Call to Order and Roll Call
The first meeting of the Interim Joint Committee on State Government was held on Wednesday, June 25, 2014, at 2:00 PM, in Room 154 of the Capitol Annex. Representative Brent Yonts, Chair, called the meeting to order, and the secretary called the roll.
Present were:
Members: Senator Joe Bowen, Co-Chair; Representative Brent Yonts, Co-Chair; Senators Ernie Harris, Stan Humphries, Christian McDaniel, Morgan McGarvey, R. J. Palmer II, Albert Robinson, Damon Thayer, and Reginald Thomas; Representatives Kevin Bratcher, Dwight Butler, John Carney, Larry Clark, Joseph Fischer, Derrick Graham, Kenny Imes, Martha Jane King, Jimmie Lee, Brad Montell, Sannie Overly, Jody Richards, Tom Riner, Bart Rowland, Steven Rudy, Sal Santoro, Kevin Sinnette, Diane St. Onge, and Tommy Turner.
Guests: Bill Thielen, Kentucky Retirement Systems (KRS); Representative Jim Gooch.
LRC Staff: Judy Fritz, Alisha Miller, Karen Powell, Brad Gross, Kevin Devlin, Terrance Sullivan, and Peggy Sciantarelli.
Announcements
Representative Yonts and Senator Bowen said the committee will not meet in July, but in August will meet jointly with the Interim Joint Committee on Local Government at the new convention center in Owensboro. The tentative agenda for the September meeting will include health services within the Kentucky correctional system.
Kentucky Retirement Systems: Update on Current Litigation
Bill Thielen, Executive Director, Kentucky Retirement Systems, gave an overview of three pending court cases involving community mental health centers that are seeking to withdraw from Kentucky Employees Retirement System (KERS).
Seven Counties Services, Inc. (Seven Counties), is a nonprofit mental health/mental retardation agency that serves seven Kentucky counties in the Louisville region. In April 2013, Seven Counties filed a Chapter 11 bankruptcy action in order to discharge its debt to KRS. On May 30, 2014, United States Bankruptcy Court judge Joan Lloyd issued an opinion that Seven Counties qualifies as a private, nonprofit corporation, rather than a governmental unit, and is eligible to proceed with its Chapter 11 bankruptcy case without state permission. The opinion also held that the relationship between Seven Counties and KERS is an executory contract and that Seven Counties may reject that contract and choose to end its participation in the system.
Mr. Thielen said the KRS board unanimously decided to appeal the decision, and a notice of appeal was filed on June 13. A motion for a stay was denied by Judge Lloyd, and KRS will be filing a motion to bypass the U. S. District Court and have the appeal heard in the U. S. Sixth Circuit Court of Appeals. If Seven Counties is able to exit the system and shed its estimated actuarial unfunded liability of $90 million, costs would go up for the remaining employers in the KERS-nonhazardous plan. Actuaries have determined that the contribution rate would increase by 2.5 percent over a 20-year period. If the other community mental health centers should leave the system, the contribution rate would increase by 6.5 percent—an additional $2.4 billion cost to the remaining employers over a 20-year period.
When Seven Counties filed for bankruptcy in April 2013, the agency quit making contributions for about 925 of its approximately 1,250 employees. Contributions continued until May 2014 for about 325 employees of Central State Hospital and the correctional psychiatric facility at LaGrange. After the stay was denied, those contributions also ceased. The employees are entitled to benefits associated with service credit earned before contributions ceased. Under the circumstances, there is some question whether they would be entitled to a refund of their contributions, although they would be entitled to a refund upon normal retirement or termination of employment.
Bluegrass Regional Mental Health/Mental Retardation Board created a separate corporation—Bluegrass Oakwood—and asked Franklin Circuit Court to declare that the employees hired by Bluegrass Oakwood are not required to participate in KERS. It is unclear whether Bluegrass Oakwood has yet hired anyone. Franklin Circuit Court ruled this summer that Bluegrass Oakwood did not have to participate because there was not an executive order by the governor requiring their participation. The KRS appeal to the Kentucky Court of Appeals is pending.
