding to a question from Representative Harmon, Mr. Burnside said that, to his knowledge, the possibility of optional pension buy-outs by individual retirees had never been looked at and that this might not be permitted under the inviolable contract. Mr. Voytko said that at least one other state system had considered optional buy-outs, which require a large amount of cash up front, but that he does not know of any system that has successfully implemented them. Representative Cherry directed committee staff to research this issue.
Representative Higdon said he is somewhat surprised that the problem remains so severe after passage of HB 1. He asked Mr. Burnside whether he is prepared to make further recommendations to the General Assembly, such as suspension of the COLA. Mr. Burnside said he is supportive of suspending the COLA and that if the Board also expresses support at its quarterly meeting in August, he will immediately submit that recommendation to the legislature by letter. He went on to explain that funding has changed due to the economic environment. HB 1 was based on the actuarial evaluation as of the end of June 2007, when there was $16 billion in the retirement fund as a whole. Currently it has only $13.8 billion, following a low of almost $10 billion last year during the recession.
Senator Thayer said that the legislature should not be blamed for making inadequate employer contributions, which was asserted by two major newspapers. He said it is clear that the level of employer contributions has been greatly impacted by the stock market. Also, Kentucky’s investment return has tracked consistently with other public plans. Although KRS investment return has been above 17 percent this year, there is no guarantee that this level of return will continue. Senator Thayer pointed out, too, that it will take 10-15 years before HB 1’s benefit design reforms will provide financial relief. When Senator Thayer asked whether KRS may be recommending further benefit changes for future employees, Mr. Burnside responded that the normal cost of retirement for a future employee hired under the provisions of HB 1 is in the range of 1½ percent of payroll—an extremely affordable system—and he believes the system will be affordable in 20 years when those employees are starting to retire. What is not affordable now is the unfunded liability that has accrued over time. His biggest concern is how to survive for the next 20 years with the existing cash flow problem.
Senator Thayer said that the General Assembly has never budgeted an ARC rate less than what the governor recommended. In fact, the legislature found funds to establish a higher ARC than recommended by the governor in five of the last eight annual budgets. KRS’ most recent system evaluation called for an ARC of 38.58 percent of payroll for KERS-nonhazardous, with only 2.99 percent of that being attributed to the ARC shortfall. Senator Thayer contended, therefore, that 35.59 percent of the ARC would be attributed to benefit structure and performance in the stock market. Mr. Burnside spoke about prior unfunded benefit enhancements and concurred that those things, combined with poor investment return, have been a major factor. Mr. Voytko said that from an analytical point of view it is likely in 15 years that the majority of the shortfall will be associated with lesser than required employer contributions.
Responding to a question from Senator Carroll, Mr. Voytko explained that for the sake of brevity, today’s presentation had not included information about the hazardous retirement system. He said that both the hazardous and nonhazardous systems were studied and that the results for the hazardous system varied but were much in line with what has been presented today.
Senator Carroll stated for the record that the General Assembly—not the KRS Board—enacted benefit enhancements such as “27 and out” and “high five,” and though investment return was good at the time, those enhancements subsequently contributed to the substantial unfunded liability.
Responding to questions from Representative Owens, Mr. Voytko confirmed that the study’s projected growth in the KRS-nonhazardous pension deficit is only an estimate. He said that although future forecasting is challenging, the direction seems clear in this case. It is also reasonable to assume that a decline in state revenue could coincide with a future downturn in investments.
When asked by Senator Blevins, Mr. Burnside said that the average retiree benefit payment is stated in the annual financial report but that he did not have that figure with him. He also discussed how benefits are taxed.
Responding to a question from Representative Yonts about the impact of reemployment after retirement, Mr. Burnside explained that under HB 1, retirees who return to work after September 1, 2008, cannot earn and do not contribute toward a second pension. The employer, however, must still contribute to the system for that employee. From that standpoint, reemployment is a benefit to the system because no liability is incurred for the employee but there is an employer contribution on the employee’s behalf. Regarding those reemployed prior to HB 1 and earning a second pension, it would basically amount to a “wash,” providing investment return and the employer contribution were adequately funded.
Representative Graham said the legislature has played a major role in the unfunded liability by not sufficiently budgeting for the ARC. He asked how much the pension fund would lose from the six-day furloughs of state employees. Mr. Burnside said that KRS has not looked at that issue. He surmised that if furloughs reduce state salaries by 2½ percent, there would be a like reduction in employer contributions. Both Representative Graham and Mr. Burnside spoke of how reduction or elimination of the COLA would drastically affect older retirees who draw small pensions.
Senator Thayer asked Mr. Burnside to first inform him and Representative Cherry if the Board recommends any change to benefits or the COLA, prior to releasing the information by letter.