Kentucky River Community Care (KRCC) created a separate hiring agency called Go Hire. KRCC then terminated its employees and rehired them through Go Hire without KERS participation. KRS sued KRCC approximately two years ago in Franklin Circuit Court on the grounds that Go Hire was a sham creation to avoid statutory requirements. The case has been on hold, pending a decision in the Bluegrass case.
Senator Robinson said he feels it was a mistake to ever allow quasi-governmental entities to participate. He suggested that the entities seeking to exit the retirement system might be covered by performance liability insurance that could possibly be a means of recovery for KRS. Mr. Thielen said KRS has not looked at that issue, but he will bring it to the attention of their attorneys. Senator Robinson later said he hopes the KRS Board will put on hold consideration of any future requests from quasi-governmental entities until current problems are resolved.
Senator McDaniel said that when Seven Counties ceased its annual employer contribution of approximately $12 million in 2013, that action also shorted the retirement system probably an additional $1.5 million in potential investment return on the contribution. He said that if the court’s ruling stands, Seven Counties, as a private employer, could bond its $90 million share of the unfunded liability at seven percent annually, which would reduce its annual $12 million payment to about $8.4 million. He also spoke in favor of voluntary “opt out” legislation, similar to what he proposed last session in Senate Bill 216. Mr. Thielen said a number of other states have legislation that provides a mechanism for nongovernmental entities to withdraw from public pension plans, but those states require payment of existing obligations as a consequence of withdrawal. This would not be an issue for a fully-funded system, but KRS believes that entities should only be able to withdraw after fully paying their obligation; otherwise, costs increase for other participating employers. He said that withdrawal legislation has benefits, but whether the entity seeking to withdraw has the ability to pay its share of the unfunded liability, either in the short or long term, is another question.
When Representative Fischer asked whether the bankruptcy ruling will discharge Seven Counties’ debt to the retirement system, Mr. Thielen said no. The ruling allows Seven Counties to pursue bankruptcy under Chapter 11, but they have not yet filed a reorganization plan that would address discharge of the debt.
Representative Yonts suggested that remedies might possibly be exercised through KRS Chapter 210, which governs state and regional mental health programs—specifically KRS 210.440. Mr. Thielen acknowledged that the mental health/mental retardation agencies are subject to regulation by the Cabinet for Health and Family Services (CHFS). He said the KRS attorneys have examined Chapter 210, but he has not. He said that the cabinet could exercise its authority under appropriate circumstances, but he is not certain whether it could replace the board of Seven Counties. It was initially created as a corporation by a private individual in Louisville, and its bylaws provide that board appointments are separate from government control. Representative Yonts noted that subsection (3)(b) permits the cabinet secretary to make personnel changes necessary to insure the continued operation of the board or nonprofit organization. He questioned whether the cabinet could mandate reaffirmation of the debt to the pension system and negate the judgment of the bankruptcy court. Mr. Thielen said he has not fully explored the cabinet’s authority or extent of its control.
Responding to Representative Carney, Mr. Thielen said the three entities seeking to withdraw from the system still have contracts with CHFS and are continuing to provide mental health/mental retardation services. When Representative Carney asked why this is the case, since those entities do not want to honor good faith contracts. Mr. Thielen said that question should probably be directed to CHFS.