Privatization of State Parks
Guest speakers from the Tourism, Arts and Heritage Cabinet were Marcheta Sparrow, Cabinet Secretary; Tiffany Yeast, Executive Director of Personnel; Gerry van der Meer, Commissioner, Department of Parks; and Mona Juett, Director of Governmental Relations. They provided the Committee with copies of their slide presentation.
Secretary Sparrow spoke about lack of funding, lagging revenue, escalating personnel costs, and major maintenance concerns for the state parks system. She said that for the first time in the Department of Parks’ 85 year history an outside firm, PROS Consulting, was selected in January 2009 to conduct an extensive 18-month study and draft a Financial and Operations Strategic Plan for the parks system. Because of strategies being employed from the plan, which was launched in June 2010, state parks will not close, and there will not be layoffs of full-time employees. The plan includes the use of concessionaires for golf courses and selected restaurants, but that does not mean that state parks are being privatized. Park managers hired by the Department of Parks will continue to oversee the parks. Many state park marinas already have successful concession operations. The plan takes on added significance, considering that the 2011 budget required a $6 million General Fund reduction for the Department of Parks. Without change, the prospect of closures is almost certain. Secretary Sparrow said she is proud of the state parks and hopes that the plan will help save these treasures for future generations to enjoy.
Commissioner van der Meer said that recommended short-term improvements include the streamlining of current operations through greater efficiency, raising quality standards, improving programs and services to meet market needs and interests, and improving management culture and practices. Under the cost avoidance plan employees currently working 40 hours a week will begin working 37.5 hours per week; an existing statewide contract for temporary services will be used for hiring seasonal employees, with park managers having final approval for all hiring; seasonal schedule reductions will be implemented at all parks; Ben Hawes State Park has been transferred to the city of Owensboro; selected dining and all golf operations will be operated by private concession companies; and debt carryover has been eliminated, due to a one-time appropriation. Estimated total cost avoidance will be over $6 million in each of the 2011 and 2012 fiscal years. Commissioner van der Meer stated that 100 percent of park operations will continue to be overseen by the Department of Parks; all parks will remain open; park employees will keep their jobs; and Kentucky will regain and sustain the title of “nation’s finest park system.”
Representative Pullin said that closing the resort parks on Mondays and Tuesdays from November 15 to March 15 will reduce employee salaries. Combined with the salary reductions from the announced six-day furloughs of state employees, this will essentially amount to a “double furlough” for those employees. She said this is unfair, in her opinion, and possibly prohibited by limits in the recent legislation that authorized furloughs. The income of some employees will be reduced to the poverty level, yet they will not be eligible for unemployment benefits. When she asked about paid overtime, Commissioner van der Meer said that overtime for the agency in FY 2010 was $675,420—which is not pure overtime because it is “coded” to vacation pay. He said that overtime in FY 2007 amounted to more than $1 million.
Secretary Sparrow said that the decision to close on Mondays and Tuesdays was due to the $6 million budget reduction and that state employee furloughs were not an issue at that time. She said that the Department of Parks will be granted flexibility with respect to the furloughs and that they will be taken when employees are on full schedule. In 1999, the General Assembly authorized parks to reduce hours in winter, and doing so is considered a necessary business decision. The reduced hours will also allow time to perform needed maintenance at the parks. Ms. Yeast said that although the parks will close two days in the off season, employees will have their hours reduced from 37.5 to 30 and will thus lose only one day’s pay.
Representative Cherry asked whether closing the resort parks completely during the winter months—as was mentioned in a Dawson Springs newspaper editorial—would make parks employees eligible for unemployment. Ms. Yeast said they probably would be eligible.
Representative Pullin asked whether there will be an effort to meld the reduced hours in winter into the two-day executive branch furloughs. Secretary Sparrow said that this would not be allowed under the law. She also stated that, based on business needs, the reduction in winter hours might not be necessary; it is a target, however, that has to be considered, based on the current economic climate.
Responding to inquiries from Representative Rollins, Secretary Sparrow said that the total operating expense and earned revenue figures for the parks system (page 18 of the strategic plan) are available by park and that the Cabinet can provide him with that information. She said that Cumberland Falls is currently the only park where revenue exceeds operating expense.
Representative Yonts asked Commissioner van der Meer to send a letter to committee staff providing details on how the Department of Parks intends to achieve the short-term improvement recommendations outlined in the slide presentation. He said he would like to know how the Cabinet will save money by contracting out concessions—considering that workmen’s compensation costs are built into a contract price—and whether there will be competitive bidding for food services. He commented that the state’s experience with privatization of food services at Otter Creek and in the Department of Corrections has lacked oversight and been a total disaster. Secretary Sparrow said the Cabinet is in the process of issuing requests for information (RFI) relating to concessions and will be glad to report back to the Committee later. Commissioner van der Meer said that food services will be bid competitively, probably in a month and a half. He said concessionaires are incented to provide quality service. The Department will monitor them, insist on high standards, and expect them to be community minded. (Later in the meeting Representative Owens said he would like to see the information requested by Representative Yonts regarding the recommendations for short-term improvement.)