Answering questions from Senator Bowen regarding admittance of quasi-governmental entities into the system, Mr. Thielen said that Seven Counties began participating in 1979 following the issuance of an attorney general’s opinion that the agency was qualified to participate. Prior to 2003, he understands that KRS accepted a governor’s executive order to allow nongovernmental entities to participate. In 2003 a new statutory provision gave the KRS board the ability to determine qualifications, both initially and on a continuing basis. Some entities entered the system following the 2003 legislative session, but since that time no new agency has begun participation in KERS, and he doubts that any new entity would be allowed in at this juncture without an IRS ruling that they are qualified to join. Requests for participation are first referred to KRS’ employer compliance and education staff. If the requesting entity is akin to other entities that are already participating, a recommendation would be made to the KRS board to allow participation. If not, or if there is any concern, KRS legal staff would require the entity to obtain an IRS ruling that they are qualified to enter a public plan. When Senator Bowen asked whether nongovernmental entities make a positive contribution to the system and whether it is healthy for the system to include them, Mr. Thielen said it is not a problem if the quasi-governmental agencies pay their actuarially required contributions. However, he said it is not a good idea to continue letting those entities participate, in view of the current situation and the fact that they do not have perpetual existence.
Representative Montell said he is not sure that Senate Bill 216, proposed by Senator McDaniel in the last session, was the right remedy, but he believes legislation is needed to address this issue and provide KRS much better legal standing in the future. He recommended that the chairs of the Interim Joint Committee on State Government, Senator McDaniel, and other interested parties work together during the interim to draft legislation to prefile, and that it be acted on quickly by the General Assembly. Representative Yonts concurred in the recommendation.
Representative Yonts questioned whether there is need to change the law relating to quasi-governmental agencies. Mr. Thielen said he thinks the law as currently written is appropriate. It gives the KRS Board the ability to determine qualifications. For several years, the IRS has been in the process of defining what constitutes a governmental entity—not for purposes of bankruptcy but for purposes of participating in a qualified public pension plan—and it is not known when it will issue final regulations. In the Seven Counties decision, the judge said she was not ruling whether Seven Counties was a governmental entity under IRS regulations for purposes of participating in a qualified plan. Representative Yonts suggested that a change in the bankruptcy code would also be needed when IRS issues a clarifying regulation.
Representative St. Onge said she agrees with Representative Montell and hopes the issue will be examined from a broader perspective. The regulatory definition of “quasi-governmental” needs to be addressed at all levels, not just for pension issues but for all issues relating to quasi-governmental agencies.
Mr. Thielen said that nonstock, nonprofit corporations account for approximately 15 percent of the assets in the KERS-nonhazardous plan. Of the 15 percent, approximately 12.5 percent is for the 13 mental health/mental retardation agencies and 2.5 percent is for other small nonprofit corporations that participate.
Representative Yonts said that language in KRS 210.440 supports the argument that Seven Counties is a governmental entity. It states that the CHFS secretary under certain circumstances may withdraw recognition of the board or organization as the local authority for the receipt of funds and operation and administration of regional community programs. Mr. Thielen said he has not reviewed the statute in depth, but that was one of the strong factors KRS attorneys used in their argument that Seven Counties is a governmental instrumentality or agency. The judge’s ruling relied heavily on other factors, such as Seven Counties controlling its own assets and salaries and having a board independent of government control. He said it may take 18 months to two years for a decision to be rendered in the appeal.
Senator Bowen asked whether KRS has identified any efficiencies or measures that could improve its operation and administration. Mr. Thielen said KRS is always looking for ways to reduce expenses and has been operating on a maintenance budget for the last four years, with expenses essentially remaining flat. KRS has operated with a contingent of about 255 employees for about 10 years, even though there has been much greater demand on staff due to the number of retirements and implementation of statutory changes. One cost-saving example was the decision to issue the member newsletter only twice a year and to use e-mail instead of postal mail when possible. KRS administrative expenses total about $40 million over the next two years of the biennium, which is a small amount relative to the asset base of almost $16 billion.
Responding to questions from Senator Robinson regarding the inviolable contract, Mr. Thielen said the inviolable contract that emanates from the statutes and Section 19 of the Constitution is between each KRS member and the Commonwealth. The obligation to pay benefits for service earned—and at the level promised when the employee began service—continues to exist and is not affected by the court decision. Seven Counties employees and retirees will be entitled to the benefits they have earned, up to the time when contributions to the system cease.
Business concluded, and the meeting adjourned at 2:55 p.m.