Representative Webb-Edgington, in reference to the state employee furloughs, requested that Chairman Cherry obtain for the Committee data from the Personnel Cabinet relating to all Block-50s that have been paid in each of the executive cabinets for the past six months.
Representative Webb-Edgington asked whether the use of concessionaires for dining and golf operations will result in a reduction of executive level staff. Commissioner van der Meer said that executive staff will be retained to oversee operations and monitor quality. Representative Webb-Edgington said she believes this will send a poor message to line-level employees. She suggested as an alternative that the Cabinet consider assigning additional duties and responsibilities to other employees. Commissioner van der Meer said the agency has already made considerable cuts but probably has not publicized them enough. He said that from 2007 to June 2010 three-quarters of a million dollars was saved by not filling some positions and by combining responsibilities. Secretary Sparrow said the agency has acted fairly throughout the process and that positions will be evaluated but that staff will definitely be needed in Frankfort to oversee the golf operation. She expressed appreciation for the comments.
Senator Higdon said he appreciated the Cabinet’s prompt response in the past any time he has had questions. He asked whether the tourism tax has benefited promotion of the parks. Secretary Sparrow said about $180,000 is collected from the one-percent room tax annually. It has been used for marketing purposes, with the money being put back into the local communities.
Senator Higdon said he supports the concept of privatization but is concerned about its affect on Parks employees. Ms. Yeast said the Cabinet wants to protect employees and will assist those who wish to transition to work for the private concessionaire. Employees who choose to remain with the Department will be kept but might be assigned to different jobs. The RFI process provides that concessionaires, when hiring, give Parks employees first refusal. It also provides that 25-year employees have an opportunity to stay on as merit employees and work on contract with the concessionaire. Secretary Sparrow pointed out that when Ben Hawes State Park was transferred to the city of Owensboro, the Cabinet took care of the park employees.
Representative Wayne complimented Secretary Sparrow, the Cabinet and the strategic plan study. He questioned how privatization will be able to achieve cost savings and whether employees of the concessionaires will receive salaries and benefits comparable to those of Parks employees. Secretary Sparrow explained that the $6 million cost savings will come not only from concessions; a significant amount will come from the change to a 37.5 hour work week. There will also be significant savings in unemployment and workmen’s compensation insurance when approximately 1,100 seasonal employees move into the temporary employee category. Ms. Yeast said that temporary employees will still be eligible for unemployment insurance but that the hiring agency would bear the cost instead of the state.
Representative Wayne stated that the legislature is partially responsible for the revenue shortage because it has not addressed the state’s unfair and antiquated tax system. He said he believes the parks system was established in large part with the philosophy of building parks in areas with high unemployment, and it appears that the Commonwealth is drifting away from that philosophy and putting pressure on its employees. Everyone involved needs to team together to protect the vulnerable citizens in rural areas of the state, where they often have no other source of employment. He commended the Cabinet for what it is trying to do but expressed hope that there will not be a rush toward privatization as the only way to manage. Secretary Sparrow said it pains her that it has become necessary to privatize some services, but she emphasized that the Cabinet is not looking to privatize every sector of state parks. She said private management of the 18 golf courses will bring opportunities such as better marketing. The agency does not want to penalize its employees. The use of temporary services will not reduce employee salaries, and additional jobs can be created on a short-term basis if business improves. Ms. Yeast said that seasonal employees are not eligible for any benefits other than sick leave and holiday pay.
Representative Ballard complimented the Cabinet for doing an excellent job. He asked whether the state will be able to control the price of the golf and food services after they are privatized. Commissioner van der Meer said it is important to remain competitive and that the Cabinet will have say regarding price.
Representative Coursey asked whether career employees with less than 25 years service will have the opportunity to work on contract. Ms. Yeast said “25” was not arbitrarily chosen but is consistent with privatization in other areas of state government. Secretary Sparrow said that merit system Parks employees who want to remain employed by the Department will be able to do so, and every effort will be made to keep them at the parks where they currently work.
Representative Hoffman said he is apprehensive about the move to privatization. He asked whether concessionaires will be required to comply with statutory directives relating to Kentucky-grown products. Commissioner van der Meer said that would be expected.
Senator Thayer noted that the Kentucky Horse Park has had a private concessionaire for many years and that it has worked very well. Secretary Sparrow concurred and said that the use of concessionaires has also worked well at the state park marinas.
Review of Executive Orders
The agenda included two executive orders for committee review: EO 2010-428, reorganizing the Personnel Cabinet, and EO 2010-436, reorganizing the Finance and Administration Cabinet. Representative Cherry briefly discussed each reorganization, and motions to accept each executive order were approved by the Committee by voice vote.
Furloughs of State Employees
The following representatives of AFSCME, which represents 9,000 state workers, addressed the Committee in opposition to the executive branch furloughs authorized for fiscal years 2011 and 2012: Wanda Mitchell-Smith, Kentucky Political Action Representative for AFSCME Council 62; Leslie Thorn, a social worker employed in McCracken County; and John Stovall, a member of the Teamsters Union.
In summary, Ms. Mitchell-Smith said that the furlough plan does not take human need into account and that purported savings from furloughs have been challenged in California and other states. She said that furloughing federally-funded state workers would not save money and could cause Kentucky to lose money. Employees at 24-hour facilities such as hospitals and prisons now work overtime just to keep them legally staffed. Furloughing will necessitate paying someone overtime, and this will result in additional cost. Social services are already understaffed. Furloughs mean that there will be fewer child protection investigations, delays in assistance, and a greater workload for employees already facing an enormous challenge and hard economic times. The furlough plan ignores the human cost of furloughs that is borne by everyone. She noted that the plan did not include input from employees or the Governor’s Employee Advisory Council.
Ms. Thorn, a child protective services investigator for the state for almost 17 years, spoke about the large amount of overtime that is already necessary for social workers. She said furloughs would make it difficult to meet time frames with respect to federal funds and would cause a significant loss of income to employees. The cost to families already in need will exceed any expected benefits.
Mr. Stovall said he is concerned that the “double furlough” of Parks employees may cause a problem with their insurance benefits. He expressed doubt that there will be cost savings from privatization.
Dinah Bevington, General Counsel for the Personnel Cabinet, gave an overview of the furlough plan provisions, which are being implemented in emergency regulation 101 KAR 5:015. She said the regulation was presented to the Personnel Board on July 9, where it met with favorable review. In FY 2011, all six days authorized by the budget bill enacted in the 2010 extraordinary session will be implemented, but no determination has been made regarding FY 2012. All merit and nonmerit employees will be furloughed the full six days, spread out across the fiscal year to minimize impact on employees and public services. Three of the days are adjacent to holidays and will result in a shutdown of state offices, beginning with Friday, September 3. In the meantime the Cabinet will have an opportunity to determine flexibility demands, since many offices providing essential services must remain open on furlough days. The Cabinet is also working on concerns about overtime and other issues that have been raised, including those relating to Parks employees. The additional three furlough days will occur in October 2010, March 2011 and June 2011. Employees will remain eligible for health insurance. Each cabinet and agency is to submit a furlough plan for approval by the Personnel Cabinet Secretary, and agencies have been asked to advise Personnel of their concerns and flexibility needs. Ms. Bevington said that no employees will be furloughed if cost savings will not result.
Representative Cherry said he has been asked by his constituents why the furloughs do not apply to the legislative or judicial branches of state government. He explained that the legislative branch, in lieu of furloughs, chose to cut its budget by eliminating 23 positions by the end of FY 2011.
Responding to concerns raised by Representative Bell about the impact of furloughs on employees at the lower end of the pay scale, Ms. Bevington said that the authorizing language in the budget bill does not allow employee salaries to be considered when applying the furloughs. Representative Bell said he believes that some “wiggle room” might be found in interpreting the language and that he hopes the human element will be looked at when any decisions are made regarding the furloughs.
Senator Carroll said he has received complaints about equity in the furlough process, and he questioned why higher paid, nonmerit employees are not going to be furloughed a higher percentage of hours. He said he would be interested to see how the equity issue is addressed in the plans submitted by the agencies. He also suggested that some members of the General Assembly might end up questioning the Personnel Cabinet’s legal interpretation of the furlough authorization. Ms. Bevington responded that the budget bill on page 250 directs that all employees—merit and nonmerit, classified and nonclassified—be placed on furlough for the same number of hours during a calendar month. She said a separate provision that would allow nonmerit employees to be furloughed an additional amount of time is not being utilized at this time.
Representative Rollins said that in executive branch agencies that do not receive money from the General Fund, the savings from the furloughs would revert to the agency. He asked whether there will be a sweep of those funds or a report on how those agencies apply the savings. Ms. Bevington said that question would need to be addressed to the budget office.
Representative Graham said that language in the administrative regulation relating to contractors needs to be clarified because it does not follow the language on page 251 (lines 20-23) of the budget bill. Ms. Bevington said that language was not restated in the regulation but that an additional provision was added to the furlough plan to require agencies to certify that contractors are not going to work additional hours as a result of the furloughs. She said that the Personnel Cabinet is now working with LRC staff to determine any technical considerations that may need to be taken into account.
Kentucky Employees Health Plan (KEHP)
Representative Cherry announced that there would not be time to discuss the KEHP today and that this topic would be included on a future meeting agenda.
Business concluded, and the meeting was adjourned at 3:40 p.m.